How
does Jack Welch compare running giant General Electric Corp. with the
post he took in 2001, as a special partner for the New York private
equity firm Clayton, Dubilier & Rice? "It's not all that
different," Welch says in his raspy Boston accent. "You use the same
financial [methods] and you review businesses in the portfolio just
like you look at subsidiaries."
That makes sense. Welch's job at CD&R, after all, is to
function as a kind of CEO's CEO - evaluating the plans and performance
of the people running the firm's dozen portfolio companies. His
presence at a buyout firm, moreover, is part of a larger trend of folks
leaving an executive suite and heading to a buyout shop. Former Alcoa
chairman (and Treasury Secretary) Paul O'Neill joined New York's
Blackstone Group as a special adviser in March 2003. Lou Gerstner, who
ran IBM Corp. for a decade, became nonexecutive chairman of
Washington's Carlyle Group in 2003. Jacques Nasser, the former Ford
Motor Co. chairman, joined One Equity Partners, the investment arm of
Bank One Corp., in November 2002. Like Welch, Nasser downplays the
differences between his former job and his current role. "I've been
more struck by the similarities in the thinking and decision process,"
he says.
Hearing such sentiments, it's almost possible to forget the 1980s,
when buyout firms and big companies often seemed fundamentally at odds.
On the one hand, there were the LBO guys, fueled by junk bonds just
like raiders, looking to grab assets and flip them. On the other hand,
there were (to cite the opposite cliché) the corporate folks, plodding
and unimaginative, letting whole divisions languish in mediocrity.
Those caricatures look a bit dated now. Like a pair of formerly
fractious siblings, the two sides have matured and learned to work
together more and more. PE has grown huge; buyout firms raised about
$184 billion from investors over the last five years and accounted for
13% of global M&A activity last year, according to Buyouts (a
Thomson Financial publication) and Dealogic, respectively. The presence
of Welch and others reflects PE's need to bring operational
improvements to portfolio companies, as easier buyout opportunities
have grown scarcer. Corporate deal teams, meanwhile, have become more
disciplined allocators of capital - helped, in some cases, by talent
moving over from the PE side.
| A bigger piece of the action |
| PE deals as a percent of global M&A activity |
|
Year |
Total M&A ($bill.) |
PE ($bill.) |
PE % of total M&A |
|
1999 |
$3,281 |
$108 |
3% |
|
2000 |
3,410 |
80 |
2 |
|
2001 |
1,760 |
75 |
4 |
|
2002 |
1,362 |
127 |
9 |
|
2003 |
1,424 |
179 |
13 |
|
|
Yet even mature siblings still find plenty to argue about. There may
be a basic distrust of motives, as old as the relationship itself.
"Given a choice, why would you ever buy a company from a PE firm?" asks
one major company's top dealmaker, resolutely suspicious of investors
who claim to be adding significant value to something they'll soon
sell. Meanwhile a former corporate dealmaker who now invests solely for
financial returns fires back: "The smartest and most demanding people
are always the financial buyers. The corporate buyers don't dig as deep
and come half-prepared."
Finally, there are the contrasts that reflect each side's
constituencies and priorities. As buyers, corporates can pay more for
an asset because they can reap synergies and, frequently, pay in stock.
PE firms must pay less if they're going to satisfy their investors. But
they can often move more quickly and sometimes think more creatively
about an asset's possibilities, since they usually don't have to
integrate it with an existing business. As sellers, PE firms are
looking for profitable exits - whereas corporates are sometimes just
looking for exits.
Still, those generalizations don't quite capture a relationship that
is one of the deal community's most complex - and which continues to
evolve.
Start with that famous price differential. Judging from the
experience of former OfficeMax chief executive Michael Feuer, it's
still huge. Feuer says he initially looked into buying out his
15-year-old company with the backing of some undisclosed financial
investors. After running the numbers, the top offer the buyout firm
could come up with was about $7.50 for each OfficeMax share.
While he was roughing out that plan, Feuer also discussed selling
OfficeMax to the paper-products giant, Boise Cascade Corp. In the end,
there wasn't much of a contest. In July 2003, OfficeMax agreed to terms
with Boise; the $1.3 billion deal closed at the end of the year.
Boise's bid initially valued OfficeMax shares at $9 each. As its own
stock recovered, the final exchange rate hit $10.50, with most
shareholders taking the majority of their payment in stock. The
difference between the buyout offer and Boise's bid totaled about $375
million.
When the deal was announced, Boise shares got rocked. Investors sold
shares amid concerns over how a forest-products company would run a
retail store, much less a chain that had just put a wrenching
restructuring behind it and was still a distant third in its field.
(For his part, Feuer left OfficeMax after it was absorbed by Boise.
He's taking some of his estimated $60 million payday and hanging out a
shingle for Max-Ventures, an investment group for the specialty
retailing business.)
Investors have warmed to Boise's plan in recent months, but
shareholder skepticism about deals is a fact of financial life.
Corporate dealmakers and their boards of directors can "take an
enormous amount of grief in a very public way" for a deal that equity
analysts don't like, says Gary Loveman, chief executive at Harrah's
Entertainment Inc. He should know: Analysts initially knocked Harrah's
mid-September acquisition of Horseshoe Gaming Holding, saying he
overpaid to best a corporate rival. (Wall Street continues to be
largely neutral on Harrah's, although the consensus rating of the
casino's shares has since inched up. )
Meanwhile, if corporate dealmakers are feeling pressures to hold
their bids down, financial buyers are finding themselves compelled to
raise theirs. They have to compete not just with revivified strategic
acquirers, but with the vast pools of private equity money now waiting
to be invested. "In the last three years," explains Welch, "there's so
much money in PE that prices have dramatically risen ... and the
relative spread [with corporate dealmakers] has narrowed. There's a lot
of competition out there."
When the two sides do go head-to-head, PE investors can often
out-sprint their corporate rivals. A classic case can be seen in the
fate of cat-food maker Meow Mix, which Nestlé put up for sale in 2001.
Nestlé was acquiring Meow Mix's then-parent, Ralston Purina, for $11.2
billion. Because the Swiss food giant already owned other pet food
brands, anti-trust regulators ordered it to give up Meow Mix.
"The natural buyer [for Meow Mix] would have been a strategic
acquirer. They would get the largest [dry] cat food brand and they
could cut all the duplicate costs and that would fall right to the
bottom line," says Meow Mix CEO Richard Thompson.
But the strategic buyers faced their own regulatory issues. They
moved too slowly, opening the way for buyout firm J.W. Childs
Associates LP to purchase Meow Mix for $160 million in January 2002.
(Last fall, Childs sold the company to another PE firm, Cypress Group,
for $430 million.) Thompson expects Meow Mix to ultimately end up at a
major corporation "but they'll have to pay a lot more for it."
In other ways, though, many of the big PE funds are coming to
resemble corporate investors. Long gone are the 1980s, when arbitrage
between the public and private markets was easy, and so-called
"merchants of debt" could leverage up their purchases, then pay down
the debt with rapid asset sales and quickly sell the companies at a
huge profit. Gone, too, are the 1990s, when PE firms invested billions
in tech and especially telecom buyouts, much to their subsequent
regret. There's a new get-tough attitude from financial investors
toward their portfolio companies.
"The relatively easily attained cost reductions are behind us," says
One Equity's Nasser. "Now the question is how do you get growth." Along
with growing the top line, operating improvements - as opposed to
financial engineering and cost cutting - are seen to be key. Often,
this approach requires longer holding periods, though the firms will,
of course, take their exits when they find them.
But even as the two sides draw closer together, differences remain.
Sometimes they crop up in matters of governance, as when Texas Pacific
Group founder David Bonderman sparred with executives before stepping
down from the board at Continental Airlines, which TPG rescued out of
bankruptcy a decade ago. The Continental executives objected to the
fact that Bonderman holds a controlling stake in rival airline America
West - a corporate no-no, but something that's not unheard of at PE
firms. Other times, the fault lines become apparent in the course of a
transaction. That happened last summer when General Electric Co. grew
frustrated with the maneuvering done by several PE firms in open
auctions for some divisions it was selling off. GE's remedy was to
select a smaller group of firms to which it would exclusively show
properties.
It takes two sides to do a deal, though. And the flow of talent back
and forth between corporations and financial firms at least assures
that, whatever frictions arise, the two sides understand one another.
After that, enlightened self-interest takes over. "People who want to
get the deal done park their egos at the door," says Greg Peterson, who
heads the private equity practice at PricewaterhouseCoopers'
Transaction Services group. "They understand it's not personal, it's
just business." - Brenon Daly
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