Dueling Fools: Private Equity Bear Rebuttal

As I expected, my Fool colleague Matt Koppenheffer raises excellent points in his defense of private equity. These battles are never easy, nor do they come with clear-cut answers.

I agree that private equity is helpful in streamlining lumbering companies. Take a look at Wilbur Ross. Using private equity capital, he was able to rejuvenate the U.S. steel industry and headed the merger that created Arcelor Mittal (NYSE:MT).

The concern is that private equity players will get too aggressive and focus on "quick flips." An example is the buyout of Hertz (NYSE:HTZ) in December 2005. Within about six months of the transaction, Merrill Lynch (NYSE:MER), Clayton, Dubilier & Rice, and Carlyle paid themselves a juicy $1 billion special dividend. Then in November, Hertz went public. According to the 2007 Q1 report, the company paid about 12% of its revenue, or $229.6 million, in interest costs. That is more than the company's selling, general, and administrative (SG&A) expenses.

So how much restructuring is possible in such a limited amount of time? It seems like there was mostly financial engineering, not a broad vision to improve the competitiveness of Hertz.

With billions flooding into private equity firms, there will be lots of pressure to get competitive returns. Keep in mind that private equity firms raised $215 billion last year, and it looks like the amount could be $400 billion this year. The influx of capital could lead to paying too much for deals. Just this week, Goldman Sachs (NYSE:GS) and TPG agreed to pay a jaw-dropping $27.5 billion for Alltel (NYSE:AT). That comes to 15 times trailing-12-months cash from operations. It's a steep price for a company that has a niche market presence, needs to make significant infrastructure investments, and competes against biggies like Verizon (NYSE:VZ) and AT&T.

Perhaps the telltale sign for investors is that mega-private equity firms are thinking of cashing out. Back in February, Fortress Investment Group (NYSE:FIG) had its IPO, and the Blackstone Group will soon hit the public markets. There is also buzz that Apollo Management, Carlyle, and TPG are making plans to take billions off the table. When seasoned dealmakers start selling out, it always gets me concerned.

Wait! You're not done. Go back and read the other arguments about private equity. Then vote for the winner.

Fool contributor Tom Taulli, author of The Complete M&A Handbook, does not own shares mentioned in this article. He is ranked 1,898 out of 28,990 rated investors in Motley Fool CAPS. The Fool has a disclosure policy.