A sequel to that '80s classic Wall Street is in the works. And this isn't because Hollywood has run out of other movies to burden with endless additional volumes (can a Shrek 4 really be far behind?). Nope, it's because just like in the '80s, leveraged buyouts (LBOs) are in style in a big way.
Looking over just the past week, we've got Cerberus paying $7.4 billion to take 80% of Chrysler off the hands of DaimlerChrysler
While there is a lot of distrust of the private equity firms out there, I believe that this run -- however long it may last -- is good news for public market investors.
They pay you, and they do the fixin'
Not all the companies that are being bought in PE deals are sickly -- KKR, for instance, bought First Data, which is an unexciting but healthy firm. A quick glance at the deals above, though, shows companies like Chrysler, Bausch & Lomb, and Express, all of which have experienced some trauma as of late.
In recent years, with often finicky investors and an increased focus on quarterly reports, it has become more difficult for publicly held firms to go through the painful but necessary process of overhauling a struggling business. In the hands of private owners, these companies often gain the flexibility to make changes that might not have been as easy in the white-hot spotlight of the public markets.
Of course, to take a company private in the first place, the buyer has to get shareholders to agree to it. This means the buyer has to pay a premium -- often a very significant premium -- over the current trading price. For investors, the obvious benefit here is that they get a return on their shares and they don't have to wait to see if/when the turnaround actually happens.
The rising tide
The benefit from private equity storming on the public markets does not stop at the shareholders of the targets alone. An illustration:
You're having some people over for a nice dinner but find out you are running low on wine. You take out 10 wine glasses and evenly distribute a little wine in each of them. When three people end up calling at the last minute to cancel, you take their three partly filled glasses and redistribute the wine to all the other glasses. Everyone is happy, right?
To some extent, that's what happens when companies get taken private. Last year, there was more than $400 billion in private equity buyouts. In all these cases, the PE shop said "thanks for the company, here's your cash" -- leaving investors with a bunch of liquid funds that they had to go out and find a new home for. As the money gets reinvested, it helps drive up the prices of other, still public, companies.
But will this all end badly?
So does all this good eventually conspire to create a bad ending for shareholders? I think the consequences could be very mild. With the sheer number of buyouts that PE firms are doing, and the increasing size of the deals, I can concede that it's probably only a matter of time before enthusiasm dulls and some deals go sour -- after all, KKR's famous RJR Nabisco deal didn't turn out so hot.
The markets have been rocking and rolling lately, at least partly because of the excitement of buyout activity, so it stands to reason that when that dries up, some wind will be taken out of the market's sails. Unlike the dot-com mergers and acquisitions between bloated public corporations in the 1990s, any missteps with the PE deals will happen off the equity markets and outside the portfolios of individual investors.
For the pensions, endowments, and high-net-worth individuals pouring money into the PE firms -- well, that may be another story.
So enjoy it. The fun won't last forever, but as long as the PE run continues, I see it as a boon to public-market investors. I'm not making any promises when it comes to Gordon Gekko and Wall Street 2, though.
First Data is an Inside Value recommendation. Limited Brands is an Income Investor pick. Fool contributor Matt Koppenheffer hasn't done any billion-dollar buyouts lately, but he did buy three CDs on Amazon.com last week. He does not own shares of any of the companies mentioned. The Fool's disclosure policy isn't a public company, but if it were, it'd go private -- it's just so chic right now.