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The Death of the Second (Third?) Golden Age of Private Equity?
It is neigh impossible to utter the words "Private Equity" in an introductory paragraph and not mention the firm that defines the industry. Created by three former Bear Stearns colleagues, Jerome Kohlberg, Henry Kravis and George Roberts, Kohlberg Kravis & Roberts (hereinafter "KKR") has been effectively synonymous with the word "buyout" ever since. Founded in 1976 with around $30 million in committed capital when the Discount Rate was between 5.25% and 5.50% the firm thrived, even finding success through 1979's crushing 12.00% (and 1981's ruinous 14.00%) Discount Rate environment. KKR's habit of completing the largest buyout transactions in history goes back at least this far, as it closed what was probably the largest "going private" transaction by that time in the form of the Houdaille Industries buyout in 1979. The firm even raised its second fund in 1980 with over $350 million in committed capital. Interest rates, it would seem, were not a condition for KKR's success.
When in February of 2007 KKR acquired TXU in the biggest ever $45 billion LBO (a record which will likely never be surpassed absent hyperinflation truly coming to roost), it looked like KKR could do no wrong. After all, KKR had simply broken its own "largest ever" record, surpassing the $25 billion 1989 buyout of RJR Nabisco. Well, that reputation might have to suffer, to wit:
The most recent top tick in the "frugal consumer" theme for KKR portfolio company Dollar General. Zero Hedge has obtained the November 25th letter in which KKR does some accounting on the recent DG IPO:
- $1,017 billion initial investment in July 2007
- $120 million sale of equity in November 2009 IPO
- Unrealized gain of $2,171 billion, or an IRR of 42.2%
- ~2.3x Cash on Cash
No mention anywhere in the letter on the apparent inconsistency of cashing out of the "frugal consumer" theme at a time when even the super wealthy, contrary to main stream media's repeatedly flawed data, continue to tighten the belt. Judging by KKR's action, the same goes double for the aspirational, middle and lower classes. However, what is most notable is not the topic of discussion, Dollar General, which KKR truly did an admirable job on, but the implication about how staggering the losses at TXU must be like. Scott Nutall points out that "...as a result of the write-down of the Partnership's investment in Energy Future Holdings [TXU], a portion of the "loss" applicable to this write-down has been netted against the remaining Dollar General capital gain...."
Oops.
Just how big a wash is TXU? If anything, this example once again underscores a comparable theme we have been seeing in the hedge fund world: the flaunting of the survivorship bias as the "losers" get swept under the rug. So many hedge funds are up 50% in 2009, yet after being down 50% in 2008, they are still 25% below their high water mark. And only the most opportunistic ones (see e.g.: Paulson) as well as the most obdurately stubborn and permabullish ones (see e.g.: Glenview) can boast with being in this "admirable" position. But, of course, the HSBC fund performance tracker drops all those which no longer wish to have their P&L grace the ridicule pages of various financial blogs. Very much in the same vein, you will likely never hear what the actual performance of TXU for KKR was.
Doubtless, as interest rates spike in the months and years to come, many private equity firms, perhaps even KKR, will whine loudly about the impossible environment. In doing so they will remind us all that today's private equity firms, and even today's KKR, are mere shadows of the efficiency creating, sloth eliminating buyout firms of the late 1970s and early 1980s. True, private equity's "golden age" may return as government intervention in public markets sours a number of public firms and throws them into the waiting arms of the buyout partnerships, but buyout partnerships were only tangentially meant to be tools of regulatory arbitrage (SarbOx being the latest example). What use are they (and what returns could they command) when that becomes their centrally defining feature?
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It takes actual wealth production to operate government - printing counterfeit tickets only works in the short-term. The US does not have a functioning productive economic system. The last few generations of "growth" have been based on nothing more than credit driven asset inflation.
No wealth, no tax revenues. No production, no debt financing. Without tax receipts and/or deficit funding, no government. No government, no intervention. No intervention, wide-open markets.
"No wealth, no tax revenues. No production, no debt financing. Without tax receipts and/or deficit funding, no government. No government, no intervention. No intervention, wide-open markets."
You are not applying the l'Hopital's rule correctly. The government will shrink slower than the private economy. So in the end it may be zero over zero, but the ratio does have a limit at all government! ;-)
Given that rates will likely trend up very, very slowly (as BB kicks, screams and makes empty promises of a return to zero), the death of this age of PE will be a painfully slow one.
I can tell you that the clients of deregulated electricity are taking a beating similar to KKR. TXU owned all our powerplants (so much for "competition" LOL) and then KKR comes along and decides to load them up with ungodly debt.
The deal is circling the toilet now, but when it finally flushes, I think the former TXU knows how to "squeeze" more money out of their customer base.
We went from paying way below national average electric rates (before deregulation) to paying way above now.
If your state ever considers deregulating the electric market, you need to grab your pitchforks and storm the state capital. Just show then California and Texas as the examples of epic failure. Thanks Governor Bush.
Marla, pardon me, but
Shouldn't the 'billion' be 'million'?
Looking at the report, the comma represents a decimal point.
There are so many rules, restrictions and...er...regulations in California's deregulated electricity market that the term "deregulation" is essentially meaningless here.
The incentives the state set up were so stupid I'm not even sure it was unethical for Enron to take advantage of them.
These large LBOs are basically leveraged cyclical plays, they'll be back...The GPs aren't worried about timing since they need to put money to work, LPs need to invest countercyclically to be successful.
Hey there! Let's not forget that $34 billion in PIK toggles (Payment-In-Kind notes) due this summer (put off payouts to high-end investors at higher basis points).
$34 billion??? Anyone taking bets on the outcomes of those private equities due to pay up?
also, the 42% IRR is a little premature. they still own approximately 156MM shares, which means with current trading volume, they have over a year's worth of trading volume to exit.
Lets not forget that whether its equity or debt, its also that most expendable of commodities, Other Peoples' Money. KKR will reap the cream as long as there are morons willing to rip up $100 bills in the name of "diversification".
Which is bullshit anyway, an equity is an equity. Private equity is just an expensive backdoor leverage play by pension funds.