A recent article in Bloomberg offers an in-depth look at the private equity industry, how it has evolved, and the ways it is “changing finance and the economy itself.”
Here are some highlights from the article:
- Leverage is at the core: Private equity is focused on using debt to take over a relatively cheap company, “spruce it up” and sell it for a profit a few years later. The article notes that, besides the telltale debt associated with these deals, private equity firms typically take a hands-on approach to overhauling a business in order to realize value for investors quickly, adding that the fees charged are “huge.”
- High returns with a catch: The fees offered by PE are sizeable, but the article notes that many –including Warren Buffett—question the reporting methods because: (1) the value of private investments is difficult to measure; (2) returns can be artificially inflated (the internal rate of return is calculated from the time the investor money comes in); (3) the best returns might be in the past—the article reports that there are now over 8,000 PE-backed companies and the industry has become crowded.
- Buyouts put pressure on companies: “Research has shown that companies acquired through leveraged buyouts are more likely to depress worker wages and cut investments, not to mention have a higher risk of bankruptcy. “Private equity owners benefit through fees and dividends, critics say, while the company is left to grapple with often debilitating debt.”
- Growing PE profits deepen inequality: “Even among Wall Street companies, PE stands out as a symbol of inequality in the U.S.,” the article argues. While the structure of PE firms makes them highly profitable for high-level management and offers high investor returns, funds are typically open only to high net-worth investors, institutions and endowments. Further, it argues, PE puts pressure on the “lower end of the wealth divide” since companies can be “broken up, merged, or generally restructured to increase efficiency and productivity, which inevitably means job cuts.”
- PE is “getting companies hooked on debt:” Ultralow interest rates have made debt that much easier to come by, and “as buyout titans have chased bigger and riskier deals, their target companies have been left with more fragile balance sheets, which gives management less room for error. This could set the stage for a rude awakening during the next recession.”