A decade after the buyout boom, those megadeals look mega meh
The big buyouts of the mid-2000s turned out to be mostly middling “The entire industry has become more disciplined”
Henry Kravis, a K in KKR, dubbed it private equity’s golden age. From 2005 to 2007, buyout firms paid fat prices to acquire about 20 supersize companies, from hotel chain Hilton Worldwide Holdings to rental car giant Hertz Global Holdings.
A decade later, the results of that debt-fueled spree can be tabulated — and they hardly shine. The megadeals yielded mostly mediocre returns,
according to separate data compilations by Bloomberg and asset manager Hamilton Lane Advisors.
“The big deals were done more out of ego than economic sense,” says David Fann, chief executive officer of TorreyCove Capital Partners, which advises pension plans that invest in buyouts. “People paid steep prices and put on too much debt.”
Private equity firms pool money from investors, including pensions and endowments, and use debt to help finance buyouts and magnify potential returns. They typically charge investors an annual management fee of 1 percent to 2 percent of investors’ funds and keep 20 percent of profit.
Buyout shops generally aim to at least double investors’ money within three to five years. According to data culled from U.S. Securities and Exchange Commission filings and the firms, 19 large deals each valued at $10 billion or more produced a median profit of about 45 percent above investment cost—well short of the target.
The results also pale when compared with the 70 percent median gain yielded by all private equity transactions during that period, according to Hamilton Lane. That group included thousands of smaller deals.
On an annualized basis, the largest deals generated a median return of about 4 percent, says the study by Hamilton Lane, which looked at 25 big transactions. The Standard & Poor’s 500-stock index returned 7.3 percent per year from the start of 2006 through the end of 2015.
The biggest transaction of the lot, the purchase of utility TXU for a record $48 billion, was a flop. The company, renamed Energy Future Holdings, filed for bankruptcy in 2014. As a result, the acquisition, led by KKR, TPG Capital, and Goldman
Sachs Group, vaporized $8.3 billion
of equity. Other notable losers: the $30.7 billion takeover of casino operator Harrah’s—now Caesars
Entertainment— by Apollo
Global Management and TPG, and the $16.6 billion buyout of satellite services company Intelsat by BC Partners and Silver Lake Management.
Have the Masters of the Universe learned a lesson? “This crop of deals dragged down private equity returns,” says Joe Baratta, the global head of private equity at Blackstone Group, one of the leading dealmakers. As a result, he adds, “the entire industry has become more disciplined.” TPG has sworn off buyouts as large as $30 billion, people with knowledge of the firm’s thinking say. No firm has led a transaction of $10 billion or more since the financial crisis.
Several factors contributed to mediocre returns. During the boom, low borrowing costs led private equity firms to buy companies for as much as twice the usual valuations, based on multiples of a target’s sales and cash flow. They reasoned that buying big, established companies would bring protection. The financial crisis that began in 2007 dashed that idea, imperiling companies big and small.
Almost all the targets were public companies, which are harder to buy at bargain prices. “The fundamental flaw with large public-to-private deals is you pay the full market rate,” says Scott Sperling, the co-president of
Thomas H. Lee Partners, which paid an above-average 16 times cash flow for
Univision Holdings. “That decreases the odds you can sell the company later for a higher multiple.” (Sperling declined to discuss the performance of his firm’s specific deals.)
Another problem, Blackstone’s Baratta says, was that many targets were already well-run, leaving less room for operational improvement—a key element of the private equity playbook. The companies also were too big to sell to another company or private equity group for cash. To cash in, buyout firms often had to arrange public stock offerings, which takes time, eroding annualized returns.
It’s harder now to finance such giant transactions, in part because in 2013 the Federal Reserve put curbs on loans tied to buyouts.
How long buyout titans will heed the lessons of the era is an open question, says Josh Lerner, a Harvard Business School professor who researches the private equity industry. “Memories often last a decade,” he says. “Getting them to last two decades may be overoptimistic.”
The bottom line Most of the big buyout deals from a decade ago made money, but not the kinds of returns investors were looking for.
“The big deals were done more out of ego than economic sense.” ——David Fann, chief executive officer, TorreyCove Capital Partners