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Saturday, January 27, 2007

Private Equity & Value Creation

Private equity firms are raising capital at a record pace, acquiring businesses, and in many cases creating tremendous value for themselves and their investors. And corporate boards of directors, which are meant to manage for the long term, are getting sucked into short-term issues, such as compliance. It is clear that private equity has been giving public ownership a run for its money. No wonder given that more than half of all CFOs say they would cut a project with a positive net present value to hit a short-term earnings target set by the market. KKR’s Johannes Huth highlighted recently that in this efficient markets unlike that existed decades back, private equity can create s value today is by fundamentally changing businesses and driving growth. They do that by making sure that management is a significant participant in value creation and by maintaining our focus.
In a large conglomerate, there is always one business that isn't a priority in terms of capital allocation, but PE folks would run every one of the businesses as a priority and dedicate the necessary capital to them. Strange it may appear, but it is likely that PE management may be more better at corporate governance than a public company. The amount of effort spent on due diligence helps them gain so much insights, that while they sit on the board, they have a detailed understanding of what the company does enabling them to be very good sparring partners for the management team in further driving value. I have also seen that an expert executive can ask for the right data and trends that a company executive with most sophisticated systems and processes might not even be tracking. Most of the publicly held big companies make their executives operate in a zone of comfort that hardly they would be encouraged to look beyond. In developing countries even public companies run by owners/ extended family mostly run in a top-down fashion or a set of cronies run business and the top guy just manages them while watching for growth. A study found that more than three-fourths of the surveyed executives would give up economic value in exchange for smooth earnings. Managers believe that missing an earnings target or reporting volatile earnings reduces the predictability of earnings, which in turn reduces stock price because investors and analysts dislike uncertainty. The Five C’s of private equity are definitely interesting. This note confirms the trend: Boards of professionally sponsored buyouts are typically more informed, more hands-on, and more interventionist than public company boards. There are several reasons for this:
• Private-equity boards typically have the advantage of in-depth due diligence that precedes a buyout, and they use this highly specific knowledge to oversee the ongoing business.
• Private-equity directors typically spend more time with their companies after the buyout than many of their public company counterparts.
• Private-equity boards are typically small working groups composed of individuals with relevant operating and financial knowledge.
• Private-equity boards are typically composed of members with substantial wealth at risk.
• Private-equity boards know how to structure financial incentives that deter reckless gambling and reward profitable growth.
• Private-equity boards rarely rely upon quarterly or monthly meetings alone. They review a continuing flow of detailed monthly earnings reports, and many directors engage in weekly and often daily conversations with management. The idea is to pursue a candid, informal, and continuing dialogue with management.
• Finally, most private-equity boards operate with a time horizon stretching beyond quarterly earnings reports, reflecting the complexity of corporate restructurings and other long-term growth strategies.
As I see it, anything that questions status quo and takes shot at inertia is welcome and more so in this dynamic fast changing world - private equities contribution in changing the nature of business are quite telling. I would like to see them more active with deals(not just activities, while I am fully aware of the various regulatory challenges that they face therein) in more promising parts of the world- emerging economies.

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Sadagopan's Weblog on Emerging Technologies, Trends,Thoughts, Ideas & Cyberworld
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