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February 07, 2007 Firms With Higher Quality Financials Are More Attractive Targets
The most recent Business Week cover story focuses on one of the four big horsemen in Private Equity, the Carlyle Group. This morning while huffing and puffing on the treadmill I listened to the Business Week podcast. While I am generally not a big fan of their podcasts, I was intrigued by the feature on Carlyle. Several points are made on the success of Carlyle (26% compound return after fees) since inception and the fact that they manage a mere $85 billion. They also cut through the surface and brought out three points, which I thought were quite interesting. The first, related to the perception of increased risk in club deals. Carlyle has graduated from small deals like Dunkin' Donuts ($2-$3 billion) to mega deals like Kinder Morgan ($25-$30 billion) in the past few years. When asked if bigger deals had greater risk and how they were managing the exposure Lou Gerstner responded that larger deals actually had less risk from their perspective. Why?
Because the quality of the financial reporting provided greater transparency; a fact that we frequently bring up with management teams, who skimp on accounting services and neglect to finish their projections. There is a great reason to invest in proper accounting and financial management and that is the simple fact that it reduces risk and enhances value.
Secondly, they spoke of the fact that the next big wave for the private equity world is creating continuity and sustainability by actually following the big investment banks and going public. With the diversity of financial services that so many buyout firms are providing, venture capital, asset management, hedge fund strategies, etc. eventually it's going to be hard to tell them apart, and the ultimate form of irony - publicly traded funds of privately held companies.
The last point that I thought was intriguing was the perspective that the large private equity groups are driving the capital markets. While they definitely are driving deals, I think its important to remember that without easy access to the credit markets, buying power is severely reduced. In fact, in the article the Carlyle group mentioned that at times they have arranged debt financing for more than they are willing to pay for the company they are buying. In the end, as we all know, credit is driving the buyout markets.
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