BULLS & BEARS: Private equity boom to spur purchases of big companies

November 21, 2005

Investors can expect to see some large transactions involving big companies going private soon.

While the $25 billion leveraged buyout of RJR Nabisco accomplished by Kohlberg Kravis Roberts & Co. in 1989 still ranks as the largest LBO in history, that could soon change.

Today, several multibillion-dollar private equity funds are actively competing for deals. Groups such as Warburg Pincus, Carlyle Group, Blackstone Group and Apollo Management each have raised funds of $8 billion to $10 billion.

In addition, several large hedge funds have allocated significant capital to private equity investments, blurring the lines of traditional private equity deals. Hedge fund ESL Investments gained control of Kmart in bankruptcy, brought it public, and bought Sears (renaming the merged company Sears Holdings).

Another difference in private equity today is that groups of firms are partnering to buy larger companies. It would not be shocking to see a $50 billion deal done in the next year.

These buyout artists use borrowed money to leverage a company's capital structure, pay themselves dividends from newly issued junk debt, and look for a "liquidity event," such as an initial public offering or sale to another company or fund.

They are spurred by huge successes, such as the Blackstone Group's LBO of the German chemical company Celanese. Blackstone took Celanese private in April 2004 for $2 billion, putting up $650 million of its own money and borrowing the rest.

Only nine months later, Blackstone took Celanese public again in an IPO (with a balance sheet holding much more debt). So far, Blackstone has reaped $3.1 billion, nearly five times the $650 million it risked.

Here's the breakdown: About $500 million in cash came from junk bond debt that Blackstone had Celanese issue, $800 million from stock sold in the IPO, and $111 million in fees paid by Celanese to Blackstone.

And Blackstone still owns $1.7 billion worth of Celanese stock. Of course, a big question is whether the second-time-public Celanese, whose debt has swelled from $640 million to $3.4 billion, is better off or in a more precarious position.

While the Celanese deal was a huge success for Blackstone's investors, the drive to realize a return on investment (the liquidity event) can lead to some nasty consequences for private equity investors.

Recently, the private equity firm Thomas Lee Partners lost $250 million when Refco, a commodities brokerage firm, went public in August and less than two months later filed for bankruptcy due to management fraud. Lee had invested in Refco in June 2004 when it was a private company. There are sure to be lawsuits filed against the underwriters and advisers involved in Refco's stock offering.

Investors also will see more of the traditional method of taking a company private. Privately held Koch Industries just bought Georgia Pacific for $21 billion. The deal will make Kansas-based Koch the largest private company in America, surpassing Cargill.

Driving these deals are huge sums of cash that need to be invested by these firms, and the large banks, which are eager to lend money at what are still relatively cheap rates. A major concern is that there is too much money chasing too few deals and that these competing buyers may overpay for their acquisitions.

Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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