News reports indicate that the Carlyle Group, a large and successful private equity firm, has priced its IPO at slightly below the initially expected range. Apparently, the firm met with some skepticism from investors about their offering, and more generally, the prospect of investing in publicly traded private equity firms.
Dan Primack of Fortune has written an article about investing in these IPOs. To start his article, he writes:
Shortly after the Blackstone Group went public in mid-2007, I advised
friends not to buy the stock. Investors didn't seem to understand how
private equity firms like Blackstone should be valued, as illustrated by
a 6% share price bump in the days after Blackstone agreed to acquire
Hilton Hotels. Private equity firms recognize value when they sell
assets, not when they acquire assets, I argued. They aren't
conglomerates that generate margin via economies of scale.
I'm quite confused by the comment. How precisely is a private equity firm different than a conglomerate? Both own a variety of unrelated businesses. Conglomerates don't achieve economies of scale. In a developed market such as the United States or Western Europe, how can one achieve scale economies by acquiring unrelated businesses? You simply cannot!
Let's get to the heart of the matter then. Private equity firms do create value in society, and they do differ from publicly traded conglomerates. How? In many ways, when private equity firms gained prominence, they offered a better governance model than publicly traded corporations. Many publicly traded firms suffer from high agency costs that come with the separation of ownership and control. Private equity ownership of a business reduces agency costs and reduces the clash of interests that often exists between CEOs and shareholders of publicly traded corporations. If' that's a major advantage of a private equity firm, then what do we make of taking these private equity firms public? Well, I would argue that such public offerings counteract one of the key benefits that private equity firms bring to the table. They would seem to interest a layer of agency problems at the top, offsetting some of the very governance benefits that private equity firms bring to the companies in their portfolio.