Earlier this month, Chrysler’s major stakeholders, including the United Auto Workers leadership, voted to take the company private; Alliance Data Systems joined the club of public companies going private, accepting the Blackstone Group’s bid; and music company EMI agreed to be bought by private-equity firm Terra Firma. This is evidence that private equity is becoming a benchmark of performance for CEOs and boards of directors.
Boards are asking, “What would we do differently if we were privately held?” The answer: “A lot.”
Public company shareholders are often passive or vote by dumping shares. And, public companies operating in the US are constrained by Sarbanes-Oxley, which can hamper fixes needed for the mid-to-long haul.
Private shareholders are like active owners. One, private-equity firms invest with a thesis for improving performance in a realistic but aggressive time frame—three to five years. Compare that with public companies’ quarterly earnings scramble and (their) sense that each business they own will be a permanent part of the portfolio. Two, the best private-equity firms test their thesis hard after the deal closes, with a detailed plan of where and how to build value. Their plans often include simple metrics (e.g., cash, market and operating measures) and top fund professionals frequently review plans with management. They swiftly move unproductive assets off the balance sheet. And, they compensate managers strictly on results.
Korea First Bank was a bankrupt industrial creditor purchased from government receivers in 2000 by private-equity firm Newbridge Capital. Newbridge believed it could transform Korea first into a world-class retail bank. It stripped branches of back-office functions, focusing them instead on customer sales. Korea First was able to shrink its network by 31 offices and add $50 million to bottom line revenues in the first year. Newbridge consolidated account-processing operations into two new customer service centres and expanded call centres. And, the bank helped train redundant workers for new positions in customer service and sales. This, reinforced by cash incentives, helped Korea First not only shift its business to the consumer side but yielded a big productivity boost, slashing loan approval times by 75%. By 2005, it boasted a strong balance sheet and new customer service infrastructure. Newbridge Capital sold the revitalized bank to Standard Chartered for $3.25 billion, a nearly fourfold return on its cash investment. A similar willingness to buck convention may play a key role in transforming Chrysler.
Private equity can present a compelling business model. From 1969 to 2006, the top quartile US private-equity funds averaged annual returns of 39% to more than 200%. No one business model holds a monopoly on performance. Despite the headlines, including last week’s revelation that the Chinese government will place $3 billion with Blackstone, private-equity’s stake in global business is small—it controls less than 3% of the assets held by public companies.
Some boards are pushing back the notion that private firms have a sort of magic dust. In April, British supermarket chain J Sainsbury resisted repeated offers from a consortium of Blackstone, TPG and Kohlberg Kravis Roberts & Co. It felt it could solve its problems without taking on the massive debt involved. But, more boards now admit a private-equity deal can be bolder and more transformative, while public companies are typically slower and must push harder to take the same level of risk. Until that changes, more iconic brands are likely to follow Chrysler.
Edited excerpts from The Wall Street Journal
Orit Gadiesh is chairman, Bain & Company. Chul-joon Park directs Bain’s Asia-Pacific private equity practice. Comment firstname.lastname@example.org