Last week, Chrysler's major stakeholders, including the United
Auto Workers leadership, voted to take the company private. In the
same week, Alliance Data Systems joined the club of public
companies going private, accepting a $6.4 billion bid from the
Blackstone Group. And earlier this week music company EMI agreed to
be bought for $4.7 billion by private-equity firm Terra Firma.
This one-two-three punch at public ownership is evidence that
private equity is becoming a benchmark of performance for CEOs and
boards of directors. Boards are asking themselves, "What would we
do differently if we were privately held?"
The answer is a lot. Public-company shareholders are often
passive or cast votes by dumping shares. And public companies are
constrained by Sarbanes-Oxley, which can slow down or hamper fixes
needed for the mid-to-long haul. Private-equity shareholders —
particularly those from top firms, like Blackstone — behave like
active owners. They understand the companies they own and drive
them to address problems more rapidly while investing more deeply
in attractive longer-term initiatives.
What does this mean? For 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 a sense within public
companies that each business they own will be a permanent part of
the corporate portfolio. For another, the best private-equity firms
test their investment thesis hard after the deal closes with a
detailed plan of where and how to build value. Their plans often
include a few simple metrics — e.g., cash, market and operating
measures — and top fund professionals frequently review and revise
these plans with management. They swiftly move unproductive assets
off the balance sheet. And finally, they compensate managers
strictly on results.
When executed well, the results speak for themselves. Consider
Warner Music Group.Thomas H. Lee Partners, Bain Capital and
Providence Equity Partners joined with Edgar Bronfman Jr. to
acquire it from Time Warner in 2004 for $2.6 billion, at a time
when few were betting on music. Digital piracy was rampant, and
consolidation of traditional retailers was squeezing the industry
on one end, with rising costs of acquiring and marketing artists
pinching on the other.
But, within two years, WMG was transformed. Working with
management, the new owners took inventory of WMG's most attractive
assets and developed a plan that challenged the conventional
wisdom. First, Mr. Bronfman (who became the CEO) and his team pared
down the roster of performers and the product pipeline. They
focused on promoting established stars and investing in promising
new acts. They also embraced digital distribution, making WMG's
content more widely available online and on mobile devices. They
created premium price digital albums, adding special bonus tracks
to entice buyers to download new releases.
WMG paid down debt and dramatically increased cash flow and
earnings. Owners took the company public again two years later,
while maintaining their equity position. The stock price rose to
the point that the buyout firms' remaining stake in the company —
combined with the money paid out to the investors as dividends —
was worth more than three times their initial investment. Now,
while the industry battles significant headwinds, WMG continues to
gain share. A similar willingness to buck convention may play a key
role in transforming Chrysler.
And when private equity succeeds, it presents an enormously
compelling business model. From 1969 to 2006, the top quartile U.S.
private-equity funds had annual rates of return ranging from an
average of 39% to well over 200% through good times and bad.
No one business model holds a monopoly on performance or
profitability. Despite all the headlines, including weekend
revelations that the Chinese government will place $3 billion with
Blackstone, private-equity's stake in global business is small. Our
analysis finds private-equity investors control assets worth less
than 3% of the assets held by the world's public companies.
And some boards are pushing back against the notion that
private-equity 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.
because it felt management could solve its own problems without
taking on the massive debt involved in going private. Others have
concluded the same.
But more and more boards acknowledge that a private-equity deal
can be bolder, faster and more transformative, while publicly
listed companies are typically slower and must push harder to take
the same level of risk. Until that changes, the private-equity
business model will keep growing — and more iconic brands are
likely to follow Chrysler and see their destiny in private
hands.
Ms. Gadiesh is chairman of Bain & Company. Mr. MacArthur
directs Bain's global private equity practice.
