Growing the 'private' club

Growing the 'private' club

Private equity is becoming a benchmark of performance for CEOs and boards of directors. Boards are...

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Growing the 'private' club

Earlier this month, 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 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 operating in the U.S. 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 the story of Korea First Bank, a bankrupt industrial creditor purchased from government receivers in 2000 by private-equity firm Newbridge Capital, a partnership of TPG and Blum Capital Partners.

Newbridge believed it could transform Korea First into a world-class retail bank. The new owners stripped branches of back-office functions, focusing them instead on customer sales. The simplification allowed Korea First to shrink its branch network by 31 offices and add $50 million to bottom line revenues in the first year. Benchmarking industry best practices, Newbridge consolidated account-processing operations into two new customer service centers and expanded call centers. Finally, the bank helped train redundant workers for newly-created positions in customer service and sales. That support—reinforced by cash incentives for top-performing employees—helped Korea First not only shift its business quickly to the consumer side but yielded a big productivity boost, slashing loan approval times by 75%.

By 2005, Korea First Bank boasted a strong balance sheet and brand-new customer service infrastructure. Newbridge Capital sold the revitalized bank to Standard Chartered for $3.25 billion, a nearly four-fold return on its cash investment. 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 last week's revelation 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. Park directs Bain's Asia-Pacific private equity practice.


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