That point was mentioned in earlier posts (see points about reorganization and industry fragmentation) – and while these are attractive traits for potential LBO candidates, companies in the public space can do the same thing as well with growth via acquisitions or improvements in valuation via divestitures…see Berkshire Hathaway, Tyco, Zimmer Holdings, etc.
Oops, guess the thread was too long for me to notice it. And sure public companies can grow via acquisitions but it’s a lot easier to work out a deal between two competitors or producer/suppliers when you own both of them…
So is the optimal captital structure different for public and private companies? If not, why would leveraging so high be advantageous in the private sphere?
Management’s job is easier at lower leverage values (until a financial engineer comes along and puts them out of a job), which explains the general history of underleverage until the 1990s when the gig was up. You’ll notice a general trend toward levering up across all firms, not just as part of a take-private (or takeover defense). Average credit ratings (which would exclude privately held firms) have dropped more than 3 notches in the last 10 years. Paying earnings to investors instead of the government (one result of levering up) is just as valuable in the public sphere as private. From a perspective of maximizing enterprise value you could argue public/private would target the same capital structure. With private owners you might be more interested in investors’ tax situations and slant the CS toward returning capital in a more tax-efficient manner.
DarienHacker Wrote: ------------------------------------------------------- > > Paying earnings to investors instead of the > government (one result of levering up) is just as > valuable in the public sphere as private. From a > perspective of maximizing enterprise value you > could argue public/private would target the same > capital structure. And there is no question that highly levered firms pay more FCF to investors than “underlevered” firms. The standard response to the why don’t we take on more debt and take advantage of the tax shield is that the company’s need for continually cash flow restricts flexibility and that bankruptcy costs and probabilities increase as more debt is added. Throw in the other 10 things that need to be consdered and there is just not much reason to believe that a private and public firm have particularly different optimal capital structures. I didn’t know that about average credit ratings dropping three notches in the last ten years but since 1997 interest rates have dropped significantly (I worked hard to get a conforming 8% mortgage in 1997) and equity markets looked like they were indestructible. It’s not at all surprising that capital structures have moved more toward debt than equity in the last ten years whether or not this is about defense from marauding financial engineers.
bchadwick Wrote: ------------------------------------------------------- > So is the optimal captital structure different for > public and private companies? I think “optimal” capital structure is different since PE investors have different risk appetite (read, they are more speculative in nature) than market in general. [“Optimal” capital structure is related to the risk tolerance of investors via perceived probability of firm’s bankruptcy due to debt.] So, the question can be re-formulized if speculators fundamentally add value (besides making markets more efficient). I personally do think so; it’s part of the freedom of choice imo.
PE deals don’t significantly change job numbers (despite the headline); 6% of deals fail: Private equity acquisitions create fewer jobs By Martin Arnold in London January 25, 2008 2:59:00 AM Marginally fewer jobs are created at companies bought by private equity, according to a survey published on Friday in Davos. The report, carried out by Josh Lerner of the Harvard Business School, looked at 21,397 private equity deals between 1970 and 2007 to examine private equity’s record in four main areas: job creation, research and development, length of ownership, and corporate governance. Employment at US companies bought by private equity decreased 7 per cent faster than at comparable companies, the report found. The difference was greatest in the first three years of private equity ownership. However, private equity-owned companies created 6 per cent more jobs than comparable companies through their more active expansion into new sites, for example by opening new factories, offices or stores. Mr Lerner said: “The greater opening of new facilities is for the large part offsetting the slowdown in job growth at existing establishments acquired by private equity.” In research and development, the report found private equity-owned companies created just as many patents although these were more closely focused on core business activity. Dismissing the accusations that private equity preferred “quick flips” – selling the companies they bought within two years – the report said 58 per cent of private equity investments were held for more than five years. Sales within two years made up 12 per cent. Buy-out deals failed more often than other companies, the report found, with 6 per cent ending in bankruptcy or financial restructuring.