"Pirate equity"

The world is rapidly evolving (or perhaps devolving) into two classes of investors.  Justice Litle of Outstanding Investments is opening our eyes to the world of private equity.

What is private equity?  Dan Amoss of Strategic Investment offers this succinct definition:  "Private equity, or leveraged buyout (LBO), deals involve a group of outside investors raising debt in order to make an offer for all of the outstanding shares of a company that they consider to be undervalued. Usually, the target companies have net cash positions and valuable assets that throw off sustainable cash flows."

But there's a seamy underside to all this, as noted in an article Justice passes along from Bloomberg columnist Michael Lewis.  And it's all about the two classes of investors I mentioned here at the outset.  Choice excerpts…

The upper class is now serviced by a vast and growing industry, loosely called Private Equity. The job of the private-equity investor is — again, speaking loosely — to exploit the idiocy of the ordinary investor, and the corporate executives and mutual-fund managers who purport to serve him…

In effect, the smartest, best-connected money has separated itself from the rest of the stock market, and has gone into the business of trading against that market. It seeks to buy from the stock market cheap, and sell to the stock market dear, and if you need evidence that this is possible you need only look to the returns on private equity, which have been running three times the returns of the public stock market.

With the shrewdest and most sophisticated investors armed with essentially unlimited capital, any company that is available to the public is almost by definition an inferior asset, i.e., an asset that the private-equity people have no interest in. We may not have arrived at the point where the publicly traded shares in a company are a sure sign that those shares are a poor investment. But that's the obvious, ultimate destination.

Here's the whole column to check out.  But check back soon for some additional thoughts from our editors.  Dan Denning will explain why private equity (or as he calls it, "pirate equity") could unleash a scandal that'll make the S&L crisis look like a back-room bunco scheme.