Mayer and Denning on private equity
Our editors are following the money when it comes to private equity — the growing phenomenon that's creating two classes of investors out there. Chris Mayer of Capital & Crisis checks in:
I think it's interesting to look at where the money goes… For example, a good slug of it is heading for infrastructure assets. People are paying absurd multiples to own airports, toll roads and marine ports.
I wrote about this in my last issue…but the basic gist of the story is that nearly every investment bank has started an infrastructure fund. There is more than $150 billion lined up – which when you factor in leverage, means $750 billion in purchasing power. Private equity is playing a big role in all of this, too.
And Strategic Investment's editor emeritus Dan Denning writes from Australia:
This is going to be the big story of 2007 for two reasons. First, a very few people are going to get very rich, but they're going to make it look like everyone's getting rich because the indexes will go up. Then, most everyone else in "the market" is going to get royally screwed.
Let's say Private Equity ramps up and buys anything it can with a 15-20% premium (no big deal if it's not your money). If you tack on an arbitrary 20% premium to the market–any market–it is not hard to see nominal levels of 15,000 on the Dow and then another $3 trillion or so to total U.S. market cap of $14.3 trillion (Wilshire 5,000).
Incidentally, the Wilshire is still below its 2000 level of $14.7, but only by about $400 billion. We could take that out by the New Year. It's an impressive accomlishment, making a new high with the Nasdaq still at half of what it was. The market has somehow slipped another $7 trillion in market value somewhere else since the tech bust wiped it out. How has the composition of total market cap changed since 2000?
Without doing a lot of homework, I'd say some has gone into energy and resources…and the rest into fiancials. But that's just a guess.
So if Pirate Equity levers up to engage in more acquisitions, that alone will increase market cap…although somewhat convolutedlly. If PE takes public companies private, the total market cap should go down. But the PE strategy is to disassemble the parts of a company and then re-float multiple entitities at new, higher, multiples! That's where you get your 20% premium to current market cap.Of course no new wealth has been created. But it's an impressive shell game, and creates impressive profits for lawyers, accountants and investments bankers.
In the end, it will make the S&L crisis look like a really trivial game of tic tac toe. PE is borrowing heavily to finance all this acquisition…and so who ultimately is left holding the risk?
I'd say the shareholders through mutual funds are most likely to get the most screwed, which is what Lewis says. In effect, this is a giant Wealth Transfer from the poor to the rich. Pretty clever if you know how to get in on it. Pretty disastrous if you have no idea what's going on.
Dan has still more thoughts about exactly what makes a company a good target for the private equity guys — citing the Harrah's acquisition this week as a prime example. So check back soon!
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