The New Tycoons
Page 1
Contents
A Visual Tour of Private Equity
Deciphering Private Equity
Prologue
Chapter 1: Find the Money
Chapter 2: All the Money in the World
Chapter 3: The L Word
Chapter 4: “When Was the Last Time You Bought a Toilet Seat?”
Chapter 5: Modern Art
Chapter 6: Put on Your Boots
Chapter 7: Aura of Cool
Chapter 8: Hundreds and Billions
Chapter 9: Take This Exit
Chapter 10: The Taxman Cometh
Chapter 11: It’s a Steve, Steve, Steve World
Chapter 12: Not-So-Private Equity
Afterword
Acknowledgments
About the Author
Index
Since 1996, Bloomberg Press has published books for financial professionals, as well as books of general interest in investing, economics, current affairs, and policy affecting investors and business people. Titles are written by well-known practitioners, BLOOMBERG NEWS® reporters and columnists, and other leading authorities and journalists. Bloomberg Press books have been translated into more than 20 languages.
For a list of available titles, please visit our Web site at www.wiley.com/go/bloombergpress.
Copyright © 2012 by Jason Kelly. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.
Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com.
Library of Congress Cataloging-in-Publication Data:
Kelly, Jason, 1973-
The new tycoons : inside the trillion dollar private equity industry that owns everything/Jason Kelly.
p. cm. – (Bloomberg Press series)
Includes bibliographical references and index.
ISBN 978-1-118-20546-4 (cloth); ISBN 978-1-118-22851-7(ebk); ISBN 978-1-118-24081-6 (ebk); ISBN 978-1-118-26567-3 (ebk)
1. Private equity. I. Title.
HG4751.K45 2012
332.6—dc23
2012017193
For Jen, Owen, William, and Henry
“We accept and welcome . . . as conditions to which we must accommodate ourselves, great inequality of environment; the concentration of business, industrial and commercial, in the hands of a few; and the law of competition between these, as being not only beneficial, but essential for the future progress of the race.”
—Andrew Carnegie
“There’s a certain part of the contented majority who love anybody who is worth a billion dollars.”
—John Kenneth Galbraith
A Visual Tour of Private Equity
FOLLOWING THE MONEY
Deciphering Private Equity
You or someone you know almost certainly works for a company connected to private equity or is invested in a buyout fund through a pension or retirement account. Getting smart about the way these things work means getting comfortable with the alphabet soup of acronyms and abbreviations they use. Some are meant for pure shorthand, but others feel like they’re meant to give it a sheen of importance and others to obfuscate what’s actually going on. For example: “TPG and KKR aren’t likely to exit the TXU LBO through an IPO. There was no way they could do a recap, and the LPs will be lucky to get their money back. The GPs can probably forget about carry and it’s going to make a huge dent in the funds’ IRRs.”
If you’re in the business, feel free to skip ahead, but for anyone who’s curious about the lingo, here’s what you need to sound conversant, with explanations in plain English.
Firms and Players
Bain Capital: The private-equity firm founded by Mitt Romney. Distinct from Bain & Co., the consulting firm, where Romney and others at Bain Capital once worked, and that provided Bain Capital with its start.
Blackstone Group: Founded by Peter G. Peterson and Stephen Schwarzman in 1985 and headquartered in New York. Stock symbol: BX, on the New York Stock Exchange.
Carlyle Group: Founded by William Conway, Daniel D’Aniello, and David Rubenstein in 1987 and headquartered in Washington. Stock symbol: CG on the Nasdaq.
General partner: Abbreviated as GP, it’s another term for a private-equity manager. Blackstone, Bain, Carlyle, KKR, and TPG are GPs.
ILPA: The Institutional Limited Partners Association. A group of investors in private-equity funds who conceived a set of guidelines to encourage more transparency and lower fees. Usually pronounced as “ILL-puh,” it began as a supper club in the early 1990s and evolved into an influential trade association.
KKR: The firm founded by Jerome Kohlberg, Henry Kravis, and George Roberts in 1976. Headquartered in New York. Trades as KKR on the New York Stock Exchange.
Limited partner: Abbreviated as LP, these are the pensions, endowments, and sovereign wealth funds that commit the money that comprises private-equity funds. Public pensions in California and Washington are examples of LPs.
9 West: The iconic sloping building on West 57th Street in Manhattan that houses KKR, among other private-equity firms, and offers sweeping views of Central Park.
TPG: Created by David Bonderman, James Coulter, and William Price in 1992 and originally called Texas Pacific Group. Headquartered in Fort Worth, Texas, though most of its senior executives work in San Francisco. Not publicly traded.
Industry Terms
AUM: Assets under management. Refers to the value of funds overseen by a private-equity manager plus the value of the companies it owns through those funds.
Carried interest: Also known as “carry,” this is the portion of profits a private-equity manager keeps from a successful investment. Unlike salaries earned in other professions, carry is taxed at the lower capital gains rate instead of the tax rate for ordinary income. Some have argued that it should be treated as ordinary income, which would roughly double the taxes paid on thisincome by managers. Managers argue that carry is investment income akin t
o the “sweat equity” in an entrepreneurial venture and should be treated like a profit from selling a public stock or bond. The fight boiled over into a mainstream issue amid the Occupy Wall Street protests and the 2012 presidential election.
Dividend recap: Short for dividend recapitalization, this involves a payout to the private-equity manager, usually through additional borrowing against the company’s assets. Called recapitalization because it’s a way of returning the manager’s initial capital investment, it’s sparked controversy around how and when private-equity firms get paid.
Exit: Shorthand for how a private-equity firm gains a profit for itself and its investors when it sells the company it originally bought. Firms can “exit” their investment by doing an initial public offering, a sale to another private-equity firm, or a sale to a corporation.
Financial engineering: A term, usually used derisively, for the practice of buying a company with lots of debt, doing very little to the company itself, and selling it quickly for a profit. Private-equity firms increasingly tout their ability to make changes to the underlying business and its operations to prove they aren’t simply financial engineers.
Fund: Private-equity firms collect discrete funds to make investments in a variety of companies. A firm typically manages a number of funds. Carlyle alone has 89 active funds around the world.
IPO: Initial public offering. A sale of shares of a company to shareholders who can then buy or sell the stock on an exchange like the New York Stock Exchange or Nasdaq. Private-equity firms including Blackstone, Apollo, and Carlyle have pursued IPOs for their own firms, as well as companies they control.
IRR: Internal rate of return. A common way to measure a fund’s performance, this takes into account the amount the manager generates as well as the amount of time the money was invested.
MOIC: Multiple of invested capital. Another performance measure, this calculates how much actual money was generated during the investment period. Investors usually use both IRR and MOIC to judge a fund and its manager’s success.
Portfolio: Such as a stock portfolio; private-equity managers use this term to describe the slate of companies they own through their funds.
SWF: Sovereign wealth fund. Refers broadly to pools of capital tied to governments. China, Singapore, and a number of Middle Eastern countries have funds worth hundreds of billions of dollars. These funds are increasingly important limited partners in private-equity funds as well as co-investors.
Vintage: Similar to the term for wine, the year a specific private-equity fund officially started. Since the broader market has an effect on a fund’s performance, investors often compare funds of the same vintage.
Prologue
Standing in Legoland in Carlsbad, California in 2011, fulfilling a promise to my then eight-year-old son William, it hit me. I was strolling around a Blackstone-owned property. We’d woken up in a Homewood Suites, owned by Blackstone-backed Hilton. We’d driven to the park in a rental car from Hertz, owned by private-equity firms Carlyle and Clayton, Dubilier & Rice. Practically every time I’d opened my wallet that day, it had been to a company owned by private equity. Even on vacation, I couldn’t escape.
A few months later, I had dinner with Greg Brenneman, who’d held top positions at Continental, Burger King, and Quizno’s, all private-equity-owned at the time he was involved. Brenneman is now the chairman of CCMP Capital, whose investments have included 1-800-Flowers.com and Vitamin Shoppe. We talked at length about the ubiquity of PE ownership—my J. Crew sweater, the Dollar General store in my wife’s hometown in the Catskills. I started a running list on my BlackBerry that quickly grew to dozens of examples. Brand names piled up, from Toys “R” Us to Petco. The more I looked, the more I found it.
The numbers are staggering. Private-equity firms globally and collectively had almost $3 trillion in assets at the end of 2011.1 The companies they own account for about 8 percent of the U.S. gross domestic product by one estimate.2
Contemplating how they got all that money in the first place triggered another thought, a memory of a colleague mentioning that her mother was a teacher in suburban Toronto and had her retirement account in the hands of the Ontario Teachers’ Pension Plan. I’d profiled that pension for Bloomberg Businessweek in early 2010—they were pursuing a strategy of buying companies directly, like vitamin retailer GNC. Thousands of other pensions, endowments, and government funds, from California to Singapore, were committing hundreds of billions to the likes of Blackstone and KKR. I thought of my in-laws, each with a pension. They, and millions of folks like them were, usually unknowingly, owners of dozens of companies on my ever-growing BlackBerry list.
While the business of buying and selling companies is far from new, the emergence of these players was relatively sudden. What began as a cottage industry known as bootstrapping and leveraged buyouts in the 1970s and 1980s, had blossomed in the 1990s as a handful of small players started to grow rapidly and others, eyeing a huge opportunity, hung out their own shingles. Somewhere toward the turn of the twenty-first century, the more genteel “private equity” became the chosen descriptor. The name may have changed, but the basic business model was the same: collect money, pair it with debt, and buy a company with the intent of selling it down the line for a profit.
The period from 2000 to the present changed everything. Small private partnerships accustomed to rounding up a few hundred million dollars suddenly were raising funds well in excess of $10 billion, accepting huge sums of money from pensions and endowments eager for investment returns topping 20 or 30 percent a year. Wall Street became an eager lender, developing new ways to provide the debt financing in order to get the associated fees. Big investment banks took to investing alongside their clients.
All that money meant that almost nothing was out of bounds for private equity, and 2005 to 2007 saw a spate of deals for companies deeply entrenched in the infrastructure of our everyday lives, from hospital giant HCA to credit card processor First Data to hotelier Hilton. My own introduction was a baptism by fire; I began covering the industry in February 2007. During my first week, news leaked of the biggest-ever takeover, the leveraged buyout of power producer TXU.
What happened next was a different sort of education. Deal making came to a screeching halt with the credit freeze of 2007 and 2008 that triggered the broader global financial crisis. The private-equity managers generally hunkered down, and tried to soothe their own anxious investors pummeled by the public markets—investors who also were worried about what they owned through their buyout funds. Unlike hedge funds, where a bad trade can mean huge losses, an ill-conceived private-equity deal can linger. When the dust settled, private-equity firms still owned all of the companies they’d bought in the boom.
Emerging from the crisis, existential questions abounded. My Legoland epiphany demonstrated just how embedded private equity was in our everyday lives. What seemed like an arcane corner of finance when I arrived was actually central to all of us and very few people actually knew who they were or what they did.
Reporting and writing about business, especially finance and especially in New York, can sometimes feel like a demented sports beat, simply keeping score and tracking rich people getting richer or marginally less rich. But in this case, that’s just scratching the surface. What these guys are doing matters to all of us in some form or fashion.
Private equity by its nature and design, is secretive, a breathtakingly wealthy corner of the world where the names only occasionally escape the business pages, names like Stephen Schwarzman, David Bonderman, and David Rubenstein. The relatively small firms they’ve created, by virtue of what they were able to buy with those ever-growing pools gave them outsized influence as owners and employers. Blackstone, Schwarzman’s firm, alone counts almost a million employees through companies it controls. They are modern day Wizards of Oz—the men behind the private-equity curtain.
The best way to understand these men is to look at what they’ve created, and it’s startling how m
uch each of the largest private-equity firms are mirrors of the founders themselves. There’s an egotism at the center of the whole exercise. After all, each of these men, some more willingly than others, ditched successful careers because they deeply believed they saw something that only a handful of others did. And then they went a step further. They decided to build what have become massively influential institutions meant to outlast them.
To understand what they created and what it means to have them so entrenched in our lives, I decided to follow the money to reveal through their words and actions the implications of their activities to fix actions. The trail begins in the sanitized meeting rooms of public pensions, moves to palatial suites in skyscrapers with top-of-the-world views, and on to discount stores and pizza chains and hotels, before it comes all the way back to those same vanilla pension offices and eventually to the retirement checks of teachers and firefighters and, in one of several twists, even some workers of the companies owned by private-equity firms.
Along the way, that money finds itself augmented by debt and pushed into companies that may thrive, implode, maintain, or simply fade away. The money befuddles Washington lawmakers and regulators, in a debate sharpened by the presidential candidacy of Mitt Romney. His private-equity career has brought the industry into the public consciousness in a never-before-seen way, prompting its largest players to explain themselves with at times surprising candor.
Their contemplation stems not only from a bright spotlight but from their own personal situations. Having created unbelievable amounts of wealth for themselves, they’re mulling their own legacies, in terms of the empires they’ve built and what they’ll ultimately do with their riches.
With all the talk of retirement, it’s easy to forget the relative youth of the industry. I’ve come to think of private equity as a teenager with a lot of potential, but still struggling with adolescent tendencies—at times unresponsive, rash, selfish, and fluctuating between arrogance and self-doubt. By virtue of some hard work and a lot of luck, it’s ended up in a position to potentially be an upstanding member of society. To ignore it or wish it away is foolhardy. It’s here and the influence is growing. And whether it’s the price of your morning cup of coffee, your bed sheets on a business trip, or the size of your retirement check in the mailbox, you’re involved.