The New Tycoons: Inside the Trillion Dollar Private Equity Industry That Owns Everything (Bloomberg)

by Jason Kelly

  Two decades later, Quinn remains a partner at the firm and still runs OMG, which is thriving. The quest for lower costs for companies they already owned took the firm to China in the early 1990s, long before most other private-equity firms, and Jordan took his lumps in order to get comfortable in the economy many think will, and already may, dominate the world. “We lost some money but learned how to do business there,” Jordan said.

  After years of meeting local officials and giving to local charities, Jordan evolved his strategy in China from sourcing for his companies and selling to Chinese customers to actually buying a state-owned Chinese enterprise, a mining concern in the Heilongjiang Province called International Mining Machinery. The 2006 deal was the first such deal in that province and a rare buyout by a foreign investor in China, Jordan said.

  The ops function and the executives it draws help dilute the recovering investment banker vibe at many private-equity firms, balancing the Ivy League pedigreed smooth-talkers with executives who have been in the proverbial trenches. True, many of them supplemented undergraduate degrees in science with MBAs and stints at management consulting firms, but many say their ability to apply their own experience gives them an advantage over someone who has just looked at Excel spreadsheets and case studies.

  At KKR, Capstone was created in 2000 and is still run by Dean Nelson, a Purdue University-trained chemist who went on to get an MBA at the University of Chicago. He proceeded to work at Boston Consulting Group, considered along with McKinsey & Co. and Bain & Co. to be one of the top consulting shops, and Shell Oil.

  KKR’s initial ops effort several years before was to use a third-party consulting firm, headed by Steven Burd, who had worked at Arthur D. Little. Burd and a small staff acted as consultants, especially on KKR’s string of grocery deals in the 1990s. He eventually went to Safeway as president and then CEO. In his absence, the operations consulting business faded away. As the decade wore on, Kravis and Roberts knew they needed to revisit the idea, as part of the broader effort to reinvent the firm. They set out to find someone to run a new operations group that would be an official part of KKR instead of an outside firm.

  Nelson was living in Chicago and working for BCG when he got a call from a headhunter at search firm Spencer Stuart about a job at KKR. Nelson was intrigued, especially because his job in consulting had evolved into a lot of administration and new business generation, and little actual consulting. He also came to learn that KKR was serious, and came to appreciate the urgency. “The late 1990s were not a good time for the firm,” he said. “Buying smart and making some basic changes to the operations of the company weren’t going to be enough anymore.”

  KKR at the time was small, with a total of 14 partners. The firm had purposefully avoided hiring people in the middle of their careers. You either started at KKR and grew up there, or maybe got a job on the back end of your career as a senior adviser. Nelson went through two rounds with each of the partners, including a 90-minute meeting in November 1999 with Kravis in his library. Nelson returned to New York the next month during KKR’s annual firm-wide meeting. He spent the day in 45-minute chunks with all 14 partners, starting with breakfast with Roberts, arguably the toughest audience in the firm. Nelson said it was hard to tell what Roberts thought because “he plays it very close to vest.”

  At the end of the day, KKR handed Nelson a case study of sorts—a deal they’d considered for Bic’s pen business—and told him to give them thoughts on it by the next morning. Once he got the job, Nelson had to figure out how his group was going to operate. Kravis, Roberts, and Raether (the KKR senior partner charged with overseeing the operations effort) told Nelson they wanted it to be defined as different from pure dealmaking. “We were easing into the model,” Nelson said. “We tried different approaches until we found the one that worked best for us.”

  Lacking any additional office space in 9 West, KKR set Nelson up in an office down Madison Avenue. The origin story stands as the exception to KKR’s typical rigor. He came up with the name on his own, and said it doesn’t really mean anything of significance. “I think I just got to the C’s and got tired of thinking about it,” he said. “I knew I couldn’t use a Greek name because there were too many of those in private equity.” He asked his sister, a graphic designer, to come up with a logo. While the firm’s brass was supportive, close-knit KKR was institutionally skeptical of this new effort, just as they would be years later with Craig Farr’s capital markets business. “It was a tough couple of years,” Nelson said of 2000 and 2001. “We didn’t do many deals in that period, and were still figuring out the right model.”

  The first deal Nelson got involved in turned out to be among KKR’s worst in its history: movie chain Regal Cinemas. He and the rest of the KKR team were able to identify the problem—the company was effectively cannibalizing itself by opening too many theaters. But it was too late. The company was deemed unsalvageable. KKR lost almost $500 million on the deal.

  KKR has never thought of itself as being in the distressed business—that is, targeting deeply broken businesses and making radical changes. Some of their deals ended up being worse than they’d thought, but KKR’s general approach is to buy businesses that are undervalued or poorly managed. In describing where he wanted him to focus, Kravis told Nelson that KKR companies ran along a continuum of performance, from great to terrible, and neither of the extremes needed Capstone. The terrible companies were likely to be getting ample attention from the deal team, and the great companies probably just needed to be left alone. In recent times, the latter investments have often been in the energy sector, where KKR has made a bet on, say, shale deposits, where very little operational expertise is needed.

  Somewhere between is where Capstone makes its bones, where pulling levers around things like procurement, pricing, or sales strategy can help generate an incremental 4 or 5 percentage points of return for KKR and its investors, which is often the difference between a decent and stellar investment.

  While Capstone has a team working at a portfolio company, Nelson or another senior member of his group will sit on the board, a practice that seems somewhat symbolic, especially in cases where KKR is the sole owner (in those cases, KKR executives on the deal effectively are the board). It seems a way to show to the company, and to other parts of KKR, that the company in question is an operational work in progress. In Dollar General’s case, Nelson sat on the company’s board for two-and-a-half years, until shortly before the retailer went public. Being on the board can be of more use in a consortium deal, where there are multiple private-equity owners. KKR’s joint ownership of US Foodservice has put it alongside a firm that’s defined itself around its operational prowess almost since the beginning, Clayton Dubilier & Rice. That group’s heritage dates back to the 1970s as well, and its story has several interesting intersections with KKR through those decades.

  The first office of what was then called Clayton & Dubilier was space borrowed from Kohlberg Kravis & Roberts. The arrangement was a product of a relationship between Martin Dubilier and Jerry Kohlberg, who’d known each other since growing up together in Westchester County, just north of New York City. While what became CD&R didn’t cohabitate with KKR for long, the two firms tracked each other through the early 1980s and, along with the likes of Forstmann Little and Wes Ray, formed the foundation for the modern LBO industry. CD&R was among the first firms to do a large-scale deal for an unwanted division of a big company, through its deal in the early 1990s to buy part of IBM.

  The deal for the office products division was not a straight-ahead “carve-out”—hiving off a unit and running it as a separate business. What became Lexmark was a collection of office products units buried across IBM’s empire. CD&R paid $1.5 billion for the business and eventually took it public in 1995.

  CD&R has largely stuck with the business of carve-outs, buying Hertz with Carlyle from Ford and US Foods from Royal Ahold in well-timed deals, and the contractor supply business from Home Depot (called HD Supp
ly), in a very poorly timed deal at the onset of the financial and housing crisis.

  In its modern iteration, CD&R has become a full- or part-time home for some of the highest-profile former chief executives of global companies, including Jack Welch, arguably the most famous CEO of all time. After Welch joined as a senior advisor in 2001, CD&R added A.G. Lafley, who ran Procter & Gamble, and former Tesco CEO Terence Leahy. Paul Pressler, the former Gap CEO, is a partner, as is Edward Liddy, who ran Allstate. CD&R showcased many of them at its annual meeting for investors in October 2011, when it gathered at Cipriani, situated across the street from Grand Central Terminal in midtown Manhattan. For a day and a half, CD&R went into excruciating detail about each company in its portfolio, usually bringing up several executives from the firm and the company to discuss the latest numbers and projections. To underscore its long history and successful succession planning—a rarity in the private-equity world—CD&R showed a video interview of founder Joseph Rice by Charlie Rose, which was followed by Rose’s live, on-stage interview with current CD&R CEO Don Gogel.

  These meetings, closed to the general public, are part information dissemination and part sales pitch for the private-equity firms. These days, very little is glossed over, and firms like CD&R arm their investors with printed PowerPoint presentations and electronic versions on flash-memory drives to take back to their offices and digest. They have a much more collegial feel than shareholder meetings for public companies, where votes for the board of directors and various shareholder proposals are the centerpiece. Proving operational chops and sharing more data and strategy about the underlying investments are increasingly important to limited partners, and Gogel said they’re becoming more vocal about those desires. “There are a lot of demands from our investor base,” he said during the on-stage conversation with Charlie Rose. “That’s probably overdue.”

  One way private-equity firms are making noticeable operational changes to their companies is by a different kind of leverage, the kind that comes when you control massive budgets and huge employee bases. In that regard, they’re reviving a corporate concept largely abandoned in the 1980s: the conglomerate.

  The notion of the conglomerate—a holding company controlling a sprawling set of companies in disparate industries largely went the way of the dinosaur as companies found it difficult to convince investors that there was value that was even equal to the sum of the parts. A few have hung on, including the Tisch family’s Loews Corporation, which owns everything from hotels to oil fields to insurance companies. And the most famous remains Warren Buffett’s Berkshire Hathaway.

  Private equity in its early days was in part a conglomerate dismantler, a solution for those wanting to disassemble empires. The firms were willing to buy unwanted companies and run them as independent concerns. Yet the size and scale of private equity during the past decade has turned them into conglomerates in their own right, each of the biggest firms owning a wide range of companies from toy makers to refineries to amusement parks. Surely there must be a way to take advantage of that.

  Blackstone’s answer is a pair of programs designed to exploit the fact that they own companies with $117 billion in aggregate annual revenue and 680,000 employees, more in headcount than General Electric or Home Depot. The programs are managed under the auspices of the Portfolio Operations Group, run by James Quellos. By using a company called CoreTrust, Blackstone goes out and shops for everything from overnight delivery services to computers, using the heft of what it owns to negotiate big bulk discounts. Companies participating in the program can keep with it even after Blackstone doesn’t own them anymore.

  One little-discussed fact that serves to underscore how deeply entrenched private-equity-backed companies are: CoreTrust is a part of HCA, the hospital company owned by KKR and Bain. The CoreTrust business was created in 2006 as a way to give HCA more leverage in negotiating contracts for its sprawling number of hospitals. While CoreTrust doesn’t hide its affiliation with HCA, it doesn’t exactly flaunt it.

  Blackstone has a similar effort for medical benefits, called Equity Healthcare, which it created in 2008 and covers about 300,000 members throughout the companies it owns. The effort has extended to portfolio companies of other private-equity managers, and employees from TPG’s J. Crew and Univision are among those that participate in Equity Healthcare, according to its website.3

  A harder-to-quantify element of operations that’s related to the conglomerate effect is the family of chief executives, financial officers, and other senior level executives who Blackstone and TPG bring together on at least an annual basis to share ideas and insights gleaned from running their companies. Blackstone has additionally put on meetings for its chief technology officers and the finance heads of its companies. This is part of the pitch, along with big potential payouts, that the firms make the would-be top executives: access to their peers and to the network of titans the buyout shops are plugged into. At TPG’s annual CEO meeting one year, the guest speaker was JPMorgan Chase CEO Jamie Dimon.

  All of this adds up to an approach that the practitioners say is much more focused on buying companies and making them better, not just playing with their balance sheets long enough to turn a profit and move on to the next deal. Conklin, though a road warrior, said she keeps in close touch with most of the executives she works with at her various assignments. Part of it is her adopted Southern nature, part of it’s the nature of the modern LBO business. Either way, holding a company’s guts in your hands tends to help form a bond.

  Notes

  1. Jef Feeley, “J. Crew/s $16 Million Settlement over Buyout Approved,” Bloomberg News, December 14, 2011.

  2. Anne-Sylvaine Chassany, “Private Equity Has $937 Billion in ‘Dry Powder,’ Preqin Reports,” Bloomberg News, October 17, 2011.

  3. www.equityhealthcare.com/what_we_do/portfolio_companies.html

  Chapter 7

  Aura of Cool

  Inside TPG

  The Phoenician resort in Scottsdale, Arizona, sits snugly up against Camelback Mountain, a manicured golf course sprinkled with rocks and cacti winding through the complex. Every October TPG and its investors descend on these posh environs for two days of meetings.

  The centerpiece of the meeting is a state of the union of sorts by Jim Coulter, the firm’s 50-year-old co-founder. He’s little known outside of the industry, younger and less visible than his fellow private-equity chiefs, including his partner David Bonderman, who while fervently press-shy has cultivated an air of diffidence and authority through an occasional industry speech or well-placed memorable remark. Coulter, long content to work behind the scenes and on deals, has begun to inch into the public eye. Coulter’s relative youth came through in his presentation, an energetic 90 minutes sprinkled with a video clip of a YouTube lip-syncher, an overarching investment theory gleaned from a decade of coaching his kids’ suburban soccer teams, an illustration citing the popularity of “Gilligan’s Island,” and even a Trotsky quote: “War is the locomotive of history.”

  Wearing an open-collared shirt with the sleeves rolled up and sporting a tiny wireless microphone that could’ve been lifted from the Lady Gaga tour, Coulter paced the blue-lit stage set between a pair of two giant screens showing his slides and videos. Speaking without notes, he moved between nerdy analysis—including a three-dimensional matrix representation of his view of TPG’s strengths—and industry crystal-balling, laying out his predictions for what he referred to as “Private Equity 5.0.”

  “This is probably the most interesting structural time in the industry during my 25 years doing this,” Coulter said. By 2020 sovereign wealth funds will pull even with public pensions as the biggest contributors to private-equity funds. The number of funds of more than $1 billion, which jumped to about 400 as of 2011 from about two dozen in 1995, could reach 900 or so within a decade.

  Coulter’s valedictory of sorts capped a morning of presentations including one by Bonderman, who set out the strategy for emerging markets, predicting that w
hen it settled out, TPG would invest about half of its money in North America and half around the world. He travels in excess of 200 days a year, ferried across the globe on his own plane. He recently upgraded from a Falcon 900 he bought used from CSX.

  Bonderman, clad in loose grey slacks and a maroon pullover, then sat with Coulter and chief investment officer Jonathan Coslet for a rapid-fire panel session on a handful of issues bubbled up from a list of 40 topics they’d polled the audience on the previous day, from European debt to residential real estate. After a break, the stage was Coulter’s, save for 15 minutes he ceded to ops chief Dick Boyce. Among the most forceful parts of Coulter’s presentation was his explanation of the firm’s decision to stay private for the time being, even as three of its largest competitors were publicly traded (at the time, Carlyle’s IPO was pending). Coulter said he wasn’t convinced that a private-equity firm can simultaneously satisfy the limited partners in its funds and public shareholders.

  He conceded that the publicly traded firms can more easily make acquisitions. Blackstone used stock as part of its 2008 purchase of GSO Capital Partners; Carlyle snapped up fund-of-funds manager AlpInvest ahead of its IPO. Public firms have touted stock as a way to recruit and retain talent. The latter hasn’t yet proven out, Coulter said. Still, he expressed his worry about the decision. “We are taking a risk that we got this wrong, but it is not clear you have to be early,” he told his investors.

  The going-public issue has been far from an open-and-shut discussion for TPG. Among the biggest benefits of an IPO is providing a means by which founders can cash out part or all of their stakes, just as Blackstone’s Peterson, who sold almost all of his portion, and Schwarzman, who sold a small portion of his, did in 2007. Rubenstein said IPOs are a way for founders of firms like his to “liquefy” what they’ve built, in part to free up money for charitable giving.1