Kings of capitalism A survey of private equity November 27th 2004 Republication, copying or redistribution by any means is expressly prohibited without the prior written permission of The Economist C B M R Y G K W C B M R Y G K W The Economist November 27th 2004 A survey of private equity 1 The new kings of capitalism Also in this section Pick carefully Some private-equity rms are much more suc- cessful than others. Page 4 Highly leveraged A gravity-defying pay structure. Page 5 Small expectations Things are likely to get harder rather than easier. Page 6 Beating the mid-life crisis What private-equity rms are doing to win in a mature market. Page 8 Gut feeling Jack Welch on his latest job. Page 9 In two decades, private-equity rms have moved from the outer fringe to the centre of the capitalist system. But, asks Matthew Bishop, can Once burnt, still hopeful they keep it up? Has the venture-capital industry learnt its F YOU made ‘Private Equity: the former commerce secretary under Richard lesson? Page 11 IMovie’, then Michael Douglas would Nixon, private equity was a cottage indus- have to play Schwarzman. The head of try that few people had heard of. There one multi-billion-dollar private-equity had always been family-owned private Draw a veil rm is talking about the head of another, rms, but family owners did not usually The attractions of privacy. Page 13 the Blackstone Group’s Steve Schwarz- aim to sell o the business; they passed it man. I’m joking, he adds quickly, Steve on to the next generation. and I are good friends. Perhaps he realises Until the late 1970s, the main activity in that comparisons with the ctional Wall private equitybuying shares in private Street banker famously portrayed by Mr companies in the hope of selling them at a Douglas, Gordon greed is good Gekko, higher price laterhad been carried out are not what his industry needs just now. mostly by the investment arms of a few In fact, Hollywood has already set its sights wealthy families, such as the Rockefellers on the men who run this enormous, rela- and Whitneys in America, and had gener- tively unaccountable pool of capital. This ally been conned to venture-capital in- year, the Carlyle Group, a huge private- vestment in small, fast-growing busi- equity rm, has been vilied in Michael nesses. America’s venture capitalists have Moore’s lm Fahrenheit 9/11, as well as become the envy of the world for develop- being named as the inspiration for a c- ing rms such as Intel and Google from tional private-equity rm that tries to in- nothing more than a bright idea into big, Acknowledgments stall its brainwashed candidate as Ameri- successful companies. But these days less In addition to those quoted in the text, the author would can president in the remake of The than one-fth of the money the industry like to thank many others who provided valuable insights, some of them o the record, this being private equity. They Manchurian Candidate. raises goes on providing venture capital include Alex Scott, David Williams, David Bonderman, Sir Yet to study rms such as Blackstone is for young rms. Much the larger part of John Craven, Sir David Cooksey, Baroness Hogg, Ken Olisa, as good a way as any to nd out what is go- private-equity money is spent on buy-outs Stuart Mills, Michael Ryan, William McCormack, Newcomb Stillwell, Steve Schwarzman, Kelvin Thompson, Teresa De- ing on at the sharp end of capitalism today. of established companies. reniak, Diana Glassman, Charles Baillie, Christopher Flow- Hedge funds may be sexier, at least for The rst of today’s big private-equity ers, Tim Collins, Angus Littlejohn, the Board of the Tuck now, but it is surely Mr Schwarzman and rms, Warburg Pincus, was formed only in Centre for Private Equity and Entrepreneurship, Conor Ke- hoe, Ray Lane, John Taylor, Venture Economics and the his peers in the private-equity industry the late 1960s, and had to raise money Private Equity Analyst who control the really smart money and from investors one deal at a time. By the wield the lasting inuence. This survey late 1980s private equity had grown big A list of sources can be found online will explain what they do, what chal- enough to be noticed by the general public, www.economist.com/surveys lenges they face and what eect they have but it made hostile headlines with a wave on the world of business at large. of debt-nanced leveraged buy-outs An audio interview with the author is at In 1985, when Blackstone was founded (LBOs) of big, well-known rms. The in- www.economist.com/audio by Mr Schwarzman and Pete Peterson, a dustry was cast in the role of irresponsible1 2 A survey of private equity The Economist November 27th 2004 2 corporate raider attacking from the Even Britain’s Philip Green, one of a small Clearly, private equity is now a big wilder fringes of capitalism. A bestselling band of powerful individual private-equ- business. In Britain, for instance, one-fth book by Bryan Burrough and John Helyar ity nanciers, declined to go hostile this of the workforce outside the public sector about the $25 billion battle in 1988 for RJR year in his bid to buy Marks & Spencer, a is employed by rms that are, or have Nabisco branded two private-equity rms, British retailer. Indeed, big companies that been, invested in by a private-equity rm, Forstmann Little and Kohlberg Kravis Rob- would once have turned up their noses at according to the British Venture Capital erts (KKR), as Barbarians at the Gate. an approach from a private-equity rm are Association. Worldwide, there are more Today, the private-equity industry has now pleased to do business with them. than 2,700 private-equity rms, reckons moved from the fringe to the centre of the Royal Dutch/Shell, a troubled oil giant, has Goldman Sachs (maybe many more, be- capitalist action. In the process, the leaders been negotiating the sale of its liqueed- cause in this private world small rms can of private equity have earned themselves natural-gas business for $2.45 billion to easily drop below the radar screen). As both wealth and respectif not always KKR and Goldman Sachs Capital. Some pension funds, endowments and rich indi- respectability. The fabulously rich Mr companies even team up with private- viduals have become increasingly keen in- Schwarzman pops up in the society gossip equity rms, as Sony recently did with vestors, the amount of private equity has pages for such things as paying a record Texas Pacic Group (TPG) and Providence soared. In 2000 alone, the peak year so far, $37m for a Manhattan apartment and for Equity Partners to buy MGM, a lm studio. investors committed about $160 billion to demolishing his Florida mansion, alleg- Having largely shed the image of cor- private-equity rms (much of it to venture edly without permission. He is often porate wreckers, private-equity rms can capital), up from only $10 billion in 1991. tipped as treasury secretary in a Republi- now plausibly describe themselves as pro- At the same time, there has been a dra- can administration. viding a safe haven in which rms can pur- matic growth in the size of private-equity sue long-term growth, sheltered from the funds, and in the size of the top rms that A magnet for the best short-term storms of the public stockmark- manage them. Most private-equity rms In the 1980s private equity was a place for ets. This role is all the more important be- raise funds as limited partnerships. The mavericks and outsiders; these days it at- cause both venture capitalists and buy-out rm is the general partner that manages tracts the most talented members of the rms work increasingly with rms under- the fund and gets paid an annual fee (a per- business, political and cultural establish- going big changes. Well-known rms that centage of the money in, or promised to, a ment, including many of the world’s top have recently been nurtured by private fund) and later a large slice of any prots; managers. Jack Welch, the legendary for- equity include Burger King, Polaroid, Uni- outside investors (who often lock up their mer boss of GE, is now at Clayton, Dubilier versal Studios Florida, Houghton Miin, money for up to ten years) become limited & Rice. Lou Gerstner, who revived IBM, is Bhs, Ducati Motor and the Savoy Group. partners who share only in the prots. chairman of Carlyle. Even Bono, the Private-equity rms can also reason- In 1980, the world’s biggest fund saintly lead singer of rock band U2, is now ably claim to oer a solution (though an (KKR’s) was $135m. Today there are scores in the business. expensive one) to the corporate-gover- of funds with over $1 billion each. J.P. Mor- Moreover, as Hollywood has noticed, nance problems that have blighted so gan’s latest one is currently the biggest, at private-equity rms have become the em- many public companies. If you examine $6.5 billion, ahead of Blackstone’s (see ployer of choice for politicians and gov- all the major corporate scandals of the past chart 2, next page); Permira has Europe’s ernment ocials returning to the private 25 years, none of them occurred where a largest, at around $6 billion at today’s ex- sector.