Blackstone Sets a New Fundraising Record
Blackstone, the biggest private equity firm in the world, will soon have the biggest fund in the world. Its latest flagship fund has already surpassed $22 billion, which puts it on target to exceed Apollo’s record $24.7 billion fund. SoftBank proved that investors have a venture capital appetite strong enough to build the 9 figure Vision Fund. Mega-funds like these, defined as worth over $5 billion, now account for over 15% of private capital raised. There is clearly no shortage of investor capital private equity firms can target, which will soon result in a yet another fundraising record. That said, there is a shortage of targets to which capital can be deployed. What’s the result? Diminishing investor returns, layoffs, and increasing levels of worthless debt.
Deals Are Getting Competitive
There is a finite number of companies being auctioned, but a seemingly infinite amount of private equity capital. This dynamic is driving up company prices. It’s a seller’s market, which makes it harder for buyers to achieve the strong returns their investors demand. Profits are more difficult to squeeze out of expensive assets, so sponsors are squeezing harder and harder. Legions of consultants are descending upon private equity portfolio companies in an effort to rein in expenses. In house consulting teams used to differentiate the best private equity firms from their competitors. These days, they’re table stakes. What happens when a private equity firm paid a fat price for a lean asset? They end up cutting into bone.
Layoffs are Masked as Operational Improvements
To many private equity firms, portfolio company employees are liabilities. They’re numbers on balance sheets and nothing more. Operators say that reducing these numbers makes companies more efficient. Efficiency, though, comes at the cost of each laid off employee. These livelihoods are disregarded in the operator’s financial calculus. Sure, we can call this capitalism. The true capitalist, though, appreciates the long term consequences of short-sighted decisions. Workers removed from the labor market are no longer helpful economic actors. Private equity involvement in companies burden the entire economic system. Moreover, private equity firms only care about the viability of their portfolio companies until they exit them. They have little interest in the long term success of companies, which means more job losses in the future.
Low Interest Rates, Low Yields, More Debt
The leveraged buyout is the bread and butter of a private equity company. To maximize returns, private equity firms use low quality debt to finance their purchases. They partner with investment banks to syndicate the debt to yield-hungry investors. In a low interest rate environment like the one we find ourselves in, investors are lining up to buy this high-yield debt. Investors are so hungry for yield that they’re forgoing standard protections, or covenants, for the privilege of recurring interest payments. These “cov-lite” deals can leave investors exposed should the market tumble and borrowers fail to service their debts. To make this more real, picture Toys ‘R’ Us driven into bankruptcy due to unsustainable levels of debt. But rather than KKR suffering anything other than negative press, its investors lose money.
Having the Last Laugh
With each fundraising record, private equity firms are laughing harder and harder. Their business model is built around the use of other people’s money (OPM), so they’re not nearly as exposed to poor investments as their investors are. Intense competition for deals isn’t ideal from the standpoint of private equity firms. They have, however, found ways to eke out profits. The standard practice of “operational improvements” has made mass layoffs acceptable. As far as market conditions go, interest rates remain low, which makes low quality, high yield debt easy to syndicate.
Private equity firms make money even when their investments turn sour, since investors nevertheless pay management fees, up-front fees, and carry. Unfortunately, their investors are left holding the bag. What’s this all mean? Private equity firms will continue to set fundraising records until their investors stop committing capital. If I were a beneficiary in a system like this, I’d be laughing too.
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