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Thursday, August 24, 2006

Shareholders Fight Back Against Private Equity Firms (via the WSJ)

There was an interesting article in last Friday's Wall Street Journal about recent developments in the private equity market. It seems that firms that would formerly have been targets are now trying to keep more of the going-private gains for their own shareholders:
VNU's board recommended in March that shareholders accept the private-equity firms' bid, but the shareholders instead rose up in a rare and vociferous revolt. The shareholders questioned why they should sell for a small premium to VNU's share price -- leaving on the table the profits the private-equity firms were likely to reap from quickly restructuring the company. Instead, the shareholders wanted to force the company to fix itself so they could enjoy the fruits of the changes themselves.

The rebels -- including some of the world's largest mutual funds -- proposed their own business plan and new executives, and tried to force the chairman to quit. "We took the initiative to defend long-term shareholders' interests," says the group's leader, Eric Knight, head of New York-based Knight Vinke Asset Management.

Read the whole thing here (note: online subscription required).

It's an interesting phenomena - shareholders see the huge gains that successful LBOs make for PE firms, and are trying to do some of the restructuring themselves (or at least, try to bargain for some of the associated gains). Not surprisingly, it's being driven by large, well-informed shareholders (like activist investors).

The question that comes to mind is whether they can pull it off like a private-equity shop can. Part of what makes an LBO work is that the firm ends up imposing brutal discipline, shedding unproductive assets, and so on.

It's a painful process, and very politically unpopular. A big part of what makes it happen, however, is the realignment in incentives that comes with an LBO. In an LBO, the newly private firm takes on a great deal of debt (hence the "leveraged" in LBO) which result sin phenomenal increases in both the risk and potential rewards of the venture. In addition, the principals take HUGE equity stakes, which further increases both their personal risks of failure and their payoffs if the LBO works out. So, they're quite willing to take the unpopular actions necessary for success, because there's a lot of their own money at stake.

The WSJ article said that the activist shareholders are in many cases bringing in their own private equity specialists as advisors. That'll takes care of the technical expertise, but it doesn't change the incentive structure. So, KNOWING what to do may not be sufficient - actually having the will to do it is a different thing altogether.

I also wonder who the PE advisors are. If there's so much money to be made conducting a successful LBO, why are these people acting as advisors instead of running a large PE firm themselves? It could be that these are "second-tier" people, but we'll have to wait and see. So, their recommendations might not be as good as what a PE firm might themselves do. I have a suspicion that the distribution of talent in PE firms is highly skewed.

In any event, these transactions might make for a good academic study.

Any Ph.D. students out there looking for a topic?

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