Posts Tagged ‘private equity’
“We use the term risk all too casually, and the term uncertainty all too rarely”*…
How private-equity giants are overhauling the financial system, and its potential impact on pensions…
A decade or so ago private equity was a niche corner of finance; today it is a vast enterprise in its own right. Having grabbed business and prestige from banks, private-equity firms manage $12trn of assets globally, are worth more than $500bn on America’s stockmarket and have their pick of Wall Street’s top talent. Whereas America’s listed banks are worth little more than they were before the pandemic, its listed private-equity firms are worth about twice as much. The biggest, Blackstone, is more valuable than either Goldman Sachs or Morgan Stanley—and has the confidence of a winner. “It’s the alternatives era,” proclaimed the company’s ebullient Taylor Swift-themed festive video in December. “We buy assets then we make ’em better.”
This is not, though, the business that has recently boomed for them. Traditional private equity—using lots of debt to buy companies, improving them, and selling or listing them—has been lifeless. High interest rates have cast doubt on the value of privately held companies and reduced investors’ willingness to provide new funds. It does not seem to matter. Core private-equity activity is now just one part of the industry’s terrain, which includes infrastructure, property and loans made directly to companies, all under the broad label of “private assets”. Here the empire-building continues. Most recently, as we report this week, the industry is swallowing up life insurers.
All of the three kings of private equity—Apollo, Blackstone and KKR—have bought insurers or taken minority stakes in them in exchange for managing their assets. Smaller firms are following suit. The insurers are not portfolio investments, destined to be sold for a profit. Instead they are prized for their vast balance-sheets, which are a new source of funding.
Judged by the fundamentals, the strategy makes sense. Insurance firms invest over long periods to fund payouts, including annuities sold to pensioners. They have traditionally bought lots of government and corporate bonds that are traded on public markets. Firms like Apollo can instead knowledgeably move their portfolios into the higher-yielding private investments in which they specialise. A higher rate of return should mean a better deal for customers. And because insurers’ liabilities stretch years into the future, the finance they provide is patient. In banking, long-term loans are funded with lots of instantly accessible deposits; with private assets and insurance, the duration of the assets matches the duration of the liabilities.
Yet the strategy brings risks—and not just to the firms. Pension promises matter to society. Implicitly or explicitly, the taxpayer backstops insurance to some degree, and regulators enforce minimum capital requirements so that insurers can withstand losses. Yet judging the safety-buffers of a firm stuffed with illiquid private assets is hard, because its losses are not apparent from movements in financial markets. And in a crisis insurance policyholders may sometimes flee as they seek to get out some of their money even if that entails a financial penalty. Last year an Italian insurer suffered just such a bank-run-like meltdown…
Funding pension providers with private equity: “The risks to global finance from private equity’s insurance binge” (gift article) from @TheEconomist.
And lest we think that publicly-funded defined benefit pensions are less risky, see “Akin to Fraud” by Mary Willliams Walsh, an account of the sorry state of the public pension fund in New Hampshire (the state with the second-oldest population in the nation).
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As we rethink retirement, we might recall that it was on this date in 1728 that John Gay‘s The Beggar’s Opera premiered. A “ballad opera” (a satirical work with lyrics set to vernacular music), it was a huge hit– it has been called “the most popular play of the eighteenth century“– a watershed in Augustan drama.
The original idea of the opera came from Jonathan Swift, who wrote to Alexander Pope in 1716 asking “…what think you, of a Newgate pastoral among the thieves and whores there?” Their friend, Gay, decided that it would be a satire rather than a pastoral opera.
In 1928, Bertolt Brecht (working from a translation into German by Elisabeth Hauptmann) adapted the work into Die Dreigroschenoper (The Threepenny Opera) in 1928, sticking closely to the original plot and characters but with a new libretto, and mostly new music by Kurt Weill.
“Humanity is actually much more cooperative and empathic than given credit for”*…
We looked earlier at the shrinking away of public companies in the U.S., both as a product of consolidation (of operations and of ownership) and of the (potentially dangerous) growth, in their stead, of private equity. University of Michigan professor Jerry Davis has a more optimistic take…
Public corporations have been dominant institutions in the American economy since the dawn of the 20th century. Whether due to their greater efficiency or power, listed corporations spread across nearly all industries. “Capitalism” in America was synonymous with “corporate capitalism,” and the number of exchange-listed companies grew with the size of the economy.
Yet since the late 1990s, the number of listed corporations has dropped by half in the US, underwritten by new technologies that lower the cost of assembling an enterprise. Meanwhile, neglected alternatives to the public corporation both old (e.g., mutuals, cooperatives) and new (e.g., open source, platform coops) have proven surprisingly durable. Given the manifest pathologies of shareholder capitalism, the combination of these two trends may suggest pathways out of our current dilemma…
[David explains how both consolidation among listed companies and the rise of private equity have contributed to this drop, but then raises a third, more general explanation…]
A more encompassing interpretation is that information and communication technologies (ICTs) have drastically changed the basic economic calculus of what an enterprise looks like and how it might be funded. In the US context, this has meant that companies prefer “buy” to “make,” as transaction cost enthusiasts might describe it. I coined the term Nikefication to describe the process of vertical dis-integration that reconfigured American industry during the 1990s and 2000s and the options it opens for alternative forms of enterprise, described in detail in previous books…
The vertical dis-integration of the American economy was driven by Wall Street and enabled by ICTs. Ironically, the result is that the capital requirements to create and scale a business can be much lower, reducing the rationale to go public in the first place. Indeed, IPO prospectuses routinely convey that the point of the IPO is not to raise capital, but to create a market for the company’s shares to enable VCs and employees to cash out – which is not the most persuasive pitch to potential buyers, and perhaps helps account for the disastrous post-IPO performance of most new listings.
The asset-lite model means fewer public companies, but it also suggests new possibilities for non-corporate forms that may be more human-scale and democratic. Nike’s profit-driven, asset- and employee-lite model is not the only option enabled by new technologies.
By “noncorporate” I mean forms of economic organization that are not owned by outside shareholders, although they may be legally organized as a corporation. These include mutuals (where consumers or members are also the owners); cooperatives (where workers, producers, or consumers are the owners); municipal enterprises (where citizens or governments own the enterprise); nonprofits; and open source projects. These forms are far more prevalent than one might expect, and in some cases they dominate their industry (e.g., property insurance, server software).
Noncorporate forms of enterprise have proven surprisingly resilient in the US. The Fortune 500 list for 2022 includes at least a dozen mutual insurance companies, including State Farm (#44), New York Life (#71), and Nationwide (#83). The single largest shareholder of over 350 of the 1000 largest American corporations is Vanguard—also a mutual. Land o’ Lakes (#213) is an agricultural cooperative owned by its producer-members, as are Ocean Spray and Blue Diamond. Ace Hardware is a retail cooperative in which local stores can be attuned to local needs and tastes yet gain the economies of scale of a large-scale brand. Jessica Gordon Nembhard’s brilliant book Collective Courage documents that cooperative forms thrived in African-American communities for generations – often overlooked by those who find data about the economy solely through online databases. And the US is home to nearly 5000 credit unions, which by law are not-for-profits, owned by their members.
Stanford Law professor Ron Gilson once quipped that if shareholders didn’t exist, they would have to be invented. That’s not quite true: plenty of American enterprises do quite well without shareholders. Indeed, civilization itself might be better without them. As I have written elsewhere, “nearly every major societal pathology in the West today – certainly in the USA – is caused or exacerbated by profit-oriented corporations,” including the opioid epidemic, the obesity crisis, the return of nicotine addiction among the young, democracy-undermining social media, and a climate catastrophe underwritten by the fossil fuel industry. Shareholder capitalism may be a suicide pact. Conversely, cooperatives are inherently democratic and accountable…
Institutional alternatives to public corporations are well-established in the US, and in some cases they lead their industry, such as mutuals in finance and insurance. But cooperatives have historically been thin on the ground here compared to Europe. According to the Democracy At Work Initiative, there were 612 worker cooperatives in 2021 –a 30% increase over 2019, but still a tiny number.
Perhaps the digital revolution has finally created the conditions for cooperatives to thrive. Research from the pre-digital era suggests that one of the factors limiting cooperatives is, for want of a better term, the transaction costs of democracy. A lot of workers’ time spent in meetings to engage in dialogue, debate, and polling is a price that corporate dictatorships don’t have to bear. But newer tools have dramatically reduced the transaction costs of democracy: the same smartphones that enable pervasive corporate surveillance also allow worker voice at scale on a continuous basis.
It is not just transaction costs that have declined: the required assets to start a business are also much cheaper now to own or rent. Capital equipment such as Computer Numerical Control tools, powered by software, gets better and cheaper much the same way other software-powered tools do. (Compare the price of a color laser printer in 1990 to one today.) This is also true of the software required to run an enterprise. It is possible to buy a knockoff version of the enterprise software underlying the Uber app for under $10,000 – and the Drivers Coop in New York is creating a version to “franchise” the locavore driver-owned coop alternative to Uber. The ICTs that dis-integrated the corporate economy have opened space for noncorporate alternatives that might be more democratic and human-scaled.
There are reasons for optimism here. Platform cooperatives merge the benefits of coops with accessible technology, and have been especially effective in industries in which the required new capital investment is low (home cleaning, home health aides, transit). Trebor Scholz’s new book Own This! provides details on the opportunities here. Municipally- or cooperative-owned fabrication facilities can enable enterprises with limited capital to launch and thrive. If the required investment to start a business is low, then the range of alternative institutions, including coops, is correspondingly larger.
The technologies exist to create low-cost alternatives to public corporations. Maybe we are not stuck with the legacy of 20th century corporate capitalism after all…
An optimistic (and aspirational) take on what might follow the economic reign of the public company: “Is This the End of Corporate Capitalism?” from @vanishingcorp via @iftf.
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As we ponder proprietorship, we might recall that, on this date in 1933 the hospitality industry got a boost as Congress ratified the 21st Amendment to the U.S. Constitution– repealing the 18th Amendment, which had prohibited the manufacture, transportation, and sale of alcohol. Prohibition had gone into effect in 1920 in an effort to reduce crime and improve public health, but it had backfired: despite massive public investment in enforcement, there was a sharp rise in organized crime (c.f.: bootleggers like Al Capone stepping in to supply black market booze) and the emergence of a “scofflaw” attitude on the part of a public that wanted its alcohol.
“Not all private equity people are evil. Only some.”*…
But as Rogé Karma explains, that could be enough to cause big trouble, as a large and growing portion of our economy is disappearing behind a veil…
The publicly-traded company is disappearing. In 1996, about 8,000 firms were listed in the U.S. stock market. Since then, the national economy has grown by nearly $20 trillion. The population has increased by 70 million people. And yet, today, the number of American public companies stands at fewer than 4,000. How can that be?
One answer is that the private-equity industry is devouring them. When a private-equity fund buys a publicly traded company, it takes the company private—hence the name. (If the company has not yet gone public, the acquisition keeps that from happening.) This gives the fund total control, which in theory allows it to find ways to boost profits so that it can sell the company for a big payday a few years later. In practice, going private can have more troubling consequences. The thing about public companies is that they’re, well, public. By law, they have to disclose information about their finances, operations, business risks, and legal liabilities. Taking a company private exempts it from those requirements.
That may not have been such a big deal when private equity was a niche industry. Today, however, it’s anything but. In 2000, private-equity firms managed about 4 percent of total U.S. corporate equity. By 2021, that number was closer to 20 percent. In other words, private equity has been growing nearly five times faster than the U.S. economy as a whole.
Elisabeth de Fontenay, a law professor at Duke University who studies corporate finance, told me that if current trends continue, “we could end up with a completely opaque economy.”
This should alarm you even if you’ve never bought a stock in your life. One-fifth of the market has been made effectively invisible to investors, the media, and regulators. Information as basic as who actually owns a company, how it makes its money, or whether it is profitable is “disappearing indefinitely into private equity darkness,” as the Harvard Law professor John Coates writes in his book The Problem of Twelve. This is not a recipe for corporate responsibility or economic stability. A private economy is one in which companies can more easily get away with wrongdoing and an economic crisis can take everyone by surprise. And to a startling degree, a private economy is what we already have.
America learned the hard way what happens when corporations operate in the dark. Before the Great Depression, the whole U.S. economy functioned sort of like the crypto market in 2021. Companies could raise however much money they wanted from whomever they wanted. They could claim almost anything about their finances or business model. Investors often had no good way of knowing whether they were being defrauded, let alone whether to expect a good return.
Then came the worst economic crisis in U.S. history…
Read on for a bracing account of: “The Secretive Industry Devouring the U.S. Economy,” (gift article) in @TheAtlantic.
* Paul Krugman
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As we clean our glasses, we might spare a thought for Ivy Lee; he died on this date in 1934. A publicity expert and a founder of modern public relations, he was among the first to persuade business clients– foremost among them, the Rockefeller family– to woo public opinion. Ultimately he advised rail, steel, automobile, tobacco, meat packing, and rubber interests, as well as public utilities, banks, and even foreign governments.
Lee pioneered the use of internal magazines to maintain employee morale, as well as management newsletters, stockholder reports, and news releases to the media. And he did a great deal of pro bono work, which he knew was important to his own public image; during World War I, he became the publicity director for the American Red Cross.
“If you don’t allow for self-serving bias in the conduct of others, you are, again, a fool”*…
Private equity firms are in the spotlight for their negative impact on health care, journalism— indeed, essentially every sector they touch in the interest of generating big returns for themsleves and their investors (some of which are sovereign wealth funds; some, very wealthy individuals/families; but largely, insurance companies and public pension firms). Now, as the inimitable Matt Levine points out, even those investors (who were already paying massive fees) are in the private equity firms’ crosshairs…
Two basic features of private equity economics are that if you raise a fund and you spend $1 billion to buy a company, and you do a good job running the company and it becomes worth $5 billion, then:
- You charge a management fee — say, 2% per year — on the $1 billion you paid for the company, not the $5 billion it’s currently worth.
- If you sell the company — to a strategic buyer or another private equity firm or in an initial public offering — you collect $800 million of carry (20% of the value that you added to the company), but you can’t charge the management fees anymore.
It would be good, for you, to mark the company to market. Raise your own new private equity fund, and sell the company from your old fund to the new one at its current market value. Then:
- You can keep charging 2% per year, but now on $5 billion rather than $1 billion.
- You can collect your $800 million of carry now, and then if you add more value you can collect more carry when you sell it.
This is called a “continuation fund.” The Financial Times reports on “a new and controversial type of transaction that is fast becoming the private equity industry’s hottest trend in the US, UK and several other markets — deals in which a buyout group in effect sells a company to itself”:
Such deals have partly been a consequence of the tidal wave of cash that has flooded private markets during the long era of low interest rates. As that era comes to an end and a downturn looms, these deals are set to become more attractive than ever for private equity groups with companies to sell.
The deals — a way for buyout groups to return cash to their original investors within a pre-agreed 10-year time period, without the need to list companies or find outside buyers — have been growing in popularity since the early days of the Covid-19 pandemic, when a market freeze prompted a search for new options…
Equity market investors are becoming increasingly vocal about how private markets value companies. Vincent Mortier, Amundi Asset Management’s chief investment officer, said this month that parts of the buyout business “look like a pyramid scheme” because of “circular” deals in which companies are sold between private owners at high valuations.
Speaking privately, some pension funds are frustrated. “This is wonderful for the [buyout groups]; it’s one of the best things they ever discovered,” says one pension fund’s head of private equity, who asked not to be named.
But “it’s one of the worst things” for their investors, he adds. “The pie is getting bigger” as private equity balloons in size, he says, but “more of the pie is going to the [private equity firm] and less is going to [its investors].”…
More on these Machiavellian machinations: “Buyout Firms Buy From Themselves,” from @matt_levine in @business.
[Image above: source]
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As we ruminate on rapaciousness, we might recall that it was on this date in 1873 that Jesse James and his gang staged the first train robbery (the world’s first robbery of a moving train), a mile and a half west of Adair, Iowa… the site of which is now commemorated as a county park.
“America’s health care system is neither healthy, caring, nor a system”*…
Care is deteriorating even as prices rise. There are a number of reasons; Fred Shulte explores a new and growing category of culprit…
Private equity is rapidly moving to reshape health care in America, coming off a banner year in 2021, when the deep-pocketed firms plowed $206 billion into more than 1,400 health care acquisitions, according to industry tracker PitchBook.
Seeking quick returns, these investors are buying into eye care clinics, dental management chains, physician practices, hospices, pet care providers, and thousands of other companies that render medical care nearly from cradle to grave. Private equity-backed groups have even set up special “obstetric emergency departments” at some hospitals, which can charge expectant mothers hundreds of dollars extra for routine perinatal care.
As private equity extends its reach into health care, evidence is mounting that the penetration has led to higher prices and diminished quality of care, a KHN investigation has found. KHN found that companies owned or managed by private equity firms have agreed to pay fines of more than $500 million since 2014 to settle at least 34 lawsuits filed under the False Claims Act, a federal law that punishes false billing submissions to the federal government with fines. Most of the time, the private equity owners have avoided liability…
The terrifying details: “Sick Profit: Investigating Private Equity’s Stealthy Takeover of Health Care Across Cities and Specialties,” from @FredSchulte at @KHNews.
See also: “Private equity, health care, and profits: It’s time to protect patients,” “Private equity health-care monopolies are on a profitable killing spree,” and “Private equity deals drive up healthcare use, costs among physician practices, JAMA study finds” (this last, source of the image above).
* Walter Cronkite
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As we muse on mercenary medicine, we might send healing birthday greetings to James Collip; he was born on this date in 1892. A biochemist, he partnered with Frederick Banting and Charles Best to discover insulin in 1921. The co-inventors sold the insulin patent to the University of Toronto for a mere $1. They wanted everyone who needed their medication to be able to afford it.
Today, Banting and his colleagues would be spinning in their graves: Their drug, on many of the 30 million Americans with diabetes rely, has become the poster child for pharmaceutical price gouging.
The cost of the four most popular types of insulin has tripled over the past decade, and the out-of-pocket prescription costs patients now face have doubled. By 2016, the average price per month rose to $450 — and costs continue to rise, so much so that as many as one in four people with diabetes are now skimping on or skipping lifesaving doses…
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