October 17, 2005
In yesterday’s NY Times, Andrew Sorkin ran this interesting article in his weekly column: “Among Wall Street’s swashbuckling buyout kings, not many words are off limits. But with private equity firms teaming up to go after bigger prey, one dirty word has become unspeakable. It is collusion.
Virtually any big company that puts itself up for auction these days is deluged with interest from private equity firms, which have too much money and too little time to spend it. Witness the $15 billion sale of Ford’s Hertz rental car unit to a consortium of private equity players including Clayton, Dubilier & Rice Inc., the Carlyle Group and Merrill Lynch Global Private Equity. Or the $11.3 billion sale of SunGard to a supersized group of seven buyout firms led by Silver Lake Partners. What has gone largely unquestioned is whether the formation of these consortiums of firms, or “clubs” in industry parlance, has the potential to artificially depress buyout prices and hurt corporate shareholders.
While no buyout executives will say on the record that the purpose of forming a team is to keep the asking price from going too high, privately, most will concede that reducing the final takeover price is sometimes the result. “You’re not going to get me to say that aloud, but let’s just say that you’re not wrong,” said one legendary private equity investor who then immediately added, “Please don’t quote me by name.”
To be sure, private equity consortiums are being driven in large part by the desire of firms to bag bigger game than they could manage on their own. And by banding together, they can defray some of the risk of an investment going horribly wrong.
Nonetheless, the players obviously remain concerned about the possibility of collusion. In an effort to prevent the strongest buyers from ganging up together, sellers include strict contractual language that keeps the private equity firms from communicating during an auction without the sellers’ permission. It is an open secret that the firms rarely adhere to the rules.
Private equity firms recently have come up with a clever maneuver. Instead of simply getting together, they are now also enlisting Wall Street banks to back their buyouts. These banking arrangements can effectively lock out competitive suitors. A case in point is the latest $16 billion auction for the supermarket company Albertson’s. In that deal, a group of buyout firms led by Kohlberg Kravis Roberts has corralled three of the biggest investment banks, Citigroup, Credit Suisse First Boston and Deutsche Bank, to exclusively lend them money to support their offer. Another team led, by Thomas H. Lee Partners, has done the same with Morgan Stanley, Bank of America and UBS. Several other bidders, including Cerberus, may be forced to drop out if they can’t find financing.
Companies involved in hostile takeovers have long used a strategy of signing up many big investment banks as advisers if only to deprive their opponents of these services. But private equity firms have taken this tactic to a new level.
Sellers may begin to fight back. In recent weeks, bankers and lawyers have been talking about the possibility of signing up as many as a half-dozen banks in advance of auctions to work for the seller and provide preapproved loans to buyers, in what some are describing as a “community staple” – a takeoff on the concept of “staple financing.” (Staple financing is when a seller’s adviser also offers financing to the buyer that is stapled onto the auction material.)
WHILE chief executives of companies thinking of selling are worried about possible collusion, many private equity folk pooh-pooh the issue. As one private equity executive said to me, “As long as two girls show up to the dance, there’s enough competition.”
That may be true. But chew on this scenario: When Kohlberg Kravis Roberts led a group that won a $4.3 billion auction for PanAmSat last year, it beat out a rival consortium led by the Carlyle Group. Several months after the deal had been completed, guess who got an offer from Kohlberg Kravis for an opportunity to buy into the group? Yes, Carlyle.
Some would say this is simply good business. Cynics may be tempted to think that unspeakable word.”