Know Your Enemy

Bush is obviously too stupid to become President of the USA all by himself. So who put him there and why?

Well, these are the same people that backed his father, obviously. And where is Bush Snr these days? On the board of the Carlyle Group, one of the world's top private-equity firms (for a revealing look at the Carlyle Group, see this documentary from ICH). But what exactly is a private-equity firm, what do they do, who runs them and what do they want?

This week's cover story at The Economist has a very good look at who these people are.

In 1985, ... private equity was a cottage industry that few people had heard of. There had always been family-owned private firms, but family owners did not usually aim to sell off the business; they passed it on to the next generation.

Until the late 1970s, the main activity in private equity—buying shares in private companies in the hope of selling them at a higher price later—had been carried out mostly by the investment arms of a few wealthy families, such as the Rockefellers and Whitneys in America [and, presumably, the Bush/Walker clan], and had generally been confined to venture-capital investment in small, fast-growing businesses.

Then came the "Greed is Good" 80's, with highly publicized hostile takeovers which often resulted in companies being carved up and sold off in pieces. Nowadays such unpopular takeovers are less common: private-equity firms tend to move in more quietly, with mountains of cash and political muscle at the ready to gently "fix" companies' problems. Because everything is done behind closed doors in this private world, there is not much transparency at all about what exactly they do and how they do it.

“If you examine all the major corporate scandals of the past 25 years, none of them occurred where a private-equity firm was involved,” noted Henry Kravis, one of the founders of KKR, in a recent speech. Private-equity firms, he said, are “vigilant in our role as owners, and we protect shareholder value.” On the other hand, if there were any impropriety in a private company, the public might not get to hear about it.

A lot of "smart money" has been thrown at these funds, and they have grown quite astronomically over the past two decades:

In Britain, for instance, one-fifth of the workforce outside the public sector is employed by firms that are, or have been, invested in by a private-equity firm, according to the British Venture Capital Association. Worldwide, there are more than 2,700 private-equity firms, reckons Goldman Sachs (maybe many more, because in this private world small firms can easily drop below the radar screen). As pension funds, endowments and rich individuals have become increasingly keen investors, the amount of private equity has soared. In 2000 alone, the peak year so far, investors committed about $160 billion to private-equity firms (much of it to venture capital), up from only $10 billion in 1991...

In 1980, the world's biggest fund (KKR's) was $135m. Today there are scores of funds with over $1 billion each. J.P. Morgan's latest one is currently the biggest, at $6.5 billion, ahead of Blackstone's (see chart 2, next page); Permira has Europe's largest, at around $6 billion at today's exchange rate. A $10 billion fund can be only a matter of time, if only for the fabulous annual fees.

Blackstone, which started life as a two-man band working from a single room, has become, in its own words, “a major player in the world of finance”. It employs over 500 people in plush offices in New York's Park Avenue, Boston, Atlanta, London, Paris and Hamburg. The 35-40 firms in which it has a private-equity stake together have over 300,000 employees and annual revenues of over $50 billion—which, were they lumped together as a single conglomerate, would make Blackstone a top-20 Fortune 500 company. Other big private-equity firms can point to similar numbers. TPG's portfolio of firms has 255,000 staff and collective annual revenues of $41 billion; Carlyle's has 150,000 workers and revenues of $31 billion.

Picture a lush green prairie field, swamped by herds of eager buffaloes. Now the field is becoming sparse and trampled, and the weaker buffalo are already feeling the pinch... Squabbles break out... Something's gotta give...

Smaller private equity funds have begun seeing losses, and shareholders who have been burned are publicly demanding answers. Many such shareholders are actually public pension funds, whose investors had no idea what was happening to their money. So what does the herd do now?

Will private-equity firms be able to maintain their privacy when transparency is increasingly expected in every walk of life? The answer may depend on politics as much as on economics. Most private-equity firms fiercely oppose greater transparency, arguing that it will rob them of their magic. Many tacitly accept that their performance will soon become subject to much more intense scrutiny, and that they will have to adopt sensible industry standards for valuing their portfolios. But they are desperate to avoid having to disclose details about the performance of individual firms in their portfolios...

But change is on its way, if only because of the growing amount of money being invested in private equity through public pension funds. In America, freedom of information acts have prompted some public pension funds to provide details of the performance of their investments in different private-equity firms, to the horror of most of the firms concerned. Yet, as Thomas Lee, founder of the eponymous private-equity firm, concedes, “We are using so much public money that we have an obligation if not to be transparent then to be a little less invisible than in the past.”