A Fee-ding Feast

The daily barrage of information about the latest private equity purchase of a public company has me asking, "what's the point?" So far I have gathered that the private equity funds are freeing the public companies of short-term thinking and the constraints of Sarbanes-Oxley. If this were truly the case, I would imagine that such companies would be purchased with large pools of money, such as insurance company balance sheets or pension plans. However, they are generally purchased by pools of money created by aggressive investors who have heavily leveraged these assets in order to purchase these companies. Such leverage incents the short-term thinking that such a structure is supposed to avert. Even more striking, the only way to ultimately pay off such debt is to take the companies public once more.

In reviewing the purchases of Berkshire Hathaway (BRK), I have noticed that BRK's purchases of private companies into this public company are motivated by giving the owners of these successful private companies a long-term home and their families an estate planning solution. Clear enough. In addition, BRK's purchase of GEICO and public utility companies are motivated by BRK's ability to supply large amounts of capital for capital intensive plans. Finally, BRK's purchase of publicly traded stocks are based on price and business model. Never does the management of BRK imply that its management can add value. For this reason, BRK's annual report always states, when looking for acquisitions, "future projections are of no interest to us nor are turnaround situations." If BRK cannot add value to these situations, either publicly or privately, what is the idea of these private equity purchasers?

As far as I can tell, the object is to create a higher return by the aggressive use of leverage while paying extraordinary fees to do so. Unless these purchases are being made at extraordinarily cheap prices, such a process seems doomed to failure. As I shared with a friend of mine, "It's hard to borrow yourself out of debt," but these private equity managers will fee-ed themselves first and leave the leftovers behind. Caveat investor.