Private Equity Giants Adapting to New Normal?

Kevin Roose of the NYT's DealBook blog reports, Private Equity Giants Use Size to Lean on Suppliers:

A single company purchased more than 50,000 Hewlett-Packard computers last year, buying in bulk to shave millions of dollars off its costs.

But it was not General Electric, Procter & Gamble or another large, multinational conglomerate with the muscle to dictate prices to suppliers. Rather, the big buyer was the Blackstone Group, a private equity firm.

Private equity firms like Blackstone are emerging as a powerful new force in the marketplace. The big investors, which collectively oversee thousands of companies, are using their size and scope to pressure suppliers, set their own prices and exert their influence in a range of industries, including health care, construction and consumer goods.

Last year, Blackstone was part of a group of companies that collectively bought 16 million reams of copy paper, 35 million FedEx shipments and 900,000 days’ worth of rental cars from National and Avis.

“We have incredible leverage,” said James A. Quella, Blackstone’s North American head of portfolio operations. “The more volume we have, the lower our prices go.”

For years, private equity firms like Blackstone have been viewed as financial alchemists who buy undervalued companies, rejigger their balance sheets and sell them for quick gain. In good times, the strategy worked. Buyout specialists could turn a tidy profit in a matter of months, without getting deeply involved in the businesses they owned.

Hence the “barbarians at the gate” stereotype, which has arisen again in recent months as the presidential election has brought the private equity debate into sharp focus. Critics of the industry have faulted Mitt Romney, the presumed Republican candidate, for his years of running Bain Capital, a large buyout firm.

The industry players have been cast as job destroyers more concerned with making money for investors than improving the companies they own. One particularly critical ad for the Obama campaign featured a company, GST Steel, that went out of business years after it was taken over by Bain Capital.

But with the financial crisis, the decline of stocks markets and the sputtering recovery, private equity has been adapting its ways. While profit remains central and layoffs can still be part of the private equity equation, buyout firms are now stuck holding on to companies longer than expected.

As a result, the firms cannot operate at arm’s length anymore and instead have had to roll up their sleeves and become full-fledged operators.

The private equity titans have huge economic influence and sway, largely because of the size of their portfolios. Blackstone owns all or part of 74 companies that employ 700,000 people and generate $117 billion in annual revenue.

Taken collectively, Blackstone’s businesses would rank as the 13th largest company by revenue, ahead of JPMorgan Chase, I.B.M. and Procter & Gamble.

Kohlberg Kravis Roberts, another megafirm, would be No. 5 on that list with its 74 portfolio companies and $210 billion in aggregate revenue.

The Carlyle Group has investments in 200 portfolio companies, including Dunkin’ Brands and Hertz, that collectively employ around 675,000 people — more than General Motors and General Electric combined.

“Historically, private equity firms were about financial engineering,” said Jason Busch, managing director at Spend Matters, a research firm that focuses on the procurement processes of big corporations. “That’s the fairy tale story from 25 or 30 years ago. Within the last decade, there’s been more operational work to do.”

Blackstone and others are taking the cues from the likes of General Electric. Decades ago, G.E. started buying in bulk for its various businesses units, including aerospace, energy, consumer and finance.

Despite the disparate industries spread across dozens of countries, G.E. decided to make buying decisions at the corporate level, as a way to save money and bolster profits. Today, most large multinational companies adhere to a similar strategy for their supply chain, buying computers, office supplies and all types of products at a discount.

Now, private equity firms are too. Both Blackstone and K.K.R. belong to a group purchasing program called CoreTrust, which has roughly 200 member companies including TPG Capital, Bain Capital, and other private equity firms.

The program, which began in 2006, helps companies save 10 to 50 percent on common items, and even lets them stay enrolled after they are sold or taken public by their private equity owners.

“It’s just common sense,” said Todd Cooper, head of procurement for K.K.R., which uses CoreTrust for some bulk purchases. “Every company, whether I’m a manufacturer or a retailer, uses FedEx. Everybody needs laptops.”

Those savings can add up. Blackstone says it has saved $600 million since 2006 through CoreTrust, direct supplier relationships and an equity health care group, which applies the same group purchasing principles to employee health insurance plans. K.K.R. pegs its total savings at north of $700 million.

“It’s a phenomenal benefit,” said Chris Karkenny, the chief financial officer of Apria, a health care company that was acquired by Blackstone in 2008 and has since used CoreTrust to buy telecommunications equipment, office supplies and other goods. “We do just over $2 billion in revenue, but we’re getting rates that companies with $100 billion in revenue would get.”

In 2005, Mr. Quella of Blackstone recruited Gregory Beutler, a former G.E. executive, to help Blackstone drive down prices in its biggest spending categories. The two set a goal of saving $100 million a year through bulk-buying. They immediately began reaching out to the company’s suppliers, telling them that they were to treat Blackstone’s myriad businesses like one giant conglomerate, and set their prices accordingly.

“We went to U.P.S. and FedEx,” Mr. Quella said. “We said, ‘Guys, we just did an analysis: our smallest company is paying $9.95 for overnight. Our largest company is paying $6.95 for overnight. You guys charge whatever you get away with. We want one price, and we want that price to be the price you give your biggest customer.’ ”

The hardball tactic worked. “We negotiate them to the wall,” Mr. Beutler said of Blackstone’s suppliers.

Another cost-cutting tactic is the reverse e-auction. In the eBay-style process, suppliers are given a set period of time, typically an hour, to bid against one another for a large contract.

Earlier this year, when Emdeon, a medical data provider owned by Blackstone, wanted to renegotiate a contract for a type of large, 112-pound paper rolls it uses to print medical claim statements and customer bills, Mr. Beutler organized a one-hour e-auction involving four paper makers.

Mr. Quella and Mr. Beutler watched eagerly from their desks as the bids began at $47.43 a roll, then fell as companies began lowering their prices. When the auction ended, a late bid of $45.87 a roll had won out. The savings were small by group purchasing standards, only about 3 percent of a contract that averages around $3.5 million annually. But at the scale of private equity, every dollar counts.

“Ten percent of a big number is a big number,” Mr. Quella explained.

While e-auctions and other aggressive negotiating tactics save money for private equity firms, they often put suppliers in a bind: should they lose out on a large contract, or win it and make the narrowest of profit margins?

“It almost is a necessary evil,” said Anthony C. Chukumba, an analyst for BB&T Capital Markets. “You want the business. But if you bid so low and then win a contract, then you have something that is only marginally profitable.”

Some large private equity firms choose not to participate in programs like CoreTrust, typically because they believe the group purchasing process strains relationships with suppliers, and requires them to micromanage companies in exchange for relatively small savings.

Private equity-owned companies, too, have raised objections to group purchasing programs, which often require them to change suppliers from the ones they have used for decades.

“It’s difficult to break companies out of their mindsets,” said Justin Hillenbrand, a partner at Monomoy Capital Partners, a midmarket private equity firm that uses a group purchasing program for its portfolio companies. “Maybe they’ve been using U.P.S. forever, and because of that U.P.S. gives them favors; maybe it delivers things at odd hours. Guess what? If my purchasing program can get FedEx for 25 percent cheaper, they’re going to switch.”

At one meeting, Mr. Quella of Blackstone said, the chief executive of a portfolio company expressed his frustration that the firm’s group purchasing plan would force him to switch the brand of toilet paper his company used in its bathrooms.

Still, group purchasing advocates defend their work as a necessary part of private equity’s fat-trimming process. Blackstone and K.K.R., rival firms in almost every sense, are now teaming up to introduce CoreTrust to Europe.

As group purchasing programs grow, they will have to tread lightly, finding a balance in getting the prices they want and not angering the companies they own, or their suppliers.

“It’s one thing to fool with the balance sheet of a company — it’s another to change its operations,” said Mr. Busch of Spend Matters. “It’s absolutely about rolling up your sleeves, but it’s about having soft hands as well.”

Long time ago, I wrote on this blog about the shakeout in hedge fund industry and the one in private equity. The article above is a perfect illustration of this point.

Importantly, this is where PE men are separated from PE mice. The private equity weenies relying solely on leverage and financial engineering are dead. In this environment, you need people with actual business operating experience, people who know how to "roll up their sleeves" and get their hands dirty.

I like Blackstone a lot. Think they are a true alternative investment powerhouse, offering their clients top funds in hedge funds, private equity, real estate and infrastructure. The firm was co-founded in 1985 by one of my favorite people in finance, Pete Peterson, a man who knows the meaning of enough.

There are many other great funds in private equity who are adapting and thriving to the post-2008 environment. A list of these funds can be found on the Canada Pension Plan Investment Board's (CPPIB) site by clicking here. Interestingly, CPPIB wisely chose not to compete but to co-invest along with these top funds, leaving direct investment only for infrastructure.

A wise senior pension fund manager at CPPIB told me flat out: "If I can hire a David Bonderman (TPG) and pay him $20 million or more a year, I would, but I can't. It's silly to compete with these guys in private equity. The few pension funds that are engaging in direct investing will drop it and opt for co-investing where they can reduce fees and be part of some sweet deals. We do directs but in infrastructure, not PE."

I agree with this strategy but some Canadian pension funds are still sticking with direct investing in private equity and thriving at it. The Ontario Municipal Employees Retirement System (OMERS) recently sold a large portfolio of 11 private equity fund investments to AXA Private Equity for $850-million:

The sale price also includes related unfunded commitments that OMERS has with the private equity funds, which are predominantly North American and global funds.

OMERS Private Equity chief executive officer Paul Renaud said the sale is part of a broader strategy to invest directly in private assets rather than through investment funds.

“This transaction is consistent with OMERS strategic shift towards direct investing,” he said.

OMERS Private Equity has concluded a string of deals to directly purchase private companies over the past year, including the U.S. chain of Great Expressions dental centres, Canadian injection moulding company Husky International Ltd., U.S. golf retailer Golfsmith International Holdings Inc., and U.K.-based V. Group Ltd., which handles ship management and crews for owners of large sea vessels.

The fund argues direct investments give it more control over its assets than investments through third-party private equity funds, and keep investment costs lower.

AXA said in a release it purchased the investments as part of a strategy it has implemented to make purchases from large institutions “looking to monetize their private equity investments.”

Last June, AXA bought $1.7-billion of private equity assets from Citigroup and a further $740-million from Barclays under the same program. AXA is a world leader in private equity investing with a portfolio of $28-billion in assets.

And Bloomberg reports that Jane Rowe, head of private equity at the Ontario Teachers' Pension Plan (OTPP) is seeking private investments in India and Latin America to diversify its emerging-markets focus beyond China and Hong Kong (not sure if this is direct; probably fund investments).

Elsewhere in private equity, the WSJ's Private Equity beat reports, Deals May Be Down But Moody’s Report Shows Dividends Are Up:

Buyout deal volume was down 26% globally and 5.5% in the U.S. during the first six months this year over the same 2011 period, according to data provider Dealogic. (The Private Equity Analyst provides an in-depth analysis of the deal data in our July issue.)

But financial sponsors are busy on at least one exit front: taking on debt to fund dividend payouts from their companies, Moody’s Investors Service said in a report Wednesday (subscription required).

Moody’s analyzed 35 dividend transactions this year, including 28 by private equity-backed companies. The ratings agency found that while the dividend payout volume was up 10% over the year-ago level, the transactions didn’t leave the companies with a worse credit profile than similarly-rated companies that were not backed by financial sponsors.

Measured by pro forma debt-to-EBITDA ratios after the dividend events, the companies are on par with similarly-rated companies, Moody’s said.

Part of the reason why the debt levels held up relatively well is that many of the dividend-paying companies were bought out after 2008, meaning their debt loads were relatively light to start with.

Lenny Ajzenman, a Moody’s senior vice president that co-authored the report, said he expects firms continue to look for windows of opportunity on the credit markets to take money out from their companies.

“Since the M&A and the IPO markets were relatively weak, dividend deals became a prevalent strategy for firms to get some money out, while waiting for the M&A market to strengthen and multiples to improve,” said Ajzenman.

It's a shame that private equity has been the subject of so much political furor. Bloomberg rightly asks, "Where Is Romney’s Private Equity Pride?". Hate to break it to to you, but Romney was never part of private equity's elite, even when he was in charge of Bain Capital.

The elite in private equity are very few and they're making an obscene amount of money which they use to amass an impressive art collection:

Leon Black’s $120 million winning bid for Edvard Munch’s “The Scream” at a Sotheby’s auction may be making the most noise in the art world now, but Black is hardly the only PE titan engaging in the go-to hobby for the idle and not-so-idle rich.

A recent article of ARTnews listing the top 200 collectors for 2012 included several private equity luminaries.

Private equity boasts a lengthy list of art aficionados, including: John Vogelstein, a managing director and senior advisor to Warburg Pincus; Henry Kravis, one of the K’s in KKR & Co.; J. Tomilson Hill, who heads up Blackstone Alternative Asset Management; Andrew Saul, founder of the eponymous firm Saul Partners; Donald Marron, the founder of Lightyear Capital; and John Phelan and Glenn Fuhrman, the managing partners of Michael Dell’s family office, MSD Capital.

These collectors manage several billion dollars worth of investors’ money in their day jobs, and spend millions on everything from traditional works by the Old Masters (like Mr. Kravis) to contemporary artists like Lisa Yuskavage, reportedly in the collection of MSD Capital’s John Phelan. He also reportedly owns works by Cindy Sherman and Richard Prince and backs the art-focused magazine “Bomb”.

Lightyear Capital’s Marron is also a collector of modern and contemporary art, with a collection boasting some big names in the international art world like Gerhard Richter, Jasper Johns, and Willem de Kooning.

The late Teddy Forstmann was also an avid collector and owned works by Pablo Picasso, Paul Gauguin, Henri Matisse and Henri de Toulouse-Lautrec as well as more recent works from artists like Jean-Michel Basquiat. Pieces from Mr. Forstmann’s collection were also offered at Sotheby’s auction in May.

Although some of these investors make the ARTnews list, Black, with a collection valued at approximately $750 million, according to the Wall Street Journal, is the only private equity financier to crack the top ten.

As one unnamed dealer told ArtNews of Black’s winning bid for “The Scream”: “Certain guys get in the ring and never quit.”

And if you think that's impressive, check out the view above from the Manhattan penthouse owned by Ted Forstmann, the private-equity billionaire who died in November. According to Bloomberg, it sold for $40 million, 11 percent more than the asking price.

All the testosterone shots in the world (lol) won't give you the edge needed to make the kind of money private equity giants are printing. They are few but very powerful and the very best of them are adapting and thriving in this cutthroat environment.

Below, Private Equity Growth Capital Council CEO Steve Judge explains the benefits and success of private equity firms. He speaks with Deirdre Bolton Bloomberg Television's "Money Moves."