My Thesis: Pricing of LBOs from 1999-2009

I finally finished my honors thesis. I wrote about LBO pricing from 1999 to 2009. LBO prices (valuation multiples) rose dramatically as the amount of capital committed to private equity surged almost 10-fold after 2001. I argue that mega-buyouts, such as TXU Corp., HCA, First Data, and Freescale, were designed to avoid the increasing prices of LBOs by acquiring companies other private equity firms could not buy. My results support this hypothesis and show that after an LBO exceeds around $10 billion in Enterprise Value, the valuation of the deal becomes more favorable. After bypassing this threshold, EV/EBITDA decreases .1-.2 for every $1 billion increase in transaction value. This result is statistically significant at the .05 level.

If you are not interested in the results of my statistical analysis, you might still be interested in the first half of my paper. Section 1 gives a thorough history of private equity activity since 1980 and illustrates how the space has changed over the last 10 years. Section 2 reviews academic research on LBO performance and pricing.

LBOs From 1999 to 2009

A Shift in American Conservatism

Over the last decade, the Republican party has not lived up to its conservative values regarding fiscal issues. Until recently, the far right-wing focused increasingly on social issues. Consider, for example, Bush's gaping budget deficits. Or better yet, the rise of politicians such as Huckabee or Palin, both of whom's appeal is their social conservatism. Both can be described as either uninformed, undistinguished, or both in the fiscal realm. Given recent developments in GOP politics, it seems this trend has finally reversed, though ironically this reversal may not be as good for the deficit as one might expect.

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Grantham on Bubbles

Jeremy Grantham of GMO has made some interesting comments recently on bubbles. In this FTfm interview, Grantham argues there is nothing more damaging to an economy than a breaking asset bubble. In his Q1 2010 quarterly letter, Grantham identifies bubbles in US equities, emerging nation equities, and commodities. Grantham also recommends continued allocation to these assets, a strange recommendation considering Grantham is a value investor, who traditionally shy away from overpriced assets.

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Kraft-Cadbury Was a Good Deal Despite Recent News

Much ado has been made about the Kraft-Cadbury deal. The consensus seems to be (especially after the overlooked pension shortfall) that Kraft overpaid for Cadbury and, even worse, used its own undervalued stock to do so. Recently, Kraft revealed CEO Irene Rosenfeld's compensation for 2009 was $26.3 million, up 41% from 2008. The compensation committee "heavily weighted the significant effort and the ultimate acquisition of Cadbury" to determine the payment. To some, the Kraft-Cadbury deal is the perfect example of empire building, suggesting that Rosenfeld executed the Cadbury deal to increase revenue (which generally determines CEO compensation) without much attention to the price. This criticism reflects the common conception that most M&A destroys value and is driven by ego and compensation. In my opinion, this view is misguided, both for M&A generally and Kraft specifically.

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A Few Words on the SEC's Suit Against Goldman

Reading the SEC's allegations against Goldman (available here), I was reminded of the case against Bear Stearns hedge fund managers Cioffi and Tannin. From the excerpts of emails given by the prosecution during this case, it seemed that Cioffi and Tannin clearly deceived investors. However, the defense argued that the prosecution's damning quotations had been taken out of context and did not reflect the concrete views of the defendants. Furthermore, it was difficult to link these discussions to actually proving that the managers mislead investors. Cioffi and Tannin were acquitted of any criminal wrongdoing.

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Expect LBOs to Make a Comeback

I've been unable to post recently because I've been finishing a long thesis on LBO pricing from 1999-2009. I will post the paper on this blog in the next coming weeks. Until then, I thought I'd share my outlook for private equity activity going forward.

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Russia's Rising Influence in Its Near-Abroad

It seems as if Russian-American relations have improved significantly over the last year. The rhetoric coming out of Russia towards the US has been much milder. Russia has shown increasingly strong support for sanctions against Iran. Most importantly, Obama and Medvedev signed the new START treaty about a week ago in Prague. Perhaps Obama's push to "reset" relations with Russia have worked. However, I doubt that's the case. A country as driven by realpolitik as Russia would never compromise on personal politics alone. A closer look reveals Russia has reason to be accommodating given its strong successes in securing its "near-abroad" over the last year.

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