"Going private" short-changes shareholders

The FT has an article today by James Politi and Francesco Guerrera (Investors ‘short-changed’ in buy-outs) on a survey showing that private equity groups are buying out public companies at surprisingly low takeover prices. The survey, conducted by Weil Gotshal & Manges (a big NY-based law firm) shows that of 50 private equity takeovers last year, bidders on average paid only 6 percent more than the highest price the target company had been trading over the previous 12 months. In a takeover, a bidder can typically expect to have to pay significantly more than what the target company is trading at on a stock exchange -- after all, when you buy a share on the New York Stock Exchange, you are buying a right to a tiny portion of the company's profits. When you are buying 51 percent of the shares, you are buying not just a right to the company's profits, but also control of the company. (Hence the term "control premium" for the amount a bidder pays above what the company was trading at in order to take control.)

The Weil Gotschal study is interesting because it suggests that corporate boards are quite literally giving away the store in these private equity deals. It's possible, of course, that private equity groups are sniping off companies in a downward spiral, with the hopes of replacing management, restructuring the target company, and improving performance. However, given the amount of equity existing corporate officers and directors are given as part of recent deals, this seems somewhat dubious. The fear is that these equity deals are bribes to corporate officers and directors in exchange for an agreement to sell the company at firesale prices, which will then be sold back to the public at some future date at a much higher price.

The FT quotes Simpson Thacher & Bartlett partner Alan Klein as saying “They are not forcing anyone to sell. For a private equity deal to be attractive they need to put a lot of leverage on the business. A lot of institutional investors and managements can’t live with that.” But that isn't quite the whole story; the target company's board of directors often is forcing shareholders to sell. And leverage is just debt. If a leverage buy-out makes sense to the tune of a 15 percent return on assets per year, why won't institutional investors live with it?