The New York Times ran a provocative piece Jan. 4 about the values private equity firms put on the companies they own – companies that are not publicly traded and thus do not have market prices. There are surprising discrepancies between the values (so-called “marks”) placed on these holdings by different PE firms that own stakes in the same companies, the story pointed out.
Given the incentive PE firms have to paper over their problems in order to placate investors, the story invited readers to ask if the numbers are simply being fudged.
One of the most striking cases the Times cited is a deal Blackstone led at the peak of the market — one of its largest investments ever. Three other co-investors now put markedly lower prices on the troubled investment:
“Freescale Semiconductor, for instance, was taken over by a pack of private investment companies in 2006 for $17.6 billion, of which $7 billion came from the firms. That $7 billion is now said to be worth $3.15 billion. Or $2.45 billion. Or $1.75 billion. The owners — the Blackstone Group, the Carlyle Group, Permira Advisers and TPG Capital — disagree on its value…. Blackstone calculates that each dollar of its initial stake in Freescale is now worth 45 cents. Carlyle and Permira value their portions at 35 cents on the dollar, and TPG at 25 cents, according to investors in the buyout funds.” (Freescale took its hits when one of its biggest customers, Motorola, had problems selling cell phones and auto sales collapsed, killing demand for the chips that go into cars.)
Is Blackstone taking too rosy a view because Freescale was its deal and the other three investors only came on board after Blackstone had been working on the investment for months? (How the deal came together is covered in detail in King of Capital.) It’s a fair question to ask.
TXU (aka Energy Future Holdings), the largest leveraged buyout ever at some $48 billion in 2007, was also cited: “K.K.R. now values its investment at 20 cents on the dollar; TPG values its stake at twice that, 40 cents.”
The Times pointed out that some of the difference is attributable to timing: As a publicly traded company, Blackstone’s financial reporting must be more up-to-date than that for non-public PE firms like Carlyle and TPG, so the difference on Freescale may be due in part to the rebound in the chipmaking industry last year.
It didn’t explain, however, just how strongly Freescale has bounced back. In the first nine months of 2010, sales soared 28%. “Adjusted Ebitda,” a measure of cash flow, meanwhile, nearly doubled: $1.06 billion in the 12 months ended Oct. 31, 2010 versus $579 million in 2009.
With a trajectory like that and a rising stock market, a fair estimate of the value of the equity becomes a rapidly moving target. If the calculations of one firm lag another’s by a quarter or more, the valuations are bound to differ. Because of the leverage, any increase or decrease in the overall value is magnified several fold in the equity.
Even without such swings in the underlying business, estimating the value of the stock of a highly leveraged company can be tricky. Take a hypothetical company that was bought for $10 billion with $3 billion in equity from a PE firm and $7 billion of debt financing. Even if the business holds steady, if the stock market falls 30% and the price of similar companies falls by that amount, in theory the PE firm’s equity is obliterated: If it were forced to sell the company, there would get only enough to pay off the company’s debt and there would be nothing left for the PE firm. The equity in theory would be worth nada.
Except that it isn’t. So long as the company doesn’t have debt coming due that it can’t pay and there is no other to force a sale now, there is value in the equity – option value, in economic terms – because the equity may regain value in the future.
What is that worth? Pity the people who have to justify a number. It hinges on how the company does in the future, what the market (and hence valuations in general) do and how the performance coincides with debt maturities (which could sink the company if they come too soon).
When you understand what’s being calculated, it’s a little easier to see why different firms come up with different figures. Indeed, if PE firms reported the same numbers, it would be downright suspicious.
Want to compare the numbers yourself? Good luck if you’re not a pension plan or other institutional investor who receives financial reports from a PE firm. There is precious little public information about individual portfolio companies.
KKR Private Equity Investors, an investment fund traded in Amsterdam, used to disclose the cost and current (estimated) value of each of its holdings. But since it was merged into KKR & Co. in 2009 and the stock was listed in the U.S., those details have been dropped. Blackstone doesn’t report detail at that level.
For information about the current marks on major buyouts, the only remaining public source is SVG Capital, a publicly traded investment fund listed in London that puts most of its money into Permira funds. SVG still regularly reports in gory detail who well and badly its holdings are doing.