On a roll

Sep 13th 2005
From The Economist Global Agenda

The deal to buy Hertz, an American car-rental firm with a global presence, shows that private-equity investors are still on top of their game. In Europe and Asia, too, they are looking for underperforming companies to buy and sell on at a profit. How long can the good times last?

PRIVATE-EQUITY firms are becoming ever bolder. Flush with cash from eager investors, many are chasing what they hope will be bigger and better deals. On Monday September 12th, American carmaker Ford said that it was selling Hertz, a car-rental business it owns outright, to a group of private-equity investors in an agreement worth $15 billion in total. Including the $10 billion or so in debt that the firm’s new owners are to assume, this makes the deal the largest buy-out since 1989, when Kohlberg Kravis Roberts paid $25 billion for RJR Nabisco—the deal at the centre of the book “Barbarians at the Gate”.

The three private-equity groups buying Hertz—Clayton Dubilier & Rice (CDR), Carlyle Group and the buy-out arm of Merrill Lynch, an investment bank—were as eager to buy Hertz, it seems, as Ford was to sell it. CDR, which specialises in buying bits of large conglomerates, had been eyeing Hertz for about three years. When Ford said in April that it was putting Hertz on the block in order to concentrate on making cars, a deal seemed inevitable. As it was, CDR still had to beat off a group of competing private-equity investors that included, among others, Bain Capital, Blackstone Group and Texas Pacific Group.

Ford had considered floating Hertz on the stockmarket, but after announcing a whopping loss after provisions for the second quarter of this year it may have decided that the certainty of a deal with private-equity investors was preferable to the lottery of the public markets. Either way, the carmaker will now get $5.6 billion in cash to help pay off debt and put towards the rising health-care costs of its workforce. For their part, Hertz’s new owners reckon that, even with petrol prices worryingly high, the company’s strong brand will ensure a bright future. They hope to move the business away from its traditional reliance on airport rentals. CDR and its partners doubtless also hope to use Hertz’s strong cash-flow to pay down the company’s hefty debts.

Thanks to a period of low interest rates and (until now) rising corporate profits, private-equity houses have enjoyed bumper returns of late. Many have been able to cash out much of their original investment at a handsome profit while retaining an interest in the target company. According to Private Equity Intelligence, a research outfit based in London, private-equity firms last year returned to investors more than $130 billion in capital, net of contributions.
Preliminary figures for this year suggest that the strong trend continues.

Although competition for target investments has pushed up asking prices and may therefore reduce the profits to come, more and more investors are piling into private equity. In addition to the wealthy individuals who have long dabbled in such deals, an increasing number of professional investors, such as pension funds and universities, are queuing up to pledge money.
As a result, private-equity houses seem to have ever-larger amounts to play with. Several firms have unveiled buy-out funds this year of $8 billion or more; Blackstone Group, a blue-chip firm based in New York, recently announced one worth $12.5 billion, the biggest ever. As this wave of investment has swollen, so the value of deals completed has grown too.

Nor are private-equity firms restricted to deals in America, their spiritual home. According to recent estimates, between one-fifth and one-third of mergers and acquisitions in Europe at the moment are financed in whole or in part by private equity. With cross-border deals in areas such as telecommunications and power on the rise, the trend is likely to continue.

Asia is also gaining in popularity among private-equity investors. India, for instance, is expected to see a fresh wave of deals in coming months. This is partly because it has established capital markets that enable investors to cash out more easily when their investments have run their course, and partly because investors have been encouraged by the mouth-watering returns achieved by a lucky few. Take Bharti Tele-Ventures, an Indian mobile-phone firm. Between 1999 and 2001, Warburg Pincus, an American private-equity firm, invested $292m in the company. Earlier this year, Warburg sold much of its holding for a cool $1 billion, and its remaining shareholding in Bharti is said to be worth $700m.

As more and more family firms wrestle with the problems of succession from one generation to another, more such investments are likely to be on offer in other parts of Asia too. J.P. Morgan Partners Asia recently raised $1.58 billion, its second fund aimed at the region as a whole. China has yet to boast a deal on the same scale as India’s Bharti, but many private-equity specialists are hopeful that opportunities will arise. The difficulty in China is that the ownership of firms is often disputed and the stockmarket has lately been in the doldrums.

The big question is how long the boom in private equity is likely to last. While borrowing costs are low, firms are able to finance large amounts of debt comparatively cheaply. And while companies’ profits remain buoyant, it is possible to pay down this debt. But if interest rates were to rise substantially and profits falter, the bonanza could come to an abrupt end—as it has done before. Investors dipping a toe into private equity for the first time will be hoping that this moment is still some way off.

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