PE

The main form of ownership of large companies operating in all parts of the economy has been ownership by shareholders, who can buy and sell shares freely through the stock market. The companies are typically groups specialising in one or more sectors, such as water, electricity and gas. Because they are quoted on the stock market they have to publish a lot of information about the company, for the benefit of investors, but this information is also helpful to others, including employees and trade unions.

More recently, financial investors have begun to take major shareholdings in some companies. Some of these are ‘private equity’ firms (PE), which specialise in buying all shares so they become ‘privately’ owned. The PE companies normally expect to make their money by improving the value of companies to investors, and then selling the company at a profit a few years later, and meanwhile load the companies with heavier debt burdens. As the funds buy a company, they normally remove it from the stock exchange, and so there is no obligation to publish detailed data, eg quarterly earnings figures, and can operate without public scrutiny.

The activity of PE investors has become very controversial. In Germany, they were described as “locusts” during the 2006 election campaigns. This is because PE funds have often introduced sharp cuts in employment, or sold off parts of a company, in order to make the company more valuable when they sell it on. The companies are thus seen as a threat to jobs, stability, and to local control of utilities and other businesses. Financial commentators have also expressed concerns that the funds activities may not be sustainable, so there are greater dangers of bankruptcies.

The PE funds are active in all sectors of the economy, including manufacturing, services, and retail, and also including private companies operating in public services, such as water, electricity, waste management and healthcare. Thus an increasing number of workers in these services are now employed by companies owned by PE funds.

One category of funds, the so-called infrastructure funds, is of particular relevance to public service operations. These aim to invest specifically in network industries such as electricity, gas, water, telecoms, roads, airports, post, and health and social care, to give a steady return over a long period of time. There is also a global trend to reduce the use of equity finance in utilities and replace it with debt. These two developments may have different implications from the activities of the private equity funds.

Private equity (PE) consists of the shares of companies which are privately owned, i.e. not publicly quoted on the stock exchange and so not subject to the disclosure rules of the stock exchange.

PE funds are created as partnerships by financial services firms, by inviting investors like pension funds or rich people to commit a certain amount. The funds are then used to invest either in companies which are not quoted on the stock exchange – ‘private’ companies - or in companies which are listed, following which they are usually turned into private companies and so ‘de-listed’. Each firm may have a number of different funds.

The firms make money by charging commission fees on the money invested, and by getting a return on their own investment in the deal. The other investors get their return through cash payments made by the fund out of the profits from the investments, and from their share of the sale price of the company, or parts of the company, when they are sold on.

The largest private equity firms such as Goldman Sachs, Blackstone Group, Carlyle Group, Warburg Pincus, Kohlberg, Kravitz, Roberts (KKR), Apax Partners, Apollo, Harbourvest, Oaktree, CVC,, etc. The sector is dominated by a number of large firms, mainly based in the USA, but operating internationally.

Compared with top US buyout groups, European private equity firms tend to be small and confined to national markets, but a number of UK firms, such as Terra Firma, are very active elsewhere in Europe In 2004, only 14% of all private equity and venture capital investments in Europe were outside the country of origin. Macquarie Bank of Australia is also a significant international PE firm, especially in utilities and infrastructure. China such as China Investment Corporation as largest PE who have active to buy mining business in Asia , South America, Australian.

The main groups may act alone in buying companies, or in partnership with each other. For example, in 2006 the Dutch publishing company VNU was bought by a consortium of AlpInvest Partners N.V., The Blackstone Group L.P., The Carlyle Group, Hellman & Friedman LLC, Kohlberg Kravis Roberts & Co. L.P. and Thomas H.Lee Partners, L.P. One reason for this is that funds need to combine in order to amass the money to bid for such large companies. In 2006 authorities in the USA started investigations of joint buyouts by a number of PE firms because of concerns over collusion and insider trading.

PE funds have become popular with investors in recent years because they have achieved good returns compared with traditional investments in publicly quoted shares. Large amounts of money are thus being invested in them: in 2005 the total invested in European PE funds was nearly €60 billion – more than double the amount in 2004.

The biggest single investors in European PE funds are pension funds, insurance companies follow by private individual. These three groups account for two-thirds of all money invested in PE funds in 2005. They also account for almost the whole of the large increase from 2004 to 2009. Investment in PE funds by pension funds and insurance companies, private individual is expected to continue growing.

PE funds are becoming so large that they are capable of buying even the largest companies in the world. According to one estimate in May 2006, there were only 200 companies globally that were too big to become the target of a private equity syndicate, and this number is rapidly shrinking as fund sizes continue to rise. In 2005, eight funds were opened which aimed to raise more than $5bn, compared with just one $5bn-plus fund for the whole of 2004. Performance so far suggests that the very large funds do not produce better profits, however.

PE firms use different types of funds for their investments. There are four main categories: venture capital, buyouts, infrastructure funds, and hedge funds. Most PE firms have funds in a number of different categories, and so the same firm may operate venture capital, buyout, and infrastructure funds. The different types of funds may also draw money from the same sources – pension funds, rich individuals etc.

Venture capital. These funds invest in new companies, and the investment is regarded as ‘venture capital’ because it takes a risk on less established companies. Profits are made from the dividends of the companies but, more importantly, from selling the company to new owners at a profit after a few years. Venture capital funds are not interested in established companies, but may provide the financial support for new companies to compete for business in public services, such as healthcare.

Buyouts. PE funds are now mostly invested in buyouts of existing companies. These existing companies may already be private, or they may be public, in which case the buyout normally leads to the newly acquired company being taken off the stock market, and so made private. As with venture capital funds, profits are made from the dividends but also from selling the company to new owners at a profit after a few years, either through an ‘initial public offering’ (IPO) or a sale – the ‘exit’. Established companies are likely to be targets for buyouts, and so buyouts are the most important category in terms of the impact on existing public service operators.

Infrastructure funds. More recently, a number of funds have been set up specifically to buy stakes in companies operating in infrastructure – including utilities such as water, electricity, and gas, but also toll roads, ports, airports. These funds expect long-term steady returns, and so are less likely to seek a short-term ‘exit’ by selling the company. Utilities and other companies operating regulated public services may be targeted by infrastructure funds or by the “buyout” funds of the various firms.

Hedge funds. Hedge funds are investment vehicles set up to make any kind of investment in search for short-term profits better than could be achieved by just investing in the stock market investments. The risks and complexities of their strategies mean that hedge funds are more volatile than other investors, but less likely to buy companies in long-term regulated sectors like utilities.

Buyout targets: listed companies, privatisations, PPPs, family businesses, spin-offs, secondary buyouts.

Buyouts are now the major activity of PE firms. There are six different types of companies which may be targeted by PE funded buyouts.

Listed companies. The first category is companies which are currently listed on stock exchanges. For example, the Danish services multinational, ISS, was taken over by PE funds in 2005. This type of PE investment converts companies from public, listed companies into private ones, which involves a loss of information as the firms are no longer subject to the disclosure rules of the stock exchange. The chart shows how the impact of this category of investment has grown rapidly in recent years.

Privatised companies. The second category is companies being sold by governments or municipalities as part of a privatization programme. PE funds became involved in privatizations because the sale of a state- or municipally-owned company is a special case of a buyout of an existing company. Even if a privatised company is initially sold to investors on the stock market through an IPO (initial public offering), or to an established company already operating in the same sector, it may later be sold on to a PE fund.

PE funds are increasingly important buyers of privatised companies in Europe. In the first half of 2006, “private equity investors purchased €7 billion of the €22 billion worth of assets sold by European governments”. These deals included the sale of 4.5% of Deutsche Telekom to Blackstone; the purchase of Dresden’s housing company Woba Dresden, by a USA fund, Fortress; and the purchase of Rotterdam’s waste company AVR by the PE funds CVC and KKR.

PE funds were also involved in large privatisations in 2005, including Macquarie Bank’s partnership with Eiffage to buy one of the French motorway groups; Italian telecoms company Wind was bought from Enel by the Weather consortium, which did not include PE funds but was backed by major banks - ABN Amro,

Deutsche Bank and Sanpaolo IMI - which have to borrow large sums to finance the purchase, in line with the PE buyout model.

The potential for further privatization as a key issue for PE buyout investment opportunities:

“Another important source of demand for private equity will be the privatisation of state-owned assets. …With state-owned assets of approximately €700bn privatised in Europe over the last 30 years, the key question is: how much is left? EU governments still hold direct and indirect stakes worth almost €300bn, mostly in France, Germany and Italy. However, the actual privatisation potential is substantially larger if one takes into account wholly- owned state enterprises as well as public infrastructure. …. More than half appear to be unsuited to private equity because their performance or public ownership structure makes them difficult to acquire. However, research by McKinsey, the management consultancy, suggests that the remainder is still big enough to provide the private equity industry with plenty of growth.”

Public private partnerships (PPPs), including PFI. Public private partnerships (PPPs) are a specific form of privatisation which usually creates a company with the right to a long-term stream of revenue from the state, or a monopoly license. PE funds have invested in these companies, usually as the financial partner in a joint venture with a construction company and/or an operating company, especially in the UK’s private finance initiative (PFI)

Family business. The third category is family-owned businesses. On average, about 1 in 5 buyouts target these companies; in Europe, there have been over 2,250 such deals since the 1990s, and in some years they have accounted for 1 in 3 buyouts. This category is of particular relevance in the waste management sector, where a number of leading operators are family-owned, for example Rethmann in Germany and Van Gansewinkel in the Netherlands.

Non-core spin-offs. The fourth category is where larger groups are selling ‘non-core’ parts of their operations. One recent example of this is the sale of the car-owners’ service company Automobile Association, by Centrica, the UK energy group.

Sales by other PE funds (“secondary buyouts”)

The final category is of companies owned by other PE funds. Funds expect to realise their profits by selling the companies they have bought to new owners, but if there are too many such companies being sold, or not enough demand, then the funds may sell to each other. For example, in 2006, PE fund Terra Firma sold Sutton and East Surrey Water to Aqueduct, a fund run by Deutsche Bank.

Partial shareholdings. Investment by PE funds in existing companies has normally taken the form of 100% buyouts, so the fund becomes the sole owner of the target company. However, the funds have also begun to buy stakes of less than 100% in companies, so they become joint owners alongside others, with the target companies themselves remaining listed.

Some of these investments are minority stakes in public service companies whose major shareholder is still the government. Blackstone own 4.5% of the shares of Deutsche Telekom, which remains a listed company, whose largest shareholder is still the German government with 32%. CVC has bought 22% of the shares of Post Danmark, while the Danish government retains ownership of 75%.

Investments in PPPs may involve the PE firm as one member of a consortium. For example the PE company 3i holds 25% in Octagon Healthcare, a PFI company running a new hospital in Norwich, UK, with the other shares owned by other partners including a construction company and a facilities management company (see below). Another example of this kind of partnership was the consortium of Blackstone, Providence Private Equity and France Telecom which bid for a 51% stake in Cesky Telekom, the Czech republic’s phone company (the bid was not successful). Blackstone states that one-third of its investments involve an industrial partner.

Finally, PE firms may form joint ventures with each other to buy a company. Examples of this include: the partnership between the PE firms CVC and KKR as joint owners of the Netherlands waste management company AVR and the ownership of the USA Company, Healthmarkets, by a consortium of the Blackstone Group, Goldman Sachs Capital Partners and DLJ Merchant Banking Partners.

Previously , PE firms are still much less active in developing countries. Because they have failed to make adequate profits, with an average return of only 3% in developing countries (compared with nearly 14% in USA and 11% in Europe). But now after global crisis , Asia is amazing space for PE, such as India, China , Turkey and Also South America. Surprisingly, some public sector financial organisations operate as equity investors and promoters of PE funds in transition and developing countries, including Indonesia.