A friend of Going Private spent a lot of time studying black markets at University of Chicago and Harvard. Among other things he devoted a lot of energy to understanding the economies of illegal drugs. He once characterized the recent trend of private equity firms teaming up to invest in much larger deals as akin to an operational move made by the larger cocaine cartels in the 1980s and 1990s. Specifically, splitting up cocaine loads via outsourced transportation. If a single plane went down containing a large shipment of cocaine that all belonged to a single smuggling group, that was economically painful. If instead the plane contained cocaine belonging to 4 different groups, the loss of a single load was distributed among the groups. Private equity funds teaming up on deals, he argued, was the same kind of diversification strategy. Aside from the obvious pleasure I derive from reciting apt comparisons between private equity firms and narcotrafficking cartels, there is a particular health care angle here too. It is for this reason that this passage from a recent LBO Wire article confuses me:
While the $33 billion LBO of hospital chain HCA Inc. is being done by a consortium, it nevertheless shows that general partners are moving to soothe the fears of limited partners by cutting back on club deals.
Why cut back on club deals? Oh sure, the returns are potentially more limited, but being able to play in one of the larger LBOs around with a lower risk profile (a significant blow up in such a large deal could cripple a firm that hadn't protected itself) should be worth the more modest returns. (And by "modest" please keep in mind that we are talking within the LBO sphere here and that, at least in my estimation, limited partners are going to have to start getting used to more modest returns).
LBO Wire points out that many private equity partnerships have restrictions on what portion of equity can be invested in any single deal (to encourage the same risk mitigating diversity that club deals take advantage of) and that since capital levels have risen dramatically they can now form smaller consortiums.
I'm mindful of the other issue LBO Wire brings up, that you just don't want eight private equity firms on the Board at the same time, but I am not particularly convinced that is as significant a problem as others suggest. As long as roles are clearly defined early on the Board tangles should be minimal. When I voiced this opinion to Armin, however, his reply was, "True. And all I have to do to solve world hunger is just get food to everyone." I would feel slighted but I am smugly satisfied in the knowledge that he still can't get the phrase "costs and arm and a leg" down right. He's improved from "costs a foot and a hand," and one comic "costs a foot and a mouth" incident (hoof and mouth disease perhaps?) to "costs a leg and an arm," though.
LBO Wire goes on to quote John LeClaire of Goodwin Procter in this passage: "With an eight times purchase multiple and HCA's strong historic cash flow performance, the firms 'are not looking to sell down risk....'"
With everything else going on I think it says something that we consider an 8x multiple low enough to suggest limited risk, but then maybe I'm being grouchy.
