Private Equity IPOs: Too Risky?
Public offerings by the Blackstone Group and other buyout firms raise red flags for retail investors, experts contend
by Ben Steverman
The Blackstone Group's (BX) initial public offering raised $4.1 billion June 22, making way for other private equity firms to test the market waters. But experts recommend that most investors avoid this hot part of the market.
For one, they say the risks are too great for retail investors. Private equity IPOs lack a track record on public markets, and with the private equity fad at its peak, prices are too high.
Even Blackstone admits that its public offering isn't like the typical corporate IPO. Friday's IPO, which valued the company at north of $34 billion, gave public investors a tiny slice of the secretive firm (see BusinessWeek.com, 6/22/07, "Blackstone Friday on Wall Street"). Based in New York, fewer than 800 Blackstone employees manage almost $80 billion in capital.
Preserving Private Interests
In its IPO prospectus, Blackstone said that although it's going public, "It is our intention to preserve the elements of our culture that have contributed to our success as a privately owned firm." Control of the firm, including the ability to set salaries, will stay with its lavishly paid executives. Blackstone will not hold annual shareholder meetings. Shareholders won't have traditional voting rights.
"You have to put a lot of trust in management," said Heather Slavkin, an attorney at the AFL-CIO, which has been critical of the Blackstone IPO.
Because Blackstone's funds hold private firms, putting a value on those holdings requires a lot of subjective accounting. "It's very hard to price what they own," said Ben Jacoby, a founder of Brinton Eaton Wealth Advisors. That means investors don't "have enough data [to] make an intelligent decision."
Blackstone's successful IPO follows a similar move by Fortress Investment Group (FIG) earlier this year. Blackstone's archrival, Kohlberg Kravis Roberts, may be considering a similar offering, The Wall Street Journal reported Friday.
Private equity firms are riding high, attracting boatloads of cash from institutions and wealthy investors looking for bigger returns than they can find in public markets (see BusinessWeek.com, 6/5/07, "The Private Equity Effect"). Regulations bar all but the wealthiest investors from putting money in private equity because of the risks involved.
Peaks and Valleys
One attraction of Blackstone stock is it arguably gives retail investors access to the same returns as private equity investors. But John Burns, president of Burns Advisory Group, disagrees. "Something that is being packaged for sale in the marketplace" is likely to be overpriced relative to a more direct private investment, he said. "It's not a good proxy."
Blackstone priced its IPO at $31—the top price in its expected range. On the first day of trading, the stock rose to $35.06. On Monday, the stock pulled back 7.5% to $32.44.
Private equity may be near its peak, Jacoby argues. The firms benefit from low interest rates and lots of liquidity to buy and take companies private. Both trends can't continue forever. Interest rates, in the form of yields on Treasury notes, have been rising. If it costs more to borrow money, or investor dollars dry up, private equity could be in trouble, he says (see BusinessWeek.com, 5/29/07, "Private Equity's Big Debt Burden").
Peter Schiff of Euro Pacific Capital predicts a scenario that would be especially devastating for private equity. A recession that occurs at the same time as rising interest rates could force private equity to sell assets at "fire-sale prices," Schiff said.
Without a long track record of trading on the stock market, it's hard to know how investors would respond to tougher times for private equity. How will investors, especially short-term traders, react if firms like Blackstone report disappointing quarterly profits?
Long-Term Focus
In its prospectus, Blackstone warns it will stick to a long-term focus. In a business where investments last three years or more, it won't be worried about its profits from quarter to quarter. Blackstone says it will focus "on making the right decisions about purchasing and selling the right assets at the right time and at the right prices, without regard to how those decisions affect our financial results in any given quarter."
Indeed, the enthusiasm about Blackstone's IPO has inspired plenty of cynicism. "When you run out of sophisticated buyers, you go public," Schiff said. "Because the public will overpay."
Blackstone says its IPO will raise money to expand and make acquisitions, build its brand name, and give better incentives to employees. But Schiff sees the stock offering as "insiders cashing out" when they know that private equity is at a peak. "You don't want to be anybody's exit strategy," he said.
Jacoby says retail investors should invest in offerings like Blackstone only with money they can afford to lose. Who knows? Sometimes risky investments pay off, he said. "These guys may be the wave of the future."
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