PE: Much Ado About Nothing?

When Buffets Holdings went bankrupt this past January, critics of the private equity industry likely let out a soft cheer. The Chapter 11 filing showcased what can happen when a leveraged buyout, dividend recapitalizations, and excessive expansion conspire to drag a company into the red. And if it was a larger company, it's probable that the politicians and the unions would have already integrated the story into their stump speeches castigating corporate greed.

A new study out of Europe, however, underscores that while private equity activity is garnering headlines, the asset class still holds little sway as it relates to the economies of the world.

Dr. Oliver Gottschalg, a professor in Insead's Department of Strategy and Management, conducted the study for the European Parliament, researching various topics, such as the time horizons of the asset class, conflicts of interest, transparency and the impact of private equity on financial stability.

What he found was that the asset class, while a force in M&A, barely appears on the radar when viewed in the context of the broader economy.

Using data from PricewaterhouseCoopers and Thomson Financial, the study noted, "The amount of equity invested by European buyout funds has increased substantially in recent years, but still represents less than 0.5% of the European GDP."

The aggregate value of PE-owned companies worldwide, meanwhile, corresponds roughly to the balance sheet of just one bulge-bracket investment bank, the study said.

"The red thread throughout the data reveals that the perceived wisdom around the asset class is not in line with the hard facts," Gottschalg says. He notes as another example that private equity returns, after fees, on average fare worse than the broad stock market average.

"People only see the exceptions. They see one deal generating a 50% IRR or they see the bankruptcies and the writeoffs," he says. "It makes private equity the perfect scapegoat, because people are either getting tremendously rich or, on the other side, destroying companies. The truth is that most of the activity is beneficial."

That said, the outcry against the asset class has become more pitched. This past January, for instance, a speech Carlyle Group co-founder and managing director David Rubenstein was giving at a Wharton-sponsored PE conference was interrupted when demonstrators from the Service Employees International Union crashed the festivities to protest the firm's investment in Manor Care.

It should be noted that Carlyle hadn't even owned the company for a month.

Meanwhile, filmmaker Robert Greenwald has created a series of videos entitled "War on Greed", taking the private equity industry to task.

In his PR materials, he sums up his message like this: "In a year dominated by economic insecurity, scholars, journalists, elected officials and regular people are taking a second look at private equity and asking themselves if firms like KKR contribute to exacerbating the country's economic woes."

To that specific question, Gottschalg's research would answer definitively, "No." But Gottschalg concedes that a high-profile bankruptcy, or mass layoffs at a PE-backed company, would likely continue "to trigger a broad public outcry."

Here again, he stresses that the impact on the economy would be minimal.

The fundamental difference, he notes, between a failure in private equity and a failure in the banking sector is that PE transactions, and funds in general, are "unlinked."

"Even if a company like Chrysler, [owned by Cerberus Capital Management], went bankrupt, it wouldn't trigger a domino effect," he says.

"The standalone structure of [PE] funds and [PE-owned] companies differentiates private equity from other areas in the financial sector. It's not like a bank going out of business, which would trigger a failure of the entire system."

While this may comfort critics, to the industry's dismay, Gottschalg's research probably will have little impact in muzzling them.