Private Equity Firms Make Money Because They Are Smarter

September 27, 2007 by Douglas A. McIntyre

A company bought and operated by private equity interests outperforms it publicly-traded counterparts. Not only are their profits better, but “an Ernst & Young survey of the biggest 100 private equity exits in both the US and Europe also found that private equity-owned companies benefited from a much bigger jump in valuation multiples than their listed equivalents,” according to the FT.

In other words, private equity executives are much smarter than management at public companies. It would also appear to say that private equity interests have a great deal of skill buying companies which they can improve.

The 100 biggest private-equity owned companies sold in the US last year had annual enterprise value growth of 33 per cent against 11 per cent growth in the value of equivalent publicly listed companies, the survey also found.

What does that say? Unfortunately, it is an indictment of public company management more than praise for private equity, especially with a performance gulf that is so large. Granted, private equity firms pick what they buy, but the price is often a large premium when they take on a company that is already public. That leaves them fighting with a disadvantage when it comes to increasing value further.

What do private equity firms do with companies? The survey doesn’t say. But, investors can guess. Private companies are likely to cut expenses more rapidly and hold them down longer. They are also more likely to raise prices. And, they are not burdened with the time and expense of being public.

If the survey is even close to accurate, benchmarking the private equity company practices would be a good use ot time at public company counterparts.

Douglas A. McIntyre