Private Equity: More Than Cut And Sell

As discussed in a recent article in Financial Week, Ernst & Young found that businesses sold by private equity firms last year had more growth in profits, and subsequent value than comparable public companies. The enterprise value of companies previously owned by private equity firms increased 24% in 2007, compared to half that amount for public companies previously listed. In fact, the enterprise value grew by a rate of 32% per year when private. Nonetheless, given the recent downturn in the markets, and the poor environment for IPOs, it is expected that many private equity firms will need to hold on to some companies longer than expected, and may subsequently see slower growth and lower returns when exiting through sale or initial public offerings. Of interest to me was the quote: “The myth of private equity as financial engineers who cut costs to make their money is false.” Actually, this may not be a total myth, but simply not all of the story. Cutting cost is one part of adding value, and apparently, many private equity firms have figured out a way to increase the value of the businesses they own through cost cutting and other means, while also selling them at the most opportunistic times. Timing may be as important as cost cutting and financial engineering.