Tuesday, August 28, 2007

Private equity companies great business strategists? Baloney!

I've been wondering when the private-equitization fad will dissipate, and maybe the current credit squeeze is our answer. Private equity firms treat companies as commodities--buying low, processing and purifying a bit, as if they're iron ore, and reselling, recapitalizing, recombining into something that has enough value to compensate their investors and cover their fees.

In the July/August Harvard Business Review, Walter Kiechel lauds the private equiticians for bringing sound strategic thinking to their acquisitions ("Private Equity's Long View" - free link). I agree on one point--with respect to scrutinizing the capital structure of the company and deploying a pretty limited toolset--leveraging up--they are certainly more creative and strategic than those they acquire from.

And, writes Kiechel,

They identify a strategy that favors the line of business in which the acquisition dominates its competitors, and then they often sell off its other businesses (it was the strategy movement that got companies thinking about their assets as a portfolio of businesses, with some stars and some dogs to be divested).

Yet all the examples Kiechel cites to prove private equity's strategic mastery are all quantitative in nature--use of debt, focus on cash flow, reducing costs and shedding of underperforming assets.

Strategic thinking also involves questions like, "How can we increase our added value with customers? What is the world likely to look like in 10 years and how can we participate in those changes? What new products do we need? What technology investments will be required? How can we keep our best people?"

Quite frankly, it's not stuff that can be captured on a spreadsheet. And, despite their "long view," PE investors have little to offer on those questions. Frankly, most plan to be long gone before those questions are answered. And that's not strategic mastery, it's myopia.

As value in business increasingly shifts from dumb assets (like oil wells, factories, mines, etc.) to smart assets (creative people), the side effects of private equity strategy--personnel displacement, loss of company culture and insight, lack of employee loyalty, poor morale--will prove fatal. Businesses will look more like professional partnerships of today, rather than plain old corporations.

In fact, they'll start to look a lot more like private equity companies, wherein upheaval results in partners and associates leaving and starting their own firms.

What will PE buy then?

(Disclosure: I worked for several years for a private-equity-owned company.)