Private Equity, Capital Structure, and Payout Policy
Summer 2007, Volume 19.3
Private Equity: Past, Present, and Future
An Interview with Steve Kaplan
A University of Chicago professor and longtime observer of private equity offers his thoughts on the current state of private equity, addressing such questions as: How does the current wave of private equity deals compare to that of the 1980s? What do private equity transactions really accomplish? How will the recent changes in credit markets affect the future of private equity? What are the lessons for public companies?
Global Debt Markets in 2007: New Paradigm or the Great Credit Bubble?
The high-yield debt markets have grown impressively, in large part because of extraordinarily low default rates, which in turn is due to unprecedented growth in global liquidity and the role of non-traditional lenders in helping companies avoid financial trouble. But the author expresses skepticism that this represents a new “credit paradigm,” and suggests that default rates are likely to revert toward their long-term averages.
The Return of the Recaps: Achieving Private Equity Benefits as a Public Company
Anil Shivdasani and Adrian Zak
The authors discuss how a growing number of public companies are realizing some of the valuation benefits of LBOs by undertaking leveraged recapitalizations. Recaps boost financial leverage and generate significant returns for public shareholders through cash distributions and share price increases, but without ceding control to financial sponsors. The choice of distribution strategy can affect the market's reaction to the transaction.
Share Repurchases and the Need for External Finance
Matthew Billett and Hui Xue
The authors speculate that undervalued companies with growth opportunities might benefit by first repurchasing shares before raising more equity as a way to reduce information costs. They find that announcement returns of repurchases were more positive when companies issued equity within three years. And the market's response to the equity offering announcements was higher for repurchasing companies.
The New Wave of Hybrid Capital-Rethinking the Optimal Capital Structure
Kevin Ryan, Jonathan Ross, and Jacqueline Yen
Tax-deductible “hybrid” securities that combine features of both debt and equity have experienced a wave of issuance following Moody's February 2005 decision to grant some equity credit. Financial institutions have been the largest issuers, but a handful of corporates have followed. Hybrids offer the benefit of expanding a company's debt capacity, and also lowering its weighted average cost of capital.
The Influence of Credit Ratings on Corporate Capital Structure Decisions
Corporate managements pay considerable attention to maintaining high credit ratings, perhaps too much. However, the benefits of higher ratings discussed in this article suggest that many firms may be justified in sticking with lower levels of leverage to secure such ratings. The author reports that companies tend to manage their capital structure to avoid a downgrade or increase the likelihood of becoming investment-grade.
What is the Market Value of a Dollar of Corporate Cash?
Lee Pinkowitz and Rohan Williamson
This article examined the cash and marketable securities of U.S. companies. Although on average the market value of the marginal dollar of corporate cash is roughly its face value, there is considerable variation across companies. The range was a high of $1.60 for companies with significant growth options to close to zero for mature firms with stable cash flows and limited investment opportunities.
Minding the Information Gap: Putting New Selection Criteria and Deal Structures to Work in M&A
Roberto Raggozino and Jeffrey Reuer
Buyers and sellers in corporate M&A transactions can have very different information about the selling company's prospects, increasing the odds of an unsuccessful deal. This article summarizes tools that can mitigate the information-induced problems. Examples include “dual tracking” with an IPO, payment structures that share the overpayment risk, and strategic alliances that enable the buyer to learn more about the seller.
Estimating the Cost of Risky Debt
Ian Cooper and Sergei Davydenko
When calculating a company's WACC, it is common to estimate the cost of debt using the promised yield on new bonds. This can materially overstate the cost of risky debt, particularly high-yield. To avoid this distortion, the promised yields on risky debt should be adjusted downward to account for the probability of default and the expected losses associated with it. The article recommends and illustrates a model.
How Good Are Private Equity Returns?
Robert Harris and Robert Conroy
This article provides an overview of existing studies as well as new evidence of the investment performance of U. S. private equity. The authors' analysis suggests that the average net returns to private equity investors have not typically been sufficient to justify the illiquidity and cost of investing in the asset class. However, the research also attests to the ability of the best buyout firms to outperform the market on a consistent basis.
Big is Better: Growth and Market Structure in Global Buyouts
Peter Cornelius, Broes Langelaar, and Maarten van Rossum
The bulk of new capital commitments in the private equity industry have gone to a few mega-funds, although a flood of new smaller entrants has kept the market from appearing too concentrated. The authors argue that while larger potential buyout targets and the fee structure provide incentives for bigger funds, buyout firms are now more likely to pursue a strategy of entering new geographic markets and new investments.
The Convergence of Public and Private Equity Markets: Cyclical or Structural?
The distinctions between public and private equity markets are blurring. Private equity firms have accessed public capital, purchased stakes in public companies, and completed buyouts with a “stub” equity component. Convergence is being driven by increased regulations for public companies, a changing private equity industry, and the benefit of non-traditional private equity investment.
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The views and opinions expressed in the Journal do not necessarily represent those of Morgan Stanley or its affiliates.