By Nanea, a private equity insider
Last week, the New York Times reported on its successful effort to unseal evidence in a lawsuit alleging that the biggest private equity firms (so called “mega-buyout” shops) colluded to limit competition with one another during the Buyout Boom that preceded the financial crisis.
The story made me think about some of my own, non-business-related experiences with cooperative behavior among private equity rivals. For example, I’ve been offered (and accepted) coast-to-coast rides on the private jets of rivals who were attending the same industry event with me and were headed to the same place next. This practice, by the way, of offering a competitor an empty seat on one’s jet is extremely common in the industry, to the point where it is almost impolite not to extend the offer to peers. Similarly, I remember once being in the office of one of the industry titans (to preserve my own anonymity, I’m going to say that it was one of these guys: Kravis (KKR), Schwarzman (Blackstone), Rubenstein (Carlyle), or Coulter (TPG)). He stepped away from our meeting for a moment to take a call from a competitor. The purpose of the call? Not to collude on a bid, at least as far as I could tell. Rather, it was to discuss the fact that both of them were, by coincidence, pursuing rental of the same vacation house for the same time. The guy I was meeting with had contacted the other guy to say that he would withdraw if the other guy wanted the house.
I offer these stories not to suggest that private equity titans are boy scouts. Rather, I am trying to illustrate that skilled deal makers generally cultivate, in addition to the expected competitive instincts, a degree of cooperative behavior among themselves . The reasons for competition are obvious. The reasons for cooperation, perhaps less so. Most fundamentally, deal-making requires cooperation because people don’t like to make deals with people whom they despise. This reality reinforces a reasonably high level of social graces among private equity people. By contrast, hedge fund titans tend to be much less socially adept, because they buy and sell securities on computer screens, and therefore don’t need to cultivate the ability to be liked. Cooperative behavior is also important in private equity because private equity dealmakers rely on many, many others to succeed. Hedge fund guys are capitalism’s rugged individualists who can, in theory, sit alone in a dark room and make billions using only a Bloomberg terminal and a few other computers. By contrast, private equity people are the “it takes a village…” crowd who need sellers to buy businesses from, bankers to finance them, and portfolio company managements to work for them. They also frequently need capital partners to write checks for parts of the deal when potential buyouts are too big for them to take on by themselves.
It’s this “cooperation with capital partners” part that has gotten the private equity firms into trouble. The New York Times story quotes emails among various private equity firm executives where they appear to be agreeing to not compete with one another in various situations where one or another of the firms was bidding on a potential buyout. If that’s actually what happened, the sellers (public shareholders in many cases) may have lost out on a meaningfully higher purchase price for deals because the prospective buyers were colluding with one another.
A wrinkle that the NYT piece doesn’t highlight, but which was a key part of the behavior in question, is that the very large private equity firms commonly formed consortia (informally referred to as “clubs”) to do many of the biggest deals during the 2003-2007 buyout boom. Were the PE firms buying companies together in order to hold down prices, or was there another reason? The answer is probably, “it depends.” Many of the very large deals that were done in this time frame were too big for any one firm to take on alone. So that was sometimes a clear reason for cooperation unrelated to restraint of trade.
I remember seeing Jim Coulter, CEO of TPG, make a presentation in 2006 on this topic to a large audience. His essential message was that the largest private equity firms, of which TPG is one, have fewer competitors when they bid on deals than the non-mega buyout firms do, and therefore obtain more favorable pricing than smaller deals offered to other firms. He had extensive transaction data from investment banks purporting to support his claim, which he displayed in PowerPoint slides. Coulter offered a straightforward reason why big deals have relatively few bidders: only a handful of firms have the capital to bid on them (basically TPG, Bain Capital, Blackstone, Apollo, Carlyle, and KKR). And the very largest deals of all, he pointed out, require consortia that even further reduces competition.
The evidence unearthed in legal proceedings suggests that the largest private equity firms sought, in some cases, to even further dampen the competition for large deals below the level Coulter claimed. They pushed their cooperative impulses too far, probably all the while congratulating themselves about how civilized it felt—kind of like withdrawing when the other guy wants the vacation house.