The Wall Street Journal-20080213-Business Bookshelf- Embracing Debt- Enhancing Value
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Business Bookshelf: Embracing Debt, Enhancing Value
Full Text (827 words)Lessons From Private Equity Any Company Can Use
By Orit Gadiesh and Hugh MacArthur
(Harvard Business, 126 pages, $18)
It takes some nerve in this economic climate to tout the lessons that private equity can teach public companies. Yet as the smoke from dozens of private-equity pileups billows across the financial landscape -- think only of Blackstone's aborted merger with Alliance Data Systems, now the subject of lawsuits, and J.C. Flowers's fizzled bid for Sallie Mae -- this is precisely what two senior consultants at Bain & Co. have chosen to do. Either they are brilliantly counterintuitive or downright foolish.
Orit Gadiesh, Bain's chairman, and Hugh MacArthur, the head of the firm's global private-equity practice, lay out six lessons that any company can use. They are: define the full potential of your business through intensive due diligence; develop a detailed blueprint for how you are going to achieve that potential; accelerate performance by matching the right people to the right tasks and measuring the right things; hire the right people by offering the right incentives and recruiting a useful board; make equity sweat by loading up on debt and squeezing every last cent from your working capital; inculcate a "results" culture throughout the firm so that everyone works with the mind-set of a private-equity investor.
Many business people will read this list and wonder: So what's new? Which ambitious company does not try to be the best it can be, with the best people and the most efficient operations? Ms. Gadiesh and Mr. MacArthur, however, argue that the practical value of such platitudes is a question of degree. There is a reason, they note, why private- equity firms are so dominant today. It is more than their ability to charge exorbitant fees to their clients, to borrow insane amounts from soft-headed banks and pay a derisory tax rate on the returns to their limited partners. Private-equity firms are better than most at enhancing the value of the companies they run. "The need to provide strong returns to demanding limited partners in a defined time frame," the authors claim, "creates a single-mindedness that fuels the rigor with which these lessons are applied."
Ms. Gadiesh and Mr. MacArthur concede that private equity is a tiered system, with the best firms offering stellar returns and most of the others struggling to match the returns of the S&P. But the authors argue rightly that the very best private-equity firms -- such as Blackstone, Kohlberg Kravis Roberts and Bain Capital, which was established by ex-Bain & Co. consultants, including Mitt Romney -- have transformed the world's financial markets. Investment bankers these days spend much of their time scurrying around in search of ideas and debt for private-equity giants. And many of the world's best corporate managers either work for private-equity-owned firms or are sitting by the telephone waiting for an offer.
At times, Ms. Gadiesh and Mr. MacArthur seem to be waiting by the phone, too. In the section about developing a detailed business blueprint, they write: "If any aspect of this blueprint process sounds daunting or foreign to you, get help." Who could these world-class management consultants possibly have in mind? More important: How useful is the help they offer in "Lessons From Private Equity Any Company Can Use"?
Many of Ms. Gadiesh and Mr. MacArthur's points, though familiar and often expressed in buzz phrases, are unexceptionable. But the authors tend to over-simplify. Take the lesson about making equity sweat. The basic idea is that the burden of meeting large interest payments on debt focuses the attention of managers, forcing them to be efficient. The authors even cite Samuel Johnson on the prospect of hanging concentrating the mind, a quotation that surely deserves to be retired by now.
But debt is not only a motivator. It can be an error or an extravagance, making profit harder to pursue. Microsoft, for example, has always avoided debt. The technological risks in its business are quite enough. They do not need to be exacerbated by leverage. Ms. Gadiesh and Mr. MacArthur seem to be so dazzled by the private-equity model that they can imagine a company enhancing the value of its operations only if its creditors are breathing down its neck. Promising a higher dividend to stockholders may have a similar and less noxious effect.
The authors also ignore the broader context in which most companies operate. Unlike private-equity firms, most company managers do not descend from Manhattan skyscrapers, buy low, perform their turnaround, sell high and disappear again. They may well live in the same communities as their employees. They cannot hand out copies of Schumpeter and tell their staffs to bone up on creative destruction. They must live with the human consequences of their actions, as well as the financial ones. "Lessons From Private Equity Any Company Can Use" offers instruction that most companies either already use or don't really need.
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Mr. Delves Broughton is a writer living in New York.
