It would be a fool's game to predict the end of the private-equity buying frenzy, but certainly some signals are there.
Over much of the past two years, the prevailing private-equity mantra has been to buy as many companies as possible and then sell as much debt as possible to help pay for them. Now, the biggest private-equity firms are beginning to diverge in their views.
Henry Kravis, the co-founder of Kohlberg Kravis Roberts & Co., recently has described current conditions as a golden age for private equity. But Ripplewood Holdings LLC Chief Executive Timothy Collins, at a conference in Tokyo in May, called current conditions a bubble that would end badly.
Carlyle Group co-founder David Rubenstein at the same conference also was bearishly looking ahead. "There hasn't been a failure for five years. We need to prepare people for the reality that some deals will fail," he said. He added: "Greed has taken over. Nobody fears failure."
Caution on the part of even some of the players could be bearish for stocks, coming at a time when one of the biggest supports for the stock market is the assumption that private equity will buy bad companies because they are inexpensive and good companies because they are good. Should private-equity firms pull back, that support could vanish.
Some analysts say that without a widespread belief in the appetite of LBO firms for publicly traded companies, stock prices would be far lower.
Not long ago, a buoyant stock market would hardly have paid heed to the views of private-equity firms. No longer. At $281 billion, U.S. private-equity deals have more than tripled from a year ago, accounting for 35 percent of all mergers and acquisitions, up from about 16 percent last year, and most of them involve publicly traded targets, according to data from Thomson Financial.
For its part, Carlyle has been the Cassandra of the industry for several months now. The year opened with "state of the industry" letter from Carlyle co-founder Bill Conway that warned his firm's investment professionals about froth in the buyout market and instructed them to be careful in their deal-making.
They have heeded that warning. Carlyle has been mostly on the sidelines this year and hasn't been involved in any of the year's 10 biggest U.S.-targeted deals. Meantime, private-equity titan Blackstone Group has notched just one of the 10 biggest U.S. deals. That contrasts with KKR, which has been a part of $120 billion of buyouts in 2007, including five of the biggest eight in the U.S., according to Dealogic.
Then there's TPG (formerly Texas Pacific Group), which accounts for two of this year's largest U.S. deals, including the pending $32 billion buyout of Texas utility TXU Corp., where it is partnered with the bullish KKR. This past week it teamed up with the private-equity arm of Goldman Sachs Group Inc. to buy wireless provider Alltel Corp. for $25.7 billion, the third-biggest U.S. leveraged buyout in history, Dealogic notes.
TPG, though, is also showing signs of caution about the markets. This month, for example, TPG has taken advantage of others' optimism to sell large chunks of the remaining shares it holds in ON Semiconductor Corp. and MEMC Electronic Materials Inc., companies it has owned since 1999 and 2001, respectively.
Other signs of TPG's caution include its quitting the group that included Bain Capital and Thomas H. Lee Partners during the bidding for radio-station operator Clear Channel Communications Inc. Bain and Lee subsequently sweetened their offer twice, to $39.20 a share from $37.60 _ significantly improving their chance of securing shareholder support. It would have been better for the two to have let the deal die, walk away and show that they have discipline, says the head of a unit that focuses on private-equity firms at one big investment bank.
"We increased the price by about $700 million on a $27.5 billion deal, all from debt," says a spokesman for Thomas H. Lee. "That's the smallest percentage increase in cash of any public deal we've seen. The crucial change is the 30 percent (that will remain listed) for the public on a completely heads-up basis. That's a lot of value for the public without increasing our downside risk."
TPG also dropped out early in the bidding for Dollar General Corp., which ultimately went to KKR in a $6.9 billion deal. By the end of the process, no competing bid came close to the amount KKR was willing to pay, according to bankers.
Some middle-market firms also say this is a better time to sell than to buy. "This economy is not going to get better, especially for manufacturing and industrial companies," says Michael Psaros, managing partner at KPS Capital Partners. "We are selling everything that isn't nailed to the floor at prices that are between stunning and inconceivable."
Indeed, KKR has been winning auctions by paying far more than any of its rivals, opponents say, leading to fears that industry-wide returns will drop as a result of paying such high prices.
A person close to KKR says rivals who question why KKR is buying so much or paying so much may be jealous and frequently lose by only trivial amounts rather than the large amounts they claim.
Being bold has worked out well for KKR before. Johannes Huth, head of KKR's operations in Europe, bought a series of companies in Germany when those firms were out of favor early in the new millennium.
Today, many of those investments have done so well that Mr. Huth sits on the six-person management committee at KKR and is widely regarded as one of the likely successors to Mr. Kravis and his cousin George Roberts to lead the firm.
And deals KKR did earlier in this deal-making cycle in which the firm was believed to have overpaid have been quite successful, such as PanAmSat.
The industry has seen this divide before. Some private-equity firms pulled back in the second half of 2005, only to regret the decision as the debt markets threw money at their braver counterparts.
Steve Schwarzman, founding partner of Blackstone, has told investor conferences that while one of his bigger mistakes was not bidding more aggressively for Hertz, which Ford Motor Co. in 2005 sold to Clayton Dubilier & Rice Inc., Carlyle and a unit of Merrill Lynch & Co., "today the biggest risk is high prices."
"Almost everything can go wrong now," said David Bonderman, one of the founders of TPG, at a recent conference. "Two years ago, we slowed down. Last year we got unskeptical. This year we are more cautious again."