'Private equity' now open to the public

The realm of financial wizardry known as "private equity" is becoming increasingly public.

The latest twist: Average investors on Main Street can buy into the trend – although they will want to consider the risks as well as the potentially rich rewards.

Privately owned buyout shops now control a sizable slice of US industry, from Albertson's supermarkets to Hospital Corp. of America. These outfits, which aren't listed on any stock exchange, have fueled a surge of corporate acquisitions in the past year.

They claim to be practicing a superior form of capitalism, freed from the constraints and regulations faced by publicly traded firms.

What's indisputable is that their presence has been growing.

Now the Blackstone Group, one of the largest private-equity players, has announced plans for a common-stock offering.

The move doesn't mean Blackstone will become a tame, ordinary company. It will still be in the private-equity business. But the move is a sign that private equity is carving out a mainstream niche for its rebel task of radically reshaping companies.

"It's a new phase," says Pavel Savor, a finance expert at the University of Pennsylvania's Wharton School in Philadelphia. "I think it will be a trend," he adds, with some other large buyout firms offering stock to the public as well.

On its surface, the Blackstone news sounds odd.

This is a firm, after all, that for two decades has been investing big bucks to buy publicly traded companies and manage them under its wing. Early this year, it clinched what is nominally the biggest private-equity deal ever – a $39 billion buyout of the real estate company Equity Office Properties.

Having espoused the virtues of close private ownership, why does Blackstone want to go public? That's a question still being debated, days after the firm's March 22 announcement that it was taking preliminary steps toward a stock offering.

But Blackstone did make clear that it was not abandoning its heritage. Its managers will still retain control of the deals they do.

And they will still have a big personal stake in the success of those deals. In fact, according to news reports, Blackstone plans to spin off only about 10 percent of the company.

The new shareholders, moreover, won't be buying any direct stake in Blackstone holdings such as Equity Office Properties. Rather, they will be buying a portion of management's returns on those deals.

Word of the initial public offering comes amid a boom in private-equity deals that has made the buyout shops the subject of attention, both good and bad.

To supporters, the deals are helping companies in a range of industries take risky but profitable steps that they would not do under the more cautious mind-set of public ownership.

But critics say the buyouts benefit the private-equity partners – and the managers of the target company who often join them – more than they help the economy at large.

"We don't have any interest in seeing Chrysler sold to a locust," Joerg Hofmann, an official with the German labor union IG Metall, told the Berliner Zeitung, according to Reuters, in response to news that DaimlerChrysler may sell its American division to a group backed by private equity.

It's not just labor unions who have doubts. The value-conscious investor Warren Buffett, whose shrewd investments have made him the world's second-richest man, has singled out private-equity firms as part of a class of "hyper-helpers" who end up diluting the returns that small investors can reap from the economy.

But the buyout kings have their fans, too. The best dealmakers, they say, have an eye for business strategy, not just on how to do quick flips in the market.

"These are the investors that make the market efficient," says Peter Zaleski, an economist at Villanova University in Pennsylvania. "Private equity has been a vehicle for patient management," in an era when public companies feel pressure to focus heavily on each quarter's earnings number.

Private equity refers to a broad class of corporate ownership outside of public markets, which includes start-up venture capital as well as the buyout of more mature companies. These deals can employ debt, or "leverage," to pay for part of the acquisition.

In the 1980s, such leveraged buyouts were often hostile, unwanted by the management of the target firm. Lately – thanks in part to the burden of regulations such as Sarbanes-Oxley accounting rules – public-company chiefs have often welcomed the buyouts and teamed up with them. Typically the company is managed privately for three to five years, then sold back onto the public markets.

One recent study found that, more often than not, these firms outperform their peers in the years following their return to the public markets. The research, written by Harvard University's Josh Lerner, with Jerry Cao, covered 496 such deals that happened between 1980 and 2002.

Those who craft the deals make enormous fees. Will shareholders of Blackstone as well?

The company is following a path treaded by Wall Street's investment banks. Goldman Sachs, for example, has retained the culture of a partnership while also becoming publicly traded.

"The returns wind up being shared with shareholders," says Clifford Smith, a finance professor at the University of Rochester's Simon School in upstate New York. "I've got no reason to believe that Blackstone's not going to solve exactly the same problem" as Goldman Sachs.

But some analysts say it could be a risky time to be buying into this cyclical industry.

The rush of money into private equity, from pension funds and other deep pockets, has pushed up the price of target firms, for one thing.

"It's definitely a seller's market," says Joe McCafferty, an editor at CFO Magazine, which surveys chief financial officers at corporations. Buyout firms are "all in capital raising mode."

Blackstone's motive could be more than raising additional capital through its offering of stock. Some analysts say the move could also help the company pave the way for a harmonious succession as founder Stephen Schwarzman prepares to retire a few years down the road.

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