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Who Should Invest in Private Equity


Buy for value, not because the guy next to you is buying.

Great news! My book, The Undoing of Cowardice, is now available in a Kindle version.

And thanks to the Kindle, I get my favorite daily paper, the Financial Times, delivered electronically daily. No need to scrounge around the newsstands to try and find a copy or two.

I always make sure to read the Financial Times' Lex column, a punchy and timely opinion segment, before I get to (or in some cases don't get to) the rest of the morning's required reading.

I certainly don't always agree with what the Lex column has to say, but I always enjoy the way the columnists say it, and I want to be sure I know what they're talking about.

Aspiring traders should put the Lex on their daily to-do list, near the top.

Anyway, today's discusses the lethargic private-equity market, or as they called it when I was learning the business 25 years ago, the leveraged-buyout market. The column gives two reasons for the lack of deal flow: inaccessible funding and unwilling sellers (for whom today's prices are still too low in view of the multiples that were being paid a few years ago).

I see an even more intrinsic problem, though it's not so much with private equity itself as the way its investors play the game. When the deals were known as leveraged buyouts (a snarky, Gekko-esque term, don't you think), they were mostly the province of patient and savvy money.

Deals happened when the businesses' conservatively forecast cash flows could comfortably repay the money borrowed to buy out stockholders. They happened because of persistently low equity valuations of stock markets that had largely given up. They were, in brief, a product of the lost equity decade of the 1970s.

But now we are late into the 2000s.

Many pension managers, and other institutions, know about the strategies that have provided good returns over the years. So they want in -- or, as I argue in my book, they fear losing their jobs if they're not doing what the other guy's doing.

That's why we started getting deals at extended prices, like Clear Channel (CCO), and why there were rumors of deals for Macy's (M), and so forth. But too many of these nouveau private-equity players deserve Jack Nicholson's remonstration in A Few Good Men -- you can't handle the truth.

Private equity makes the most sense after stock prices have been persistently depressed. It's absolutely not for chasing performance. But when most private equity (such a friendlier name than LBO, don't you think?) investors should've been looking to get into solid, low-leverage deals six months ago, most of them were trying to get out at any price. Markets, such as they were, were developing to buy out panicky interests at fractions of what they were probably worth.

We need to encourage long-term capital formation and give people incentive to buy where they see value. When you only buy because something's worked recently, or the other guys are buying too, rarely will you see any value.

Private equity is for those who can handle the truth.
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No positions in stocks mentioned.

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