Private equity victimizing public markets?
Recently read an article, “Texas Pacific Group Made Money On J. Crew, Did You?,” that seems to paint a rather damning picture of private equity, particularly Texas Pacific Group and its investments. The article makes note of the fact that TPG recently sold the last of its shares in J. Crew and officially exited its investment after a 12 year relationship with the Company. In the end, it estimates that TPG managed to make over $600 million on an investment of just $137.4 million (15.2% annualized return). Unfortunately for public market investors who bought into JCG’s IPO, the stock has actually lost value since its $20/share IPO in 2006. The article then points to TPG’s investment in Burger King (BKC) as yet another example where TPG took a company private and supposedly victimized public market participants upon exiting via public offering.
I’ll be the first to admit that private equity firms can sometimes be short sighted. After all, no good private equity investor goes into a deal without an exit strategy already in mind. Many funds have lifespans no more than 10 to 12 years and this can sometimes lead to an urgency to manufacture “return” through financial engineering or hasty operational window dressing. Everyone has heard the private equity horror stories of buyout targets being left bloated with both financial and operational leverage – resulting in businesses that can barely maneuver in flush times and are disasterously undercapitalized during recessionary times. But, this is not all private equity, and this is not a reason to avoid all private equity public offerings.
The idealistic definition of a private equity transaction is one in which a buyout firm takes a company private, frees it from the restrictions of [insert rationale here] (public market expectations, an overwhelming corporate parent, inefficient balance sheet, etc.), and installs a management team and an overarching strategy to create a more efficient and profitable business. Just a year or two ago, the media was writing glowing reviews about how Texas Pacific Group did just that with J. Crew. TPG, it was said, didn’t just purchase the Company and attempt a whole bunch of financial tomfoolery. Instead, it took its ownership seriously and went about creating value the right way. The buyout shop was intensely involved in planning and strategy and ultimately executed a patient and thoughtful rationalization that included the very un-characteristic sacrificing of operational profits for several years. It then recruited a top flight CEO (Mickey Drexler) to lead the business back to prosperity. Even after all of this and likely near the end of its fund life, TPG made an additional commitment to the business during the Company’s IPO, almost ten years after its initial commitment.
Does the sequence of events described above sound like a greedy and short sighted plan to stiff public market investors so that a private equity giant can make its exit? Yes, TPG has exited its investment over the last three years. And, yes, at this point, it has no voting rights at the business and no commitment to remain active in the J. Crew’s future success. But, the real question is, “Is this such a bad thing?” The role of private equity firms is not to own a Company forever, but to buy them and give them the flexibility and resources to optimize their operations. After this, wouldn’t it only make sense to turn the business over to a more long-term oriented ownership?
In the case of J. Crew, I tend to side more with the positive article printed in Businessweek two years ago than with the negative piece written just days ago. Does anyone really believe that TPG washed its hands of J. Crew after taking it public? For the last three years, TPG has maintained a significant ownership stake in the business, demonstrating a commitment beyond simply looking towards the public market for an exit. Rather than shortsightedly invest in capital expenditure and other fixed investments in hopes of squeezing more growth out of the Company, J. Crew has pared its long term debt down from $350 million to $100 million since IPO. Is it really fair, then, to blame the Company’s “poor” stock performance during an unprecedented financial market meltdown on TPG? The real focus here should be, “Did TPG position J. Crew to operate successfully as a public market company at the time of IPO?” That is, could J. Crew continue to operate as a going concern, maneuver through difficult economic climates, and have the capital necessary to continue invest in future growth? Whether or not the stock goes up or down is a question left only for Mr. Market to decide. Playing the blame game and going after TPG for stock price performance may yet be another example of why many business would be better off under the auspices of a private owner, not subject to the what-have-you-done-for-me-lately mentality that many public market participants seem to be afflicted with.
I, for one, view this as a tremendous opportunity to pick up the reigns from a private equity firm which, by all accounts, has done exactly what anyone could have asked it to do. Purchased a floundering company, rehabilitated it, and brought it back to market (admittedly all while making a handsome profit for itself). More importantly, though TPG may no longer be in the picture, its compensation package for CEO Mickey Drexler (who now controls 13.34% of the Company’s oustanding stock) all but ensures that the J. Crew will continue to be in good hands even after TPG moves onto its next challenge.
Full Disclosure: Author has no position in any of the stocks mentioned in this article, though positions may change at any time.
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