You can’t help but be flattered when
someone goes to the effort of producing an eight page critique of an article,
as David Symons did (here) in response to my original article regarding buying into floats where the vendor is a Private Equity firm (Crikey 18/01).

Symons
disputed the notion that companies being sold by Private Equity are
poor investments, noting that “Private Equity floats can be among the
most attractive opportunities presented to Australian investors and is
counter to the Crikey statement.”

The basis for Symons’s comparison
was the returns achieved between Private Equity Floats and Non-Private
Equity Floats. A more logical comparison would be to compare returns
achieved by investing in Private Equity Floats (as an index) with those
achieved with the ASX as a whole. In effect, Symons’s argument was that
Private Equity floats are actually good because based on a tiny sample
size they outperformed Non-Private Equity floats. That may be well and
good, but nowhere was it argued that Non-Private Equity floats were
superior to Private Equity floats – rather, investors are better off
avoiding floats where the vendor is floating to realise an investment
rather than to access capital for profitable expansion.

Even
considering Symons’s very small sample size of seven Private Equity floats,
their performance across the board could hardly be deemed “the most
attractive” of investments. Pac Brands, Just Group and Repco (three of
the biggest Private Equity floats) have all massively
underperformed the market.

To accurately gauge the success of
Private Equity floats, I have created a Private Equity Float Index
(PEFI) using the seven Private Equity Floats named by Symons. Like any
index, the weighting of each company was based on its size.

Company

Market Capitalisation at Float (approx)

% of PEFI index

Pacific Brands

$1,250 million

44%

Repco

$442 million

15%

JB Hi Fi

$184 million (based on price paid by institutional investors)

6%

InvoCare

$173 million

6%

Vision Group

$142 million

5%

Bradken

$245 million

9%

Just Group

$428 million

15%

Total

$2,864 million

100%

Using
Symons’ data based on share price increases, the PEFI index (assuming
that the investor bought at the time of each Private Equity float and
re-weighted their portfolio accordingly) would have increased by 23%
(over an approximate two year period). During that time, the All
Ordinaries have increased by approximately 45%. Rather than being “the
most attractive of investments”, using an index basis, Private Equity
floats performed only half as well as the market as a whole.

Symons
was correct in one regard, not every single private equity float will
necessarily be a dud. However, on a theoretical level, it seems
difficult to dispute the notion that buying into a Private Equity float
is more likely to produce a sub-standard return – unless you are
prepared to argue that the people who run private equity firms are
idiots.

Private equity firms will time their sale (by way of
float) in order to maximise their returns. Occasionally, they will time
it wrongly (as Macquarie did when they floated JB Hi-Fi just before a
consumer electronics boom) but generally they get it right. So long as
the people running private equity firms remain outstanding business
people and strategists (and have inside knowledge regarding the
operations of the business) buying shares in a Private Equity float
remains akin to playing blackjack: sure it’s possible to win (like
investors in InvoCare), but the odds just aren’t in your favour.

Peter Fray

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