You can’t blame private equity for selling dud floats to ignorant investors. Buying underperforming businesses, gearing them up, turning them around and then selling out at the highest possible price is the what private equity should do. The fact that many floats now trade below their issue price is evidence of a job well done — stiffing mug punters just happens to be part of it.
But each time private equity “wins” by flogging an over-priced business, getting the next float away becomes that much harder. Eventually, even the most naive of investors will catch on and avoid private equity floats altogether. That’s a bit of a problem for the float pushers; if everyone realises they’re often selling garbage, who will be left to buy it?
Enter the private equity industry body, the Australian Private Equity and Venture Capital Association, which recently released a rather impressive report.
“Private equity study back sector’s floats” claimed the headline in The Australian. Rothschild (Rothschild!) undertook research that revealed that from January 1, 2003 to the end of February 2014, floats from private equity vendors significantly outperformed “non PE-backed” offers, delivering “average return of 95% since listing, compared with a 2.2% decline for floats that were not backed by private equity”.
So the mugs are the investors who don’t buy private equity floats. Who would have thought it? As AVCAL chief executive Yasser El-Ansary said:
“This puts to bed the view held by some in the marketplace that companies backed by private equity tend to underperform once listed on the capital markets — the data makes it very clear that’s simply not the case.”
Anyone smell a rat here? Gareth Brown of Intelligent Investor Funds Management certainly did. After spending a few hours trawling through the full report rather than the press-friendly media release, Brown found that the data isn’t quite as categorical as El-Ansary claims.
The PE-backed average results are completely skewed by three big winners: JB Hi-Fi, Seek and Invocare, all of which were massively oversubscribed. And yet there was no adjustment for the fact that most investors would have had their allocations scaled back, perhaps to zero.
The fact that the good floats were popular distorts the data (the same effect will have distorted non PE-backed floats). Trouble is, average returns are even less useful than the median number.
On this measure, PE still wins out (+6% versus -8.9% for non PE-backed floats) but these are total rather than average annual returns. Far less impressive-sounding than 95%, don’t you think?
Another thorny issue is the cherry-picking around what constitutes a private equity sale in the first place. Seek, despite being less than 30% owned by private equity, was considered a private equity sale in the data set. Nine Entertainment, which was more than half owned by PE outfits Apollo and Oaktree, wasn’t. Seek delivered a +715% return while Nine managed just 12%.
And what’s with the 11-year-and-two-month study period? Why not a nice round number like 10 years, or 20? Funnily enough, the period selected included two of the three big winners in the report — JB Hi-Fi and Invocare (both floated in 2003) — but not the swag of non PE-backed floats in the 1990s, like Commonwealth Bank, CSL and Woolworths, all of which were crackers.
But here’s the clincher: despite cherry-picking the start and end points of the data set, fluid definitions, a small sample size, no adjustments for over-subscribed floats and using averages rather than medians, the results still don’t stack up. A 95% return sounds impressive, but over an average holding period of about eight years that’s only about 9% a year, which happens to be 1% less than the performances of the All Ordinaries Accumulation Index over the same period. After all that massaging and selectivity, PE floats still can’t beat the index.
In future, private equity should stick to selling over-priced floats to ignorant investors and avoid all that complicated data stuff, lest it look like a load of PR fluff to gull time-challenged journos and number-challenged punters. Full marks for trying, though.