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Private Equity, Public Gain (source: BusinessWeek, August 21st, 2007)

Let's lay to rest the myths about private equity, once and for all. There's no question PE is a boon to society
by Bill George

Recent turmoil in credit markets and hedge fund losses, along with the public offering of the Blackstone Group (BX), have reignited controversies over the growing power of private equity. Critics call private equity outfits such as Blackstone (BusinessWeek.com, 7/26/07) the new robber barons, ready to plunder great corporations and leave them in a shambles.

Nothing could be further from the truth. The dynamic leadership of private equity is providing great benefits to corporations, the economy, and society.

Let's take a closer look at some myths about private equity:

Myth No. 1: PE's growing power threatens public corporations.

Unlike the deals done by the raiders of the 1980s (such as Michael Milken, Irwin Jacobs, and Carl Icahn), private equity deals are friendly. Private equity shows up when public buyers aren't interested. For example, when Daimler (DCX) put Chrysler up for sale, automobile companies declined to bid, so Cerberus Capital Management stepped up to take on Chrysler's challenges.

Myth No. 2: Under private equity, acquired firms get torn apart and their value destroyed.

To the contrary, private equity does the kind of restructuring public companies wouldn't undertake. Managers of public companies are often reluctant to make these massive changes because they are trying to protect their short-term earnings and stock price, or are locked into a traditional view of their companies. PE firms achieve high returns by creating value that public managers didn't see, and monetize their gains by going public once again.

When Blum Capital Partners purchased real estate giant CB Richard Ellis Group, the firm was restructured and taken public after three years. In three years, CB Richard Ellis' (CBG) market value has grown 600%, from $1.3 billion to $9.1 billion.

Myth No. 3: CEOs are fleeing public companies to avoid the scrutiny of demanding investors.

If they are, they're in for a rude awakening. Private equity investors are far more demanding than public investors and more engaged in the business.

Look at venerable Sears Roebuck (SHLD), whose retail sales and market valuation slumped for 20 years. When ESL Investments' Eddie Lampert purchased Sears, he consolidated it into bankrupt Kmart, monetized its real estate, and took it public. Four years later, its stock has risen 10 times.

Myth No. 4: The greed of private equity owners is harming the economy.

PE owners have their personal money at risk. They give the economy new vitality by restructuring moribund corporations and making them healthy and competitive. These revitalized competitors reduce the economic drag from poorly managed firms.

What enables PE firms to perform so well?

1. They take on high leverage and spread risk. High liquidity and low cost of debt make the PE model very attractive. To mitigate the risk, PE firms spread their debt across many companies. Public companies that cannot meet debt obligations are bankrupt, à la Delphi (DPHIQ) and Delta Air Lines (DAL). If a PE-owned company gets in trouble, the PE firm covers the losses from its diversified balance sheet.

2. They compress the time frame for changes. PE firms don't waste time making changes. They move with surgical precision, compressing 10 years of changes into three. They are unconcerned with internal objections, reluctant boards, or unfavorable publicity. All too often, public company executives worry about quarterly earnings, morale, and external criticism, and wind up rationalizing problems with "quick fixes" rather than addressing fundamental issues.

3. Leadership: PE managers are leaders, not just financial engineers. PE attracts highly talented leaders to run its firms and to run acquired companies. Their leadership is extremely intense and focused on results.

So what's the risk of PE's growing power? First, turmoil in the financial markets and the resulting liquidity crunch have made it difficult for PE to fund the high levels of debt required to make its models work. Second, with more money chasing fewer deals, there is the risk of private equity overpaying for companies, and not being able to monetize gains by going public once again.

Third, PE benefits from paying capital-gains taxes rather than ordinary income tax. Tax loopholes benefiting PE are wrong: Public and private firms should play by the same rules.

Finally, it is questionable whether PE works for well-run, long-payout businesses such as high tech, pharmaceuticals, and aerospace. Thus far, PE firms have steered clear of these industries.

If the benefits of the PE model are so evident, shouldn't public companies do the same thing? Why not look at their business as if it were acquired by PE? Where would they find value? What would they jettison? If they can make these changes without damaging long-term value, publicly held firms should absolutely take similar actions.

The bottom line? Private equity is good for business and for the economy. It will be around for a long time.

The U.S.'s Hidden Asset: Global Capitalism (source: BusinessWeek, August 5th, 2007)

Our bid to spread democracy has had mixed results. What other countries really want is capitalism—and there, the U.S. is the undisputed leader
by Bill George

For the past seven years our political leaders have been trumpeting the spread of U.S.-style democracy, with decidedly mixed results. Developing countries aren't eager for the U.S. to impose its form of democracy on their fledgling—and often fragile—governments. In fact, many of them resent our government's attempt to tell them how to run their countries, especially when threats of "regime change" are not so subtly mentioned. It is U.S.-style capitalism, not democracy, that is spreading like wildfire around the globe.

Every government leader and business executive I have met in developing countries—from the mayor of Beijing to the ruler of the United Arab Emirates—is eager for one thing: U.S.-style capitalism to build their economies, create jobs and wealth for their people, and bring their countries fully into the global trading network. From Kazakhstan to Vietnam, people are hungry for capitalism. They want to study it in the U.S., learn how to create local capital markets, acquire our technology and know-how, and build companies that can export their goods around the world, especially to the U.S. But most of all they want our hidden asset: leadership of global capitalism.

Let me emphasize that this is not the old-style business leadership of the 20th century, which was based on the assumption that U.S.-based companies had superior products and management processes and could simply export them to the less sophisticated markets around the world that were eager for U.S. goods and know-how. That day passed by 20 years ago.

They Come to Learn

In recent years our new competitive advantage has emerged: the ability to train and develop global leaders who are capable of leading global organizations. These new leaders, who are mostly in their thirties and forties, have lived all over the world and are as comfortable doing business in the Ukraine or Indonesia as they are in Des Moines—perhaps more so. Many of them have attended the best U.S. graduate business schools, where they have interacted with a vast array of foreign nationals and newly immigrated Americans with similar leadership abilities and like ambitions.

After attending my class at Harvard Business School my wife remarked, "I feel like I am in the United Nations." In fact, more than one-third of Harvard's MBAs and two-thirds of participants in its executive programs come from outside the U.S. to learn the latest leadership approaches in global business. (These percentages do not include the substantial number of newly immigrated Americans from all over the world attending these programs.)

This new generation of U.S. business leaders—as well as foreign nationals who have been trained in our leading academic institutions—is very different from the previous generation. They are authentic leaders; collaborative, not imperial, in their relationships. They genuinely respect and appreciate the comparative advantages that people of other nations bring to their global companies—from manufacturing skills to ingenuity. Most importantly, they know how to bring together and motivate people of very different backgrounds to build high-performing organizations.

Still the Melting Pot

The U.S.'S competitive advantage is seen most vividly in financial markets, where governments and business people around the world are eager to have our investment banks help them restructure their financial institutions and industrial companies to become competitive in global markets. Serving on the board of Goldman Sachs (GS), I have had the opportunity to witness first-hand just how important this leadership is to countries like China, Saudi Arabia, and the United Arab Emirates. In building financial institutions in these countries, U.S.-based companies are developing the relationships with business leaders that will sustain this competitive advantage in global leadership for the next several decades.

For all the xenophobia about immigration and widespread panic over outsourcing, the reality is that the U.S. is the world's melting pot. We are more accepting of people of diverse national origins and ethnic backgrounds than any country on earth. Progressive business leaders such as IBM's (IBM) Sam Palmisano, Andrea Jung of Avon Products (AVP), GE's (GE) Jeff Immelt, and PepsiCo's (PEP) Indra Nooyi recognize that diversity is not a challenge to be overcome, but a source of sustainable competitive advantage.

Whatever issues diversity may create—both real and perceived—our hidden competitive advantage is the ability of our leaders to operate effectively in integrated global organizations and to deploy the principles of capitalism throughout the world.

Our political leaders would be well-advised to recognize this strength and use it to build relationships with countries around the world, while helping them build their economies through capitalism, irrespective of their form of government.

Bill George, professor of management practice at Harvard Business School, is the author of two best-selling books, True North and Authentic Leadership. The former chairman and chief executive officer of Medtronic, he serves on the boards of ExxonMobil, Goldman Sachs and Novartis. His Web site is truenorthleaders.com.