Thursday, March 14, 2013

Private Equity As It Was Meant To Be and What It Has Become: Apollo and Carlyle

Private Equity As It Was Meant To Be and What It Has Become: Apollo and Carlyle

In the last twenty four hours we've had an of example of what private equity should be at its best with the acquisition by Apollo and Metropoulus Advisors of the Hostess Brands for $410 million.  We’re also seeing the caricature that private equity has become in the decision by Carlyle to offer its products in $50,000 increments, rather than its traditional $5 million to $10 million minimum.

Last November, when Hostess announced it was liquidating, I wrote that someone in private equity would buy the assets, and that consumers would not lose their Twinkies and Hohos.  Hostess had already been through bankruptcy and a private equity firm, Ripplewood, had lost all its money trying to turn around the brand. When the debt holders attempted to get more concessions from the unions in a last ditch attempt to save the company, the union balked and the company went into liquidation.
Quarterly Meeting (2002)

Apollo and Metropoulus have an opportunity to reintroduce the Hostess brands and establish reasonable economics for running the business.  Metropoulus has been successful in turning around the PBR beer brand, and Apollo has owned consumer brands in the past.  This acquisition will not be an exercise in financial engineering.  Rather, the private equity sponsors will have to go about building a company, which is what private equity should really be all about.  While most firms talk about operational intervention and active management, most big deals are mainly exercises in leverage and refinancing. The operational aspects tend to serve as window dressing.  Operational issues will be front and center in the Hostess deal.

Meanwhile over at Carlyle, it’s time to vastly expand the number of investors eligible to access their products by dropping the investment minimum to $50,000.  While Carlyle is still known for offering alternative products such as private equity, it has morphed into an asset gatherer.  The goal of Carlyle and other large firms like Blackstone and KKR is to bulk up on assets.  Now that they are public companies, the imperative is to service public investors rather than their clients.

Lowering the minimum will open Carlyle’s funds to individual investors with about $1 million in net worth.     However, the investment will come at a very high price.  In addition to paying Carlyle a 1.5% management fee and 20% carry, investors will also pay Central Park Group, a fund of funds manager, an additional 1.8% fee.  Central Park Group will bundle up all those $50,000 investments into a fund that will, in turn, invest in Carlyle’s fund.  This arrangement allows Carlyle to avoid having to deal directly with all those pesky “small” investors.  Meanwhile, Central Park will be extremely well paid for providing service.  With Central Park’s marketing and Carlyle’s brand, I expect the new minimum will attract billions in new investments.  As money managers enjoy success, they inevitably face the decision to cross over from being investors to gatherers.  Carlyle has crossed that bridge.

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