Friday Letter: Public nuisances

This week has highlighted some of the downsides of being publicly listed.

Listing on a public stock exchange has obvious attractions for a private equity group. It offers access to a new and possibly permanent source of capital. It provides a mechanism to mitigate difficult succession issues and incentivise staff. And it helps to build the firm's brand among business owners and the broader financial markets, taking the message about private equity’s value-add (not to mention the wealth it generates) to a wider audience. These are all benefits worth having.

On the other hand, as we've been reminded this week, public markets can also be an uncomfortable place to be for private equity groups, especially when things aren't going so well. One of the key benefits private equity ownership offers is that it allows companies to fix their problems away from the glare of quarterly public scrutiny. But listed private equity groups don’t have this same luxury.

Take 3i, the venerable London-listed private equity group: its difficulties since the financial crisis have been very obvious to all, since it has had to tell the world all about them at three-month intervals. Its share price has recovered lately, thanks to a strong focus on cash generation. But although it announced this week that it had secured another £400 million of exits, it still found itself having to explain the fact that it hadn't made any new investments during the quarter.

Then there's Better Capital, the listed turnaround specialist founded by Jon Moulton: it had to explain this week why its debut fund had lost ten percent of its net asset value last year, which meant going into brutal detail about the operational and management problems at its two biggest investments. Better has been admirably frank and transparent about the situation, putting out an interim management statement at the first sign of trouble. But not surprisingly, as it admitted this week, all the negative publicity has damaged investor confidence. And that was always going to be a danger: this is a difficult and risky segment of the market, where even the deals that do work can be a bumpy ride, so it's not always well-suited to the constant scrutiny of the public markets.

But it's not just about the constant scrutiny. And it's not even just about underperformance.

Look at London-listed investment trust Electra Private Equity, which by pretty much any measure you care to mention (discount, shareholder return, capital raising, etc) has been one of the best performers in the listed private equity sector over the last decade. Yet now it's having to deal with some unwanted attention from Edward Bramson, a hedge fund manager with a penchant for activism, who has accumulated a 19 percent stake this year. It's still not clear what Bramson actually wants – maybe it's a change in manager, or investment focus, or distribution policy. But judging by Electra’s admission this week that he's trying to get his hands on more board seats and lead a strategic review, he clearly wants something. That’s his right as a shareholder, of course. But it's a huge distraction for the manager and for the board; and at this point, it's not clear what the benefit would be.

At the same time, analysts fret about firms missing quarterly forecasts, even if the numbers are actually pretty good. That creates strange situations like the one with Carlyle this week, where the firm was able to report a doubling of its quarterly net economic income year on year, but still technically managed to 'disappoint' (since it came in below analysts' predictions).

In short: there’s a lot to be said for going public. But it can also be an unwanted distraction and irritation, which sometimes makes a bad situation worse – and, arguably, discourages the sort of long-term management thinking that private equity is so keen to preach as an asset owner.