If asked, most GPs from very large private equity firms can wax loquacious about how they don't encounter much true competition in pursuing megadeals. But in this case these same GPs may well display some uncharacteristic reticence.
According to reports, the US Department of Justice has launched a probe into whether private equity firms, including Kohlberg Kravis Roberts and Silver Lake Partners, have engaged in anticompetitive practices when bidding in auctions. Several private equity firms have reportedly been contacted by the DOJ and asked for documents related to auctions as far back as 2003.
In communicating with federal authorities, one suspects that these firms aren't going to be as adamant about how uncompetitive the megadeal market is as they are with their own LPs. Far from it – they will likely highlight how the auctioneers have created new measures to ensure truly competitive auctions among small clusters of GPs who all know each other.
For years, general partners with the biggest funds have been touting the merits of bidding in the company of giants. With strategic buyers still relatively unacquisitive, the list of buyout megafunds that can credibly arrive at the auction of a large company is short – so short that assets are not bid up to the same dizzying multiples as might be found in the much-maligned middle market.
This bit of market analysis is usually stressed in conjunction with a fund offering of enormous proportions. As rival buyout funds seek to outdo each other in the size department, each returns to its LP base (of essentially the same investors) and argues that failure to keep up with the big boys will mean a ejection from competition discount club.
The DOJ's New York office, which is reportedly leading the probe, must be especially impressed by these claims of sparsely attended auctions. Of course, a comparatively low level of competition is not a crime. According to Sean Boland, a partner and co-chair of the antitrust group in the Washington DC office of law firm Howrey LLP, says that evidence of improper conduct, including price fixing, bid-rigging and the like, would be found in “contemporaneous documentation that the purpose and effect of operating as a group was not to pool resources or spread risk but to engage in a plan to suppress the price of the target company. If such activity was also conducted in a clandestine way (i.e. without disclosure to the target), the DOJ may have added interest in the activity.”
Oligopolies are a natural occurrence at the high end of finance. Why not among private equity firms?
While much has been made of the recent chumminess of large buyout firms, it is still an understatement to say that these firms remain competitive with each other on the deal front, which in turn affects their ability to compete for resources in the fundraising and talent recruitment markets. The DOJ will find it hard to prove the opposite.
As the DOJ turns its spotlight on the voluminous documentation of the private equity deal market, perhaps the strongest evidence of a lack of price suppression will be found in the practices of the largest investment banks. These bulge bracket firms have in the dispensation of the club deal created ways of enhancing competitiveness and thus ensuring the highest fee possible from a sale.
Megadeal auctions today might be thought of as analogous to team selection in grade school playgrounds, with team leaders taking turns picking teammates, and teachers sometimes intervening to correct gross inequities. Investment banks now work from “prohibited partner” and “acceptable partner” lists to ensure a more balanced bidding process. You wouldn't want a jocks-against-wimps auction, for example.
A GP at a very large buyout firm confirms this process, noting that investment banks all but dictate the members of the rival bidding consortia. The GP notes that, far from colluding, he sometimes balks at being paired with a less credible private equity firm. “Some of these firms you just know won't have the money,” he says.
If the probe goes much further, the DOJ will likely also hear the argument that oligopolies are a natural occurrence at the high end of the financial world – they exist among sellers' agents and among sources of financing. Why not among private equity firms?