David Rubenstein, co-founder and managing director of The Carlyle Group, runs one of the biggest and most influential private equity firms in the world. Last year Carlyle took its current funds under management to more than $40 billion, while Rubenstein himself continued to be a powerful and eloquent advocate for the industry – making him an obvious choice for our Editors’ Award for Private Equity Personality of the Year 2006.
PEO caught up with Rubenstein on a recent trip to London to get his thoughts on some of the issues currently afflicting the private equity industry.
PEO: David, welcome. Let’s start with the transparency debate that’s currently raging around private equity. Do you think the industry should be more transparent?
PEO: Will this greater disclosure also apply to rewards and compensation?
DR: “To some extent, the reason shareholders of public companies want to know salaries of executives is because those salaries are being paid by the public shareholders. It is not quite the same for us. We are a privately held company; when we make investments, people want to know what we’re going to do with them and how we’re going to make those investments better. So the concern is not really about our compensation – clearly some people will want to know what we’re making, but these people are not necessarily investors in our funds or shareholders in our companies.”
“Anyway, our investors know exactly what we are making. Anybody that does due diligence on our fund will know exactly what the carried interest is and will have found out how it is split. Any sophisticated investor will ask for that information.”
PEO: Can performance be maintained as more money flows into the asset class?
DR: “First of all, it’s true that more money is going in quantitatively than ever before, but more money is going into every asset class in the world. It is not really clear yet that there is proportionately more money going into private equity than into, say, fixed income or equities.”
“The real issue is whether the returns are still going to be there. Ultimately we get our rewards on the basis of the returns we provide – so if returns go down, the whole asset class could shrivel up a bit. When you look at the statistics, the upper quartile funds are providing better returns than almost anything you could legally do with your money – the question is will that continue?”
“I think returns will come down, but I think they will come down parallel to the rates of return from public equities. So the question is whether the gap between the two will remain sufficiently attractive. In our case, our funds have been out-performing the S&P500 by 2000 basis points – but I don’t think you need 2000 to keep people happy. 1000 would probably suffice. As rates of return go down across the board, I still think the gap will be significant.
PEO: Is private equity nothing more than a rounding error, as David Bonderman has said?
DR: Yes and no. If you take the total value of just the companies on Nasdaq and the New York Stock Exchange, the amount of money available for buyouts is something like 3.2 percent of this. So the money available is still a very small proportion of the total value of companies in the US.
But at the same time, it’s now a significant industry, capable of buying some large companies. It’s not hard to get multi-billion dollar transactions done these days. The question is whether this is a good or bad thing… My own view is that private equity has made companies more efficient, but the industry has to do a better job of explaining what it does to make this happen. We need to explain why tax revenues and employment numbers go up, rather than just bragging about rates of return and multiples on investment. At the moment you never hear people say when they sell a company: ‘We increased employment by 50 percent’. Nobody ever talks in these terms.”
PEO: Do you think the current negative attention might make this a difficult sell for you?
DR: “Let’s suppose we buy a company today with 50,000 employees and we lay off 500 as a result of some kind of restructuring – that would currently get an enormous amount of publicity. Whereas if a public company with 50,000 employees laid off 5,000 people, it wouldn’t create anything like the same adverse attention – even though the lay-offs are much bigger. Most of the big job cuts have actually been in public companies.”
“Private equity seems to have become a bad phrase. In the early days, these kinds of deals were known as “bootstrap” deals; that had some negative connotations so it was changed to ‘leveraged buyouts’. Then leverage became a relatively dirty word, so it changed again, to ‘management buyout’ – except the term ‘buyout’ still wasn’t very popular, so it became ‘private equity’.
“But now it seems that this phrase has taken on a meaning that is unpopular; that causes media commentators and politicians to look askance at what we’re doing. So maybe it’s time to change the phrase to reflect what we really do. My suggestion is that we call this “change equity”, because that’s really what we’re trying to do – whether in a public or private setting.”
PEO: Are the mega-funds scooping up all the available capital at the expense of smaller firms?
DR: “There’s no evidence that people who are qualified to raise money have a hard time fundraising – if they have the track record and experience. What may be happening is that people who don’t have the track record may be having a harder time – but I’m not sure this is a bad thing.”
PEO: Will greater disclosure be enough to see off the recent criticisms?
DR: “We need to be clear about this: even if every private equity firm agrees to disclose every single thing about everything we do, that isn’t going to dissipate all the objections – because they’re fuelled by the fear that change will occur, and this brings doubt and uncertainty. Full disclosure won’t make that go away.