Warren Buffett: Be wary of M&A bankers, private equity
Warren Buffett owned 3 percent of Goldman Sachs as of December 31, 2014.
By ansaradaMon Mar 02 2015Advisors, Investment process
Mr Buffett’s annual letter to Berkshire Hathaway shareholders warns chief executives about deal hungry investment bankers as well as private equity firms seeking to acquire their businesses.
“Investment bankers, being paid as they are for action, constantly urge acquirers to pay 20 percent to 50 percent premiums over market price for publicly-held businesses,” write Mr Buffett. “The bankers tell the buyer that the premium is justified for ‘control value’ and for the wonderful things that are going to happen once the acquirer’s CEO takes charge. What acquisition-hungry manager will challenge that assertion?”
Mr Buffett then describes the subsequent investment banking pitch. “A few years later, bankers – bearing straight faces – again appear and just as earnestly urge spinning off the earlier acquisition in order to ‘unlock shareholder value.’ Spin-offs, of course, strip the owning company of its purported ‘control value’ without any compensating payment. The bankers explain that the spun-off company will flourish because its management will be more entrepreneurial, having been freed from the smothering bureaucracy of the parent company. So much for that talented CEO we met earlier,” quips Mr Buffett.
“If the divesting company later wishes to reacquire the spun-off operation, it presumably would again be urged by its bankers to pay a hefty ‘control’ premium for the privilege,” adds Mr Buffett. “Mental ‘flexibility’ of this sort by the banking fraternity has prompted the saying that fees too often lead to transactions rather than transactions leading to fees.” Mr Buffett is equally caustic in his assessment of private equity.
“For some years, these purchasers accurately called themselves ‘leveraged buyout firms.’ When that term got a bad name in the early 1990s – remember RJR and Barbarians at the Gate? – these buyers hastily relabeled themselves ‘private-equity,’” says Mr Buffett. “The name may have changed but that was all: Equity is dramatically reduced and debt is piled on in virtually all private-equity purchases. Indeed, the amount that a private-equity purchaser offers to the seller is in part determined by the buyer assessing the maximum amount of debt that can be placed on the acquired company,” Mr Buffett says.
“Later, if things go well and equity begins to build, leveraged buy-out shops will often seek to re-leverage with new borrowings. They then typically use part of the proceeds to pay a huge dividend that drives equity sharply downward, sometimes even to a negative figure,” says Mr Buffett.
“In truth, ‘equity’ is a dirty word for many private-equity buyers; what they love is debt. And, because debt is currently so inexpensive, these buyers can frequently pay top dollar. Later, the business will be resold, often to another leveraged buyer. In effect, the business becomes a piece of merchandise,” concludes Mr Buffett.