Published: May 22, 2006, Financial Times

TALKING HEAD

Making sense of the private/public equity push

Private equity syndicates' move on public companies is causing concern, says Bruno Raschle. But such active involvment is crucial to private equity

Large transactions by private equity managers and the increasingly blurred line between public and private equity is fuelling controversy within the market. In the new era of mega funds, we are seeing a rising number of public to private deals where syndicates of private equity managers acquire controlling stakes of publicly listed companies.Their intent is to take the company private, thereby enabling smoother and simpler implementation of its strategies. Potential deal sizes are already large, and with private equity managers joining forces and making use of significant debt financing, deals are likely to get even bigger.

If you compare such transactions with the stock market capitalisation of the world's largest companies, the result is revealing: there are only 200 companies globally that are too big to become the target of a private equity syndicate, and this number is rapidly shrinking as fund sizes continue to rise.

This trend of private equity straying into the territory of public markets reached a new level recently when Blackstone bought into Deutsche Telekom - a listed company that includes the German government among its shareholders - without taking full control.

Do such transactions and the resulting convergence between private and public equity make sense? Certainly not with a traditional understanding of the role of private equity that is seen purely as an "alternative" asset class.

Traditionally, private equity operates in niche areas and thrives on the lack of transparency surrounding these niches.

According to this point of view, mega funds and deals falling into the realm of public equity are a sort of perversion of the system. The success of private equity funds in outperforming other, mostly large cap, investment classes has lead to an over-abundance of money available. Desperate to put the capital to work, private equity managers are increasingly playing an arbitrage role by taking companies off and on the public market, an area where by definition they do not belong.

Such a view, although understandable from a traditional standpoint, is crucially missing what private equity is all about. The original premise of private equity is to create value in investee companies from active investment management. This holds true for all the different sectors of private equity, from venture and development capital to buyouts.

Over time, private equity managers have developed a highly sophisticated industry that based on longstanding experience has resulted in tremendous know-how in how to do this.

In contrast to most other investment managers, who are betting on a certain outcome when making an investment decision, private equity managers are betting on being able to create that outcome through active involvement in the companies they own.

This active role is part of the very mindset and DNA of private equity and leading private equity firms have built up the resources that allow them to play this role. In venture capital this active investment approach has led to spectacular successes over the past two decades, where, with relatively little money, new technologies have been backed and companies built that have completely changed the way we work and live today. Examples of these are bandwidth technologies for media and communications applications, algorithms for intelligent search engines, and nanotechnology in biopharmaceuticals.

Over the last few years, the active investment style of buy-out managers has also become an important driver for increasing global economic efficiency and promoting effective governance. It is ironic that a fund that fuelled the "locust" debate in Germany last year has now been welcomed by the same  oliticians as an active stakeholder in a large listed German company.

It has only been a question of time before private equity managers forcefully entered the public equity domain and that these active equity managers would take a role that was formerly the domain of management consultants and investment banks.

In that sense, recent developments do not mean traditional private equity  has lost its way.

With its increasing involvement in the public equity domain, the active management role of private equity has become more visible.

Bruno Raschle is managing director of Adveq Management AG, a Swiss-based independent private equity fund of funds.