How can I get in on these private equity IPOs?

John W. Schoen • Profile • E-mail

Last week’s news that the private buyout firm KKR & Co. plans to sell shares to the public has some readers, like Judy in Portland, Ore., wondering if the stock is a good way to tap into the huge profits these firms are making. Robert in Boston, meanwhile, is trying to figure out the best way to move a big chunk of cash with him when he moves to Canada.

How do I take advantage of private equity IPOs?
— Judy, Portland, Ore.

Judging by the performance of the recent initial public offering of anther big private equity player, Blackstone Group, the best thing the average investor can do is to stay as far away from these stocks as possible.

There's no question these buyout firms are hugely profitable for the principals — some of whom have become billionaires. These firms buy up all the stock of a public company, borrow big money on its behalf and then beef up profits, hoping to sell the company back on the public market for more than they bought it.

The business plan is not a lot different than buying a “fixer-upper” house and making improvements that raise the value of the house by more than those improvements costs. (Except that there are a few more zeros involved in the sales price.)

People who like support these firms do say they’re making stronger companies; opponents say they’re just like real estate flippers and simply cash out by loading up companies with debt. (We’ll leave that debate for another day.)

But consider this. The principals who are now selling public shares in these private equity buyout firms made all their money in the first place by knowing when it’s time to buy and when it’s time to sell. So if they’re offering shares in their company now, you might be wondering why they believe it’s time to sell. Here are a few reasons to think about:

• Shareholders will own the company, not the deals: The big money in private equity comes from the firms' individual “fixer-upper” projects — buying up a public company, boosting its profits and then selling public shares again for big gains. But if you buy stock on one of these buyout firms, you’re not buying into these deals. The shares in the buyout firm are backed only by the fees the firm gets for doing deals, not from the capital gains from those deals.
  
• The party may be getting old: The record pace of multi-billion-dollar deals can’t go on forever. Though there are still plenty of public companies to buy, many of the most promising candidates have been bought up already. Worse, the torrent of capital that has been flowing into private equity to finance these deals will eventually begin to slow; some market watchers say the recent uptick in bond market interest rates is a sign that may be about to happen. Without a flood of cheap, easy money to work with, it will be a lot harder to finance these mega-buyouts.
  
• Who’s in charge? Shareholders of public companies are at least nominally in charge of how the company is managed: they vote for the board of directors, which oversees the CEO and senior management. Firms like Blackstone and KKR are set up as so-called master limited partnerships. In simple terms, that means the people who buy these shares (technically called "units") don’t get to vote for directors. Which means they also have no say in how much of the profits the partners decide to pay themselves.

• The tax wild card. Because these firms make most of their money when they sell their “fixer-upper” companies, they pay the 15 percent tax rate applied to capital gains, not the income tax (of as much as 35 percent) you shell out on your paycheck. That has some members of Congress calling for changes that would substantially raise the taxes these principals pay — and seriously cut into the profits they’ve historically enjoyed. Such a change would almost certainly clobber the shares in these firms held by the public.

In any case, getting in on an initial public offering is all but impossible for individual investors; these shares are usually divvied up by the underwriter for their regular (read: big) customers.

Even if you did get in on the first day of trading, you won’t necessarily make money. Blackstone, the 900-pound gorilla of private equity, was priced at $31 a share when it first traded on June 22 but it opened at $36.45 and was still selling for $35 by the close. Individual investors who bought at that price then watched the stock drop for the next five trading sessions — to below $30. At this writing, it’s back up to a little over $31.

MORE FROM ANSWER DESK

Answer Desk Section Front

Slow stimulus spending Raiding college savings There’s a reason GM stock is cheap Housing rebound may be slow Beware the hidden agendas of 'experts' Meltdown will leave vastly changed economy Yikes! Series I Savings Bonds paying 0.0% Who's going to fix my Pontiac? Bailouts and banks’ bottom lines How does the Fed ‘mop up’ extra cash? Answer Desk Section Front   Add Answer Desk headlines to your news reader: