Purchasing power

Private equity firms increasingly resemble massive conglomerates. Can they become more than the sum of their parts?

As some of the corporate conglomerates assembled through rapid-fire deal making in the 1990s are busy dismantling themselves today -- witness the proposed breakup of former serial acquirer Tyco International -- they are being replaced by private equity firms.Outfits such as Blackstone Group and Carlyle Group are doing so many leveraged buyouts these days that their collected holdings are often bigger, in terms of revenues and employees, than many multinational corporations. Texas Pacific Group’s portfolio companies, for example, have some 300,000 employees and combined annual revenues of $69 billion. Together they’re bigger than 19 of the 30 Dow Jones industrial average component companies. Carlyle’s portfolio companies employ 370,000 workers and bring in revenues of more than $40 billion.

And those numbers are likely to grow. J.P. Morgan Chase & Co. estimates that private equity firms now have $150 billion in their coffers. Factor in the debt they employ when acquiring companies and that could equal as much as $750 billion of buying power.

Some LBO firms are trying to boost returns by treating their vast holdings as more than just a collection of businesses. One strategy: encouraging portfolio companies to collectively negotiate with suppliers of everything from energy and raw materials to financial services. London-based Alchemy Partners buys vehicles, insurance and telecommunications services collectively for the 25 companies it owns, which include mining and lodging concerns. Founder Jon Moulton estimates these arrangements save $10 million a year, or 1 percent of the companies’ total costs. “We’re a modern-day head office,” he says.

Blackstone, whose portfolio companies’ annual revenues exceed $50 billion, is starting a separate entity for this purpose. Senior managing director Prakash Melwani said at a December conference in New York that Blackstone expects to save up to $100 million per year by centralizing purchasing. The new group will be headed by James Quella, a former vice chairman of Mercer Management Consulting who joined Blackstone from DLJ Merchant Banking Partners in 2004 to improve the operations and performance of its portfolio companies.

Because private equity firms typically sell their holdings after a few years, saving even modest sums through consolidated purchasing could significantly boost their returns over the long haul. Companies are sold at an average of seven times earnings, so a $5 million improvement could add $35 million to the exit price. Saving what seems like petty cash on paper clips and envelopes, then, can mean the difference between outsize or simply average returns.

But it’s not easy. Executives of portfolio companies may resist cooperating with one another, seeing only meager cost savings. And in many cases, buyouts are made by a group of firms pooling their assets, a situation that complicates any effort toward joint purchasing. For these reasons, not all financial sponsors think the potential extra returns are worth the trouble. Carlyle, for example, doesn’t centralize buying for its 90 companies because it’s too complex, says a spokesman. Others limit arrangements to services that all companies need, such as insurance.

“It’s a way to add value when you own a company,” says Lawrence Schloss, CEO of private equity firm Diamond Castle Holdings and a former head of DLJ Merchant Banking. “But it’s extremely hard to get portfolio companies to work together, and it doesn’t happen overnight.” His former firm pursued joint purchasing, but Diamond Castle, formed in 2004, hasn’t bought enough companies yet to make it worthwhile, Schloss explains.

Despite the difficulties, some expect more LBO shops to maximize their purchasing power. Private equity performance is robust now because debt capital is cheap and plentiful. But over the past 20 years, returns have shrunk as the industry has matured.

“The long-term trend of returns coming down has forced funds to learn how to add value to portfolio companies,” says Daniel Haas, a partner with Boston-based consulting firm Bain & Co.

If that trend continues, expect even the biggest and boldest of private equity titans to consider how pinching pennies might power profits.

The new conglomerates

Private equity firms are becoming so big and so active that their portfolios resemble huge corporate conglomerates. Below are employee and annual revenue totals for companies owned wholly or in part by some of the nation’s largest LBO shops.

Firm Employees Revenues
Blackstone Group 300,000 $50 billion
Carlyle Group 370,000 $40 billion
Kohlberg Kravis Roberts & Co. 237,000 $56 billion
Silver Lake Partners 250,000 $40 billion
Texas Pacific Group 300,000 $69 billion

Sources: The firms.

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