Barbarians at the gates of our miners Jennifer Hewett. 2337...

Barbarians at the gates of our miners
Jennifer Hewett.
2337 ¦r
2006 ¦~ 11 ¤ë 8 ¤é
Australian Financial Review

© 2006 Copyright John Fairfax Holdings Limited. www.afr.com [http://www.afr.com] Not available for re-distribution.

One of the world's biggest private equity players says resource companies may be the next target, writes Jennifer Hewett.

Australian mining and resources companies are no longer exempt from the long reach of private equity firms now scouring the world for assets.

Key industry player David Rubenstein - founder of giant US private equity firm The Carlyle Group, which has $57 billion under management - has told The Australian Financial Review that the traditional reluctance of private equity firms to acquire natural resources companies because of their unpredictable cash flow has changed.

Australia has been relatively sheltered from this growing tidal wave of global private equity funds. But this year's billion dollar-plus deals involving companies such as DCA Group, Brambles' Cleanaway business, Myer and Publishing & Broadcasting Ltd's media interests - as well as the attempt at Coles Myer - means private equity players are now a powerful force in the local market.

"There is a lot more money around, so people are looking for more assets," Rubenstein says.

"Our ability to predict commodity prices is also a little better than it was. But also there is this general feeling that the world is growing in terms of population - yet the amount of natural resources is not growing commensurate with that.

"So I think people have the general sense that commodities will probably increase in value, and mining and natural resources properties will increase at a greater rate than they have historically."

Rubenstein made a lightning visit to Melbourne and Sydney in his private jet last week to look at potential deals, saying Carlyle had recently raised another Asian fund of $US5 billion, some of which he hopes will be spent here. And in the highly leveraged world of private equity, $5 billion translates into several multiples of that available for acquisitions.

Carlyle, which opened an office here last year, was part of the $18.2 billion international private-equity consortium bid for Coles that the Coles board recently rebuffed.

Rubenstein makes it clear the experience has not put the firm off looking for more deals, including in the resources industry.

"If we can find good deals, we will certainly look at them for sure," he says. "You wouldn't want to open an operation in Australia and say Australia's greatest assets are its natural resources, but we don't want to be in that area. We wouldn't do that."

The Carlyle Group has been one of the most active private-equity players in the Asian region, along with its massive investments in the US and Europe.

Rubenstein describes the past few years as "the golden age of private equity" and says the industry has become "the face of American capitalism", with private-equity capital now America's single greatest export. It is also the biggest source of fees on Wall Street, worth more than $6 billion in fees this year.

Nor does the Carlyle founder see any let-up in the pace or size of deals done globally, and in Australia, though he warns that the spectacular private-equity returns in the US are more like to decline as prices of assets rise, largely as a result of competition.

Rubenstein calls what is happening in Australia a "land rush", with so many private-equity firms looking for assets.

He says that as well as a flourishing global buy-out industry, thanks to cheap debt and readily available exits, Australia has additional attractions that are only now being recognised.

These include the fact Australia has been less involved in private-equity deals than the rest of the organised buy-out world so far, with "a lot of very good companies that have not yet either employed leverage or gone private".

"Australia is not an economy so large it can absorb everyone who wants to do deals here," he notes. "On the other hand, the companies are pretty well run, there are a lot of good assets to buy and there are some very strong things that are unique to Australia and where Australia really is a leader.

"So if you have an interest in and a belief that natural resources will compound dramatically in terms of value, investing in San Franciso-related companies probably won't get you there, but investing in Australia-related companies means you will probably do pretty well.

"My biggest regret is we weren't here earlier."

He also points out that six of the 10 biggest buy-out deals in Australia happened in the past 18 months, with the prospect of more "sometime soon", and confidently predicts private equity will become an ever-larger part of the domestic economy.

As a percentage of merger and acquisition activity, Australian deals involving private equity doubled in dollar terms from 4 to 8 per cent from 2001 to 2005, a figure that will have dramatically increased again this year.

"What the Coles Myer deal showed, among other things, is that good assets will attract the best private-equity firms in the world and even those that don't have offices here are willing to fly down here and spend time," he says. "That is not atypical of what you will see in the future."

The Coles board has faced considerable criticism for refusing to entertain the private-equity consortium and its bid of $15.25 a share, nearly 50 per cent above where the price was when the bid lobbed. But despite intense market scepticism about management's ability to meet its targets, Coles maintains it will not hand over what it says is billions of dollars of potential shareholder value to private equity.

While the Kohlberg Kravis Roberts consortium has withdrawn, many observers believe a return by private-equity players is still certain if Coles management doesn't deliver relatively quickly and shareholders become irritated.

But the Coles bid also highlighted the increasing concerns globally about the amount of leverage involved in private equity and whether the current terms are sustainable.

Westpac chief executive David Morgan criticised the recent spate of private-equity transactions, telling The Australian Financial Review last week that history would show that this was a point in the cycle for a lot of "unwise deals".

Rubenstein says the key to successful deals and returns is maintaining price discipline.

"In 2001 in the US and in Europe, the average multiple you would pay was 61/2 times cash flow," he says. "In the most recent period, people have been paying 81/2 times."

But he avoids predicting when there will be an end to the frenzy of deal-making and economic good times. "I would be a fool if I sat here and said the business cycle has been repealed and things are going to keep going up and up," he says. "That never happens. Clearly at some point something will produce a break."

The huge returns mean the temptation is always to keep going as long as possible - momentum compounded by the size of the fees for investment bankers and advisers.

As the size of the deals has increased, many private-equity firms have clubbed together to fund acquisitions and spread the risk - a practice the US Department of Justice is looking at for possible collusion.

The amounts of money taken out of highly leveraged companies - often quickly - is causing increasing scepticism about the benefits of private equity and the legacy of the rush to flee the public market and its accompanying regulation and oversight.

Rubenstein says the pattern of ever-shrinking time frames for extremely lucrative exits from deals - down from four to seven years, then three to five years and in some recent cases only a year - is at an end.

This is because the ability to refinance on better terms is no longer possible given interest rates are no longer going down.

As for all the criticism that private-equity firms have a habit of flipping deals, sacking workers, taking out the assets and leaving their debt behind, Rubenstein begs to differ.

"If I get a reputation for coming into Australia or any country and I buy something that is seen to be at an unfair price, where we strip assets, we fire people, we quickly flip the asset, maybe I will make money on that one deal, but I will not build a long-term relationship with the community and so, in the end, I will will make less money," he insists. He argues that the aim is always to improve a business not shrink it.

Seeing will be believing as far as Australian shareholders are concerned. But Rubenstein concedes that private-equity firms have not been good at explaining their role and argues that the chief beneficiaries are blue-collar workers all over the world whose pension funds have invested with them.

A former lawyer and White House adviser in the Carter administration, Rubenstein and three partners set up The Carlyle Group in 1987, naming it after the famous New York hotel because they wanted something that sounded "classy" and as if it had been around for a long time.

The firm has returned an average of 30 per cent a year to investors over that time and it now controls companies with more than 300,000 employees and $US68 billion in annual sales. Its major investors are the large pension funds.

It has attracted plenty of controversy in its time for hiring high-profile politicians, ranging from former British prime minister John Major to former US defence secretary Frank Carlucci. President George Bush Snr had an advisory role and even the current President had a minor part well before he followed his father into the White House.

Rubenstein says it had been his idea to employ such high-profile political figures to give the firm credibility with investors when it was small but the relationships have now ended.

"After I realised they were getting so much attention with people thinking they were getting deals from government for us or lobbying on our behalf, none of which they were doing, I realised it was counter-productive," he says. "We were always a private-equity firm and not a political operation and now I think people understand that."

But Rubenstein still likens the practice of private equity to a game of musical chairs. " You keep participating in the game as long as you think you can make money, but you want to be able to sit down at the right time," he says. " Nobody knows when that is.

"So you have to be disciplined and hope that by being disciplined, when the music stops, you will not be pregnant with a deal you have paid way too much for."

He insists that even when the economy turns down, however, there are still opportunities for smart private-equity players. It's a lesson he learned early, given Carlyle was established a week before the October 1987 sharemarket crash.

"In the buy-out world, there is no doubt that when economies slow down, while the value of what we own may be worth less, it makes it more more attractive to buy things at lower prices," he says.

"You have to invest in private equity over a period of many, many years. You can't say now is the right time, you can't exquisitely get in - like in a traded situation - and get out in a year.

"You tend to go into private equity and partnerships that last 10 years and therefore you have five or six years to invest the money and maybe four or five to exit the investment.

"So over any 10-year period, there will be some up and down cycles and you have to hope as an investor that you will invest with someone who knows when the right time to buy and the right time to sell is."

But he maintains private equity remains a high-risk business, which is why the standard fees of 2 per cent of the money invested and - the source of the big bucks - 20 per cent of the profits from any deal can be justified.

"It is not a God-given right you are going to make staggering returns when you do these things," he says. "These are leveraged buy-outs and that means there can be risk.

"If doing these value-creating activities were so easy, presumably the CEOs of companies would do it themselves. Just because we make money doesn't mean that someone else has lost it. Just because we make money doesn't mean that we haven't earned it."

According to Rubenstein, the key to earning that money is still buying at the right price, which requires extensive due diligence. "If you pay too much you can almost never recover," he says. "The second thing you do is come up with plans for how you can improve the company. Can the company make acquisitions that make sense, can it divest things that don't really work? How do you make your employees more efficient?

"The private-equity players would typically have a plan for how to implement value within the first 100 days, the first year and so forth.

"Then we will often put people on the board who know something about the industry. We may bring in a CEO who knows the industry pretty well, who knows how to operate in this environment. We will also help open markets. In Carlyle's case, we can open doors in the US, Asia, Europe.

"In addition, we try to get the CEO and managers to think like owners, to make them really believe they are in control and can effectuate value and earn a lot of wealth."

However, there is real irony in is his prediction that sooner or later, private-equity firms will decide the best way to "monetise" the value they have created is to go public.

Buyer beware.