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Private Equity Firms Play Key Role in U.S. Business

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August 25, 2009 by   Leave a Comment

New companies are stepping in to buy up the area plants owned by bankrupt auto parts and RV makers. And it seems in every case, the new owners are privately held and often new to the sector into which they’re buying.

Private-equity firms have a bad name in some circles. The private investors often disclose little about themselves and seldom plan to operate a company for more than five years. They’re suspected by critics of facilitating the flow of U.S. manufacturing jobs overseas, according to the Fort Wayne, Ind., Journal-Gazette.

But they can also identify the most valued parts of a troubled company and preserve jobs, said Kenneth Carow, a professor of finance at Indiana University-Purdue University Indianapolis.

“They’ve been called ‘vulture capital,’ ” Carow said. “They pick over the carcasses of bankrupt companies.”

And just as vultures play an important role in nature, business experts say private-equity firms play an important – and growing – role in the U.S. economy.

“Clearly, you have a shift in the ownership structure of the U.S. industrial base,” said Gary Moore, chairman of the University of Toledo’s finance department.

The shift has been away from companies with shares traded on stock exchanges, Moore said.

Many of the private firms doing the buying these days are 10-year funds at the end of which wealthy investors expect a healthy return on their money.

An example is American Industrial Partners Capital Fund IV LP. The fund raised $400 million late in 2008. It plans to make industrial investments, spend about six years improving their value and then spend the next four selling them at a profit, said Paul Bamatter, a partner in the fund.

In July, AIP bought the Decatur motorhome assets of bankrupt Fleetwood Enterprises Inc. The operation now employs about half the 1,300 who worked for Fleetwood in Decatur in 2007. But, Carow points out, Adams County kept 650 jobs because AIP stepped in.

“They didn’t go to zero,” he said.

But a Fleetwood plant in Edgerton, Ohio, has gone to zero, and one in Garrett, Ind., almost did when AIP didn’t include them in its purchase. The Edgerton travel trailer plant shut down in March, when Fleetwood declared bankruptcy. Unless a buyer is found, its 175 employees will remain on the street.

Eighty workers at the Fleetwood manufactured-housing plant in Garrett might have faced a similar fate if a group of local investors hadn’t stepped up and bought it this month.

Different take

Wally Comer, one of the local investors, said his group has a strategy different from private-equity funds.

He and two partners bought the Garrett plant for $1.75 million, plan to make it profitable and operate it long term. AIP, however, bought the motorhome operation for $53 million and plans to sell it within the decade.

“To them, they don’t want to tie up $2 million to make $1 million in profit,” Comer said. “They’d rather tie up $50 million to make $50 million in profit.”

The difference in philosophies also is illustrated in how employees in Decatur and Garrett were treated, Comer said.

The motorhome workers lost their vacation time and took a 10% pay cut. The manufactured housing workers, now working for Adventure Homes LLC, kept their pay and vacation and got increased bonuses.

That’s because Comer said he and his partners put a premium on maintaining the loyalty of their workforce.

Driving force

Private-equity owners act only after considering what’s in the company’s best interest, said Lawrence J. Lawson III, managing director of co-founder of Lincoln International LLC, a Chicago-based investment-banking firm.

“What’s in the best interest of the company and what’s in the best interest of the employees aren’t always the same thing,” said Lawson, whose firm advises companies on acquisitions and provides other services.

It’s hard to find numbers showing private-equity’s increasing control of American manufacturing, but there’s broad agreement that’s the case.

“Private equity raised a tremendous amount of capital between 2005 and 2007,” Lawson said.

Not going back

He estimates that private-equity firms worldwide now have $1.5 trillion at their disposal. That means they’re going to buy more businesses — including Midwestern manufacturers, Lawson said.

“There’s more in private hands, and it’s not going to go back down to where it was 20 years ago,” Lawson said.

The slew of industrial bankruptcies in the past year also have created an opportunity for private-equity firms to buy manufacturers.

Investors in private-equity firms are more tolerant of risk than investors in publicly traded companies, said Carow, the IUPUI finance professor. Expecting greater returns, private-equity investors are much more likely to go along with the purchase of parts of a bankrupt company than those who are buying stocks, Carow said.

In fact, some private-equity firms such as AIP specialize in buying and turning around troubled companies. Some buyers specialize in other areas, such as adding market share or making a domestic company an international one, Lawson said.

And because most funds last only 10 years, firms look to buy, make changes and sell companies within five years, Lawson said. That frees private-equity firms from the obsession with quarterly profits faced by publicly traded firms but maintains pressure to produce results.

“There’s a sense of urgency to private equity,” Lawson said.

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