Private equity spending spree

Stacks of hundred dollar bills

KAI RYSSDAL: Jones Apparel is pulling itself off the rack. The New York Times says the company couldn't find any buyers. There were reports some private equity firms were interested. But it looks like they weren't willing to shell out the nearly $4 billion the clothing maker was asking. That's one of the few times in recent months private equity firms have steered clear of making a big deal. And it might be a sign of things to come. Adam Lashinsky's been on the private equity beat for Fortune Magazine.

Hi, Adam.

ADAM LASHINSKY: Hey, Kai.

RYSSDAL: I think, probably, we have to define a term first here that a lot of people have heard, might not really understand: Private equity.

LASHINSKY: Private equity refers to firms that raise large amounts of capital and then go out and buy other companies, using a ton of debt in the process and then pay back that debt in various ways until they eventually sell the company, which is how they make money for their investors.

RYSSDAL: You've been looking into this and you have a theory now that we've seen what's happening in private equity in some other markets before.

LASHINSKY: Yeah, we absolutely have. We've seen this happen in private equity in 1987 and again in 1998. These were times when conditions appeared to be extremely good for making private equity investments. Low interest rates. Plenty of capital for the private equity firms to invest. Plenty of companies that the stock market isn't valuing fully for whatever reason. What happens at times like this is that many, many private equity companies raise a ton of money, they go in and buy more and more companies in more competitive situations with each other — which means that they're bidding against each other and bidding up the prices and, eventually, they start to do stupid deals and it all comes unraveled. This has happened before. It will happen again.

RYSSDAL: Let me look back for a minute at a couple of deals that have happened in the last month or so that have had really big dollar amounts attached to them and get your take on those. The first is HCA, the Hospital Corporation of America. And it went for $33 billion.

LASHINSKY: Yeah, it stands to be, if not the biggest, among the biggest, private equity deals ever. This may end up being a good deal. But what has not been proven in the private equity world is whether or not they can buy very large companies. They're extremely good at buying relatively small and medium-sized companies because they can bring enough capital in where they can handle the situation. Complete unknown, Kai, if they can do something this large.

RYSSDAL: This isn't my money. It's not your money. It's not somebody whose living on a pension in Iowa's money. It's a bunch of rich guys playing around. Really, who cares if they lose.

LASHINSKY: Oh, no! Oh, no, Kai! It is your money. It is my money. And all the other people you just described. Because these firms are raising ever-larger funds. The most recent funds have been in the $15 billion range. There's only one place where you can get that kind of money, and that's from pension funds, whether they belong to teachers' retirement funds, large insurance funds, all of us have our money in those types of funds in one form or another.

RYSSDAL: Alright, Adam, one more for you before I let you go. And this is maybe the toughest question. How do you know we're at the top of the private equity market?

LASHINSKY: The short answer is, you don't know. the longer answer is, in the past the peak of the private equity market has come at a time when two things have occurred. One, the fund sizes are getting bigger and bigger. And the second thing is, is when they start paying higher and higher valuations for the companies that they're buying. Both conditions exist in the market today.

RYSSDAL: We shall see. Adam Lashinksy at Fortune Magazine. Thanks, Adam.

LASHINSKY: Thank you, Kai.

About the author

Kai Ryssdal is the host and senior editor of Marketplace, public radio’s program on business and the economy.

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