About the same time that “junk bonds” became “high yield” and shortly after “third world” became “emerging markets,” the finance industry quietly engineered another rebranding: “leveraged buyouts” became “private equity.”
So as Andrew Ross Sorkin notes today, the idea of a private-equity shop without debt is fundamentally at odds with the genesis of the industry. This is private equity done the old-fashioned way, where “old-fashioned” means “unprecedented.” But in Brazil, it makes perfect sense: rates there are simply too high to be able to make LBOs profitable, and meanwhile there are lots of efficiencies to be found turning smallish family-owned companies into much larger professionally-run operations.
Brazil is particularly suited to this model, as it has a lot of family-owned companies, and it also has a large elite professional class which is more than capable of taking them on and running them efficiently.
Sorkin is a bit credulous when he wonders at how Brazilian private-equity shops can “make such huge profits,” citing returns of “more than 20 percent annually.” The fact is that many of these family-owned companies, if they’d simply waited two or three years and gone the IPO route instead, would have seen bigger returns than that on the amount of money that they actually sold for. The IPO market in Brazil has been white-hot for a while now, barely taking a breather for the global financial crisis to come and go. Brazilian private-equity shops fund themselves with 100% equity not just because debt is expensive, but also because equity is extremely cheap.
That said, it does make a certain amount of sense for a deep-pocketed investor to buy a good but small franchise and spend the money needed to get it big and efficient enough to IPO effectively: private-equity firms are probably a good way of shepherding companies to the promised land of an IPO, or some other big exit. Effectively, private equity in Brazil is behaving more like US venture capital than it is like US private equity. Except it’s more interested in old family-owned companies than in young technology start-ups.
All of this is a welcome development, in a world with enormous systemic risks associated with debt finance. Private equity might not be as good as public equity, from a public-policy point of view. But it’s still better than debt.