The Spectacular Rise (and Imminent Collapse) of Private Equity

the rapid growth of private Equity has been blamed  for pretty much every problem in America today   from Mass layoffs to unaffordable homes some of  this hate is totally justified and some of it is   just coming from second generation Wharton grads  who didn't land a summer internship at Blackstone   whatever your reason is for hating private Equity  you will be happy to know that after a meteoric   rise the whole model that this industry was based  on is now facing a wild collapse and I really do   think that when you have a group sitting as  a state pension fund or all they're doing is   lying a little bit to make the money come in  yeah yeah that sums it up that's because that   borrowed money becomes the responsibility of the  company private not the private Equity among the   most malevolent sources in American economic life  and global economic life private Equity is very   simply any investment into assets not listed on  public markets there are hundreds of thousands   of Highly profitable and promising businesses in  America and millions around the world that you   would never be able to buy using Robin Hood  and some pocket money private companies are   not listed on public exchanges and don't have the  same reporting requirements so it can be extremely   difficult and timec consuming for investors to  get a good idea of a business is worth buying   and how much it would be worth if it is this is  where private Equity firms stepped in as middlemen   to offer Rich investors access to this untapped  Market if you were a billionaire or the manager   of a pension fund their pitch to you was simple  they could give you a higher average investment   return than you could get in the boring old stock  market your returns would be less volatile and   your money would be safer from Market crashes they  could do this because they employed a crack team   of the best analysts in the world to do all  the hard work of finding and buying a private   company or alternative assets on your behalf and  extracting as much money as physically possible   out of it sounds too good to be true right well  it is private Equity has pushed its business   model too far and now it has trillions of dollars  worth of assets that nobody wants which sounds   like a good thing for regular people who have  been the victim of the layoffs and cost cutting   that private Equity has become famous for right  wrong there are four reasons why private Equity is   failing and four reasons why all of us are going  to be the ones paying for it the first reason is   that the returns they promised weren't as great  as they actually looked schinger cat is a thought   experiment whereby you put a cat in a box with a  poison vial that has a 50% chance to burst and a   50% chance to do nothing unless you open the box  to see what happened to the cat there is an equal   chance of it being both alive and dead physicists  use this to describe quantum mechanics but private   Equity managers have used it to raise trillions of  dollars using one simple trick my friend Ben Felix   a professional portfolio manager and non-nonsense  finance Creator first brought these problems to my   attention in a post on Twitter or X you should  definitely give them a follow if you aren't   already subscribed the value of the private  company is an alternative assets that private   Equity firms built their portfolios around are  hard to determine even by company Insiders with   full access to their financial information  an unlisted private company doesn't have its   stock price instantaneously updated like public  companies do which makes their shares harder to   buy harder to sell and harder to assign a value to  in the past investors expected a premium on their   returns for compensation for this IL liquidity  if you are a rich investor that suddenly needs   money to cover an unexpected expense shares in a  public company or listed bonds are much easier to   sell than almost any other asset liquidating a  large number of shares in a private company or   selling alternative assets like art real estate  or patents takes at least a week to find a buyer   draft paperwork and settle on a deal and that's  the absolute minimum all of these assets also need   someone like a realer auction house or Investment  Banking team to handle the sale and they are all   going to take a cut of their proceeds which  could eat into your returns for this reason   more liquid assets that are easier and faster to  sell at a well-known fair market Price are just   better and the only reason why you would invest  in less liquid assets is because they could offer   higher returns for Less risk private equity firms  have changed this though by taking advantage of   their asset's biggest weakness and using it as a  marketing tool if they never sell the assets they   hold and they never release financial statements  nobody has any idea how much their portfolio is   worth so they can just say a higher number every  year and as long as it doesn't get too ridiculous   nobody can call them out encap a large private  Equity Firm found itself in a controversy for   exactly this specifically with its investment in  Southland royalty an oil and gas company they form   Southland with over a 1 $.1 billion investment  contributing 80% of the capital or 880 million   with other investors making up the rest with  their newly formed company they acquired oil   and gas fields around the us including in the  San Juan Basin in New Mexico and the Green River   Basin in Wyoming as well as purchasing 313,000  Acres from another Oil Company when encap set   up Southland in 2015 it was hoping for a recovery  in oil prices from a drop the year before in June   2014 it was almost $100 a barrel but by the same  time in 2015 it hit $55 a barrel the problem is   that oil prices didn't reach those prices again  and their new oil fields didn't produce nearly   as much as they wanted fast forward to September  of 2019 and they still valued Southland close to   the same amount as their original investment but  2 months later they marked it down to $0 and filed   for bankruptcy when private Equity firms represent  the fair value of their companies accurately on   their books it's called marking to Market and  since they need to compete with other private   Equity firms to raise money from investors for  their next fund they're not always going to be   honest about their underperformers if they don't  have to private Equity managers could reinforce   this idea by only selling their highest performing  assets furthering the illusion that everything in   the portfolio was doing equally well the very  fact that these assets don't have instantly   updated price information actually made them  even more attractive with certain fund managers   because it lets them claim to their own investors  that their money was growing steadily even during   turbulence markets for a while this was true after  all something is worth whatever a buyer will pay   for it but now the investing public has realized  that private Equity firms are holding on to a lot   of garbage that is going to be very hard to sell  all investment carries risk and if this were just   a story about financial managers delivering  bad returns to Rich investors after making   big promises it wouldn't need its own video but  a lot of private Equity money is your money and   if this convenient lie unravels it's not going  to be the private Equity Partners losing their   job jobs so it's time to learn how money Works to  find out how private Equity failed to live up to   its promises and how we are all going to pay the  price of that lie this week's lesson was sponsored   by manscaped it's time to throw away that bulky  beard trimmer you've been using for years and   make an upgrade because manscaped is going full  head-to toe grooming with their beard hedra Pro   kit with a powerful 7200 RPM Motor and 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convenience get  your hands on the new beard hedger in handyman   head over to manscape.com howon works today  and get 20% off plus free shipping when you use   promo code hmw2 at checkout join over 10 million  men worldwide who trust manscapes today private   Equity used to be an elite investing strategy only  open to ultra wealthy sophisticated inv vors and   back then it did deliver returns above the Market  Warren Buffett's Berkshire hathway can attribute   a lot of its early success to operating like a  private Equity Firm with famous Investments like   the Nebraska Furniture Mark and Hines being  private Equity Acquisitions investors saw   the potential of private equity and now it's gone  mainstream according to data from Morgan Stanley   and published by the financial times the assets  under management and private Equity have grown   by 1, 1400% since the year 2000 private Equity  strategies like growth Equity have grown even   faster there is now 10,000% more capital in this  space than there was just 24 years ago and that   alone is the second reason why the Golden Age  of private Equity is over charts that look like   this in finance are notoriously always very  sustainable safe long-term plays that never   end up collapsing aggressively for legal reasons  that was sarcasm before you load up on Blackstone   call options obviously this can't go on forever  and already private equity's biggest threat has   been become private Equity itself if you are the  only person in town buying real estate and there   are a lot of renters looking for a place to live  you can pay whatever you want for a house because   sellers have nobody to sell to but you and you can  charge whatever you want in rent because renters   have nobody to rent from but you your returns  from this kind of Market should be extremely   strong for a long time this is how private Equity  made their money there weren't many firms buying   private companies so anybody that wanted to  sell their business had to basically accept   what these new firms were willing to pay as more  firms moved into the space and raised more money   though there was more competition to purchase  these businesses if you are a private Equity   manager and you can buy a business generating an  iata of $500,000 a year for $1.5 million using all   debt you will pay down the loan in a little over  3 years and then you could sell the company for   the same price profiting 1.5 million if you get  into a bidding war with another private Equity   Firm though and the acquisition price becomes  $5 million then you are no longer even beating   regular market returns now this simply won't  do because if you can't beat the market your   investors will withdraw their money and you will  miss out on your multi-million dollar bonuses so   you need a way to keep people invested which is  the third reason why private Equity is struggling   private Equity managers get most of their money  from delivering investment returns in excess of   broad market performance but data from Cambridge  Associates Capital IQ and Bloomberg shows that   the competition for buying companies has pushed  valuations up and using EB over EV a measure   to determine Returns the average private Equity  Fund underperforms the S&P 500 before fees this   was also shared by Ben whose literal job it is to  pick good Investments for his clients to try and   maintain their relevance private Equity managers  have resorted to leveraging up their business as   much as possible and cutting expenses wherever  they can to increase their earnings the most   popular way to do this is with layoffs a report  by the private Equity stakeholder project found   average job losses of 4.4% in the years after  an acquisition by a private Equity company that   doesn't sound too bad until you remember that most  companies add employees over time and this study   was conducted during a period when unemployment as  a whole fell by 4.5% Nationwide cost cutting has   also resulted in businesses offering worst quality  service to their customers this is bad when they   buy your favorite fast food franchise and cut  the quality of ingredients in your Whopper but   private Equity companies have even cut costs  in businesses like nursing homes preschools   hospitals and prisons according to studies from  the National Bureau of economic research as well   as reports from the Atlantic the New York Times  and Bloomberg the endless push to lower expenses   and maintain margins has been responsible for tens  of thousands of premature deaths in some of the   country's most vulnerable people private Equity  managers may be willing to do this to maintain   their margins and keep their carried interest but  now the whole industry has become so large that   it's attracting the attention of regulators who  are cracking down hard on these investors at the   end of last year the Senate budget committee  announced a bipartisan in investigation into   private Equity ownership of hospitals and  simultaneously the White House announced   a Crackdown on anti-competitive practices in  the space Congress is also pushing for a new   bill that would limit tax breaks for corporate  investors buying single family homes currently   they can claim interest and depreciation as tax  writeoffs which is making family homes one of the   most attractive asset classes for investment funds  that have grown too large to acquire more private   businesses 20 years ago private Equity was a niche  investment strategy that nobody heard of but its   rapid growth in high returns got the attention of  big investors who ruined a good thing by taking   it too far now it's got the attention of young  people who can't afford a home utterly people   who can't afford care and politicians who can't  afford to not look like they are doing something   to fix this problem I am writing an article on  the best and worst firms and investors in the   private Equity Arena over on my completely free  email newsletter compound and daily if you want   to read that and get all my videos day early sign  up at the link below the bonus fourth reason why   private Equity is overdue collapse is that it was  never built with longevity in mind go and watch my   video on what the private Equity actually does  to find out how the early investors made their   billions and got out and don't forget to like  And subscribe to keep on learning how money works

Channel: How Money Works

Views: 884,196

Keywords: private equity, rise of private equity, how money works, how history works, private equity housing, bain, blackstone, blackrock, blackstone vs blackrock, what does private equity do, private equity collapse, what is private equity, venture capital, investing, shares, stock market, alternative assets, crypto, the overdue collapse of private equity

Id: z_yyKN30Qyg

Length: 13min 12sec (792 seconds)

Published: Sun Mar 31 2024