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Teva, Check Point and the Black stone14/02/2006. Source: Israel Venture Capital Journal (IVCJ). Eyal Shamir, Vice President of Business Development, BDO Ziv Haft
 In this Israel Venture Capital Journal article, Eyal Shamir, Vice President of Business Development at BDO Ziv Haft looks at the resurgence of buy-out funds. He finds that their growing power makes even the largest companies potential takeover targets. Israeli companies, too, are not immune to their grasp.
$50 billion is not the annual budget of the State of Israel, $12.5 billion is not the Israeli defense budget, $3.2 billion is not Intel’s projected investment in its new Kiryat Gat plant, and $250 million is not the annual budget of the Office of the Chief Scientist. We have news for you. These numbers are the day talk in one of the hottest global investment markets that is experiencing an upswing, big time – private equity funds.
$12.5 billion is the amount raised for a new buyout fund by the private equity firm the Blackstone Group that was founded 20 years ago by Peter Peterson and Stephen Schwarzman. The huge raise broke the world record shared by Goldman Sachs ($8.5 billion) and the legendary Carlyle Group, which reported a fund of some $8 billion, creating new standards for the industry. In order to put things in perspective, the defense budget of the State of Israel is NIS 39 billion (slightly more than $8.5 billion).
The investment potential of a fund that size is $50 billion (assuming solid leverage of 75 percent), an amount that is equal to the annual budget of a small country or the combined defense budgets of Israel, Egypt, Jordan, Syria, Libya, and Iran. So we are talking about serious firepower by any standard.
$250 million is the annual management fee (reflects two percent of the fund) that is likely to be divided each year among the fund’s managers (5- 10 people), not including their expected share of the carried interest, which is 20-25 percent. For the sake of comparison, the Chief Scientist’s investment budget for 2005 is NIS 800 million (slightly more than $175 million).
$3.2 billion is the average annual return expected by the fund’s investors, assuming an IRR of 25 percent. For comparison, the largest single investment by a foreign corporation in an Israeli plant stands at $3 billion-$4 billion. This refers to the expected investment of Intel in its new Kiryat Gat plant of which 25 percent is being financed by the State through grants or tax exemptions.
What exactly are buyout funds?
Buyout funds are funds that leverage their capital with loans in order to finance acquisitions, and that is the origin of the concept leveraged buyout. The buyout fund industry had its heyday in the late 1970s and 1980s, and managed to create a legendary aura for itself and its managers. KKR, the most famous private equity fund of all time, was headed by Henry Kravis and his two cousins, Jerome Kohlberg and George Roberts. It contributed significantly to this glory following a hostile takeover of RJR Nabisco for the once unrealistic sum of $31 billion. This deal stunned the US capital markets, but opened a new leaf for the industry. The deal was forever etched in the annals of US corporate history thanks to the all-time best-seller (and later movie) Barbarians at the Gate. The book describes the course of the RJR Nabisco hostile takeover, as well as the corporate culture of those times. It became must reading in all elite business schools for any student with eyes cast on Wall Street.
Over the years, the buyout industry lost its aura. The new players became VCs, and hedge funds offered investors better risk/return and short-term strategies. Recently, however, perhaps because of investor disappointment with the latter two, buyout funds are big-time back in business. The hottest names in the industry are KKR; Blackstone; Texas Pacific, which recently announced that the outgoing CEO of the giant Indian software firm Wipro had joined as a partner; the Carlyle Group; and Global Atlantic among others. According to Bloomberg, this industry made a remarkable $148 billion in acquisitions during the first half of 2005 alone! Back to Blackstone. Its new mega-fund illustrates two key points.
Firstly, Blackstone’s management has thoroughly internalized Donald Trump’s view, "In any case, you need to think, so why not think big?" The second refers to a broader perspective on buyout funds or, more accurately "mega-funds," and the unprecedented financing obtained giving them the potential to take over global conglomerates and to enable them to indirectly affect all of our lives. We should remember that industry managers such as Blackstone point only toward performance (in this case, an average annual return of $3.2 billion) in order to continue receiving their $250 million yearly management fee as well as their share of the upside in their next funds.
How to choose the target
As with every investment, here too there are assorted strategies (distressed securities, yield/income, special situations, value investments, etc.). However, the amount of liquidity in the private equity sector and the targeted IRR require the use of more aggressive strategies. Thus, the preferred alternative is to identify target companies with a relative local or global advantage. The private equity firm would then take the aggressive action of a hostile/friendly takeover followed by an accelerated process of maximizing the return potential. In certain cases, this may mean breaking up the company into pieces and selling it to the highest bidder. The appeal of a target may be a strong balance sheet, spare cash and cash equivalents, weak management, company dormancy, hidden assets, a winning technology, a high-potential brand or one with a leading position in a local or global market. Companies that meet the last criterion are like a lighthouse in the dark that attracts all the pirates. Since their essence makes them a potential target, they are being monitored until weakness is encountered that exposes them to takeover.
How do you play?
It seems that sums of tens of billions of dollars intended for aggressive investments, such as hostile takeovers, open a vast new canvas for potential investments. The ownership structure of companies in the US stock market and the wide distribution of shares among the public, in effect, make it possible to acquire control of a company by purchasing as little as 10 percent of its shares. The firepower of $50 billion, even before realizing the potential of creating a consortium of several funds to increase the size of the investment, essentially makes it possible to take over any large corporate entity.
In practice, these mega-funds recently made several such deals, including the acquisition of the exclusive department store chain, Neiman Marcus; the amusement parks run by Swedish toy manufacturing giant, Lego; the British department store chain, Marks and Spencer; the software giant, Sunguard Data Systems; and the toy retailing giant, Toys ‘R Us, which was bought for its hidden real estate assets. Other companies valued at tens and hundreds of millions of dollars that display any weakness will now be potential targets regardless of size or industry such as Disney, Johnson & Johnson, Alcoa and Du Pont.
Israeli perspective
Undoubtedly, major local corporations are also considered to be a spark in the dark global investment world and are drawing the attention of buyout investors. The $1.5 billion Israeli software firm Check Point, with its cashbox, market leadership and potential to sell its attractive technology to companies such as Cisco, make it a preferred target. Teva Pharmaceutical, which will take over leadership of the worldwide generic drug market following its merger with Ivax, is positioning itself as an attractive target with no ability to protect itself due to the substantial debt it will incur in the wake of the merger deal.
It should also be noted that one of the most famous, aggressive and well-known players in buyout funds (not mentioned in this article) traveled all the way to our little country and is now in the process of acquiring one of Israel’s strongest and biggest organizations, while also searching for other opportunities of every shape and size.
This article appeared in the Israel Venture Capital & Private Equity Journal (IVCJ). IVC Research Center publishes the Israel Venture Capital & Private Equity Journal, a quarterly review of trends and developments in the Israeli-related venture capital industry. IVCJ, distributed worldwide, is dedicated to provide wide-range coverage of Israel's venture capital industry. For more information please visit www.ivc-online.com
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