Market and Rates Helped Private Equity Chiefs Thrive Last Year
March 4, 2014
The New York Times
Payouts for the top executives in private equity have rocketed into the stratosphere, thanks to a soaring stock market and shrewd maneuvers by their firms in the aftermath of the financial crisis.
But the millions upon millions in earnings disclosed in recent days were so great that the same executives may not be able to reap quite so much in the future. Some of the dynamics that enabled these princely payouts are now posing a daunting challenge for private equity’s deal makers, who must reload their profit machines by finding cheap deals when stock indexes are soaring.
The founders of the top four publicly traded private equity firms took home $2.6 billion in 2013, according to recent filings. Leon D. Black, the chief executive of Apollo Global Management, personally made $546.3 million, more than twice his take a year earlier. Stephen A. Schwarzman, the head of the Blackstone Group, took home $452.7 million, also more than double what he made in the previous year.
The three founders of the Carlyle Group, a private equity giant based in Washington, together earned $749 million, while the two cousins who co-founded Kohlberg Kravis Roberts, Henry R. Kravis and George R. Roberts, each made more than $160 million. These payouts are largely dividends and they include any profits from the executives’ personal investments in their firms’ funds.
The compensation for the top executives at many of the industry’s other large firms, like Bain Capital and TPG Capital, remain unknown since those firms have stayed private and thus are not required to disclose executive compensation.
Fairly or not, private equity’s rewards have also become a political lightning rod, and probably will continue to be, as the midterm elections draw near. President Obama on Tuesday once again proposed to end a tax benefit for some of these private equity executives, and last month, the chairman of the House Ways and Means Committee proposed a similar measure, though the bill is seen as having virtually no chance of success.
The enormous sums for private equity executives vastly exceed the already-rich pay packages at Wall Street banks, booming technology companies and Fortune 500 corporations. For instance, Wall Street’s top banker, Jamie Dimon, the chief executive of JPMorgan Chase, made $28.5 million in 2013, including dividends, about one-nineteenth of Mr. Black’s haul.
But for all the wealth that has been generated, last year’s handsome payouts are in large part a product of the particular financial environment — one of low interest rates and high stock prices — that was ideal for selling investments.
“Those payouts can’t last,” said Charles M. Elson, a finance professor at the University of Delaware. “The question is: Will you continue to have that kind of frothy market that will enable them to take companies public at such significant premiums?”
A booming market creates challenges of its own for the industry. Private equity firms are collectively sitting on nearly $1.1 trillion of capital they must invest for clients — “dry powder” in Wall Street parlance — more even than they had before the crisis, according to the data provider Preqin. But if the buyout firms overpay, investment returns, and executive payouts, will fall, a conundrum weighing on the minds of the industry’s leaders.
“We can still survive and make clever investments in the environment we’re in now. However, you have to be careful,” Joseph Baratta, the head of private equity at Blackstone, said in an interview on Tuesday. “With the available credit at high levels, and the cost of it at historic lows, you can talk yourself into doing things that may not be prudent in terms of values you have to pay.”
Private equity firms, which buy companies and typically hold them for several years, ran into this problem in the years leading up to the 2008 crisis. But a number of investments that seemed doomed when the crash hit have been sold or taken public at rich valuations, thanks in part to clever management and financial engineering — and thanks as well to the soaring market.
Blackstone, the biggest of the firms, realized a $9.5 billion profit in December when it held an initial public stock offering for Hilton Worldwide Holdings, a hotel chain that struggled in the downturn. That gain was outpaced only by Apollo, which achieved a profit of roughly $10 billion from its investment in the chemical maker LyondellBasell Industries.
Mr. Black of Apollo captured the mood last spring when he said at a conference in Los Angeles that his firm was “selling everything that’s not nailed down in our portfolio.”
Certainly, private equity’s clients — pension funds and other institutions that provide the capital — are also benefiting handsomely from the firms’ successes. The industry returned an estimated $124.1 billion to investors last year, 8 percent more than in 2012 and more than five times the level in 2009, according to the consulting firm Cambridge Associates.
Now these investors are demanding more. Buyout funds raised $169 billion in capital last year, 77 percent more than in 2012, according to Preqin. Apollo, for its part, raised a fresh $18.4 billion fund.
Market forces also played a role in fund-raising. Pension funds, which often aim to invest a certain percentage of their assets in private equity, must increase those investments when their total assets grow on the back of rising stocks.
One private equity chief went so far as to publicly thank Ben S. Bernanke, the Federal Reserve chairman until last month, whose program of extraordinary economic stimulus has helped push stocks higher, feeding the private equity machine.
“Thank you, Ben Bernanke. I saw him last Thursday, and I thanked him,” Mr. Schwarzman of Blackstone said during a conference in December. “The opportunity for us to be able to attract funds is very, very high.”
But some private equity chiefs recognize that these returns may not last. David M. Rubenstein, a co-founder and co-chief executive of Carlyle, told students at Harvard Business School last month: “The days of getting fabulously rich in private equity may be a little bit behind us.”
Mr. Black, too, sounded a note of caution at a Columbia University conference last week. He quoted the Kipling poem “If,” which encourages the reader to “meet with Triumph and Disaster” and “treat those two impostors just the same.”
“We had a very good year,” Mr. Black said. “It’s important that it doesn’t go to our head.”