Fixing the greed in private equity
Private equity pioneer Warren Hellman explains how the ego-ridden world of high finance can be saved. Fortune's Michael Copeland reports.
SAN FRANCISCO (Fortune) -- Warren Hellman, chairman and co-founder of San Francisco-based private equity firm Hellman & Friedman, doesn't like what he sees these days in the industry he helped pioneer more than two decades ago.
Hellman thinks private equity firms like Steve Schwarzman's Blackstone Group (Charts), which recently went public, and those that plan to like KKR, are doing so, not from competitive drive but from something far more basic. "It's plain and simply a five-letter word that begins with G and ends in D (for all of you playing at home, that's GREED)," Hellman says. "Nothing more."
Hellman & Friedman, known for its successful buyouts of companies like Levis Strauss, Young & Rubicam, and most recently selling DoubleClick to Google for $3.1 billion, will never be a public company, he told a small gathering recently at Stanford Law School. "Our philosophy is investing for the long-term," Hellman says. "We don't want to be held to quarterly scrutiny. Going public would just be a distraction from our business."
As to the $20 billion fund raised by Goldman Sachs (Charts, Fortune 500) earlier this year and the $21.7 billion fund raised by Blackstone over the summer? "Look, we recently raised an $8.5 billion fund, and we could have raised a lot more," Hellman says. "But we are not in the testosterone business - $20 billion has a lot to do with testosterone, it has a lot to do with a high price of an IPO."
"Big egos have impacted our industry adversely. I wish our competition would try and keep a lower profile. Buying fancy homes in fancy places doesn't help us get along with governments or other investors."
Clearly, much of Hellman's disdain is aimed at private equity's bull's-eye of the moment, Blackstone's Steve Schwarzman. The recent move in Congress to tax the earnings of private equity companies that go public at a rate more than double the typical 15% capital gains has been dubbed the Blackstone Bill. It's not hard to connect other legislation afoot, that would tax all private equity earnings at a higher rate, to the high profile profits of Schwarzman.
While he put a theatrical hand over his mouth to avoid any comment on the pending tax issue, you get the sense that having his taxes doubled because guys like Schwarzman are profiting and spending like kings is not a popular idea with Hellman.
The two men are quite a contrast in many ways: Schwarzman's 60th birthday bash in February was a reported $3 million to-do in Manhattan for the NYC media elite that featured Rod Stewart as entertainment. Hellman's idea of a party is more low-key and low-budget. He throws an annual bluegrass festival in San Francisco's Golden Gate Park that features the likes of Emmylou Harris and Steve Earle. About 100,000 people showed up two weekends ago for the free three-day festival, which Hellman pays for out of his own pocket (he won't say how much it costs him, but it's likely much less than $3 million).
Just as his taste in music isn't part of the master-of-the-universe norm in private equity, so too is the way Hellman runs his shop. Hellman & Friedman is in one line of business - private equity buyouts. There is no mezzanine fund, no hedge fund, nothing that competes with the company's focus. "Everybody is pulling the same sled," Hellman says "We are involved in making that sled go fast, and it's worked for us."
Hellman & Friedman likes to wear its fees on its sleeve. Unlike many private equity firms, Hellman & Friedman doesn't charge its portfolio companies for transactions associated with say, M&A or real estate leases. Hellman and his colleagues get paid a management fee and a carry if the fund makes a profit. "I believe that people really do what they get paid to do," Hellman says. "We are not incentivized to get a transaction done, we are incentivized to do good deals."
As to what he looks for in a potential target company: "We like free and clear cash flow," Hellman says. "And we like elevator assets, so rather than a factory I'd rather have a very high human content business, that's why we have done deals involving a number of money management firms or the advertising firm Young & Rubicam."
Hellman looks for a management team that he can bring into a deal, or if he believes in a team already in place, he'll let it stay. But if the choice is a great team and a so-so business, or a great business and a so-so team "We'll take the great business every time," he says.
And there may be a whole lot of great businesses ripe for his buyout team soon, Hellman says. There are a lot of promising companies that are over-leveraged at the moment. When that debt comes due in the next few years, and these companies can't afford to service it: "We can step in and buy the debt," Hellman says. "It may sound a bit vulture-ish, but those are lots of the opportunities that I see coming."