Staples investors should take the money from private equity and run By Mark Hulbert | July 1, 2017
Why investors should be cautious about private equity’s ability to improve a company’s profitability
CHAPEL HILL, N.C. — Is going private going to save Staples?
I have my doubts, even though many believe that being acquired by a private-equity firm improves the odds that Staples SPLS, +0.15% can survive in the cutthroat retail arena. My doubts trace to a recent study that found that companies undergoing a private-equity leveraged buyout don’t perform any better after going private than they did when they were publicly traded.
In theory, of course, a company should be able to improve profitability once it is freed from the short-term constraints of having to please Wall Street and thereby able to invest in long-term growth. But until this recent study, it was impossible to know whether this conventional thinking was right, since — by definition — the performance of private companies is private.
This seemingly insurmountable obstacle was overcome by a study that appeared in the Journal of Financial Economics in 2014. The authors were able to gain access to the tax returns of companies after they underwent an LBO, and thus able to measure their operating performance after going private. Their study focused on more than 300 previously public companies that were acquired in LBOs between 1995 and 2007; those companies represented close to 90% of all LBOs during this period.
The researchers found “little evidence that LBOs in the 1990s and 2000s result in improvements in operating performance, on average.” Particularly revealing is what they found when focusing on just those companies that, before the LBO, were unprofitable. This is the relevant group for comparing with Staples, since the company lost money last year. They found that these unprofitable companies performed no better after undergoing LBOs than similarly unprofitable companies that nevertheless remained public.
There are two investment implications of this study that are worth emphasizing. The first is that, insofar as investors begin to recognize and appreciate what this study found, they may become less willing to invest in private-equity funds, thereby reducing the amount of money available for such deals.
This may be at least part of the reason why private-equity activity has been running at a much-reduced pace in recent years. The Staples deal announced Wednesday, for example, would be (if it goes through) the biggest so far this year.
The second investment implication is that we need to become much more realistic about the kind of performance we can expect from investing in private equity. Though measuring private-equity returns is fraught with methodological difficulties, many studies have found that the average private-equity fund lags the market. One widely cited study was authored by Ludovic Phalippou of Oxford University in England and Oliver Gottschalg of HEC Paris, the French business school, and looked at performance from 1980 through 2003. They found the average private-equity fund lagged the S&P 500 by 3% after fees were deducted, and even more—by 6%—on a risk-adjusted basis.
None of these investment implications affects Staples investors, needless to say, since they are on the verge of selling their shares at a 20% premium to the price prevailing before the announcement of the LBO. My advice is to take the money and run.
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