Private Equity: Nothing Lasts Forever

I think every investor should read the piece written by Andy Kessler in the June 21 Wall Street Journal. Kessler, a former hedge fund trader makes some telling points regarding the world of private equity, and what it may mean for the overall markets.

He discusses the liquidity issue, and how Wall Street is awash with cash as companies, which are already priced to perfection, continue to be bought at higher premiums. All this money, and the historically low borrowing rates that come with it have enabled companies such as Blackstone (BX), and Kohlberg Kravis Roberts & Co. [KKR] to conduct deal after deal.

He also mentions the use of a debt instrument that has resurfaced from the last buyout cycle. They are payment in kind bonds (PIK). Kessler writes that the name may have changed to Covenant Lite, and PIK toggle, but nonetheless, they are back in vogue. These instruments allow companies to suspend cash payments when times get tough while being sold to hedge funds which can book profits on them up front. These lending arrangements leave very little fiscal discipline for anyone.

With all this buzz and hype of course surrounding the buyout cycle, it has not taken long for the creators of this buzz to cash in on their names. Blackstone Group came to Wall Street first, and BX 29.27 began trading last week. Wanting to seize the moment and the cash, KKR indicated that it also may be public before long.

I find a great deal of wisdom in Kessler's view because anyone who knows Wall Street knows that nothing lasts forever. Private equity, and the buyout buzz it is generating could be signaling a major top. As the ten year bond inches higher, and money supply tightens, the rest of the investment world could sober up from this three to six month buyout binge, and a sharp hangover-like correction could be in the offering.