Barbarians back at the gate

Private equity is circling ASX-listed businesses – just one more sign that today's market is cheap

a woman

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So, Chesty Bond might fall into the dastardly clutches of the overseas raiders.

KKR, the company profiled in the wonderful book 'Barbarians at the Gate' has expressed an interest (which, let's face it, is almost a euphemism given the nature of private equity) in Pacific Brands Limited (ASX: PBG).

A euphemism, because these guys almost always get what they want. They have deep pockets, iron wills, and an investor base who are either longer-term focussed, locked-in or both.

A formidable record
That's not to say private equity deals always end in joy for the acquirer. Redgroup, the owner of booksellers Borders and Angus & Robertson, was itself owned by private equiteer Pacific Equity Partners. As we all know, that particular gamble didn't pay off for PEP, with Redgroup ending up in voluntary administration.

Redgroup is far more likely the exception that proves the rule, however.

Private equity investors, as a group, are far more like traditional investors than many would like to admit.

Yes, they often leverage the acquired business to the eyeballs, and that makes the company a much riskier proposition as a going concern. That, along with the structural downturn in physical book purchases, is what probably bought Redgroup down.

Patience and a plan
They also, however, take a longer view. In my opinion, the only reason KKR is looking at Pacific Brands right now is that they probably believe the market has oversold the company, to the point where the price is well below the value they believe they can extract.

Being willing and able to look beyond the next quarter's results, and beyond the current retail downturn, is core to their business model. They buy at opportunistically cheap prices. They fix, refinance and sell – and do it very well.

So what can we take from the potential take-over of Pacific Brands?

Lessons for investors
First, KKR almost certainly believe today's price is cheap – why else would they buy? The purchase is not without risk – Pac Brands could become the next Redgroup – but they obviously believe the price makes the risk worthwhile. It's hard to argue – the announcement from Pacific Brands came out as the shares were trading at around 6.5 times next year's forecast earnings.

Secondly, you can bet these guys have already planned for a number of exit scenarios – so they would have a sense of how they plan to make Pacific Brands more valuable to someone else in 3 -5 year's time. While individual investors don't have the range of options that KKR do, we had the opportunity to take a similar view – that the business would ride out this slump and be worth more in 5 years than it is today – and buy at Monday's price of $0.56 per share.

Next, it's a well-worn maxim that you should never buy when private equity – or in the past, Kerry Packer – is selling. You just know they wouldn't sell unless they were doing better out of the deal than you are. If you believe that – and I do – then the reverse is likely true. That is, if private equity is buying, then the sellers are leaving a lot of money on the table.

Bought out from under our feet
For me, that's one of the most frustrating parts of some private equity takeovers. I'm a Pacific Brands shareholder, and fundamentally believe the company is worth more than both Monday's share price and yesterday's closing price, even after the bump from yesterday's news. If the takeover is successful, however, I won't get the chance to benefit from that upswing – the company will be in the hands of KKR.

Unfair, you say? Perhaps, but that's the nature of the free market. What it reminds me is that the market can be irrational – and keep prices low for a long time. Maybe KKR is wrong, and they'll be nursing a serious loss by 2017. It's certainly possible, and maybe they'll do me a favour by taking the shares off my hands.

Possible, but not likely. These guys are smart, successful and rich. You don't have to like the way they do business, but it's hard to argue with their overall track record.

Foolish take-away
I think this potential takeover also has a broader message for investors. Private equity is circling ASX-listed businesses at the moment, and for my money, that's just one more sign that today's market is cheap. I've said it before – I think we'll look back on this time and rue the fact we didn't invest more – or have more to invest – in the stock market (both here and overseas) at the beginning of 2012.

Oh, and one last thing. If this takeover goes ahead, you might be well served ignoring the re-floatation of the business a few years hence – if you don't believe me, just ask the investors who took part in the floats of Myer (ASX: MYR) and Kathmandu (ASX: KMD)!

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More reading
Seeds of a new boom for shares?

Scott Phillips is The Motley Fool's feature columnist. Scott owns shares in Pacific Brands. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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