Chapter 6: Is Private Equity Going Mainstream? Trends, Bubbles and Dry Powder
Private equity used to be the quiet kid in the back of the finance classroom. Small groups of rich people pooling money together to buy companies, fix them up, sell them. Nobody outside the industry really cared. That changed. PE firms got huge, went public, and started buying companies the size of small countries. Chapter 6 of Demaria’s book asks the obvious question: is private equity going mainstream? And if so, what does that mean for everyone involved?
When PE Firms Got Really, Really Big
The numbers from the mid-2000s are wild. Blackstone bought Equity Office Properties for $36 billion. KKR, Bain, and Merrill Lynch took HCA private for $33 billion. Apollo and TPG grabbed Harrah’s for $27.8 billion. Then in 2007, TXU was bought for $45 billion, the largest leveraged buyout ever. The Financial Times even floated the idea that Microsoft could be a PE target. Microsoft.
But many of those mega deals went badly. TXU failed spectacularly. Harrah’s failed. Freescale and First Data nearly followed. The SEC started investigating “club deals” where PE firms teamed up, worried they might be colluding instead of competing. The aftermath of 2008-2009 forced changes: regulators said keep debt under six times EBITDA, club deals gave way to co-investments, and corporate buyers with cheap debt became serious competition.
Large deals did not disappear though. In 2013, 3G Capital and Berkshire Hathaway bought HJ Heinz for $23.2 billion. Dell went private for $24.4 billion. PE’s share of global M&A stayed between 14% and 19%. They are permanent now.
PE Firms Go Public (And It Got Awkward)
One of the most interesting parts of this chapter is about PE firms trying to get permanent capital. See, the traditional PE model forces fund managers to go back to their investors every few years and beg for money again. That process is exhausting and expensive. So they tried alternatives.
Some firms listed investment vehicles on stock exchanges. KKR listed a fund on Euronext Amsterdam in 2006. Raise money once, invest forever, no more fundraising. Sounds great. But the share price tanked. Listed PE funds trade at roughly a 30% discount to their actual net asset value. Investors have almost no transparency into the underlying companies, quarterly reports come with a lag, and unused capital drags down performance.
Then Blackstone went public in 2007, and KKR, Apollo, Oaktree, and Carlyle followed. They all underperformed the S&P 500. When you list a PE firm, public investors just see an asset management company. They price in the management fees but can not really value future carried interest. The PE magic disappears when you report quarterly.
Some firms tried longer-duration funds, 15 years or more. Hold companies longer, create more value. But keeping staff motivated when the performance fee is a decade away is hard. This experiment stayed marginal.
Does PE Actually Create Value?
This is the question that keeps coming back. Demaria tackles it head on.
The common explanation is the “illiquidity premium,” that PE returns more because your money is locked up. Demaria pushes back. He says this concept only applies to fixed-income, like bonds. In equity investing, the lockup is not a risk you are compensated for. It is just how the strategy works. PE firms need 3 to 8 years. That is not a bug. That is the product.
The real value creation comes from active management. PE board members are deeply involved. They know the companies inside out from due diligence. They call management directly, visit sites, push for specific operational changes. Compare that to a typical public company board that meets a few times a year and mostly rubber-stamps decisions.
For venture capital, value creation means helping startups hire and go global. For LBOs, it means operational improvements, buy-and-build strategies, and restructuring. KKR designs a “first 100 days” plan for every acquisition. Blackstone built business units across LBO, distressed debt, and real estate that share intelligence.
But there is a catch. A 2006 Citigroup study applied the same financial leverage used by PE firms to a basket of public mid-cap stocks. The backtested return? 38% annualized, which is higher than both the top-quartile buyout funds (36%) and the LBO average (14%). In other words, a big chunk of PE’s reported performance might just be from using borrowed money, not from actually being smarter operators.
Demaria is fair about it: value creation is real, but it is not automatic. You have to look past the IRR numbers and understand how the returns were generated. Was it leverage? Multiple expansion? Or actual operational improvement?
Bubbles: When Too Much Money Chases Too Few Deals
PE is not immune to cycles. Economic cycles hit portfolio companies. Financial cycles determine how much capital flows in. Interest rate cycles decide how cheap debt is.
When CalPERS and other big pension funds suddenly increased their PE allocation, a wall of money hit the market. Too much capital chasing deals means higher prices, worse deals, losses. In the 1980s, junk bond default rates went from 4% to 10% as LBOs overheated. By 2006, the same pattern was forming.
The tricky part is identifying a bubble in real time. PE funds deploy capital over 5 years, hold companies for 3 to 5 more, then sell. Everything is lagged. By the time data shows a problem, you are already in it.
Demaria points out something useful though. It is not the total volume of money that causes bubbles. It is the acceleration. When capital floods into PE too fast, fund managers pay too much for deals and stretch on leverage. The best vintage years for returns? 2002 and 2009, right after the crashes. The worst? The years right before them.
The Myth of Capital Overhang (Dry Powder)
Every few years, someone writes an alarmed article about PE firms sitting on mountains of unspent cash, the so-called “dry powder.” Demaria argues this panic is mostly based on bad math.
The mistake is comparing money raised in a year to money invested in that same year. But PE funds deploy capital over 3 to 5 years: roughly 20% in year one, 25% in years two and three, 20% in year four, 10% in year five. When you normalize the curves for this schedule and the typical holding period, the “gap” mostly disappears. LBO funds carry about one year’s worth of deals as a reserve. That is not a crisis. That is plumbing.
The real issue is whether investors have the discipline to deploy steadily instead of flooding the market. The same investors who complain about capital overhang are often the ones who caused it by dumping huge allocations into PE all at once.
The Takeaway
PE grew up. It went from a cottage industry to a global financial force. But growing up came with growing pains. Going public did not work well. Mega deals blew up. The question of whether PE creates real value or just borrows more than everyone else is still not settled.
Demaria is not a cheerleader or a critic. He lays out the evidence. And the evidence says: PE works, but only if you pick the right managers, invest at the right time, and understand what you are paying for.
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