Private Equity - Deserving the Undeserved

 


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As Adam Smith observed, ‘in order for markets to set prices and values, two conditions are necessary: willing buyers and sellers, and those same participants’ possessing perfect knowledge. ’ Should one side possess more information than the other, then that side has a tremendous advantage. Therefore, the holder of the information can utilise this additional knowledge to extract ‘undeserved profits. ’

Although private equity companies would protest that their profits are far from underserved, the very nature of their operations depends on making optimum use of all available information. As a result, the logic follows that the most informed companies are those that possess not necessarily the most information on target acquisitions, but the most relevant.

However, anyone who has knowledge of market theory will also be aware that as more companies look to join the party, prices inevitably rise as a result of increased demand. With potential profit margins being limited due to the sheer number of active players in the sector, the boom time experienced in private equity throughout 2005 is logically expected to be followed by a sharp downturn in 2006 as private equity companies shy away from paying over-inflated prices that do not justify the return on risk. Too many private equity companies are now seemingly possessing similar knowledge leading to no competitive advantage. Deals of the magnitude of SunGard, Hertz, Cadbury Schweppes and Wind, supposedly picked up because of the value that lies behind them, could well become relics of a nostalgic golden age. 2006 may be a more conservative year with fewer bargains to be had.

Yet to write 2006 off already may be slightly myopic. There still remains an opportunity for private equity firms when looking at targets and running existing portfolios to optimise or approach the common knowledge they have at their disposal in a different way.

As with the opaque nature of the private equity world, the potential for profit and acquisition optimism could depend upon the equally (yet perhaps unfairly) enigmatic world of working capital. Identifying the REL Consultancy Group are global specialists in optimizing working capital. They are the only international corporate financial consulting firm that focuses exclusively on improving cashflow from working capital and operations. They work with people to transform your organization, your customer’s and your suppliers in more than 60 countries around the world.

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