Milken Institute Global Conference

The stock market is shrinking and that's a good thing, private equity honchos say

Key Points
  • "We're a better model for governance. We don't have to deal with all the hassles of the public boards," says Jonathan Sokoloff of Leonard Green & Partners.
  • The number of publicly traded U.S. companies has been cut in half over the past 20 years, falling to 3,671 from 7,322 by 2016, according to Credit Suisse.
  • Private equity raised a record $453 billion from investors in 2017, affording managers more than $1 trillion to funnel into ventures, Preqin reported.
Leon Black, Chairman, CEO and Director, Apollo Global Management, LLC, speaks at the Milken Institute's 21st Global Conference in Beverly Hills, California, May 1, 2018.
Lucy Nicholson | Reuters

The fact that more public companies are being acquired by large global private equity firms is neither shocking nor problematic, at least according to the titans of private equity.

It's hardly surprising that boards of formerly public companies elect to give private equity a chance, said Jonathan Sokoloff, managing partner of Leonard Green & Partners.

"Our view is that we're a better model. We're a better model for governance. We don't have to deal with all the hassles of the public boards," Sokoloff told CNBC's Leslie Picker at the Milken Global Investment Conference last Tuesday.

"You go to a private company board meeting: we get right down to the meat of the business, and we help the businesses and we're involved," he added. "It's a pretty dramatic shift that's going on, and the public equity markets are really losing share."

Bain & Co: Private equity funds attracting record amount of capital

Other private equity managers on the panel echoed Sokoloff's comments. The panelists also included Apollo Global Management's Leon Black, Vista Equity Partners' Robert Smith and Brookfield Asset Management's Bruce Flatt.

According to a Credit Suisse report published in 2017, the number of publicly traded U.S. companies has been cut in half over the past 20 years, falling to 3,671 from 7,322 in the two decades ending in 2016.

While private equity buyouts can account for some of the drop in the number of public companies, some executives of companies such as Uber and Airbnb are simply electing to delay their IPOs. Their explanations for the delay have ranged from increased regulation in the public sphere to shareholder lawsuits and activist pressure.

While notable in its own right, the decline in the number of public companies has been accompanied by a mass migration of capital into private equity as some of the world's largest pension funds remain strapped for reliable returns.

Source: Credit Suisse

Private equity raised a record $453 billion from investors in 2017, bringing the available pool of money to invest to $1 trillion, industry tracker Preqin said earlier this year. The amount of money raised exceeded the previous record of $414 billion set in 2007.

Much of the new capital flow has helped balloon so-called megafunds (those with more than $4.5 billion), with raises for all buyout megafunds up over 90 percent year over year, according to McKinsey, which concluded that had growth in the largest funds stalled in 2017, overall fundraising would have fallen by 4 percent.

At the top of the list of top fundraisers, Apollo took in $24.6 billion last year, and the firm manages a total of $69 billion in private equity assets.

Black said that taking a public company private is a natural step in the business life cycle and gives companies a chance to implement initiatives without increased regulatory or public scrutiny.

"What happens when a company goes private?" Black said. "It is private for a while, it doesn't have to report quarter-to-quarter, things can get done — as John said — more efficiently. And then there's an exit."

The flood of cash into private equity, however, has attracted the criticism of federal regulators, especially as managers look to foreigners for cash.

In its most recent move, the Committee on Foreign Investment in the United States — which monitors and reviews potential national security implications of foreign investments in U.S. companies — warned President Donald Trump against allowing Singapore-based Broadcom's hostile takeover of San Diego-based Qualcomm to go through.

CFIUS, which rarely weighs in publicly on a deal it is scrutinizing, told both companies it was concerned that Broadcom could use a "'private-equity'-style" approach to Qualcomm, slashing investments in research and development as part of a focus on short-term profitability.

Broadcom was forced to abandon the Qualcomm bid.

Private equity executives often say their ownership of private companies creates a better relationship between owners and management compared with publicly traded companies, where managers may hold a very small amount of the company's stock, and so their incentives aren't necessarily aligned with other stakeholders.

"The fact of the matter is, private equity has just, frankly, a better alignment of incentives between stakeholders, stockholders, management and the company," said Smith, founder and chairman of San Francisco-based Vista Equity Partners, which focuses on software and technology companies.

"The challenge, I think, that the public markets have run into is that often the managers of those businesses don't actually have a meaningful stake in the companies any longer," he said. "That fundamental difference in alignment is why I think the private equity model is going to continue to gain momentum."