Would Twitter have been better off to remain a public company rather than be taken private by Elon Musk?
We’ll never know for sure, of course. But it’s hard to imagine that it would have performed any worse. Twitter as a private company is hemorrhaging advertisers, and according to a recent Fidelity analysis its market value is down nearly two-thirds from the $44 billion Musk paid for it.
Grading Twitter’s performance as a private company is more than an idle armchair exercise. It goes to the heart of an age-old debate over whether companies can be more profitably managed when private rather than public. The private equity (PE) industry not surprisingly claims that its approach is superior, and much of Wall Street agrees since many PE firms have produced impressive long-term returns.
The industry’s claims are not devoid of dissenters. Consider a recent study from Verdad Capital entitled “Private Equity Operational Improvements.” It was conducted by Minje Kwun of Dartmouth College and Lila Alloula of Yale University.
In order to overcome the otherwise insuperable obstacle of being unable to measure how private companies are performing, the researchers focused on a subset of leveraged buyouts (LBOs) from 1996 to 2021 in which the private equity firms issued public debt. In order to sell debt to the public, of course, the PE firms had to issue financial statements publicly, and that enabled the researchers to analyze the LBOs’ performance after going private, relative to public companies in the same industry sector.
Kwun and Alloula focused on six indicators of financial performance: Revenue growth, EBITDA margin, capital expenditures as a percentage of sales, and the ratios of gross profit to total assets, EBITDA to total assets, and debt to EBITDA. (EBITDA, of course, refers to Earnings Before Interest, Taxes, Depreciation and Amortization.)
Relative to public companies in the same sector over the three years after going private, LBOs on average did not show any operational improvement along these six dimensions. The researchers conclude: “The [private equity] industry mythology of savvy and efficient operators streamlining operations and directing strategy to increase growth just isn’t supported by data.”
Their results are consistent with those of a near-decade ago study by Jonathan Cohn and Lillian Mills of the University of Texas and Erin Towery of the University of Georgia. They used a different technique to access the otherwise inaccessible financial data of newly-private companies: Their tax returns. The professors focused on the operating performance of a sample of companies that had gone private between 1995 and 2007, comparing them to otherwise-similar companies that remained public. On average over the three years after going private, the researchers found, the private companies performed no better than the public ones.
The source of PE’s industry high returns
What, then, is the source of the increased return that the private equity industry often produces? The answer appears to be increased leverage. Leverage increases returns on the upside, even if it magnifies losses on the downside. Leverage has worked to the PE industry’s advantage over the last several decades since public markets have on balance have risen significantly.
Notice that increasing leverage requires no particular management expertise or shrewd strategic planning. In principle it’s no more difficult than you or me purchasing stock on margin.
These studies are not the final word on the subject. Some other studies, using alternate methodologies, have found some operational improvement at companies after being taken private. If different methodologies can reach such different conclusions, however, that would suggest that the benefits of going private are not as obvious and overwhelming as the private equity industry would have us believe.
At a minimum, Kwun and Alloula argue, we should be skeptical “of any claims of operational improvements being a major contributor to PE’s performance relative to public markets.”
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]
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