Private Equity Veteran Addresses State of the Industry in Millstein Center Talk

After a period of flying high, private equity is facing significant challenges in the current economic climate, said Russell Carson, cofounder and general partner of Welsh, Carson, Anderson & Stowe (WCAS), one of the country’s largest private investment firms. He spoke to an audience of Yale SOM faculty, students, and staff on November 20, 2008, as part of the Millstein Center’s Lunch Forum Corporate Governance Speaker Series.

"If the mortgage market was the front end, private equity will be the back end," Carson said, referring to recent turmoil in the financial markets. He expects lower funding for private equity as institutional investors, many of which have lost significant amounts of money in stocks, will be either seeking liquidity or completing required rebalancing of portfolios. That challenge is added to the disappearance of the credit which had been critical to the multi-billion dollar buyouts that were increasingly common in recent years. (Read an analysis of how the private equity boom was driven by the credit cycle by Yale SOM professor Andrew Metrick in Q4 magazine.)

Despite the turmoil, Carson pointed to some bright points. The present environment rewards solid, long-term decision-making. "We’ve had way too many people reap enormous rewards for flash-in-the-pan performances," he said. And rather than trying to find blockbuster deals that take large public companies private, mid-sized private equity firms often do better acquiring privately-owned companies, anyway. Since these deals can be largely self-financed, such opportunities continue to exist. However, Carson sees available capital remaining on the sidelines for the moment, because potential sellers "still remember what their business was worth six months ago and haven’t yet adjusted."

Carson began his career at Citicorp’s venture capital subsidiary, where he was from 1967 to 1978, including serving as Chairman and CEO from 1974 to 1978. He cofounded WCAS in 1979. While Carson believes he has brought a venture capitalist’s analytical sensibility and comfort with risk to his approach to private equity, he said, "The real value in private equity is common sense." While financial analysis is an important aspect of a deal, the questions he keeps in mind are: "Is this a business we want to own?" and "Can we buy it for a price we want to pay?"

Once a company has been bought, from purchase to exit, Carson said, "The choice of management is the single most important decision you make. Who is going to run the company and how are they going to run it?" The majority of WCAS’s acquisitions involve change in top managers, often drawn from a pool of experienced executives who have run other WCAS-owned businesses. The firm specializes in healthcare and information services. A broad and deep industry-wide perspective of each field drives the firm’s acquisition strategy, Carson explained. He aims to give managers space to execute day-to-day operations that produce significant growth in the company.

The firm has raised 15 institutionally-funded limited partnerships with total capital in excess of $20 billion and has invested in more than 250 companies.

Commenting on Carson’s presentation, Ira Millstein, Senior Associate Dean of Corporate Governance, said, "He gave a very candid appraisal of the pluses and the minuses of the industry, not only pointing out the benefits of the governance structure, but also pointing out some of the defects — leverage, in particular. It was an honest, frank discussion. You don’t normally get that kind of candor from someone inside the industry."

This Millstein Center lecture was part of an ongoing effort to improve corporate governance. Noting that the financial crisis is also a crisis of corporate governance, the Center has three new projects in the planning stages which will emphasize the theme of "Restoring Trust in the Capital Markets." Each will address key issues highlighted by the failures of financial institutions: risk management, shareholder stewardship, and compensation alignment. These projects dovetail existing efforts on ratings agencies, the role of independent board chairmen, and shareholder communication.