How the private equity boom ends, part 2

June 8, 2007, 11:50 PM UTC
Fortune

Last month I wrote an item called How the private equity boom will end that laid out the barest of details on how the great 2002-2007 era of leveraged buyouts will eventually come tumbling down. The post generated passionate comments, which told me that plenty of folks have plenty of thoughts on private equity.

Since then, the drumbeat has gotten louder. A succinct column by Dennis Berman this week made similar points, as did a front-page story in the Wall Street Journal today. The Web site breakingviews.com weighed in today with an article arguing that overly ambitious buyout firms, like Blackstone, will usher in the fall. A snippet:

Sure, Blackstone has hired more people to watch over day-to-day operations at their portfolio companies. But the founder Steve Schwarzman is said to be the man with the magic touch, who oversees all its investments. With Blackstone’s IPO around the corner and the firm rapidly raising new funds, there’s a danger of investment overstretch.

There’s more. The Financial Times published a great interview with short-seller James Chanos. Here’s his synopsis:

What’s driving it is easy credit availability and, as importantly, the boom in structured finance, whereby lenders are parcelling out the loans in various collateralised obligations and investors are buying small pieces as they see it. It’s diffused the risk but the risk has not been eliminated. (emphasis added.)

I love that last line. People always assume that diversification alone mitigates risk. But if you’re diversified among different securities in the same market, you’re going to get hit when the market gets hit. Chanos is saying that just because lots of entities own pieces of the buyout risk doesn’t mean it isn’t risky.

The fever pitch is building. Typically the end doesn’t come until the fever recedes – a head fake, if you will. Stay tuned.