IBS

FOR the past few years the wild men of private equity have rampaged through the public markets. They have ventured into the drowsy glades of badly managed companies and they have stormed the citadels of multinationals. The wind has been at their backs for so long that it has been hard to imagine how anything could stop them (see article).

This week witnessed the biggest private-equity offer in history, a buy-out of BCE, a Canadian telecoms operator, that would be worth a total of $48.5 billion. Virgin Media, a British cable company, faces a $22 billion bid. The value of takeover deals—plenty of them involving private-equity firms—soared to $2.7 trillion in the first half of the year, almost half as much again as in the last six months of 2006. Optimists will take all that as further evidence of private equity's bright hopes. But it is also possible that the weather is turning and the debt that powers private equity's siege engines is starting—just starting, mind you—to become harder to scrape together. It may not happen this month, perhaps not even this year, but sooner or later the private-equity boom will come to an end.

This possibility will delight private equity's many critics. Private equity is routinely charged with all sorts of iniquity. It strips companies of assets and flips them for a fast buck. It loads them up with dangerous amounts of debt, to suck out capital for its investors. It pays scant attention to employees and suppliers. Its greedy partners avoid the tax that others have to pay. If the markets turn, the volume of condemnation will only increase. Imagine the derision when funds stop making money even as their partners take home large salaries on the basis of past achievements; when private-equity-owned companies default on debts, leaving insurers and pension funds saddled with the losses; when workers are put on to the street because of desperate cost-cutting or bankruptcies.

There's some justification for complaints against the tax regime that private equity enjoys. Partners in private-equity firms benefit from a tax break on their earnings. It should be withdrawn. And, because of tax breaks on interest payments (from which all companies, private or public, benefit), the growth of debt finance erodes the tax base. Other charges are mostly groundless. Takeovers, whether by private or public companies, tend to lead to redundancies and cost cuts. In the longer run, private equity makes money from investing in a business, because a thriving company is worth more than an ailing one. Studies in Britain suggest that over time buy-outs add jobs rather than cutting them, and, in America, that buy-outs that rejoin the stockmarket perform better than other new issues.

That would not be surprising, because of the weakness of public markets that private equity has pointed up. Since managers and boards of public companies are spending other people's cash, they sometimes do so wastefully. That is why public-company shareholders put a lot of effort into monitoring managers and boards, who, even then, can be hard to control without resorting to boardroom coups and confrontation.

Sometimes shareholders cause trouble. They often make conflicting demands that managers must struggle to reconcile. Institutional investors tend to insist on instant performance, because their funds are judged on that quarter's returns—which undermines criticism of private equity's short-termism. The threat of shareholder lawsuits and the regulation of the public markets have added to the distracting burden of compliance and to enterprise-sapping bureaucracy. Because private-equity managers answer to a single shareholder, they have clear instructions and can spend more time creating a business with a healthy future.

At the same time as providing a critique of the equity markets, private equity has helped turn illiquid bank-dominated debt markets into highways for delivering cheap credit. It has shown that debt can finance takeovers on an unimagined scale and in industries, including finance and technology, once thought beyond its scope.

The power of this debt-market transformation looks as if it is about to be tested. Rising long-term interest rates have pushed up the cost of borrowing. Sensing a shift in the economics of the industry, creditors around the world have started questioning the easy money offered to private-equity firms, which feed off risky types of debt. Last week US Foodservice, an American wholesaler being bought by private-equity groups, cancelled a $3.6 billion bond-and-loan deal when lenders balked at the lack of protection they were being offered. In Australia, private-equity firms pulled out at the last minute from the country's biggest takeover, complaining of the high cost of debt. This week the sale of a British retailer fell into confusion, after two private-equity bidders withdrew. The prospect of dwindling returns makes buy-out firms reluctant to club together to buy the big companies they covet; banks, meanwhile, are growing wary of offering their own capital as “bridge” finance. Shares in Blackstone, a private-equity chieftain that listed on the stockmarket last month, have fallen below their offer price—though it is still worth a tidy $32 billion.

That's not to say their bull run is over yet. Following Blackstone's lead, big buy-out firms continue to tap the public markets for fresh capital. There may well be a few more record-breaking takeovers. But if these squalls continue, it is not just private-equity investors who will shiver. Banks have raked in profit from the buy-out industry's appetite for loans and deal-making advice. Stockmarkets have climbed on takeover fever; more than a third of all deals in America so far this year were done by private-equity firms (in 2000, the last such takeover boom, it was a meagre 4%). High share prices make targets more expensive, and private equity is still raising record amounts of money, meaning more competition—and higher prices—for acquisitions, lowering potential returns. Private equity has scaled amazing heights; but its headiest days are probably over.