Reversion Of The Mean Caused By Private Equity

During his recent interview with Tobias, Michael Mitchell, who is IgnoreNarrative on Twitter discussed Reversion Of The Mean Caused By Private Equity. Here’s an excerpt from the interview:

Tobias: I couldn’t agree more, and I had a similar experience. The first decade of the 2000s, I watched all the really great businesses just went sideways for an entire decade even though the underlying was doing well because it was so expensive. It just took years and years and years to work off the overvaluation. The opportunities were in things trading at three times EBITDA, that might get bought out. It was just an easy game. You didn’t really have to do that much work on them because the business is almost irrelevant at three times EBITDA with a whole lot cash on the balance sheet and activists roaming around looking to do something.

Michael: Tobias, it’s almost like somebody should write a book about reversion of the mean caused by private equity buyers of inexpensive assets. [laughs] I feel like I’ve read one of those.

Tobias: It feels like such an old-fashioned strategy. This is the thing. I’ve been doing it for 10 years, I’ve been doing the wrong thing for 10 years, basically, even though it did work up until 2017, but it wasn’t like a standout easy. The first part of the decade was like a 45-degree ramp. The second decade of the millennium was like maybe a 15-degree ramp, something like that. Then, the last three years have just been misery, it’s sort of all gone backwards.

Michael: I would have lost the bet. I would have told you– If we go back five years ago, and you said, “Well, this is what I’m doing.” My belief is, at the time, I forget the number, but private equity sitting on $100 billion of cash and Berkshire Hathaway has a similar amount of cash, I’m like, “What are you going to buy? Are you going to go buy Amazon at 20 times revenue?” By the way, they should have, that would have been the right move.

Tobias: Evidently.

Michael: Yeah, that would have been the right move. My thought would have been like, “Oh, no, we’re going to go buy things that are–“ There is a discount embedded in the valuation because of something I can fix. There’s some strategically they’ve got maybe a good group of assets, but they just can’t bring them to market. Well, I’m a little bigger than them, I can do it, or their access to capital has been constrained and some private equity are buying. Private equity hasn’t touched that stuff maybe that’s going to continue. I really don’t know.

Tobias: Why is that do you think?

Michael: That’s a great question. That’s what I’m saying, I would have been wrong. I would have told you that’s a logical outcome of all of this, but that’s not where private equity is. They’re just not there. They’re doing other things. I don’t know why they’re not interested in that stuff. It may be for the same reason that the public markets aren’t, because they look at public markets to tell them what’s going to work in an IPO, and if they can’t underwrite a high terminal value, then they’re just not going to do it. That would make sense to me, but I confess I understand very little about most things, I understand even less about the internal workings of large private equity firms.

Tobias: I remember very clearly, in 2014, when I pitched Wiley for Deep Value, I said, there’s a whole lot of private equity capital out there. In fact, it’s like it’s a cyclical high, so that means typically what that has meant is that in the next five years, there’s going to be this cyclical boom, in–

Michael: Tidal wave.

Tobias: Yeah. It didn’t eventuate, it didn’t come through at any stage. I feel like we really hit an air pocket from 2015 to date where they’ve been silent. I don’t know why.