Robert Friedman is the New York-based senior managing director, chief administrative officer and chief legal officer of The Blackstone Group, one of the largest and most successful private equity firms. He says that large transactions’ stability is an advantage, in part because it makes the debt-raising process easier. "You get more competitive financing," he notes. The exit strategy is also more efficient with larger deals, he argues. "Bigger initial public offerings tend to be more successful because they give the market the greater liquidity that it wants."

Expanding the Expansive
Despite this, size can bring its own problems. It is easier to create value by buying, say, a chain of restaurants in the Midwest with a view to increasing its advertising budget to gain market share than it is to grow a multinational company like SunGard or Hertz. "There is no doubt it is harder to grow a $5 billion company 10 percent a year than a $200 million company 50 percent a year," notes Paul Deninger, Boston-based vice chairman of investment bank Jefferies, which provides financing for private equity deals. McGovern adds, "When we meet with the bigger buyout fund managers, we talk a lot about competitive dynamics, and we try to figure out whether they are just competing based on price, or whether they have some kind of factor that differentiates them from their peers in the market. That’s what investors need to look for."

Gaining a sense of the probability of success when no two transactions are the same may be best left to the professionals, either fund of fund managers or specialist private equity advisors. "Each deal has its own investment thesis and its own strategy," Friedman says. Take General Motors’ $7.4 billion sale of a 51 percent stake in its GMAC financing business to a private investor group led by Cerberus Capital Management in April. GMAC itself is a healthy company and is very profitable. By detaching it from its struggling parent, the aim of the new owners seems to be to reduce its cost of capital and eventually secure credit rating upgrades. If they succeed, they will make GMAC an even more profitable business. However, it looks as if GMAC’s core business, financing GM’s sales, will remain unchanged. Here, investors have to weigh the probability of those credit upgrades against the risk that their main customer may go bust.

And, despite the fact that a driver of these deals is the need to avoid concentrated risk, investors in funds involved in these mega transactions may find themselves exposed to risk in another way. "You may have put money in various different funds to spread your risk out, and now these funds are all clubbing together and making one investment," explains Malcolm Wright, a partner in the New York office of KPMG, an international network of financial firms.

The viability of deals done by consortia depends, crucially, on the ability of these rival firms to set aside their differences and work together effectively. "Each one of these firms has a different point of view on almost every issue, I suspect, and I think it’s the nature of the beast that you add more layers of complexity the more people you add," says Charley Jacobs, who heads the private equity practice area at Boston-based law firm Nixon Peabody.

Even so, many of these firms partner again and again. And, as an October 2005 analysis from the Private Equity Leadership Network, an industry group, noted, classic game theory holds that while one-time partnerships are fraught with distrust, the value of cooperation increases dramatically for those who anticipate working on a series of deals together.