Private-Equity Buyouts Shortchange Shareholders; Dell Deal an Example of the Upper Hand Held by Smart Financiers and Knowledgeable Insiders

July 15, 2013, 6:26 p.m. ET

Private-Equity Buyouts Shortchange Shareholders

Dell Deal an Example of the Upper Hand Held by Smart Financiers and Knowledgeable Insiders

FRANCESCO GUERRERA

Would Dell be better off away from the tyranny of quarterly earnings and what-have-you-done-for-me-lately shareholders? Francesco Guerrera joins the News Hub with his take. Farewell, then, DELL DELL -1.31% . After a quarter century of service, the stock ticker for Dell Inc. is likely to be consigned to the dust bin of history this week. On Thursday, to be precise, shareholders are expected to seal the sale of the computer company to the private-equity firm Silver Lake Partners and founder Michael Dell.The soon-to-be owners argue—and shareholder-advisory firms agree—that this is for the best. That turning around a struggling personal computer maker simply can’t be done in the public markets. That the tyranny of quarterly earnings, fickle share prices and what-have-you-done-for-me-lately investors is too hard to endure.

Mr. Dell summarized his reasoning last month. “As a public company,” he wrote in an investor presentation, “we must take a more cautious approach to our transformation, because we must consider how our stock price will react to the steps we take and what effect that will have on the company and on customers and employees.”

It is a tried-and-trusted argument that corporate restructurings can be carried out much more easily away from the prying eyes of the market.

Is that true? Or are public shareholders selling too soon, leaving money on the table for private-equity groups and corporate management?

Edward Garden, chief investment officer of the activist investing firm Trian Fund Management LP, thinks it is the latter.

Mr. Garden, who co-founded Trian with Nelson Peltz and Peter May, told me that the idea that private equity knows best “has led to a huge transfer of wealth from public shareholders to private shareholders.” In his view, fund managers have finally realized that and are pushing back. “There has been a sea change in the mind of public shareholders,” he said.

Mr. Garden’s perception may be colored by the fact that activists often compete with private-equity firms on deals. But his points strike at the heart of the debate over the merits of being a public firm.

The argument in favor of buyouts of ailing companies is based on the twin premise that stockholders can’t stomach the share-price and earnings volatility caused by turnaround plans, and that having a handful of highly focused owners is more conducive to radical change than a diffuse band of holders.

The first assumption runs counter to the mantra chanted by pension funds, mutual funds and even some hedge funds: “We are long-term investors.” If that is the case, then shareholders ought to be more willing to forgo short-term gains in order to reap the benefit of big corporate changes.

Those fund managers who believed in the turnarounds of, say, Apple Inc. AAPL +0.22%and International Business Machines Corp.IBM +1.00% in the mid-1990s, are probably reading this from a very large mansion.

Bill Riegel, who oversees $214 billion as the head of global equity at TIAA-CREF, believes shareholders can, and should, look at the long term. “I wholeheartedly disagree that restructurings can only be done in private,” he said. “This is how I built my career. I am a value guy and that’s what value guys live for,” he said, referring to the investment strategy of seeking undervalued companies.

It helps that, in Mr. Riegel’s case, he is assessed and compensated over a five-year time frame and not quarterly, as are colleagues at some rival firms. But given the noise big funds make about their patience, the onus should be on them to push for and support turnaround plans that create long-term value for their companies, rather than taking the private-equity money and running.

There is little sign of a sea change. The first six months of 2013 were the best half-year for U.S. buyouts since 2007, according to Dealogic.

There is even less debate on the management. I haven’t found a single executive who thinks that being in the public markets is preferable to being behind the private-equity veil.

Not even Robert Nardelli, whose career spanned public markets (General Electric Co.GE -0.55% and Home Depot HD -0.17% Inc.) and private ones (Chrysler Group LLC and other senior roles at Cerberus Capital Management LP). “We were able to get quick yeses, quick nos and no slow maybes,” Mr. Nardelli said of his time at the Cerberus-owned Chrysler. (Chrysler ended up in Chapter 11 in 2009, but that is another story).

Mr. Nardelli, who now runs his own investment firm XLR-8, recalled that, shortly after Cerberus bought Chrysler in 2007, the car maker raised about $1 billion by selling noncore assets. The divestments bolstered its finances but hurt earnings in the short-term, something the public markets would have hated.

Dell is following a similar playbook now. Its shareholders, and those in future private-equity targets, should be concerned that they are being picked off by smart financiers and knowledgeable insiders. And then do something about it.