Undue influence

One of the side effects of private equity's swelling size is the difficulty of flying under regulators' radars. With larger and larger transactions in reach, firms are capable of scooping up sufficient enough assets within a given industry to spark the interest of the antitrust constituency. The Pollyannas within the asset class have been warning of this increased scrutiny, as well as of the resulting slowdown in deal flow and returns.

The tact the Federal Trade Commission, led by Chairman Deborah Platt Majoras, took with Carlyle's acquisition of gas pipeline company Kinder Morgan doesn't do much to discount such concerns. The private equity behemoth and its energy affiliate Riverstone already own a fifty percent stake in energy firm Magellan Midstream. When the firm moved to finance the buyout of Kinder Morgan, a rival of Magellan's, the FTC issued a complaint challenging the terms of the $22 billion deal (€16.7 billion).

The regulator found that in its initial form, the transaction would lead to ?a reduction of competition? in the eleven oil and gas markets of the American southeast where the two currently compete, and where the FTC concluded there were ?few competitive alternatives.? The acquisition's threat to competition was defined as ?the right to board representation at both firms, the right to exercise veto power over actions by Magellan, and access to non-public competitively sensitive information from or about KMI or Magellan.?

In order for the deal to win FTC approval, the regulator demanded that Carlyle and Riverstone turn their investment in Magellan to a ?passive one.? Making that investment ?passive? involves four steps: Carlyle and Riverstone must remove all its representatives from the Magellan board of managers and board of directors; they must cede control of Magellan to its other major investor, Madison Dearborn Partners; they must not ?influence or attempt to influence? the management or operation of Magellan; and finally, they have to establish safeguards against sharing ?competitively? sensitive information between Kinder Morgan and Magellan.

The Wall Street Journal suggested that the decision could have been worse. Carlyle and Riverstone may have been forced to sell one of their stakes outright. However, for an asset class relying more exclusively on operational reform to drive returns, a shift to ?passive? investment is hardly an ideal scenario. While clearly not a merger between Kinder Morgan and Magellan, there would be an overlap between the firms' GPs in applying their experience and expertise to both in the hopes of improving their performance. The inability to exert operational control is no small concession, and many firms differentiate themselves with an industry focus, which as they grow will only court similar situations to the Kinder Morgan/Magellan one.

One element that may have not been considered in discerning the FTC's interest in the case is the industry in question. In the press release announcing the complaint concerning the deal, the regulator noted that it was ?an example of the Commission acting to ensure that mergers and acquisitions involving energy firms will not lead to higher gasoline prices for consumers.? This prompts the questions whether less politically charged industries will warrant their attention quite so soon.

Regardless, the FTC response is evidence that the regulator has begun to look at private equity firms as the ?conglomerates of tomorrow? as some have predicted. That vast sums of capital can be deployed to concentrate market power in the hands of the few may well prompt watchdogs to probe deeper into portfolios to find further evidence of threats to competition. Luckily the industry has recently created a Washington lobbying group called the Private Equity Council to address the public perceptions and political climate for buyout funds. Given the recent moves from the Federal Trade Commission, the industry needs all the help it can muster.