Private Equity Firms Followed The Golden Rule Of “(Don’t) Overbid Others As You Would Have Others (Not) Overbid You”

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There's a field of mathematics called "game theory," and in that field mathematicians write papers about math, and those papers are read by other mathematicians. Meanwhile, in another part of town, people who do M&A deals are all "let's talk about the game theory here," and then they all nod sagely and punch each other in the face and think back fondly on the time they got an A- in freshman calculus.

Prisoner's dilemma! Nash equilibria! Coöperate! Defect! I will build you a model though I am neither a mathematician nor a person who does M&A deals:

  • If you want a thing, you bid for it.
  • If you get a thing at your bid, you are happy.
  • If you get outbid for a thing, you are sad.
  • If you outbid someone for a thing, you are initially happier than if you got outbid, but sadder than if you didn't have to outbid anyone.
  • (Later, you might be sadder than if you got outbid.)
  • You keep doing that.1
  • You are smart.
  • You start to feel feelings and think thoughts.
  • You stop jumping your rivals' bids.
  • They stop jumping your bids.
  • Except sometimes you do! And sometimes they do!
  • Because, y'know, you really want the thing more than they do, or whatever.
  • And so you muddle along, not getting into horrible bidding wars over every deal while still trying to get the things that you want much more than other people want them.

Now, I am not an antitrust lawyer, but nonetheless, I say unto you, that is an okay model. It's even an okay model if you do stupid, stupid, but still basically okay things like this:

Two colleagues at the private equity firm TPG e-mailed each other about the firm’s reasons for deciding to not compete for HCA, according to the lawsuit.

“All we can do is do [u]nto others as we want them to do unto us,” Jonathan Coslet, a TPG executive, wrote. “It will pay off in the long run even though it feels bad in the short run.”

We've talked before about the private-equity antitrust lawsuit but now it comes with 100% more incriminating emails, due to the Times's intrepid motion practice. At least some of which are less strictly incriminating and more "WHAT I WAS QUOTING JESUS," but others of which ... I continue to not be a mathematician/lawyer/banker/anything but this skeeved me out a bit:

After a Blackstone group outbid a K.K.R. consortium to buy Freescale for nearly $18 billion, Hamilton E. James, the president of Blackstone, e-mailed his colleagues about Henry Kravis, the billionaire co-founder of Blackstone’s rival.

“Henry Kravis just called to say congratulations and that they were standing down because he had told me before they would not jump a signed deal of ours,” Mr. James wrote.

Two days later, Mr. James sent an e-mail to Mr. Kravis’s cousin and co-founder, George R. Roberts. “We would much rather work with you guys than against you,” Mr. James wrote. “Together we can be unstoppable but in opposition we can cost each other a lot of money.”

“Agreed,” responded Mr. Roberts.

Now of course you can explain this away too. That "together we are Voltron" email maybe means "I enjoy spending time with you and your cousin," or even - nefarious but legal! - "I like it when managements ask us to work together to construct a joint bid because we end up paying less than when we don't coordinate," more than it does "let's have a secret conspiracy in restraint of trade." And I actually read "he had told me before they would not jump a signed deal of ours" with the emphasis on "signed" rather than "would not jump": lots of private equity firms have good reasons, grounded in reputation and reliance on management and board goodwill (and breakup fees) rather than price-fixing, to prefer not to lob in hostile bids or ask companies to breach signed contracts. But if you read this as Q. "Conspiracy in restraint of trade, anyone?" A. "'Agreed,' responded Mr. Roberts," I would not be able to say you were insane.

Still the basic gist of this complaint looks more, not less, insane after looking at the emails. For some reason it doesn't occur to the plaintiffs' lawyers to say "you sent dumb emails now give me money," so instead they build a massive and all-pervasive multi-year conspiracy and since that is plainly false they just end up sounding like cranks. Here is Dan Primack:

Worth noting that Blackstone and KKR did bid together on Clear Channel, but they were beaten out by a rival offer from Bain Capital and Thomas H. Lee Partners. Somehow, all four firms are named as defendants in this suit (sometime co-conspirators, sometime rivals?).

In fact, such contradictions are peppered throughout the entire suit. As I wrote back when the complaint was originally filed, it's tough to argue conspiracy against so many firms on such a large number of deals, particularly when the record is clear that many of the defendants competed against each other on some of those very transactions.

BUT THEY BID AGAINST EACH OTHER TO THROW THE COPS OFF THE SCENT, etc. etc., if you want to be nonfalsifiable about it. I don't, so I'm kind of not a fan of the all-pervasive conspiracy theory. I prefer the theory in which (1) they often didn't jump each others deals because it was expensive, (2) they sometimes did because they really wanted that deal, and (3) there were dumb emails.

But if there's one thing that I do know, and I tell you this both as your lawyer and as your mathematician, it's that dumb emails --> money, so this looks kind of good for the plaintiffs' lawyers.

How does it look for everyone else? How do you "fix" this? One thing to do is build a system where private equity firms are somehow forced to bid against each other more fiercely - maybe they all agree to extensive go-shops and fewer consortia, or whatever. It's hard to imagine that working - you can force PE firms to create the conditions for overbids, but it's harder to force them to actually overbid each other - and it's not clear a priori what it would do to deal prices. Making consortia dangerous means making consortium deals scarce.

The other fix is to let private equity firms keep doing much of what they're doing - playing repeat games, and deciding by their informed selves not to bid against each other in situations where that will cost them money - but just stop emailing each other about it. That seems like a more likely solution.

E-Mails Cited to Back Lawsuit’s Claim That Equity Firms Colluded on Big Deals [DealBook]
Unsealed docs: Did private equity firms conspire? [Fortune / Dan Primack]

1. This is called a "repeat game."