Schafer: Schulze's partners will show who's in control

Best Buy Co. founder Richard Schulze enjoyed a lot more control as chairman and 20 percent owner of a publicly held Best Buy than he ever will have with his new private equity partners.

The Schulze group is fast approaching the date when it needs to make a bid for the Richfield-based retailer, under terms of an agreement Schulze reached with Best Buy in August. There have been media reports that Schulze and his prospective financial partners are at loggerheads over control.

Of course they are.

Schulze is pursuing this deal precisely because he wants to regain control of the company he founded. And the money he needs has to come from investors who don't like to give it up.

Schulze's prospective partners are big and well-established firms -- TPG Capital, Cerberus Capital Management and Leonard Green & Partners, as reported by my colleague Thomas Lee.

They are the kinds of firms that were caricatured by political opponents of presidential candidate Mitt Romney, who famously made his money leading Bain Capital, as being in the business of stripping out asset value at the expense of employees and other stakeholders.

It's probably more accurate to say that private equity executives want to own businesses that they can figure out how to grow and make more profitable.

Howard Anderson, a senior lecturer at the MIT Sloan School of Management and a veteran private capital investor and consultant, said it's axiomatic that private equity investors seek to control the companies in which they invest, saying that "if you are putting up that kind of money, you do not want to be outvoted."

If not simply more seats on the board, it's by other means, such as taking a class of stock with rights triggered by specific corporate events.

My own simple financial model suggests that an $18 per share bid for Best Buy would require roughly $1 billion of private equity capital, about matching what Schulze contributes of the stake he now controls in the company. That means no clear control position.

Schulze first raised the possibility of buying the company in a letter released in August, saying it was best to reshape Best Buy out of the public sphere. But he cannot take it private and turn it into a family business, not with the likes of TPG and Cerberus as partners.

It was really more family business before May 2012, with Schulze presiding over the Best Buy board. A bad quarter or bad year was no threat to his position. As chair he set the agenda and dealt directly with the CEO and other members of management.

When public company investors expect an explanation from management, they mark their calendars. Private equity managers look at their watch.

Anderson said it is common for private equity owners to develop, and then demand to see executed, a 100-day plan upon closing a new takeover. Assets to be sold. Stores shut. Employees terminated.

"There's an enormous amount of pressure to perform" in a private equity portfolio company, Anderson said. "It's not like, 'Oh, did we hit our numbers?' It's continual. Can we turn our cash faster, can we get better deals from suppliers, can we hire fewer people in a store, can we get out of these leases? It's a daily, never-ending pressure."

But more than any detail of operations, private equity investors want to decide who works for them in senior management.

What is shaping up here is that Schulze is the proposed leadership solution, and what he's going to get from his private equity partners, Anderson speculated, is "the first shot. If it goes well, great."

It's unfair to suggest all private equity managers think alike, but it's not like there aren't ready examples to illustrate Anderson's point. One comes from an industry insider, the 2010 memoir "Overhaul" by Steven Rattner, who led the Obama administration's rescue of the Detroit automakers.

Rattner had co-founded the private equity firm Quadrangle Group before heading to Washington. His story has his "Team Auto" rolling over the Detroit lifers to bring radical change to the auto industry, thus saving it. Among the flattened was Rick Wagoner, the CEO of General Motors, fired after Rattner had met him just once.

Wagoner had too little charisma, too little urgency, and was an executive who, Rattner wrote, "gave listeners very little to grab onto." Rattner replaced him eventually with a former phone company executive.

The writer Malcolm Gladwell, reviewing "Overhaul," was fascinated to see Rattner so enamored of his own private equity model that he felt no need to even mask his condescension.

"An investor like Warren Buffett has to think that he is smarter than the market," Gladwell wrote. "Private equity managers aim higher. They see themselves as smarter than the managers of the companies they are buying. It is not a field for someone with any obvious deficits in self-confidence."