Wednesday, April 26, 2006

Private Equity Collars

hercules and cerberus Says the fast food vendor of financial journalism, BusinessWeek of the GMAC-Cerberus deal: "Feinberg [Cerberus' manager] won the day in part by accepting risks that every major bank and marquee buyout firm that GM approached about the deal turned down."

Oh?  It is not entirely clear to me that Cerberus took on much risk here at all.  I am not alone in this view either, it seems.  The stereotypically yummy Abnormal Returns cites DealBook, citing an Institutional Investor article citing Clay Lifflander, President of New-York based hedge fund, Millbrook Capital Management who opines:

"Looking at it, people are having such trouble putting capital to work. It’s clear to me [Cerebus] is betting the ranch in terms of their reputation. They clearly didn’t get this [money] from their fund; they had to go to their limiteds and get co-investments."

He continues:

I’m starting to think about the dynamic of what’s going on in the [private equity] world: If you have a very limited downside but execute a [business] plan and make a double or triple on one of your deals when no one else would, you look like a genius.

Remember the Cerberus guys are distressed debt guys by origin. And distressed debt guys are really good at protecting their downside and buying low. If it doesn’t work out, they don’t get hurt that bad. If it does work out they get huge pops. That’s their game and this one looks like [Stephen Feinberg] did a pretty good job on it.

There was a time in the height of the 80s buyout crazes where management acumen was less important.  Financial structuring was the key to making double and triple digit returns.  Load on the debt, streamline waste, exit.  The interesting property with buyouts through, say, 2005 is that the addition of "management excellence" was required to meet the same goals.  It is beginning to look to me like this is less and less the case.  Financial structuring (along with the public debt markets, IPOs and special dividends) are all that is required to capture massive returns.

Well, there may be one other element.  As I obliquely implied out in my earlier entry today on cable acquisitions in Europe, a long view might also carry the day.  Buy in when an industry is on the outs, impose "adult supervision" even in the face of embedded cultural impediments to anyone doing "real work" (ahem, Germany, France), lend to your acquisition when no one else will to keep it afloat long enough for the recovery and then reap 50% IRRs, even in the face of a 5 year investment wait.  This is what an LBO is supposed to look like, I believe.  GMAC is a far different flavor of deal.  Why?  Hedgefund buyer?  Vegetable Capital?  The flood of cash that has poured into deals?  All three?

Art: Hercules and Cerberus, artist unknown, Musée du Louvre.

Sunday, August 27, 2006

Brilliant Business Journalism

the fast food of financial news Leave it to the Financial Times to mint humor so subtle and sublime (subscription requried), so nuanced and multi-layered as to befuddle the "financial journalists" of the United States into something approaching dumbstruck madness- though astute readers will find this only slight at odds with the natural state of the typical financial journalist psyche.  (Leave it, of course, to Abnormal Returns [yummy!] to point us to this wonderful Sunday find). In this particular case, John Plender weaves a wonderful reductio ad absurdam chain with such skill and craft that both proponents and opponents of private equity are made light of.  It is artful to such a degree that lighter intellects might miss the joke.  Not surprising then that McBusiness Business Week rises to take the bait.  Spins Plender from the Financial Times:

With private equity investors gobbling up bigger and bigger chunks of the corporate world, fuddy-duddies worry that quoted equity will shortly become extinct. The usual party-poopers see a bubble and warn that hubris will soon lead to nemesis. For them, over-ambitious private equity folk deserve their status, shared with hedge funds, as the new bogeymen of the western world.

They have, of course, got it all wrong. The problem with private equity people is, in fact, their timidity. They have been desperately slow to raise their sights when so many institutional investors have been hurling ever larger sums at them in pursuit of better returns than those available in public markets. Why have they failed to tilt at the scores of companies much larger than HCA or NTL that have far less efficient balance sheets, bigger cash flows and a crying need for focus? Consider Microsoft, which has a balance sheet so inefficient that it would make a private equity investor weep.

[...]

In short, [Microsoft] has been preoccupied to such a degree with technology – so 1990s – that it has completely failed to take advantage of a period of unprecedentedly low interest rates, of banks that are falling over themselves to lend, of weakening bank covenants and a widespread recognition that leverage is the new alchemists’ gold. It is all too obvious: Microsoft just does not get it.

Before long he's gotten to:

The new management could take the axe to Microsoft’s $6.6bn of wasteful research and development expenditure. The bloated workforce of more than 60,000 could be slashed, to the point where the huge resulting increase in cash flow would at last permit the company to borrow mega-billions.

This brings us to the real joy of private equity: the so-called “dividend re-cap”, a dividend-for-debt swap. The enhanced ability to borrow would permit the newly private company to make the greatest dividend payment of all time. At a stroke it would solve the financial problems of the army of private equity investors who have been trying – hitherto unsuccessfully – to punt their way out of pension fund deficits.

...and the punch line, sarcasm served with a side of sausage, and delivered after a deadpan fry, as only the English can (good thing too because it is also the only cooking they can do):

Only the bankers will need a way out. Their horizons are traditionally fixed more on entrances than exits. Yet even they now have an exit strategy for private equity deals. It is called the credit derivatives market. This allows them to hedge the most outlandish risks. Of course, a curmudgeon might argue that this is morally hazardous since individual banks will take bigger risks in lending for over-leveraged deals because they can now shift risk on to others. So the quality of lending in the system deteriorates overall. But because in a very opaque market nobody knows where the risk ends up, why worry? Grab the dividend while it is on the table and let the devil take the hindmost.

Business Week, in an article dated September 4th (!?) and which displays the brazen gall to be found in the "News and Insights" section displays a dark flash of dazzling daftness:

Could Microsoft be bought out? That's precisely what the Financial Times of London recently called for. A consortium of private equity firms, the FT wrote, could cobble together the $288 billion needed -- nearly nine times more than the largest deal ever made. Why dare? "In truth," wrote the FT, "Microsoft would be worth more off the [public] market than on it."

The fact that anyone is talking seriously about such a colossal deal might in itself signify the high-water mark of the private-equity boom.

No, my dear, dear Business Week writer.  The fact that you are talking seriously about this Financial Times article might in itself signify the high-water maker of the "financial journalism" boom.  Honestly, is there no spell, no potion, no chant, no animal sacrifice... no human sacrifice that might rid us of suchlike?  Perhaps a buyout of McMedia ConglomerateGraw-Hill?

Ah, but it gets better.  No, really.  The diva of digital democracy herself, where everyone has a voice, i.e. the Business Week online comments section, yields this wonderful gem:

I've got most of my money invested in MSFT because its safer than a being in a bank.
- A Real Conservative

Ah, the delicious delights of Sunday afternoon.  The only pity is for those who must now travel in London on financial business while bearing the scarlet letter of a United States passport.

I do so love the intellect that recognizes there are wingnuts on either side of the Microsoft and LBO debates, and very few reasoned types in between.  Seeing the double entendre of "bi-polar" in the United States (a two party political system and the propensity to have schizoid breaks of mood) is what makes the Financial Times so charming and full of character.  Well, that and the sort of early-morning-vomit after-a-night-of-screwdrivers-and-peach-martinis color of the newsprint.

Tuesday, December 05, 2006

Agendas

hidden agenda Interesting tidbit on my entry yesterday, spurred by the Market Watch piece with a rather anti-MBO spin.  The industry expert Market Watch quoted, Nell Minow, is apparently also a Going Private reader, as today Minow wrote me to point out that Market Watch had been somewhat "selective" about the way in which the comments had been used.  Color me unsurprised.  Says Minow:

Marketwatch was very selective with my quote -- in the interview I actually said many of the same things you did in your comment, including the point that anyone who buys into it knows what he is getting and that the price reflects the control discount.  And I noted that no world-class American newspaper has ever had anything but dual class stock.  When the Chicago Tribune and LA Times switched from dual class, they suffered immediately.   Just wanted to let you know I think you're right.  While I might not buy into a dual class company, I am delighted that our capital markets permit variety to address the needs of all providers and users of capital.

Despite the constantly strong showings of certain people in the field (Vipal Monga and John Morris over at TheDeal.com, among others, come to mind) I am strongly tempted at this point to introduce a category for inept or agenda laden reporting by financial "journalists," that is, if a clever idea for a category title comes to me.

(Art Credit: Hidden Agenda, Paul Martinez-Frias)

Wednesday, December 06, 2006

Would You Believe...?

hello? department of justice? Journalism just got a bit more sinister, at least it may have.  It is hard to avoid fancying conspiracy theories about private equity, the secrecy, wealth and power associated with the brand breed all kinds of resentment and suspicion.  I would think, however, that if you are Andrew Ross Sorkin, you'd want to steer clear of that sort of thing.  Particularly, as it happens, if you don't appear to know much about the subject.  Alas, it is not so.  Consider today's entry on PEHub:

On October 16, 2005, Andrew Ross Sorkin of the New York Times authored an article titled “One Word Nobody Dares Speak.” The word to which Sorkin referred was “collusion,” and his second paragraph went like this:

Virtually any big company that puts itself up for auction these days is deluged with interest from private equity firms, which have too much money and too little time to spend it. Witness the $15 billion sale of Ford’s Hertz rental car unit to a consortium of private equity players including Clayton, Dubilier & Rice Inc., the Carlyle Group and Merrill Lynch Global Private Equity. Or the $11.3 billion sale of SunGard to a supersized group of seven buyout firms led by Silver Lake Partners. What has gone largely unquestioned is whether the formation of these consortiums of firms, or ‘’clubs'’ in industry parlance, has the potential to artificially depress buyout prices and hurt corporate shareholders.

Notice something very important about this paragraph. Specifically, the four firms Sorkin cites are the exact same firms reported to have received DoJ letters of inquiry. This limited scope has always seemed odd, particularly given that a relatively small player like Merrill Lynch was lumped in with Carlyle, CD&R and Silver Lake. Oh, and the fact that established market heavyweights like Apollo, Bain, Blackstone, Goldman Sachs, KKR, TPG, etc. apparently didn’t get letters.

So the theory goes like this: Someone in the DoJ’s New York office picked up his Sunday Times, read Sorkin’s article and thought: “I don’t know really what private equity is, but I sure know what collusion is. In fact, it’s my job to investigate collusion. But we’ll keep it low-level for now. No need to bother the big boys in DC… Now where is the cream cheese?”

Again, this might not be accurate. But it certainly is becoming conventional wisdom.

Unfortunately, there are so many journalistic Maxwell Smarts out there that I simply have to give the species its own category.

Tuesday, December 19, 2006

Tedious Corrections

you wish The process of reading through LBO related articles and then commenting here with long corrections to misconceptions, myths and outright lies has grown so tedious that I am going to start taking a different approach, that of a high school English teacher correcting a paper, as that is the level many of these articles have sunk to.  Specifically, the format you will see below with David Toll's recent piece on peHub.  My additions in underline, deletions in strikethrough and [comments written in the margins in between brackets and in red].

Useless and uninformed Ddebate continues to rage over whether buyout firms are somehow cheating on their deals. [Avoid passive voice.  What debate?  Who is debating?] Are they stealing companies from hapless willing shareholders with access to detailed transaction characteristics in a free and highly transparent market for corporate control? [Interesting thief that pays a premium to the market for what he "steals."] Despite the ample evidence that some of the highest multiples in recent memory are being paid, Aare they colluding on large transactions in a blatant violation of anti-trust laws that don't yet exist but are likely to surface now that the democrats look about ready to get around to crippling the markets, leveling commercially lethal taxes to support ineffective social programs and generally fucking up the country again?  And if not, how else can the enormous profits limited to the top firms of the top quartile so many buyout firms generate be explained other than by the complete failure of the public equity markets to provide frictionless access to capital and the compensation of substantial structural and operational risk by buyout firm investors?

All are interesting questions that will do doubt be answered in time. [Avoid useless transitional sentences like this.  Avoid complimenting yourself for asking "interesting questions," especially when they aren't interesting.]  But to me, the most important question related to the morality, if you will, of buyout firms is whether they are good for the companies that they own. [Morality has no place in the market for corporate control.  Your argument is already lost.] Buyout pros like to talk about the value that they add to their portfolio companies—the new management teams they recruit, the customer leads their advisory boards provide, the resources they provide to outsource operations to India, China or The Philippines. They’re not as eager to talk about the pressures they place on companies because of all the money borrowed to buy them, despite the fact that the incentives created by debt have proven over and over again in scholarly research to improve the efficiency and performance of companies, create investment opportunities and extract previously locked-up value.

Cash flow that previously got plowed back into the company to make new redundant hires, finance unneeded and non-core new product development, or provide an excessive and low-return cash cushion to weather theoretical bad times, instead gets hauled off by the banks, finance companies and institutional investors that hold the company’s debt securities, and loaned out or used as equity investment to other businesses to make new hires, finance new product development or provide a cash cushion to weather bad times. Having once worked at a publishing company that, owing to its poor performance, ended up being owned by a buyout firm, after the existing shareholders were paid a handsome premium, I know the stress that’s added to senior manager lives knowing that having a bad quarter or two could mean a distressed sale or even a bankruptcy filing. Sure, we learned to operate mean and lean; but what leisure could we have enjoyed, what waste and redundancy could we have created if only more could we have accomplished had we had more flexibility?  [Avoid drawing on personal experience to support a case as a single instance is unlikely to be a representative sample.]

A recent study by ratings agency Moody’s Investors Service, Default and Migration Rates for Private Equity-Sponsored Issuers, highlights the negative effects that leverage can have in a very limited subset of cases. No surprise, the ratings agencies often slap companies undergoing leveraged buyouts with downgrades as they grow nervous about the company’s ability to pay off a heavier debt load.

Is the worry unjustified? Not according to the study, [avoid double negatives] which found that companies whose debt was rated Ba (the least risky of the speculative-grade categories, as defined by Moody’s) just prior to being acquired in an LBO have double the default risk of other Ba-rated issuers, hinting that firms already in hoc shouldn't be in LBOs in the first place. Those whose debt was rated B (the next most risky category, after Ba) just prior to being bought in an LBO have a roughly 75% higher default risk than other B-rated issuers.The only silver lining for buyout firms: Companies whose debt is rated Caa to C—in other words, those most likely to default—prior to an LBO actually have a much lower risk of default than other Caa-C-rated companies. That suggests that buyout firms that specialize in turnaround deals often end up resuscitating companies that might otherwise have gone under. [This is pretty thin evidence for this conclusion.  You are also not supporting your argument and have gone way afield of your original premise].

Are buyout firms making great returns? Yes. But at what cost to the portfolio companies? That’s what I want to know. For a copy of the report send me an email at david.toll@thomson.com.

Check out this and other ill-informed and misleading stories from the latest edition of Buyouts Magazine at www.buyoutsnews.com. Subscription required. [You want us to pay for this?  Puh-lease].

All in all unconvincing, plagued by limited support for your conclusion that doesn't actually address the original (silly) premise that buyouts are potentially immoral.  Facts are lacking, half-truths, or just plain wrong and your bias is clear from the first paragraph.  Smacks of agenda-laden sensationalism and appeals to emotion rather than reality.  Might play in your journalism class (if you make it into a decent school) but here it is not going to fly.  I did like your use of punctuation though.]

D+ 

Thursday, February 22, 2007

One of These Things is Not Like the Other

all times are london timeIt is simply amazing sometimes to compare different publications and their take on the news.  More so when international borders are thrown into the mix.  Usually, it seems to be political leanings that fix the timber of headlines, so it's amusing when it's something else.  Like cultural views on regulation.  So we aren't surprised when CNN highlights the White House connection (and the article is found just below the leader "Man With Sword Mistakes Porn for Rape"), when the Wall Street Journal points to the capitalist personality, Paulson, in its lead, when Fox News makes it all about promises and commitment, and when the Financial Times is in its own little world.

Wall Street Journal: "Paulson-led Group Suggests No New Hedge Fund Regulation."
CNN: "White House group: Hedge Funds Need No New Rules."
Fox News: "Government Pledges Vigilance Over Hedge Funds."
Financial Times: "U.S. Hedge Funds Face New Guidelines."

Friday, March 02, 2007

Thick as Thieves

get your own story ThievesStolen Property. Whistleblower (yummy).

Tuesday, March 20, 2007

Robbed, Again

hand it over The always yummy Abnormal Returns points out that I have, once again, been robbed.  This time, however, Time (in partnership with CNN) stole my piece (poorly) after two others.  Late to the game, folks.  Additionally, this Justin Fox quote, taken from the Time piece, wins Going Private's 2007 Maxwell Smart Prize (awarded to the financial journalist issuing the most sweeping generalizations, possessed of the weakest grasp of finance and most the deficient command of economics).  I'm confident awarding it this early in the year because it is pretty clear, even at this early date, that no one is going to get more qualified for the honor than this:

It does nicely underscore the basic truth of the private equity business, which is that without public markets on which to buy and sell companies, it couldn't exist.

Congratulations, Mr. Fox.  The prize (a well worn and pungent shoe, owned by a man whose religious convictions forbade him to own socks and which the recipient is expected to use like a phone) can be accepted in London or forwarded by post provided the recipient compensates Going Private for shipping.

Thursday, March 29, 2007

The (Not So Paradoxical) Blackstone Paradox

butt of joke, or joker? Any number of McMedia types have emerged from their lairs to decry (or, more likely, scoff pretentiously at) the great "irony" of Blackstone's IPO.  Amusing, perhaps, if you are writing for one McBusiness paper or another, and content to study the surface of the water rather than dive deep and understand the bigger picture.  And, of course, the irony tag line "makes for good copy," a particular circumstance that seems to override any hint journalism which might have, by some unfortunate oversight in the accounting department, actually have been left in the financial journalist.  Sadly, even the Wall Street Journal seems to have succumb (subscription required) to the trend, though, thankfully, they limited themselves to commenting thus in their editorial pages and through the guise of "Breaking Views."  A Google search of "Blackstone and ipo and irony" returns 79,300 hits (for whatever that is worth given that a search for "financial and journalist and moron" returns 289,000 hits).

So should we be surprised that Blackstone, "Going Private" advocate of distinction, should resort to the public capital markets?  Not really.

If we view, as I believe we should, the boom in private equity markets as a mandate on the suitability of public markets for fostering long-term growth, and, in particular, their myopic, short-term focus on quarterly earnings, the regulatory burdens of the beloved section 404 and the inability of the investing public to sufficiently reward rational risk taking by management teams of publicly held firms, then using Blackstone as a conduit, a proxy if you will, for public capital markets inflows without imposing the value destroying constructs of the public markets on Blackstone's  daughter firms, then there doesn't seem much ironic at all about Blackstone's decision.  Quite the reverse, dear reader.

It seems, especially given the valuation Blackstone has commanded, that even the public markets know that the public markets are badly broken.  There, dear friends, is the real irony.  The markets, and the retail investors that froth therein, themselves thirst for a construct to escape the tyranny of the quarterlies, a construct that has been denied most of them by the Securities and Exchange Commission via the irritating and expanding Rule 501 of Regulation D and the (3)(c)(1) regulations, until the recent float of a number of private equity type vehicles.

Actually, the joke is on you, public markets.

Monday, April 16, 2007

(Lack of) Business Intelligence

top of the world (not) Today, some frequent short-bus patron I had never heard of over at "Portfolio," Conde Nast's new business rag, packed my already quite corpulent mailbox with 5.2 megabytes of unsolicited high-resolution color copy of the Conde cover.  This prompts me to wonder which is less "intelligent," sending 8,432,928 pixels to people who have little or no interest in your magazine, using a flagging travel publication "empire" to found a new monthly business publication, or putting a bunch of hideous downtown rooftops bathed in the caustic acid of sodium lights on a business magazine cover that doesn't even have the grace to contain a feature article on the financial performance of local roofing contractors or sodium light distributors (don't miss the article on the "Zen of Fly Fishing" though).

Oh no, I get it.  I see that someone was trying to be clever and suggest it was a top down view or perhaps even a "view from the top."  Not clever.  Sorry.

If (when) the articles are boring you can head over to the website's "Jock Exchange."  No, not a athletic supporter market (that's what I thought too), but rather a market for supporters of athletes.  Fortunately, the website also has a piece titled "Table for One: Where to Eat Unaccompanied in New York," a missive you will definitely want to avail yourself of if your friends happen to descry you reading Portfolio.  Note to Long or Short Capital: Short Portfolio in your portfolio.

Thursday, May 10, 2007

"Fairing Up" Carried Interest

dangerous fool? Anyone can be wrong about a person once or twice.  I mean really, that is ok, right?  Once or twice.  So I was wrong about Andrew Ross Sorkin.  I originally thought he was an almost charming but mostly harmless, boobish gadfly who didn't really understand finance.  I couldn't have been more wrong.

In fact, after reflecting on this carefully, it is now my considered opinion that Sorkin is a dangerous fool who is prone to do some serious damage wandering around carrying a Louisville slugger with nails driven through it while wearing a red bandanna fashioned into a blindfold and swinging wildly at dangling financial issues in the middle of a seven year old's birthday party.

So no surprise, then, that when Percy Walker's blog recently outlined a wonderfully Nixonian "enemies list" that enumerates (quite accurately in my view) the many enemies of private equity (that is the many people who would remove the capital gains treatment from carried interest in private equity, effectively more than a 100% tax hike on the funds in question) Sorkin (who ranks #1 on the list) goes over the deep end.  He blows a gasket at Walker and lowers himself (in typical leftist style) to attacking the man, as if credibility in this game was the match point.  To wit:

...but when contacted last year by Forbes magazine — which failed to find any mention of Mr. Walker in public documents — the operator of the blog said: 'I lack the desire to establish that I even exist,'"

I suspect that both Sorkin and Forbes missed the essence of the joke that is the fictional Percy Walker.  True, it is a little subtle.  Hint: your first clue should have been the stock photo of the annoyingly diverse (two minorities on a four person team) office staff- but, given that this must trigger far-left fantasies of utopian workplaces, perhaps the blinding effect explains the sudden mental density on the part of Sorkin and the financial press.  Still, it was obvious to the rest of us.  But then, no one (that I know) accused Sorkin of having any qualities even remotely resembling a sense of humor.

Interestingly, I had an exchange with Sorkin (who I have actually met in person on at least one occasion) not so long ago where he worried that I was "out to get him." I explained that I was merely "out to get" his anti-market prattle (and it is hard for this not to be a full time job by the way).  He seemed unconvinced, but his concern in this regard seemed not to prevent him from asking me out, sight unseen since he could not remember who I was (women, finance, it happens a lot).  (I will, by the way, post the logs of this exchange only if Sorkin first denies it occurred).  Luckily for me he promised to safeguard my identity if we met.  Thank god, imagine if my friends found out I was out on a date with him.  Very generous offer, given the circumstances.

You know, on further reflection, I feel that making this change in tax treatment is entirely logical and needed to sustain the economy.  We know how desperate the Treasury (subscription required) is for revenue this year.

Sorkin is right behind me on this:

Let’s be honest: it is a charade that private equity firms have claimed their 20 percent performance fees at the lower capital gains rate. To qualify, they invest a nominal amount of their own money to demonstrate that they have put something at risk, but it’s a ruse. They are paying capital gains rates for doing their job, which should be taxed at the regular income rate.

Indeed.  We cannot let people take capital gains on profits derived from "other people's money" after all.  And I agree with Sorkin.  And he is right.  The 1% of capital contributed by the general partner on a $1 billion dollar fund is definitely "nominal" in terms of personal wealth.  I know Sorkin sneezes in intervals of $10 million.  By this standard I think we might need to examine the investments of some of the limited partners too.  To the extent they only have a few percent in the game how can their capital be said to be "at risk?"  See, because ignoring diversification and betting the ranch on natural gas futures is what we want to encourage.  (It makes for great copy when those blow up too, you know).

In fact, while we are at it, there are any number of situations that have a similar stench about them.  Closing these criminal loopholes for "the rich" will be an outstanding way to boost revenue for the Treasury and deter the use of leverage in all situations.  For that matter, the tax deduction on interest payments in general is a terrible idea.  All we have to do is look to any number of the more conservative organized religions (or the Germans) to get a good view on the evils of "Schuld."

Actually, this idea didn't originate with Sorkin.  I know.  Surprise.  It seems to have found traction after a paper written by Victor Fleischer which, in the much more measured fashion of its later drafts, worries after salary that would otherwise have been paid to private equity professionals being pumped back into their funds to enjoy tax deferral and capital gains treatment.

Mr. Fleischer, however, at least has the grace to appear a little embarrassed about the brouhaha he has caused, and it is easy to forgive him if you read the original work, one that has been taken far afield of its original intent by democrats eager to geld private equity in the deluded belief that it will somehow improve the economy (or perhaps just to fleece the productive segments of the economy in the interest of "fairness.")

Fleischer toned down his suggestions, which have more to do with tax deferral and shifting of real income into partnership structures than with the capital gains treatment, I think but am not sure, in response to peer review.  Sorkin is quite late to the party here, but then he probably never read the paper in the first place.  Obviously he hasn't been reading Going Private carefully, or he would know this as I commented on Fleischer's paper more than a year ago.  That doesn't stop him, of course, from flailing about as if he were leading the charge.  I suppose that's what financial press do, however.

Mr. Fleischer, by contrast, even had the courage to self-nominate himself for Going Private's Thai Medal, one of the prizes offered in connection with the Going Private Awards.  (Nominations are still open).

The Thai Medal
This beautiful, forty eight pound brass and pewter medallion is ribboned for display around the neck of the recipient.  Awarded to the individual or organization most responsible for fostering regulatory or legislative initiatives leading to the frustration of efficient markets.

I reproduce his letter (with his permission) below:

On Tue, 20 Mar 2007 19:42:02 -0500 Victor Fleischer wrote:

Dear Equity Private - I hope you are doing well.  I hereby self-nominate for the Thai Medal.  I actually think changing the tax treatment of carry is good for economic efficiency, altho I gather from your previous blogging that you disagree.

Anyway, here's the most recent version of the paper, which is a bit more moderate than the version you saw before.  The paper has reportedly  contributed to the stirrings on Capitol Hill.

Don't hate me.

Vic

Says Fleischer in another email to me:

Apparently some folks on the Hill are still reading from my March 2006 version, which wasn't as balanced a view as the current version.

Victor Fleischer, dear readers, is a class act, even if he is from California.

Interestingly, Sorkin only manages to credit Mr. Fleischer in passing and then only because he is listed on Walker's "enemies list."  Convenient, that.

But let's not shoot the messenger.  Despite what he would have you believe was original thought, it's not his idea after all.  Let us instead consider the many ways that people earn money with "other people's money."  Obviously, all of these should be closed as "loopholes."

Housing Loans

I mean really.  A home owner puts down a paltry 20% of the purchase price, borrows the rest from big and stupid banks that don't know they are being taken advantage of and then pockets the gain for themselves.  Big stupid banks only get the interest rate but when the house is sold all the gain to the homeowner is taxed at capital gains rates.  And what does the homeowner have at risk?  Hurricane?  Insured.  Flood?  Insured.  Fire?  Insured.  Let's be honest.  It is a charade that home owners have claimed the gains on home sales as capital gains.  They were only doing their job, servicing interest rates and improving the property.  What's worse, if they buy another house they can defer the taxes until their next sale and then defer them again after that one.  We have to close this loophole immediately, clearly.  No wonder the housing market has been out of control the last ten years.  Think of the revenue to the Treasury too.  That's always a priority for market actors.

Car Loans

This is exactly the same thing.  Someone else's money (the stupid finance company) being used to make money for the car owner.  Not only do they get the use of the car, but if they profit from it at the end, well, you can see where I am going.  We need to close this loophole.  Anything this car trades for or sells for over the Blue Book value should be taxed at double ordinary income rates.

Margin Purchases of Stock

Again, traders are ripping off the brokerages by borrowing someone else's money to make a profit.  How can we allow this to be taxed favorably?  I don't care if you held that stock for 4 years and paid margin on it the entire time.  This should be taxed at ordinary income rates.  We'd hate to encourage participation in the capital markets, after all.

Employee Stock Options Plans

Well it's clear that the employee didn't pay for these.  They borrowed them from the company until the time of exercise, in effect.  Definitely, ordinary income.  Come to think of it, why are we letting the company get away with promising stock that hasn't been paid for yet anyhow?  That looks like a loan.  This needs to be taxed.  This would solve a lot of the Treasuries problems along with a lot of the problems around excessive executive compensation.

Debt Funded Purchases of Capital Assets

Why in the world, when these are resold, should we permit companies to use other people's money to get tax breaks?

I think you can see that this solves several problems.

1.  It destroys the advantage of evil leverage and thereby reduces the incentive to borrow (with predictable advantages for the economy).

2.  It makes everything fair.  Who says life cannot be fair?  Let's just move to a flat tax of 40%, in fact.  That's much more fair.

3.  Left as an exercise for the reader.

DealBook closes with:  "You would think that all the buyout kings who wear American flags on their suit lapels would be proud to pay a big tax bill."

I think that we need to consider this too.  Any true, red-blooded American firm should work hard to maximize taxes.  After all, it is the Treasury that is important.  Corporations that fly the American flag in over their headquarters should be proud to pay a big tax bill.  We have massive unfunded liabilities in union negotiated pensions to bail out, after all.

Monday, September 17, 2007

Portfolio Incentives

so bored of this alreadyPerhaps because it is the only way Portfolio magazine can persuade anyone to even look at their rambling, ad infested prattle that passes for financial journalism, I have somehow been sentenced to a term on their mailing list.  The result?  Various individuals at Portfolio repeatedly demonstrate their audacity by emailing me 1.5 megabyte .pdf files of various uninteresting (or oddly leftist) articles from their publication.  My repeated requests to end the sending of same have resulted in exactly nothing.

Heretofore I have generally ignored Portfolio, excepting one article after the unveiling of the publication.  I realize now that this has misaligned incentives for the magazine, which has apparently taken my lack of interest as license to "win me back" as a fan (hard to win back what you never possessed, but still).  Therefore, as of today, I will begin to review the writing on Portfolio.  Whenever I encounter a well written, financially astute piece, I will simply ignore it.  Whenever, however, I come across a piece that leaves an opening for stinging commentary, I will bring the full weight of what literary prowess I possess to bear with a particular emphasis on the way each piece reflects a total lack of talent at every level throughout the publication.

Who do readers have to thank for this distraction?  The author of the latest Portfolio spam that clogged my in-box, Ms. Emily Weber.  Please feel free to deliver your opinion on the topic to Ms. Weber.  Fortunately, she has provided her contact information in the latest spam:

Emily Weber
emily_weber@condenast.com
212-286-6373

The irritated Going Private reader may find my email to Ms. Webber instructive:

----- Forwarded message from Equity Private <equityprivate@hushmail.com> -----
Dear Ms. Webber:

For months now, I have attempted to ignore the inane, poorly
written, badly researched and shallowly conceived print which
purports to pass for "writing" in your publication "Portfolio." 
Unfortunately, your repeated, unsolicited, uninteresting and
uninspiring emails (typically with large .pdf attachments designed
to clog my inbox) have not permitted me to continue ignoring your
work in perpetuity.  Accordingly, and while I am not typically a
vindictive person, I have elected to take a more serious interest
in the "work" of your publication.  (See my latest weblog entry:
http://equityprivate.typepad.com/ep/2007/09/portfolio-incen.html )

Unfortunately for Portfolio, my appraisal of that work is almost
universally negative.  It is my intention, therefore, to publish my
most stinging and biting commentary for my 1200 or so regular
readers in the financial community whenever I am reminded of your
publication (for instance, when I receive unsolicited email from
you or any other associate of Conde Nast) until I lose interest. 
Of course, the only way I will eventually lose interest is if I
stop receiving unsolicited email from you.  I leave it to you to
decide how to handle this most recent development.

Best Regards,

-ep

Equity Private
http://equityprivate.typepad.com

On Mon, 17 Sep 2007 09:16:49 -0500 Emily Weber
<Emily_Weber@condenast.com> wrote:
>
>FOR IMMEDIATE RELEASE
>SEPTEMBER 17, 2007
>
>THE BANANA WAR
>
>[Blah Blah Blah]
>
>
>Emily Weber
>emily_weber@condenast.com
>212-286-6373

Wednesday, January 09, 2008

Activism is Hot

dangerous fool? Long-time Going Private readers will express little surprise when confronted with hints that I dislike Andrew Ross Sorkin's style.  (Or that I just plain dislike Andrew Ross Sorkin).  My disdain tends to be connected to the phrase "a little knowledge is a dangerous thing," and, unfortunately, that tends to be magnified by the fact that Sorkin has the resources of the New York Times at his disposal to spread his pet theories.  Like all good practitioners of the narrative fallacy, Sorkin's explanations sound reasonable at first blush.  They do not, however, stand scrutiny well- but then I don't think the typical New York Times reader regards skeptical inquiry as a virtue.  This would not disturb me so much were most of his spoutings not of the populist variety.

This sort of demagoguery previously prompted me to describe Sorkin as...

...a dangerous fool who is prone to do some serious damage wandering around carrying a Louisville slugger with nails driven through it while wearing a red bandanna fashioned into a blindfold and swinging wildly at dangling financial issues in the middle of a seven year old's birthday party.

So back in August, Sorkin speculated aloud that "...the credit crisis may have just claimed its latest casualty: the so-called activist shareholder."  He went on to spout off that:

"...activism, for the most part, is a one-trick pony. For all of activists’ hemming and hawing about strategic change, their real mission boils down to four things: have the company sold, break the company up or push it to take on debt so it can buy back stock or issue a big dividend."

Let's examine that closely.  Activism is a "one-trick-pony."  What if we were to outline the activist strategy as a "one-trick" approach?

1.  Activist Goal:

1(A).  Sell company
1(B).  Break company up
1(C).  Assume debt to:

1(C)(1).  Mount stock buy-back program
1(C)(2).  Issue dividend

So that's how Sorkin defines "one-trick" I suppose.  Of course, Sorkin has neglected some activist "tricks" in his analysis, including:

1(D).  Acquire company in tender offer, and:

1(D)(1).  Improve operations before:

1(D)(1)(a).  Selling company to private buyer
1(D)(1)(b).  Going public

1(D)(2).  Hold indefinitely for cash flow

1(E).  Agitate for corporate governance improvement and:

1(E)(1).  Sell stake for gain, or
1(E)(2).  Push for sale of improved company, or
1(E)(3).  Mount proxy fight, and:

1(E)(3)(a).  Sell stake for gain
1(E)(3)(b).  Push for sale of improved company

I am, of course, only scratching the surface.  Still, that's a pretty big "one-trick" for a pony to have.  Sorkin continued:

All of those strategies rely on cheap capital, but because of the current credit squeeze, that financing is vanishing. The big buyout firms have already been stopped cold in their tracks. That may mean the activist bravado of yore — and the typically unspoken symbiotic relationship between buyout firms and activist hedge funds — may disappear along with easy credit.

Reading this, I suppose Sorkin couldn't have been much of a Going Private reader, since that "unspoken symbotic realtionship" was the subject of much discussion on my part several months earlier.  Indeed, almost a year before Sorkin's great revelation about the one-dimensional nature of activism, Going Private already had an entire category dedicated to the topic.  I was hardly the first person to cite these kinds of relationships either.

Equally unsurprising, given the shaky ground his assumptions stood on, is the fact that Sorkin was dead wrong.  The only surprise is that DealBook (a.k.a. Sorkin) bothered to cite Sorkin's wrongness.  But Sorkin seems to like citing Sorkin, so perhaps that was actually more predictable than we might have thought.  Funny, I wouldn't have even noticed had it not been for (the always yummy) Abnormal Returns.

We can hardly blame Sorkin, however.  Like many (most?) of his peers in financial journalism, familiarity with the basic tenants of investor strategy is, apparently, not a compelling prerequisite to writing pieces on the investors who employ them.  It is difficult to hold Sorkin to any kind of higher standard.  Really, his awareness that there is such a thing as an "activist investor" probably gives him a B- on the curve of the financial journalism knowledge test.  Being unaware that activists do more than just employ leverage is par for the course when it comes to the universe of anti-capitalist journalists.

Still, one gets a lot of negative points from me for badmouthing activist hotties.

Thursday, January 10, 2008

Deep Debt Impact

deep debt? While I tend to bristle when pressed into involuntary service as a professor, teaching first year investment theory or financial instruments to people who, though they love to belittle MBAs, never bothered to learn these concepts- believe it or not, my role simply is not to correct the many misconceptions exhibited by, or to fill the gaps in financial education possessed by, certain financial journalists who find themselves the subject of my musings- the connection between debt, debt markets and activism as an investment strategy bears some additional scrutiny.  Lest I be accused of failing to substantiate my accusations of intellectual sloth, a somewhat in-depth discussion is probably warranted.  In this vein, the role of debt generally as it is tied to returns (alpha, if I may be so crude) realized by active (not just activist) strategies likely could benefit from some discussion.

To complete the professorial metaphor, some classroom background may be helpful.

It amazes me how many market actors profess to be adherents to "perfectly efficient markets" theory (all information is perfectly reflected in prices all the time) and still engage in active investment strategies.  Below this threshold there are any number of more limited versions of efficient market theory- but unless one finds oneself on the far opposite side of the spectrum (no information is reflected in prices- they are a perfect source of entropy- and this would be beyond fascinating for reasons only interesting to those investors, like me, who also have a deep lust for theoretical physics and information theory) you should agree that information asymmetry, while not the only source of alpha, is probably the most influential.

My own disposition is towards limited market efficiency- prices reflect all sufficiently scrutinized information, subject to sufficiently saturating capital.  This implies two major sources of pricing error:

1.  Insufficient distribution of material information.
2.  Insufficient capital applied by those in possession of material information.

This further suggests that active management can exploit asymmetric information (learn something the market doesn't yet fully understand) or asymmetric capital (apply capital where the market hasn't yet bothered to) in the pursuit of "true" alpha.  Although, technically asymmetric capital is just a derivative of asymmetric information.

There is hope for those of us who believe that information grows more and more "imperfect" every day, at least if you listen to the likes of Moody's (though the wisdom of that decision could occupy several posts by itself).  Abnormal Returns points us to Alea which, quoting Moody's, suggests that:

One of the key reasons for the lack of information on the extent of risk and its location has been financial innovation, leading to greater complexity.

The combination of financial innovation, opacity and leverage is generally explosive.

Financial innovation often leads to an uneven distribution of the information available to the different parties at risk.

The problem in the case of extreme complexity of inter-connecting financial systems is that it is hard to see how the level of information could reach levels adequate to enable reasonable risk management standards.

Overall, the financial system suffered from flawed incentives that encouraged excessive risk-taking.

In no small measure, information asymmetry as a pricing force has all the elegance of a unified theory and (ironically) a certain symmetry (even super symmetry) in application.  I have referred to this phenomenon before in the context of CDO/CLO structures and the incentive structures that encouraged the (potentially reckless) growth of these instruments, as well as in the context of "debt attitude arbitrage."  The take-away message is that information asymmetry is a thread that runs through what are essentially pricing models.  To the extent one, as an investor, does not examine the incentive structures of the market, one risks being on the wrong side of the information asymmetry balance.  As an aside, this has what can only be termed "very serious" ramifications for an analysis of investment banking markets.

The passage from the Financial Times' Raghuram Rajan that follows may well be the most important thing reproduced in these pages in 2008, as brought to my attention (again) by Alea.  To wit:

Alpha is quite hard to generate since most ways of doing so depend on the investment manager possessing unique abilities – to pick stocks, identify weaknesses in management and remedy them, or undertake financial innovation. Such abilities are rare. How then can untalented investment managers justify their pay? Unfortunately, all too often it is by creating fake alpha – appearing to create excess returns but in fact taking on hidden tail risks, which produce a steady positive return most of the time as compensation for a rare, very negative, return.

For example, an investment manager who bought AAA-rated tranches of collateralised debt obligations (CDO) in the past generated a return of 50 to 60 basis points higher than a similar AAA-rated corporate bond. That “excess” return was in fact compens­ation for the “tail” risk that the CDO would default, a risk that was no doubt perceived as small when the housing market was rollicking along, but which was not zero. If all the manager had disclosed was the high rating of his investment portfolio he would have looked like a genius, making money without additional risk, even more so if he multiplied his “excess” return by leverage. Similarly, the management of Northern Rock followed the old strategy of taking on tail risk, borrowing short and lending long and praying that the unlikely event of a liquidity shortage never materialised. All these strategies essentially earn the manager a premium in normal times for taking on beta risk that materialises only infrequently. These premiums are not alpha, since they are wiped out when the risk materialises.

True alpha can be measured only in the long run and with the benefit of hindsight – in the same way as the acumen of someone writing earthquake insurance can be measured only over a period long enough for earthquakes to have occurred. Compensation structures that reward managers annually for profits, but do not claw these rewards back when losses materialise, encourage the creation of fake alpha.

This is important enough that it bears repetition.  Particularly this bit below.  Really.  Read it again.  It's that important:

If all the manager had disclosed was the high rating of his investment portfolio he would have looked like a genius, making money without additional risk, even more so if he multiplied his “excess” return by leverage.

The important thread to follow into the rest of the discussion is that these questions should have set off alarm bells loud enough to deafen, if only market actors bothered to listen.  Of course, the social rub is that this analysis shifts the burden of loss to the market actors who incurred the losses (an effect that tends to inspire rejection of the premise of information asymmetry, or prompt the invocation of the magic regulatory conjuring spell "That's unfair!" which is often laid across a rotting floral bed of "the losers were snookered by sophisticated financial insiders," where "sophisticated financial insiders" usually translates to "educated investors" and "losers" usually parses to "armchair investors who feel entitled to abnormal returns.")  Let's face it, losers make sympathetic victims, and, as I quoted recently:

...[the somewhat spoiled sense of American entitlement] can spawn vices. One is impatience. Another is a culture of chronic complaint. A third is the belief that every problem has a solution, that trial is possible without error, that risks must always be zero, that every inconvenience is an outrage, every setback a disaster and every mishap a plausible basis for a lawsuit.

One can see the change over the last few decades in the comments of one astute reader's response to the Alea entry.

Nearly 3 decades ago, at a large commercial bank, the risk management effort was based on not ‘what-if’ analysis (the statistical analysis relied on by firms like Moody’s) but ‘if-what’ analysis. That is, first determine all the conditions under which an transaction could lose money. Then assign probabilities to those conditions. If you couldn’t determine the conditions under which the transaction would lose money, you didn’t execute.

There is no entitlement to abnormal returns.  And, to quote our favorite tag line (from Abnormal Returns), "investing is hard."  This, I think, is the point where certain financial journalists and other pundits fall off the moving train and start looking for explanations that permit them to reject this basic (and very undemocratic) inequality.  Information asymmetry looks awfully unfair.  This is because it is.  The mistake is not in the label "unfair," but the assertion that "unfair" is, somehow, intrinsically evil.

Investing is hard.  But it is not impossible.  I will make no claims whatsoever to having "called" the credit crunch, but the incentives issues in these markets were a frequent topic on these pages early on.  Part of this approach flows from my personal view of the human condition:

Confucius: Man basically good.  (Significant evidence during the brutal warlord infighting of the Chou Dynasty to the contrary notwithstanding).
Rousseau: Man basically good ("Noble Savage").  Society makes man evil.  Widespread peasantry is the ideal state.
Scientologists: Man basically good, but the machinations of certain evil aliens long ago complicate matters.
Kierkegaard: Man is impossible to classify.
Puritans: Man is basically evil.  Fire purifies.  (Though this is hard to compute given how deeply carbon stains).
Baptists: Man is plagued by total, hereditary depravity.
Equity Private: Man is basically lazy.  Innovative and complex incentive and disincentive structures must be continually created and refined to compel any desirable behavior (including the absence self-destructive behavior).  Excessive gaming of the system will be employed at every opportunity to avoid doing anything resembling work.

It is ironic that those with more optimistic views of behavioral sciences ("give sanctions a chance!") end up defending these notions to the death in the face of all evidence to the contrary.  And so, myths and misconceptions not only appear about the world of finance, but are latched onto by those desperate to defend the rosy refractions that color their world view.  When so colored, these misconceptions tend to show themselves rather glaringly to anyone who cares to subject the assertions and predictions of these human optimists, (dare I say, populists?) to scrutiny.

This brings us to certain attitudes about activist investors, and the most prevalent in my field of view today happen to be those of Mr. Sorkin.  (In my defense, this is entirely the fault of Mr. Sorkin).

Misconception number one is a common one among Maxwell Smarts, that is that financial investors (as opposed to "strategic investors," and there is much fudging among Smarts as to where the line here actually lies) are short-term profiteers.  The corollary to this misconception is the conviction that short-term investment is intrinsically evil, but we will leave that for another day.  Taking just activism,
we find that average holding periods range from 1 to 3 years (depending on the study and whether the investment holding period is measured from the filing of the first 13D, or from the first appearance on a 13F).  In the case of activists this misconception stems from a basic misunderstanding of what activist investing is, and in particular that activist investors are generally value investors first.

Misconception number two is that activists are just reformed corporate raiders.  It is true that former raiders make up a large portion of the list of who we might call "activists" today, but anyone convinced that the game is the same (or that greenmail takes place with any frequency anymore) has simply seen Wall Street too many times (and forgotten that it was released in 1987).  It is probably prudent to point out that back in their day, raiders did not have available to them the plethora of tools for injecting accountability to corporate management that they do today.  The only tool was the threat of a loss of control and liquidation (which begs the question if liquidation is also intrinsically evil).  Regardless, activists today have a much broader set of tools to inject accountability.

Misconception number three is that activists depend on cheap debt for their returns.  The corollary to this misconception is that debt today isn't cheap anymore.  Even the most cursory study of historical debt rates and relative debt prices today (72kB .pdf from Clearbook Financial as cited by Infectious Greed) would disabuse the most research averse financial journalist of this misconception.  (Only five countries have rates lower than the United States today).  But "work is for suckas," in the world of the average financial journalist- and unnecessary as the narrative fallacy is alive and well in the psyche of the news consuming public.  Maxwell Smarts wouldn't bother to notice that in mid-2000 LIBOR rates were nearly 7.5%.  Chapman Capital was busily squeezing change out of the American Communities Property Trust back then.  And in 1988, 1989 and 1990, when the same rates were in or nearly in double digits for a period of over 18 months?  Ralph Whitworth (who would later found Relational Investors in 1995 when rates were again peaking around 7-8%) was running insurgent campaigns via the United Shareholders Association (T. Boone Pickens was a major investor). Today LIBOR rates sit around 4.3% or so.

So it is not surprising that Mr. Sorkin might be possessed of the mistaken belief that the last six months of activist performance (which he documents poorly in any event) could somehow be explained by debt prices.  (Even if there were a connection as direct at Mr. Sorkin claims, it is his lack of understanding with respect to activist holding periods that compounds his error- since a six month debt pricing spike will hardly show dramatic results on returns if investor holding periods average at least twice if not six times that duration).

All of this is a rather extended way of saying that astute Going Private readers will regard with skepticism any pundit or financial journalist (or indeed, anyone) claiming that leverage is intrinsically evil, that returns for a given strategy are dependent on cheap debt (amazing the profits the early buyout kings made when they had to borrow at 12%) or that "losers" in a given marketplace have de facto been the subject of fraud and deception.

Indeed, Going Private regulars will smirk at such suggestions, and recognize the attempts of lesser students of financial markets to disguise their ignorance, and that of their populist peers, by calling investment strategies "black magic," and mistaking the role of leverage in legitimate strategies as often as they are fooled by its complexity creating effects for merely beta-based returns.

Debt can either magnify returns generated by true alpha, or disguise (that is increase information asymmetry in) returns that may or may not have anything to do with alpha.  The correct response to investment strategies that appear to generate abnormal returns but are of such complexity to defy understand is not to invest.  Or, to emphasize the commenter of earlier fame:

If you couldn’t determine the conditions under which the transaction would lose money, you didn’t execute.

Follow that?  If you don't understand what you are buying, don't buy.  Quite simple.  Or so you would think.

Cheap debt does not cause losses.  Being on the wrong side of information asymmetry does.  When structures are complex, falling back to a careful look at incentives often is the best (and only) behavioral prediction mechanism.

Activism is, along with value investing strategies and in my view, one of the few pure sources of alpha.

Activism is not hard to understand.  If you bother to educate yourself.

Monday, January 14, 2008

Wealth and Fame

you have no idea At least in contemporary finance culture (is there such a thing?) the interplay between money and fame is most glaringly apparent in the world of hedge funds.  Be this as it may, some recent incidents have caused me to wonder to myself if this dynamic, like many in contemporary finance culture (if there is such a thing), isn't more complex than it first appears. Incentive fees (and management fees) being what they are, there are strong incentives for hedge funds to grow assets at (nearly) any expense.  There are some noted exceptions to these rules (I can think of an activist or two who have returned rather large sums to investors when they have been unable to, in good faith, place the funds in sufficiently worthy investments) but these are few and far between.  Getting the word out, and pushing the hype is, as with any financial product, part of the fundraising game.

Of course, technically hedge funds aren't supposed to be engaged in "general solicitation."  That is covered by Rule 502(c) which provides in part:

Except as provided in Rule 504(b)(1), neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising, including, but not limited to, the following:

(1) Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and

(2) Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising;

Hedge fund managers who are prone to quoting returns and figures in publications, or chatting too liberally with members of the press are likely to get something of a spanking from the SEC.  We must, after all, protect non-accredited investors from themselves (though I suspect this bit of nanny-statism is preferable to a legislative unwinding transactions between consenting parties because they are judged "unfair" after the fact and in the context of a shift in markets to something other than permabull dynamics).

Fame, then, would seem a shortcut, even a loophole, to such restrictions.  Many managers court such publicity actively.  This is, to the extent this term has any meaning whatsoever, "marketing."

It amuses me then when such managers are described as "secretive," "publicity shy," "reclusive," or "intensely private."  It is hard to take, for instance, Bloomberg very seriously when they "speculate" on the "ever secretive Renaissance."  Apparently, Renaissance wasn't so secretive that its founder the "reclusive" James Simons couldn't be persuaded to give Bloomberg an exclusive interview (or three), pan his life story and sit for an extensive Bloomberg photo shoot.  Of course, Bloomberg tries to maintain the illusion of hard hitting investigative financial journalism with lines sprinkled with breezy comments like "...according to Bloomberg calculations," and "...though Simons dislikes talking about it...."  Ah, yes.  Of course he does.  But not so much that he won't talk about it.  Guess the hard hitting investigative reported had a nice pair.  ("Of what," is the question- but then I think Simons' smile in the picture might be a clue there).

Any number of hedge fund mangers or private equity firms have found themselves in warmer-than-comfortable water with the SEC after a puff-piece appeared on Bloomberg under the "Bloomberg.com: Exclusive" banner.  And Bloomberg, by the way, is particularly guilty of such sins.  This should be enough to land them in Going Private's Maxwell Smart category by itself, but their ethical lapses are not limited to managers cast from the publicity hound mold.

Rare are the managers who are, in fact, "secretive," whatever Bloomberg may try to sell you- but they do exist here and there.  Not that Bloomberg has much regard for such privacy in the rare instance that they encounter it among the rolls of professional managers.

Recently, a good friend of Going Private pointed me to a Bloomberg profile on a number of hedge fund managers, including his boss, the head of a rather successful family of funds which have made him quite wealthy by almost any standards one would care to articulate.  In the course of reading the article I managed effortlessly to determine:

1.  His street address
2.  The price of his house
3.  His daily exercise habits and, thereby, his daily whereabouts
4.  The school his two minor children attend
5.  His performance and management fees for the year
6.  His wife's habits

I could go on, but time forbids me.

Ah well, I thought, another ego-driven hedgie who's publicist managed to score a puff on Bloomberg.  *yawn*  Yeah, except not.

Turns out that the subject of the article had nothing to do with it, refused to comment and asked Bloomberg not to print it.  Forgive me my cynicism, but I wonder if the classic journalistic threat (Want a favorable piece?  Give us access.) wasn't at work here.  If so, and this is just my speculation, it borders on criminal in my opinion.

Suffice it to say, if I was running an international kidnapping cartel, my arrival in New York would be followed immediately by a visit to the most anonymous internet cafe I could find (or some wireless wardriving perhaps) and several Bloomberg searches.  (Law and Order had a totally cool episode about a hedge fund manager kidnapped by his employees recently, so you just know that I'm current).

Still, some hedgies, and other professional "money runners," do get some use out of publicity.  For some, this is merely an ego gratification.  (You people know who you are).  Indeed, publicity hounds in this category are, at least in my view, violating at least the spirit of Rule 502(c), and the hedgies I respect avoid rather than court publicity.  Still, it can be useful in some circumstances.  For instance:

Your investment vehicle is going public.  I don't know that anyone would make the argument that Steve Schwartzman's stock suffered when the over-the-topness of his birthday parts became (and by this I mean, was encouraged to become) public.  Sure, Congress might be pissed off, but a few dollars in share price buys a metric ass-ton of lobbyists.

You are an activist.  Before you ever get to the point where you are soliciting shareholders for your proxy fight, the pure intimidation factor your name lends to the initial discussion with management can keep campaigns simple, quick and effective because you are a "credible threat," (Dan Loeb filed a 13D?  Go to threat level RED: severe risk of activist campaign!)  This helps even more if management decides to fight and you need to go to street for support.  So here, well, I'm more sympathetic.

As for the rest?  Really, let your performance do the talking.  Or my hedge fund friend would say:

"Just because you have $10.00 and everyone knows about it doesn't make it $11.00."

But then, he gets mad when investors leak their (outstanding) performance figures to the press- so he's a rare bird.  Think, dear hedgies, about the company you keep:

In America, I find, it's fame, rather than money.  Now, after all this unpleasantness, I always get the best table.

- Klaus von Bulow

Monday, March 03, 2008

Not This Shit Again

awwww g'z I must be in the minority in thinking that the term "sophisticated investor" implies a degree of self-reliance, confidence in nothing one hears and a percentage of what one sees that won't cross the threshold requiring a 13D filing.  How else can one explain the increasingly common notion that relying with complete or near complete exclusivity on third party research when making investment decisions is not only appropriate, but what "sophisticated investors" do.  Have things slipped so far in the United States that we need third party research as a crutch- and a scapegoat for everyone who invests?  Seems so.  Moreover, people who should know better have taken the bait.  To wit:

Many of these investors have been so sophisticated that they created a demand for services which provide them with the underlying ratings of muni bonds regardless of bond insurance.

Wow, now that is sophisticated.

But then?

It may help to take a look at why muni investors require such granular credit analysis. The reason is relatively easy to understand: municipalities have far less and less consistent financial transparency than corporations, especially public corporations.

Oh, of course.  Less available information, less individual research.  Silly me, I thought the rule was "less available information, less investment."  I have seen my error.  Makes perfect sense now.  If only we had better more detailed more exclusive, more inclusive, more granular, ratings, everyone would have the great American dream entitlement, low no risk, high return investments without any never-ending bubbles.

Thursday, May 08, 2008

Financial Journalism for the Mathematically Challanged

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