Going Private

Private Equity Apprentice

After putting the finishing touches on a deal that took 3 months to orchestrate:
Armin: "So long as they leave the management team intact we have a deal."
Associate: (Bursting in)  "They just fired the CFO!"

Swords at Dawn

If in the course of a discussion, during which the rules of politeness have not been transgressed, but in consequence of which expressions have been used which induce one of the party to consider himself offended, the man who demands satisfaction cannot be considered the aggressor, or the person who gives it the offended; the case must be submitted to the trial of chance.

But if a man sends a message without a sufficient cause, he becomes the aggressor; and the seconds, before they allow a meeting to take place, must insist upon a sufficient reason being manifestly shown.

All these are insisted on because the selection of the weapons and the kind of duel rests with the offended party.

The swords are measured to ascertain that they are of equal length, and in no case must a sword with a sharp edge or a notch be allowed.

The combatants are requested to throw off their coats and to lay bare their breasts, to show that they do not wear any defence or cuirass that could ward off a thrust.

A refusal to submit to this proposal is to be considered a refusal to fight. If, on comparing weapons, the swords are found to differ, the choice must be decided by chance, unless the disproportion is of a material nature.

At the word ALLEZ, "commence," they set to, the seconds holding a sword or a cane, with the point downwards, and standing close to each combatant, and prepared to stop the fight the moment the rules agreed upon are transgressed.

Unless previously stipulated, neither of the combatants is allowed to turn off the sword of his opponent with the left hand; should a combatant persist in thus using his left hand, the seconds of his adversary may insist that the hand shall be tied behind his back.

When one of the parties exclaims that he is wounded, or a wound is perceived by his second, the combat is stopped; but with the consent of the wounded man it may be renewed.

If the wounded man, although the combat is ordered to be stopped, continues to press upon his opponent, this act is equivalent to his express desire to continue the conflict; but he must be stopped and reprimanded. If, in the same circumstances, the combatant that is not wounded continues to press on his antagonist, although ordered to stop by the seconds, he must be immediately checked by them, and considered to have infringed the rules.

- Andrew Steinmetz, "The Romance of Duelling in all Times & Countries" (1868)

As with much written by Steinmetz about dueling and gambling, there are direct parallels to Steinmetz everywhere in Private Equity.  We could easily be discussing the process of putting a company in play, and going to due diligence in the passages above. In Private Equity the weapon of choice is usually the discounted cash flow analysis.  (DCF).

The concept is simple.  What would you have to pay me today to forgo $1,000,000 per year paid for 10 years?  It should be obvious to most that the chance of seeing $1,000,000 next year is worth less than having $1,000,000 this year.  This is the time value of money.  How much less?  That depends on how risky you think things are.

Clearly, we think that a loan by a bankrupt company is riskier than a loan from GE.  We quantify how risky we think these obligations are with something called the "discount rate."  It's the return we need to see on the capital at risk in order to be compensated for that risk.

That said, when we guess what a company will spill out to us in "free cash" each year and apply the discount rate back against it, we then decide how much those cash flows are worth paying for today.  The higher the risk we perceive, the higher the discount rate, and the less we are willing to pay today.

It should be clear that sellers have several interests here: First, to boost revenues.  This will, holding all else equal, boost free cash and thus boost the value of the firm. Second, to minimize costs.  This will, holding all else equal, boost free cash and thus boost the value of the firm. Third, to keep the "discount rate" low.

These, dear readers, are the protocols for the DCF duel.

The duel can begin anywhere.  In discussions fostered by the LOI.  Before the LOI.  In the management meeting.  After the management meeting.  Anywhere.  But it typically starts in the same way.

Last month I was engaged in a fencing match along these lines.  I recount it to you now set to the background of the mortal duel fought in 1613 between Lord Sackville, 4th Earl of Dorset and Edward Bruce, 2nd Lord of Kinloss, over Venetia Stanley, the grand-daughter of Edward Stanley, 3rd Earl of Derby, and who was 13 at the time.

The part of Lord Edward Sackville is played by me.
The part of Lord Edward Sackville's Second is played by our attorney, Michael.
The part of Lord Edward Sackville's Third is played by our banker, Thomas.
The part of Lord Edward Bruce is played by the company's CFO, Ike.
The part of Lord Edward Bruce's Second is played by the sell-side investment banker representing the company we are considering purchasing.
The part of Lord Edward Bruce's Third is played by the company's general counsel.
The part of Venetia Stanley is played by the company.  (It's a non-speaking part).

Act I

Scene, Manhattan, an elegant boardroom encompassing an obscenely expensive conference table, leather chairs and a wide range of expensive looking (but probably cheap) art on the walls.  Present are Lord Edward Bruce, and the Friends of Lord Bruce, his Second and Third.

Enter Lord Edward Sackvlle with Second and Third, armed with swords and bucklers (pens and laptops).

Sackville's Second: "Gentlemen.  I think everyone knows everyone else, so let's just get started, shall we?"

Handshakes all around.  The newcomers sit.

Bruce's Third: "Alright.  We have reviewed the provisions in your LOI and I have to say we don't feel we are very close on the purchase price."

Sackville: "What exactly do you base that on?"

Bruce: "I don't know who put together the valuation, but it needs to be reviewed.  It's quite low."

Sackville (offended, icily): "I did the valuation."

A brief silence.

Bruce: "Management's projections are realistic and conservative."

Sackville: "Which are they.  Realistic or conservative?"

Bruce (annoyed): "Look, anything less than 7 times [this means 7x EBITDA] isn't worth talking about."

Sackville: "Where are you getting that figure from?  We aren’t going to pay 7 times just because that's management's favorite number."

Bruce's Second: "Ok, ok.  Let's bring this back to reality.  Do you have specific issues with management's projections."

Sackville: "Well, yes, we do.  Shall we go over them?"

Bruce's Second: "I think that would be a good place to start.  How did you do the valuation."

Sackville: "We did a discounted cash flow after making adjustments to management's projections, of course."

Bruce's Third: "I'm certain that if we go over those you will see our perspective on the company and why we are optimistic."

Sackville's Third (aside to Sackville): "First realistic, then conservative, now optimistic."

Sackville (drawing sword/laptop): "Ok, let's start with the projections management made for revenue growth."

Bruce (drawing sword/management spreadsheet): "Alright."

The two salute each other.

Sackville: "You show revenues of about $156 million in 2005."

Bruce: "Yes." Sackville (a gentle thrust): "Those are audited?"

Bruce (a weak parry): "Yes.  Well, no.  Not yet.  We are expecting the auditor's to finish up soon."

Sackville: "Soon?"

Bruce: "Soon."

A long pause.

Sackville (steps forward): "Ok.  Now for 2006 you are forecasting $185 million."

Bruce: "Yes." Sackville (a quick lunge): "Growth of 18.5%?"

Bruce (another weak parry): "Yes."

Sackville (a second thrust): "In an industry with an average of 8.5% growth over the last 5 years?"

Bruce (stumbling back): "We have several new initiatives which we feel..."

Sackville (sensing weakness, presses the attack): "In the same industry?  Or are you moving away from your core competency?"

Bruce (wavering): "We're not unfocused if that's what you mean."

Sackville: "So in the same industry.  You're not going to start making plastic bookends, right?"

Bruce: "Same industry, but we feel..."

Sackville (a quick slash drawing blood from Bruce): "See, this is the problem I have with your projections.  You are forecasting 18.5% growth in the year after a transaction when your company, by your own figures, has never seen more than 9% growth in the last 7 years.  I might add that the number one player in the industry averaged 11% growth over the last 3 years and their record growth year was 12.4%  How are you going to get..." (Looks at the figures) "18.5% in 2006, 22.0% in 2007, 16.0% in 2008, 13% in 2009, 12% in 2010... The list goes on.  It looks to me like someone just picked a bunch of even percentages and figured revenue forward that way."

Bruce (wounded): "We are quite confident in the numbers."

Sackville: "Did you do a revenue build-up?  Or did you just pick percentages?"

Bruce (wounded twice): "We didn't 'just pick' anything."

Sackville: "Did you do a revenue build up?  Is there some way I can see where these huge growth figures are coming from?  Which products are contributing what?"

Bruce (pushed to the ground): "I'll get back to you on that.  I am sure we have something."

Sackville (backing off to let Bruce get back on his feet): "Alright, that would be helpful.  Let's do this.  For the moment let's just give you 11.5% growth.  Better than industry average, yes?"

Bruce: "I don't think that's right."

Sackville: "Well, we certainly don't think 18% is the number.  Even 12% is generous here, I think, but let's use that for the moment, at least until I get those buildup figures, ok?"

Bruce: "Alright, alright."

Sackville (cleaning the first blood from the sword/typing into excel): "12% across.  Ok.  Now, why is your cost of goods sold steadily decreasing every year?  You're at 64% of revenue in 2005 but by 2008 you're down to 61%.  How does that come about."

Bruce: "We've instituted improvements in our processes."

Sackville (renewing the attack): "Well, this would put you at the top of the industry for cost of goods sold too.  The industry average is 63.6% and the only player I could find with lower is a Chinese firm that doesn't even sell to the U.S.  They were 60.5%  How are you going to be at 61% in 2 years?"

Bruce: "Part of that is through outsourcing arrangements."

Sackville: "You're already outsourcing 65% of your production costs, how much more savings can you get?  Look, let's flat line that at 63%.  Top quartile in the industry.  We can live with that for the moment, can't we?"

Bruce (weak counter-attack): "Well I really don't think that's a good figure.  We can do better than that."

Sackville: "Do you have pilots you've done?  Have you gotten vendors to do studies?  Where do these figures come from?  It looks to me again just like someone picked a nice even number.  It's not even 61.02% it's exactly 61%.  Look, let's flat line it at 63%.  We can come back to it."

Bruce (wounded again): "Alright."

Sackville (a brutal stab now): "Typically, I'd go into add-backs next, but let's just see where we are, ok?  Just changing the revenue figures and the cost of goods sold figures to be in line with the industry, no at the HEAD of the industry, my DCF shows $196 million."

Bruce's Second (crying out): "That's WAY out of line."

Sackville: "Ok, well, where did this $350 million figure you have come from? I assume that was a discounted cash flow?  Something of the sort?"

Bruce: "That's right." Sackville: "Well, what did you use for your discount rate?"

Bruce: "11%."

Sackville (lunging again): "11%?  I could get 12% out of the S&P 500 in 5 years.  Are you trying to tell me this middle market company here is no riskier than a strong index fund?"

A long silence.

Sackville: "Ok, you did the discounted cash flow at 11%.  Did you apply a liquidity discount?  It's not like the buyer of this company has a ton of liquidity here folks.  20% even 30% of discount on the final DCF figure is not out of line in a case like this."

Bruce lays on the ground, bleeding from multiple wounds.

Sackville: "Alright, maybe we should take a break."

Exeunt all but Bruce and his Second and Third.

In this case we fought another 30 minutes, they seemed to even acquiesce to our points.

In the duel between Sackville and Bruce, Sackville killed Bruce, but then found that Venetia Stanley had decided to marry Sir Kenelm Digby instead.

You can win the duel over a DCF and still lose the company.  This company sold for $365 million to someone else (thank god) dim enough to buy management's assumptions without fighting a duel. 

They've gone through 3 layers of layoffs already, even though the company was already having problems meeting demand, and it's hard to imagine how they will survive given all the debt they took on.

As you may have noticed, this week is Andrew Steinmetz week.  What can I say?  I'm feeling romantic. 

The graphic is from Jean-Léon Gérôme's "Duel After a Masked Ball" (1857). -ep

The Power of Small

After reading the old, wonderfully offensive and quite true article on The Leveraged Sellout I couldn't help but notice that an article in Today's Wall Street Journal makes a point of pointing out the major ground "boutique" banks have covered in the last 5 years.  (I wonder what Mr. Jonathan A. Knee had to do to get a puff piece like that in the Journal?) 

Surprise

Associate #1: "Tara slept her way into that job."
Associate #2: "With that Vice President?"
Associate #1: "Yep."
Associate #2: "Alan? You've got to be kidding. That guy is a serious asshole."
Associate #1: "Uh no.  With the other Vice President.  Jessica."

Compelled to Submit to Privations

M. Olivier de ---- was a dissipated young gentleman.  His family was one of the oldest and most respectable of the country, and deservedly enjoyed the highest consideration.  M. Olivier de ----, his father, was not rich, and therefore could not do much for his son; the consequence was that owing to his outrageous prodigality the son was sorely pinched for means to keep up his position; he exhausted his credit, and was soon overwhelmed with debt.  Among the companions of his dissipation was a young man whose abundant means filled him with admiration and envy; he lived like a prince and had not a single creditor.  One day he asked his friend to explain the mystery of the fact that, without possessing any fortune, he could gratify all his tastes and fancies, whilst he himself, with certain resources, was compelled to submit to privations, still getting into debt.

Chauvignac--such was the name of the friend thus addressed--was a card-sharper, and he instantly seized the opportunity to make something out of the happy disposition of this modern prodigal son, this scion of gentility.  With the utmost frankness he explained to the young man his wonderful method of keeping his pockets full of money, and showed that nothing could be easier than for Olivier to go and do likewise in his terrible condition;--in short, on one hand there were within his grasp, riches, pleasure, all manner of enjoyment; on the other, pitiless creditors, ruin, misery, and contempt.  The tempter, moreover, offered to initiate his listener in his infallible method of getting rich.  In his frame of mind Olivier yielded to the temptation, with the full determination, if not to get money by cheating at cards, at any rate to learn the method which might serve as a means of self-defense should he not think proper to use it for attack--such was the final argument suggested by the human Mephistopheles to his pupil.

Taking Olivier to his house, he showed him a pack of cards.  'Now here is a pack of cards,' he said; 'there seems to be nothing remarkable about it, does there?'  Olivier examined the pack and declared that the cards did not appear to differ in the least from all others.  'Well,' said Chauvignac, 'nevertheless they have been subjected to a preparation called biseautage, or having one end of the cards made narrower than the other.  This disposition enables us to remove from the pack such and such cards and then to class them in the necessary order so that they may get into the hand of the operator.'  Chauvignac then proceeded to apply his precepts by an example, and although the young man had no particular qualification for the art of legerdemain, he succeeded at once to admiration in a game at Ecarte, for he had already mastered the first process of cheating.  Having thus, as he thought, sufficiently compromised his victim, Chauvignac left him to his temptations, and took leave of him.

Two days afterwards the professor returned to his pupil and invited him to accompany him on a pleasure trip.  Olivier excused himself on account of his desperate condition--one of his creditors being in pursuit of him for a debt of one thousand francs.  'Is that all?' said Chauvignac; and pulling out his pocket-book he added,--'Here's a bank-note; you can repay me to- morrow.'  'Why, man, you are mad!' exclaimed Olivier.  'Be it so,' said Chauvignac; 'and in my madness I give you credit for another thousand-franc bank-note to go and get thirty thousand francs which are waiting for you.'  'Now, do explain yourself, for you are driving ME mad.'  'Nothing more easy.  Here is the fact,' said Chauvignac.  'M. le Comte de Vandermool, a wealthy Belgian capitalist, a desperate gamester if ever there was one, and who can lose a hundred thousand francs without much inconvenience, is now at Boulogne, where he will remain a week.  This millionnaire must be thinned a little.  Nothing is easier.  One of my friends and confreres, named Chaffard, is already with the count to prepare the way.  We have only now to set to work.  You are one of us--that's agreed--and in a few days you will return, to satisfy your creditors and buy your mistress a shawl.'

'Stop a bit.  You are going too fast.  Wait a little.  I haven't as yet said Yes,' replied Olivier.  'I don't want your Yes now; you will say it at Boulogne.  For the present go and pay your bill.  We set out in two hours; the post-horses are already ordered; we shall start from my house: be punctual.'

The party reached Boulogne and put up at the Hotel de l'Univers.  On their arrival they were informed that no time was to be lost, as the count talked of leaving next day.  The two travelers took a hasty dinner, and at once proceeded to the apartment of the Belgian millionaire.  Chaffard, who had preceded them, introduced them as two of his friends, whose property was situated in the vicinity of Boulogne.

M. le Comte de Vandermool was a man about fifty years of age, with an open, candid countenance.  He wore several foreign decorations.  He received the two gentlemen with charming affability; he did more; he invited them to spend the evening with him.  Of course the invitation was accepted.  When the conversation began to flag, the count proposed a game--which was also, of course, very readily agreed to by the three comperes.

While the table was prepared, Chauvignac gave his young friend two packs of cards, to be substituted for those which should be furnished by the count.  Ecarte was to be the game, and Olivier was to play, the two other associates having pretended to know nothing about the game, and saying that they would content themselves by betting with each other.  Of course Olivier was rather surprised at this declaration, but he soon understood by certain signs from Chauvignac that this reservation was intended to do away with the count's suspicions, in case of their success.

The count, enormously rich as he was, would only play for bank-notes.  'Metal smells bad in a room,' he said.  The novice, at first confused at being a party to the intended roguery, followed the dictates of his conscience and, neglecting the advantages of his hands, trusted merely to chance.  The result was that the only thousand-franc bank-note he had was speedily transferred to the count.  At that moment Chauvignac gave him a significant look, and this, together with the desire to retrieve his loss, induced him to put into execution the culpable manoeuvres which his friend had taught him.  His work was of the easiest; the count was so short-sighted that he had to keep his nose almost upon the cards to see them.  Chance now turned, as might be expected, and thousand-franc bank-notes soon accumulated in the hands of Olivier, who, intoxicated by this possession, worked away with incredible ardour.  Moreover, the count was not in the least out of humour at losing so immensely; on the contrary, he was quite jovial; indeed, from his looks he might have been supposed to be the winner.  At length, however, he said with a smile, taking a pinch from his golden snuff-box--'I am evidently not in vein.  I have lost eighty thousand francs.  I see that I shall soon be in for one hundred thousand.  But it is proper, my dear sir, that I should say I don't make a habit of losing more than this sum at a sitting; and if it must be so, I propose to sup before losing my last twenty thousand francs.  Perhaps this will change my vein.  I think you will grant me this indulgence.'  The proposal was agreed to.

Olivier, almost out of his senses at the possession of eighty thousand francs, could not resist the desire of expressing his gratitude to Chauvignac, which he did, grasping his hand with emotion and leading him into a corner of the room.

Alas! the whole thing was only an infamous conspiracy to ruin the young man.  The Belgian capitalist, this count apparently so respectable, was only an expert card-sharper whom Chauvignac had brought from Paris to play out the vile tragi-comedy, the denouement of which would be the ruin of the unfortunate Olivier.

At the moment when the latter left the card-table to go to Chauvignac, the pretended millionnaire changed the pack of cards they had been using for two other packs.

Supper went off very pleasantly.  They drank very moderately, for the head had to be kept cool for what had to follow.  They soon sat down again at the card-table.  'Now,' said the Parisian card- shaper, on resuming his seat, 'I should like to end the matter quickly:  I will stake the twenty thousand francs in a lump.'

Olivier, confident of success after his previous achievement, readily assented; but, alas, the twenty thousand francs of which he made sure was won by his adversary.

Forty thousand francs went in like manner.  Olivier, breathless, utterly prostrate, knew not what to do.  All his manoeuvres were practised in vain; he could give himself none but small cards.  His opponent had his hands full of trumps, and HE dealt them to him!  In his despair he consulted Chauvignac by a look, and the latter made a sign to him to go on.  The wretched young man went on, and lost again.  Bewildered, beside himself, he staked fabulous sums to try and make up for his losses, and very soon found, in his turn, that he owed his adversary one hundred thousand francs!

At this point the horrible denouement commenced.  The pretended count stopped, and crossing his arms on his breast, said sternly--'Monsieur Olivier de ----, you must be very rich to stake so glibly such enormous sums.  Of course you know your fortune and can square yourself with it; but, however rich you may be, you ought to know that it is not sufficient to lose a hundred thousand francs, but that you must pay it.  Besides, I have given you the example.  Begin, therefore, by putting down the sum I have won from you; after which we can go on.' . . .

'Nothing can be more proper, sir,' stammered out young Olivier, 'I am ready to satisfy you; but, after all, you know that . . . . gaming debts . . . . my word . . . .'

'The d--l! sir,' said the pretended count, giving the table a violent blow with his fist--'Why do you talk to me about your WORD.  Gad!  You are well entitled to appeal to the engagements of honour!  Well!  We have now to play another game on this table, and we must speak out plainly.  Monsieur Olivier de ----, you are a rogue . . .  Yes, a rogue!  The cards we have been using are biseautees and YOU brought them hither.'

'Sir! . .  You insult me!' said Olivier.

'Indeed?  Well, sir, that astonishes me!' replied the false Belgian ironically.

'That is too much, sir.  I demand satisfaction, and that on the very instant.  Do you understand me?  Let us go out at once.'

'No! no!  We must end this quarrel here, sir.  Look here--your two friends shall be your "seconds;" I am now going to send for MINE.'

The card-sharper, who had risen at these words, rang the bell violently.  His own servant entered.  'Go,' said he, 'to the Procureur de Roi, and request him to come here on a very important matter.  Be as quick as you can.'

'Oh, sir, be merciful!  Don't ruin me!' exclaimed the wretched Olivier; 'I will do what you like.'  At these words, the sharper told his servant to wait behind the door, and to execute his order if he should hear nothing to the contrary in ten minutes.

'And now, sir,' continued the sharper, turning to Olivier, 'and now, sir, for the business between you and me.  These cards have been substituted by you in the place of those which I supplied . . .  You must do them up, write your name upon the cover, and seal it with the coat of arms on your ring.'

Olivier looked first at Chauvignac and then at Chaffard, but both the fellows only made signs to him to resign himself to the circumstances.  He did what was ordered.

'That is not all, sir,' added the false Belgian; 'I have fairly won money from you and have a right to demand a guarantee for payment.  You must draw me short bills for the sum of one hundred thousand francs.'

As the wretched young man hesitated to comply with this demand, his pitiless creditor rose to ring the bell.

'Don't ring, sir, don't ring,' said Olivier, 'I'll sign.'

He signed, and the villany was consummated.  Olivier returned to his family and made an humble avowal of his fault and his engagements.  His venerable father received the terrible blow with resignation, and paid the 100,000 francs, estimating his honour far above that amount of money.

An old tale by Robert-Hondin, Tricherics des Grecs devoilees, retold by Andrew Steinmetz, Esq. (c. 1860).  Steinmetz was an interesting character and among other things was the Officer Instructor of Musketry for the Queen's Own Light Infantry Militia.  This tale struck me because if we replaced Olivier with "Seller," Chauvignac with "Banker," and the Belgian Capitalist with "Private Equity Partner," it could have taken place in 2005.

-ep

PE Titles

"Vice President of Dust Collection" (also: "VP of DC," "VPDC," "Voice Mail VP") Refers to the token position in a portfolio company afforded a favored employee of a Private Equity firm whereby she may enjoy a myriad of corporate benefits, expense account privileges and salary from the portfolio firm for doing essentially nothing.  Derived from the dust collecting action of the empty chair and empty desk in the empty office where the "employee" is not sitting or the fact that only the voice mail system ever answers the employee's phone.

Example:
Senior Partner: "Ok, we've closed the SillyCorp deal.  Sally, good work.  You are promoted VP of DC for SillyCorp.  Talk to HR about getting a corporate credit card and signing up for payroll there.  Oh, and see if they have any decent laptops we can use over here.  It's about time we upgraded."

Related Terms:
"Chief Strategy Officer":  The direct superior of a VP of DC.

Executive Liability

Armin, in response to alarmed looks from bankers on being invited to hunt on The Estate:
"Don't worry.  The Vice President is not invited."

The Fit

I have been struggling for a while to define what this business is.  Where I fit in it.  How it plays against and with my quirks.  At some point half a dozen loose pieces slip together with a loud "click."  Like some kind of complex, three dimensional, mechanical puzzle.  Clicking from configuration to configuration with a muted, soft -thack- -thack- until all the pieces align with a tight, metallic snap of perfection.  -click-

Buyouts are hard.

Obtaining "superior returns" is a tough business.  Everyone in the market is out to beat you to it.  Everyone has an idea how to do it.  Almost all of these ideas are premised on doing it at the expense of someone else.  Because they are unable, unwilling or unaware of the value you, uniquely, can extract.  It is a dog eat dog world out there.  No one is, after all, in the market for inferior returns.  Well, almost no one.

I am not sure I would say that obtaining superior returns via buyouts is "harder" than via equity hedge funds, mezzanine or venture capital. But within private equity buyouts are a particular kind of hard.  There is that particular thrill of the chase.  Finding the deal.  Chasing the deal.  Losing the deal.  Or catching the deal.  For every 20 opportunities we look at perhaps one actually grabs our attention and earns out real sprinting effort.

The jockeying for position starts.  Our angling for an advantage. Deciding if we should pull out all the stops, or hold back, quietly trailing the pack and spring at the last moment.  There is the crafty temptation to coax intelligence about the other bidders.  The long run up to the auction itself.

Then there are those last minutes of panic.  The moments before the call comes.  Won.  Lost.  The unsealing of the bids.  How can I explain that feeling?  The last moments of an eBay auction that lasts for 4 months and costs thousands even hundreds of thousands of dollars even to the loser?  The culmination or final frustration of expectations? Knowing you must not "get emotional about stock," but failing miserably as your investment in time, diligence, even love, vests.  I'm not sure there is a parallel feeling outside of the deal world.

The loss.  It is difficult, but critical to shake and move on.  Or the win.  It is precious and sweet.

But it only begins there, the hard part.  A slow, grinding agony hard. After the close the lawyers are off the hook for the most part.  The investment bankers pack up and go on to the next deal.  The leverage folks, they check their mailbox every quarter for the seven figure check we send them.  The accountants... do whatever accountants do in their off hours.  The seller takes the cash and (one hopes) deploys it to more efficient ends.  We... we are now stuck with a wounded animal. Poked and prodded and backed into a corner.  Run around frantically, unsure of its fate.  Its leaders defecting.  Its employees struggling with new benefits forms.  Its morale low.  Its cash strapped.  Its balance sheet burdened now with debt.  A sword over its head should a payment be late.

Our capital is frozen.  Illiquid.  We will be the very first to lose if things go more than a just little awry.  Our ongoing participation is expensive.  In every way.

This is where the challenge is.  Not in finding the deals.  Not in chasing the deals.  Not even in winning the deals.  Well, not only that.  But seeing the deals on which you can execute after the victory.  Buy nothing you cannot run better than it is already being run.

Making money elsewhere is a different story.

I don't think I would be suited for a life in the trading world of hedge funds.  Too intense too often.  Too much volatility compressed into too little time.  But in a way it might be easier emotionally.  Or not.

The market has no face.  You cannot look the market in the eye.  You do not have to look the party on the other end of your trade in the eye. There is no body language in crowds theory.  There are no intentions to read.  No tone of voice to hear.  A trade is an idea, a position is taken, and closed and it is done.  3 months is a long position for most hedge funds.  3 years is a short run for an LBO.  With the market there are no interpersonal politics.  Traders read impersonal markets.  True, they live, they breathe, they grow, they die.  They do all these things impersonally.  "A stock doesn't know you own it."  A company does.

There is a lot of talk about hedge funds getting into the buyout world.  Or the reverse.  I don't think hedge funds would make good buyout investors. That could be my ego talking.  I certainly wouldn't be the first to make the argument.  The short attention spans.  The rapid fire decisions.  All you have to do is read Barton Biggs' "Hedgehogging," which is less a book than a collection of anecdotes that all seem to follow the same plot:  Investor has different style.  Style is compared to investor's personality.  Path of investor to gather great riches is outlined.  Investor embarks on the hedge fund journey.  Investor succeeds spectacularly in the face of crippling near-failures.  Or investor fails spectacularly in the face of enlightening near-victories.  Return percentages are tossed about.  The word "billion" is overused.  In 15 paragraphs it is all over.  But then, this is the book we expect from a hedge fund manager.  A 7 year position?  Learn to manage cash flow, distribution networks?  How could they cope?

Venture capital is closer, perhaps.  But at least the venture gods can remake their world from near-scratch.  The downside is they have no platform to work from.  The upside is they have no platform to work from.  They thrive on the new.  Though their time frame, their horizon is similar, they themselves are much different animals.  There is not bank waiting to take the keys if a startup has three bad months.  In fact, a startup is expected to have 48 bad months from the very beginning.  Controlled failure (from a cash flow perspective) is planned.  We cannot afford it.

Buyouts don't have the advantages of these others.  We buy a closet after being afforded only a 10 second flash with the door open, guessing as best we can at the contents.  Then we laboriously comb through the closet, sell the old rusted bicycle we cannot use, if anyone will buy it, and try to cobble together what we can from the drawer of old, naked Barbies, socks and shoe stretchers.  Sometimes you find a gold pen.  Maybe it dropped, forgotten, behind the shoe rack. Other times you find a dead rat.  So that's why the socks smelled so badly.  Whatever is in there, you own it.  And if you want to keep owning it you better make a pretty spiffy looking closet out of it pretty quickly.

Politics are the essence of the first part of an LBO.  The Chase.  And this, I finally discovered, is why I was brought on board so quickly, elevated with such speed and saddled with such responsibility without, from what I could see, even a second thought.

My mentor, Ron, had sold me pretty hard to Armin.  I found this out only later.  Perhaps, I think now, to keep me from pestering him for the many months after our dinner.  Maybe because my father would have pestered him for not, after all my years of expensive education, finding me somewhere to land.  When he sold me, however, he sold me on a political platform.  As the answer to the political element in an LBO.  And, without indulging too freely in immodesty, I have to say that this was a good guess on his part.

I enjoy nothing more than reading the "other side."  Having grown up amongst bankers, lawyers and CEOs anyhow they all seemed transparent to me.  I am gawked at, yes, but if I remain quiet, I seem invisible to them once the discussions begin.  Perhaps because I am slight of build, too pale, or that my demographic is rare in the deal world.  If I am really noticed, perhaps I am taken for a plaything of the senior partners.  I don't know exactly what it is that makes me nearly invisible, but being underestimated is a very VERY valuable thing in the LBO world.  Unfortunately, most practitioners have egos too substantial to exploit this advantage.  I, on the other hand, quite enjoy engaging without warning in a fencing match with an opponent who, Princess Bride like, intends to fight the match with me left handed. The best way to fight an unarmed opponent is to disarm them first.

Before this I had never thought after my ability to size up a room, decipher the relationships of the parties and understand the interlocking of competing interests.  It had been a casual annoyance before.  Now it was gold.  Exploitable.  Monetized.  Ron saw this. Armin uses it.  For my part, I am content to be used in this way.  It is my nickname now.  "The Empath."

I am teased in the typical team-building way.  Victim of crass (but mostly mild) jokes.  Babied a little perhaps.  But whereas I started off being resented, a pair of big wins, the credit of which was laid (rightly or wrongly) at my feet, made me instead valued.  Paraphrasing a favorite film of mine, "No one is more prized than who brings victory in battle."  I acquired a pack of big brothers, all protective of me. All eager for my attention.  All wanting my view on everything from their girlfriends to their portfolios.  I, who know nothing about trading public equities, try to demure, but they are insistent.  I am at the point where I just say "Short Google," knowing none of them have the courage to short anything.

But then, and it happens in every deal we are serious about, the option on me is exercised.  "What the fuck is that guy thinking," Armin might rave after some inexplicable behavior by a target company's CEO.  It takes only one of these before he is intercomming his assistant.  "Get The Empath in here.  I need my crystal ball."  Time for me to go to work.

Fears

With such long horizons as one finds in the LBO world, it is quite easy to get very nervous about the economy.  One is almost certain to meet at least a slowdown in any seven year period.  Add to this the sudden bubble in private equity, and buyouts are no exception, and it is even easier to be even more nervous.

Someone once told me that the time to dump a sector is when you first hear someone who never traded a share of stock in their life tell you they were going long on it.  Drop it like a hot rock.  Today, everyone and their brother is pouring into private equity.  It feels a little like venture capital in 1999.

Now add another wrinkle.  Debt is plentiful and cheap.  The Wall Street Journal's always interesting (sometimes scary) "Heard on the Street" is posting articles with titles like "Din of Roaring Corporate-Debt Market Drowns Out Growing Talk of a Bubble" (Wall Street Journal subscription required).

Says the Journal's Henny Sender:

But these blissful conditions are prompting rising concern among some veteran analysts about a possible bubble, fueled by a still-easy monetary policy, despite 14 consecutive short-term interest-rate increases by the Federal Reserve since June 2004. "The Fed hasn't done much," says William Dudley, an advisory economist for Goldman Sachs Group. "Overall financial conditions are much easier than in 2002."

The clearest understanding I had of the tech bubble boiled down to this: The thing you least want to be in a bubble is the greatest fool. The last guy (gal) to buy before there is no one more foolish left to pass the bag to.  When you start creeping into people who have neither bought stock before, nor know anything about it, you are clearly running out of greater fools.  Time to be worried.

In the tech bubble days the "greater fool" was the public markets. Armed with less information on what they were buying and more distant in terms of the number of intermediaries between them and the source of information to begin with, each intermediary, by the way, with an interest in passing it forward and taking a cut along the way so the stock gets more and more expensive with each jump, it is pretty easy to see how things get overpriced and overhyped.

The angels funded looking to dump to the seed gang.  The seed gang funded looking to exit via the venture gang.  The early stage venture gang funded looking to dump to the late stage gang.  The late stage gang funded looking to pass it off to the investment banks via an IPO.  The investment banks scraped the top off and tossed it to the rest of the market.  The rest of the market looked to pawn it to... uh, the rest of the rest of the market.

None of the players early in the chain were all that worried. The deals they were cutting and the stability of the firms they were underwriting were quickly to become "someone else's problem."  After they collected their fat checks.  That sound you hear is the strained surface tension on the bubble.

Unfortunately, debt in buyouts has taken on similar tones.  "Covenants" are eroding in an effort for groups to place more debt ahead of the competitors.  The Journal article mentions Neiman Marcus and AMC as "covenant lite" deals done not long ago, with few if any serious restrictions by lenders.  Why would lenders forgo their customary protections that reduce their risk over the lifetime of the loan?  They have no intention of holding the loan for long, that's why.  It's all about to become "someone else's problem."

An old tool, recently dusted off, called "Collateral Loan Obligations" packages a series of loans and boxes them up for sale in large chunks to other investors (who are quite a bit removed from the sources of information about the quality of these loans).  Worse than that, CLOs are themselves bought by loans.  Whole funds use 4:1 leverage to buy 4:1 leverage.  That sound you hear is strained surface tension.

How do you know when you're running out of fools?  Your investment of choice ends up on the cover of a major "McNews" publication like Time, Newsweek or such.

Thank god that's not happened yet.  It's not like someone stole the name of my blog and put it on a McCover about private equity.  -cough-

Cracked Crackberry

Maybe it's just me, but doesn't it seem like Research in Motion is ripe for a hostile takeover?  Expensive?  Sure.  But what shareholder could possibly be happy with management for giving away one whole year's EBITDA because they forgot to file the right fricking form many years ago and have been hard nosed idiots in settling with the, admittedly opportunistic, NTP?  Not to mention that the competition hasn't exactly been standing still and new subscriptions are way down.  Death to the Crackberry?

Deporting Private Equity

Yesterday Victor Fleischer, professor at the UCLA School of Law presented, "'Two and Twenty' Partnership Profits in Hedge Funds, Venture Capital Funds, and Private Equity."  Fascinated by this subject, and immediately alarmed at Professor Fleischer's proposal to impose reform to more aggressively tax these gains, I sought out a copy.  Professor Fleischer replied to other requests on the always thought provoking Conglomerate thus:

"It's not quite ready for prime time, but I will post it to SSRN in a couple of weeks."

I guess he shouldn't have left a Google searchable copy of the draft in the open then.

-giggle-

Ok, ok.  I know. Sorry.  I didn't want to wait.  Bad Equityprivate.  No bone.

It is most certainly worth the read, and contains some very good analysis.  I think, however, the professor has missed some things.

First, the central issue with respect to character of compensation centers around the premise that:

...while the carried interest can give rise to capital gains (depending on the character of the underlying partnership income), management fees give rise to ordinary income.  Some GPs, recognizing the tax play, opt to reduce the management fee in exchange for an enhanced allocation of fund profits.

The argument goes that since these reduced management fees are exchanged for higher carries, there is a structural wrong being perpetrated.

The professor eventually concludes that:

The granting of a profits interest in a partnership should not be treated as a taxable event.  When those allocations of profits eventually arrive, however, they should be treated as compensation, not investment income, and taxed as ordinary income and not capital gain.

I believe this fails to account for several issues.

1.  Capital calls often are allocated proportionally to a partner's carry in the fund.  Accordingly, if management fees are exchanged for carry, these fees are "at risk" in a more substantial way than I think the professor accounts for.  Since when is ordinary income treated compensation for service subject to the foibles of interest rates (other than in hyper inflationary situations)?  If a GP puts these at capital gains risk levels he should be compensated via capital gains rates.  The professor ducks this by hinting that "risks are not as large as they seem" but I don't think he has studied hedge funds carefully enough.  The reality is that management fees in most funds barely even pay the bills.  Only the supermassive funds can hope to promise more.  2% of $200,000,000, for example, makes for a very lean fund in Manhattan.  The source of those fees, and most compensation, eventually comes from capital gains.  We might as well make the argument that none of the gains obtained purely due to structuring (i.e. leverage and deleveraging) should be afforded capital gains treatment either.

2.  Enforcing the distinction between "carry for service" and "carry for non-service" necessarily requires a document somewhere demonstrating that that tradeoff has actually been made.  It also seems to suggest that some "standard" in the industry would serve as a benchmark to determine if "gamesmanship" is being played. General partners typically have their own funds at risk.  (1% of a typical buyout fund comes from GPs).  How we can distinguish the carry we give GPs between service or non-service carry is somewhat beyond me.

3.  These thoughts are not new.  Similar hintings have caused quite the uproar in the UK. Funds would likely flee to jurisdictions without burdensome tax schema designed particularly to impact investment funds if the current status quo were tinkered with.  And there are plenty of places to go. Luxembourg, for instance.  Many funds already take clear advantage of these jurisdictions.  Soros is famous for it.  (His Quantum fund is domiciled in Curacao though it is managed in Manhattan).  See how a sudden exodus would impact tax revenues.  (The professor does acknowledge this at least).

Nothing is more sacred than the 2 and 20 we PE types lust after for our sweat and tears.  I don't recommend toying with them if you want funds to stick around.  I think we do want funds to stick around also. Drawing any more attention to the benefits they would gain from offshore domiciles is not a good bit of policy.

I suppose I'm not surprised that he's from California.  What does surprise me is that he's not a Stanford grad.

(Do examine the professor's other work, of note: "The Missing Preferred Return.")

-ep

Straight Talk

At a dinner on the Estate, just before the desert course:

Fortune 500 CEO: "The thing is, once the gays move into the neighborhood it picks up.  They have a dual income household, no kids to drain their money and they pour cash into the property they buy."
Room: *20 seconds of silence*
Fortune 500 CEO: "The next thing you know the entire place is on a real-estate upswing and the original owners are looking to sell to move into the next 'unique fixer-upper' opportunity."
Armin: "Shall we have more wine?"
Fortune 500 Corporate Development Officer: "You know, this could be a hedge fund strategy."
Wife of Fortune 500 CEO: *clears throat*
Fortune 500 Corporate Development Officer: "We could track demographics, identify the new gay homeowner pockets and invest in the area.  This could be very profitable!  We could put a REIT together easily."
Armin: "How exactly do you plan to describe this strategy in your offering documentation?"
Fortune 500 General Counsel: "Well, it is gay arbitrage, isn't it?  Gay arb.  'Garb!''"

Rejected

So somehow I've been roped into reviewing the candidates for summer associates here at the firm.  We are planning to hire 3 or so.  We started the process late.  But, since the job is educational for me, I thought I would present you with:

Ten Brutally Honest Application Suggestions for Private Equity Hopefuls
(As Taken from Actual Applications).

#1:  If your resume says "Fluent in English" or you claim a TOEFL score of 99%, please do not make four verb tense or subject verb agreement errors in your cover letter.

#2:  If forwarding your resume electronically to a buyout firm the filename should probably not be "Consulting-Resume-Draft.pdf."

#3:  Please get my gender right in your salutation, or display the cleverness to craft a gender neutral salutation.  "Dear [first name]," is a good start.

#3a: "To whom it may concern:" is not a wise choice of salutations.

#3b: In today's day and age, "Sirs-" is not a wise choice of salutations either.  (Particularly if you are a female hopeful).  Maybe if you explain that you are a rabid Economist fan I might understand.

#4: If the firm is hiring for three totally different positions, please make sure you pick one.  No, the criteria for "Aerospace Industry Analyst" is not the same as "Generalist," but then you should know this because you read the job posting carefully, right?

#5: Yes, I will hire an ex-consultant.  No, not if their mission tagline is "To obtain a challenging and rewarding position in consulting."

#6: The last lines of your resume, if they are under a section called "personal interests/hobbies" should probably not describe "animal husbandry," "daytime television" or "true crime."

#7: It is wise to have earned a college degree when applying to a position that requires an MBA.

#8: I can add.  Accordingly, I will, in fact, notice if you got your undergrad in 2003 right after high school, your MBA is expected in 2006 and you have "6 six years of professional work experience."

#8a: I don't know what "professional work experience" is.  I do know exactly what "unprofessional work experience" is though.  6 years of "unprofessional work experience" will get you hired as a partner.

#9: Active verbs in accomplishment bullets are good.  "Plowed through institutional resistance," "conquered last minute reticence," and "penetrated tight inner circle" are a bit much.  (Though you had a few of us laughing for an hour, and I would probably hire you just for giggles, I would also probably be fired for hiring you after the first harassment suit and so you're just not on the right side of the risk/reward curve).

#10: If you are from Stanford and don't have a lick of banking experience, listing "Golf" as a hobby and "Stanford Golf Team Treasurer" as employment experience is probably a bad idea.  Try the left-coast VCs.

-ep

Hip To Be Square

Did you know Patrick Bateman had a mini-revival in 2000?

Fear II (The Sequel)

The well filtered stuff at Abnormal Returns yesterday turns up a bit more scary news on the buyout front.  This time by reference to a Forbes article titled "Private Inequity." (Subtitled: "The mad rush into private equity-is your retirement at risk?" Catchy, no?)  It is a parade of horribles about all that is bad about "private equity" (though the article seems to fail to realize that buyouts are only one class of private equity investments).

Among other things, the article notes:

“There’s a group of new private equity guys chasing deals for the sake of putting money to work,” says Darrell Butler of Billow Butler & Co., an investment bank in Chicago. “They’re affectionately known as ‘dumb money.’ They’re going to have a hard time when the economy turns, profits go south and covenants get blown and banks come calling. And it will happen.”

No doubt.  Well, except those smart enough to do "covenant lite" deals.

Over here we too have been feeling a lot like the tanks of money being poured around have been elevating prices beyond all reasonability.  Still, seems people believe they can make money at those kinds of valuations.  Everyone seems to be dumping money into the mega funds.  Greater fool theory in large fund private equity?  Uh oh.

The most interesting point the article makes, in my view, is with respect to pension funds.  If you are an underfunded pension fund then alternative investments (like private equity) and those high returns are a tempting way to get yourself into three digit percentages of obligation coverage.  The weaker the coverage the more allocation you will be tempted to put in private equity.  A deadly race to the bottom?  Maybe.  Perhaps we'll see the weakest pension funds take the biggest hits if the private equity crunch is around the corner.

Then we have Warren Buffet berating the "hyper-helpers" for their high fees. (He means private equity and hedge funds).  Of course, there are still investors lining up around the block to pay these "high fees."  With returns to the top buyout houses upwards of 50% IRR why not?  After fees they are still superior.  Of course, the rest of the class doesn't command those kinds of returns.  And here, as everywhere in the market, fees might bring total returns below even the S&P 500.

Certainly, there are some shifty practices in the buyout world.  Don't even get me started on dividend recapitalization.  But much of this recent language sounds to me like the national paranoia that hit in the 1980s in response to the buyout craze then.  The Forbes article even dusted off the old "locusts" comment from Germany's Social Democrats.  Ugh.  I expected more than petty fear mongering from Forbes.  Ok, nevermind, no I didn't.

Pretenders may jump on the private equity band wagon, and they may crash spectacularly, but solid professionals will always find ways to improve efficiency and add value though the incentives of debt. Buyouts are as American as apple pie.

The problems arise when funds get to big and unwieldy (-cough- Blackstone V -cough-) to manage well, and the law of large numbers starts eating into returns.   Add to that the level of pain SarOx has mandated public companies now endure and then who could act surprised when they jump off the exchanges by the dozen?

No doubt there is a bubble.  No doubt it will burst.  Soon.  But, as in the 1990s, buyouts will go on. Thank god I work in a smaller fund. I'm looking forward to seeing the riff-raff cleaned out.

-ep

They Didn't Become Artists for the Pay

In the Adolphe-William Bouguereau exhibit at the Getty:

Associate: "You know, I really want to know where all these paintings came from.  Where is the place on earth where I can walk around and just happen upon a nude woman bursting forth from a seashell?  What park is it nearby where unclothed women writhe around together in the foliage?  Look at this one.  I swear that's a nude Maria Sharapova!  Where are the police that would surely descend upon this orgy scene within seconds if Sharapova was really nude in public?  Where are the throngs of ravenous males?  This exhibit is total bullshit."

PatArb: Leveraging Law

In economics, arbitrage is the practice of taking advantage of a state of imbalance between two or more markets: a combination of matching deals are struck that exploit the imbalance, the profit being the difference between the market prices.

When used by academics, an arbitrage is a transaction that involves no negative cash flow at any probabilistic or temporal state and a positive cash flow in at least one state. A person who engages in arbitrage is called an arbitrageur. The term is mainly applied to trading in financial instruments, such as bonds, stocks, derivatives and currencies.

If the market prices do not allow for profitable arbitrage, the prices are said to constitute an arbitrage equilibrium. An arbitrage equilibrium is a precondition for a general economic equilibrium.

                            - Wikipedia

It is hard to dislike the Wall Street Journal's Law Blog.  Today a posting by Peter Lattman quotes a Washington Post story with background on the Research In Motion/NTP case.  I think it illustrates an interesting market trend.  The trend towards exotic arbitrage.

There was never any dispute that Research in Motion Ltd., the Canadian firm that introduced the world to the BlackBerry in 1999, came up with its own technology to power the wireless e-mail device.

But Thomas Campana Jr., co-founder of a small McLean firm called NTP Inc., noticed an uncanny resemblance between the BlackBerry technology and a technology he had developed years earlier.

When he and business partner Donald Stout contacted RIM in 2000 about obtaining a license for the NTP technology, however, they didn’t get a response. (emphasis added)

Six years later, the dispute has been settled, with RIM agreeing to pay $612.5 million to NTP to resolve the patent dispute.  I keep hearing the words "nuisance suit" used to describe NTP's action, but for some reason the authors of that sort of text never mention that RIM had an offer of $450 million on the table.  Hardly the kind of price one would expect a firm to voluntarily offer to dispose of a mere "nuisance." These authors also seem to forget that a jury found against RIM on 5 patents.  They also found that the infringement was "willful."  Ouch.

Also remember that RIM was hardly underrepresented.  Jones Day and Howrey Simon Arnold & White, RIM's attorneys, are about as big as those guns can get.  I wonder what their bill was.  NTP spent at least $7 million.  The return to NTP after legal fees?  Assuming we amoritize the legal expenses equally over the timeframe of the lawsuit, with about a 20% boost to the first year for "start up legal expenses" and minus the 33% cut the patent firm will take, I show IRR returns to equity for NTP of around 1,090%.  Wow.  Rim, by contrast, took a $294.2 million "litigation charge" back in April of last year.  That number seems large to me.  I wonder what it is composed of.

How did things get so far?  Said U.S. district court judge James Spencer: "It seems to me that some of the folk took it personally, and that's how it got this far."  NTP started talking settlement immediately.  According to NTP's Donald Stout: "We were always surprised that RIM didn't want to explore settlement. We had a very preliminary discussion after the suit started. They offered us nothing, so we said, 'Here we go.'" Arrogance on the part of RIM?  Imagine that.

Of course, the case has stirred up a lot of loud squawking about reforming the patent system in the United States.  To some degree I believe these calls are warranted.  In other ways, I think this "egregious" case isn't all that egregious.  Recall from the text above that RIM had a chance to deal directly with NTP and come to an arrangement (back when the valuations were small and a fairly harmless deal could have been struck).  RIM decided instead to stonewall.  In this, I think it is quite easy to underestimate the importance of the date.  2000.  The high-flying, invincible tech attitude that drove the markets to the outer reaches of the atmosphere also made it easy to blow off a small McLean, Virgina firm writing with patent concerns. (They aren't even in California, for christsakes!  How can they be a serious tech company?)

There is an issue in patent law in the United States that is somewhat obscure, but also important.  In short, the critical element is that the patent holder has a lighter legal burden to meet than the potential infringer.  This is where the arbitrage part comes in.

I define arbitrage a bit differently.  I define an arbitrage opportunity as any case where costs, returns or price differs between two choices in an amount in excess of the switching costs.  Using cashflow as a criteria, which the Wikipedia definition does, seems wrong to me.

A patent with its potential for injunctive relief, is really an option on an injunction.  In fact, options theory is often used to put values on patents via Black-Scholes.  One author, Alan C. Marco, goes so far as to develop a real options theory for patent litigation.

All this is a long way of getting to the point that because there is a perceived "mispricing" between patent holders and accused infringers, (the cost of an option on an injunction and therefore some finite level of expected value) is far below the cost to the accused infringer to dispose of the matter.  Arbitrage theory would suggest that money will quickly pour into patents with litigation potential.  Of course, this is already happening and firms that do nothing but hold patents and litigate them have cropped up.  To the extent they have investors to cover the litigation costs for a percentage of the carry (NTP had 20 stockholders in addition to the founders and the founders gave away only about 50% of the ownership in NTP to 20 other shareholders) they already look like a hedge fund.

As conventional arbitrage opportunities begin to thin (that's what happens when you pour money into an arbitrage opportunity; it approaches equilibrium) hedge funds in particular, beset by hyper-expectations they have managed poorly over the last several years, will be forced to look for more creative opportunities.  Enron's trading desk took advantage of these sorts of imbalances in the California energy market, which cannot have been designed by anything other than Stanford grads.  You cannot have your cake and eat it too in a near-liquid market.  Arbitrageurs will eat your lunch, and then happily snack on the cake you were counting on for dessert.

So, what areas might we see big growth in?  Anyplace where there are regulatory or other mispricing issues.  Patent Litigation Arbitrage is clearly on the rise.  (We had one firm recently pitch us on funding a bankrupcy filing for a residual in the assets, not that this is a new thing).  And, of course, NTP just woke up the sleeping bears by nabbing an entire year of EBITDA from RIM.  Minority Shareholder (Shareholder Activism) Arbitrage (read: Greenmail Arbitrage) is nothing new, but the focus on shareholder rights and the increasing levels of suspicion afforded management in the wake of Enron, SarOx and the like are the incentives here.  Hello Carl Icahn. And, of course, SarOx arbitrage (i.e. "Going Private").

Ten Years. That's Half Our Lives.

The Wall Street Journal is out today with an article on the 10 year Treasury note.  This is important to us LBO types, and anyone who does DCF valuations, because the 10 year note is what we use to determine the "riskless rate."  (It's not really "riskless" but it's close enough for the moment).

It bothers me, of course, because it is a hint of higher interest rates to come.  (That means higher payments on all that debt we have out there).

I like it because the yield curve is flattening out.  Yum!

Not Safe for Work

Associate #1:  "Ooooo.  That's hot."
Associate #2:  "Are you surfing porn over there?"
Associate #1:  "No, my model is showing a 26% IRR for my conservative assumption set."

Arbitrage Blood in the Water

I have to think that, cool as it looks, the folks at Intrade are in way over their head in the futures markets.  They currently have trading in daily closing price futures for indexes like the S&P 500.  Though they bill their service as "prediction markets," in fact, they aren't totally.  Instead, they are acting as a new financial futures market.  I cannot imagine that the market there is sophisticated enough or liquid enough to be efficient yet.  Some aspiring young trader type, or even just a good script programmer with some finance theory under their belt, could clean house, I suspect, by taking advantage of the exchange (owned by what is effectively a sports betting company) and the naiveté of its traders.  One could easily arbitrage their entire S&P contract set against CME's E-Mini S&P 500 futures.

Just looking at the market briefly today I spotted a quick arb play between the "S&P 500 to close DOWN by 2.5 points or more at 1pm EST" and "S&P 500 to close DOWN by 5 points or more at 1pm EST" futures pricing.  There looks to be about $750,000 at risk in Intrade's top 5 contracts.  Pulling even a 2% per day return would be a nice catch.

I'm not sure what Intrade thinks they are adding to the equation.  These kinds of futures in exchange indexes are already VERY well covered and the people who play with them at the smaller capital levels Intrade is permitting are unlikely to have the needed sophistication to compete with the real sharks in the futures world.

Then again, it is interesting to see that the "market" thinks there's an 18.5% chance that "Abu Musab al-Zarqawi to be captured/neutralised by 31 Dec 2006" will pay off.  (The British spelling is ubersexy enough to make even a hardened finance girl moist too).  Still, they don't seem to be capitalizing on the real opportunities in prediction markets that the DoD bungled.  Where's the "major terrorist event by January 2007" contract, for example?

Well, even if the DoD missed the boat, there are a series of these upstarts.  Perhaps someone will get serious about them eventually.  As with any new market, the early period of inefficency is a huge opportunity for a seasoned player.

Project Sinister

Being at the upper end of middle management (or the lower end of senior management?) in an buyout firm means you spend a lot of time dealing with portfolio companies.  In theory I don't mind that.  In fact, I always thought it would be a plus and add some variety to the job.  It was even part of my "early employment theory."  You know, the lofty aspirations you have for how cool your finance related job is actually going to be.  I did, after all, want to use my strategic and marketing casebooks.  Those are fixed assets.  They were expensive.  I need a positive Return on Assets figure for them.

"Sinister, LLC" is a portfolio company on the left coast.  Sinister has issues.  Armin would tell you that the problems started after a bad month in November.  Personally, I think the problem was that we bought the company.

Sinister was snapped up just before I joined the firm.  Good thing too because I would have put all my waking hours into sinking the acquisition.  It is not that the firm doesn't have potential.  It is not that there are a bunch of Stanford grads running it.  It is not that it isn't in an interesting industry (financial services, basically).  It is not that the firm's name starts with the wrong letter.  (You know, I've given it time and effort but I still can't get over what a yahoo Kawasaki is).  It is that the firm's management and sales team have zero concept of what it means to work for a living.

Part of the role of being a parent to the firm is nurturing and helping the firm along.  Of course, we don't do this because we are the Red Cross.  We do it because that big debt payment needs to get serviced with regularity.  We do it because we paid for the damn thing and we want our money back.  Yesterday.

Building value in a daughter firm means that, at least if you want to be credible, you need to have some kind of operational expertise.  It has grown quite fashionable among LBOs to claim a high level of operational expertise.  It shows your limited partners that you can extract value out of a firm by doing more than just restructuring the balance sheet.  You can build revenue.  You can help the firm excel. Well, most firms.

Right after we bought Sinister we pushed them to put together an entirely new product line.  Armin thought it up and cracked the whip until something presentable was crafted.  I had mostly been able to avoid entanglement in Sinister's affairs until late last month when I was asked to help review some materials for the product line.  They were mostly ok. Perhaps a little techno-babble filled, but that was to be expected as the development team was composed of 6 Ph.D. holders and one graphic designer.  A little tailoring and it was a solid B+ presentation.

This month, through no small amount of effort and the leveraging of a series of personal contacts, Armin managed to secure for Sinister a Wednesday meeting with one of the members of the "Hedge 100" list, the top 100 hedge funds in the world ranked by size of assets under management.  It should go without saying that adoption by this firm of Sinister's product would, by itself, make the firm.  It should also go would out saying that this would, therefore, be the biggest and most important sales call Sinister's sales team would make. Should go without saying.

Armin, quite cleverly in my opinion, generally has visiting luminaries, be they from clients, limited partners, daughter firms or even competitors, stay at the estate if their visit is to be short, so when 3 of the Sinister team were put on the list to make the sales call in Manhattan their efforts to book rooms at the Peninsula ran into a hard stop (against a brick wall).  Instead, they have been booked at "Chateau Armin."

You would think this presented no problem.  Chateau Armin is, in fact, much nicer than the Peninsula.  Particularly, as it happens, with respect to scenery.  You would think.  You would think wrong.  In fact, the whining was so intense it prompted a detailed review of the last 18 months of expenses and, though he won't know it until Friday, one of the team has already lost his job on this account.

Two days ago, because I made the tactical error of agreeing to review the materials last month, I was asked to review the sales presentation and provide some direction.  Herein lay the abyss.

Yesterday, I arranged a conference call with two Ph.D. Vice Presidents and the sales guru assigned to the project.  Of course, the first thing I asked for on the call was the PowerPoint presentation.  It took me 20 minutes to finally extract from them that there was no PowerPoint presentation whatsoever.  None.  This is now two days before the meeting with the hedge fund.  Well, there was really no reason for us to be talking then, was there?  They should immediately put one together and we would reconvene in three hours.  I set up a conference line and went off to other things.

As is my habit, I called in 10 minutes before the appointed time and left the speakerphone on mute, listening to the hold music and trying to pretend it wasn't bad.  The meeting time came.  And went.  And so did 10 minutes.  Then 20.  I called into Sinister's offices and asked for each one of the scheduled participants.  Their morose voicemails greeted me with taunting malaise.  I had them paged.  That only returned 15 minutes of holding, 5 for each of the AWOL participants. Finally, tracking down the head of marketing, I managed to determine that all three of them had been out of the office for the last 90 minutes.

"Where in the world are they?"  I was so foolish to ask.

"Well, I expect given the hour that they are at lunch."

"For 90 minutes?"

"This isn't New York, you know."  Oh, that's quite clear, I think.

Cell phones rang the full 6 rings (telling me they weren't turned off, I was just being ignored) after which even more morose voicemail recordings were the only reward for my efforts.

By this time I was tempted to pass the issue up to Armin.  Mind you, I don't like to be a tattletale, but I, to some extent, was on the hook for this presentation and I knew the lengths Armin had gone to in securing this meeting.

When I finally got the three stooges on the phone again (don't worry, they had been at a "working lunch") I was told to take it easy.  They had matters in hand.

"How many slides is the presentation."

"Twelve."

"How long have you scheduled the meeting for."

-silence-

"You have given them a timeframe right?"

-silence-

"Ok, who is presenting?"

-silence-

"Is anyone presenting?"  I could feel the anger, swelling in me.

"Hey, Dave, why don't you do it?"

"Yeah, ok, cool.  I'll do it."

"Ok, are you bringing a projector?"  Personally, I think this is critical.  Why depend on someone else's machine which you have never used before at someone else's facility?  I can't tell you how many times I've been witness to the embarrassing desktop icons on some young presenter's laptop revealed to a laughing audience of twenty because the wrong button was pushed on the projector.

"Well, don't they have one?"

"I have no idea," I replied.  "Hasn't anyone called them?"

-silence-

"Ok, so have you talked to their IT department?  You do plan to do an online demonstration right?  You will need an internet connection, right?"

-silence-

"Guys, you are the sales team.  Who is it you think is going to do this for you?"

"Well, we thought that since it was your contact that all that stuff would be arranged," whined one of them.

"Yeah," chimed in the fat one, Dave.  "Will there be food?  And diet soda.  I can't drink non-diet soda."  Given his bulk, how he was even going to remain standing for 12 slides was beyond me.  Then it occurred to me that the real problem was the food.  Maybe he could remain standing all that time, but he was never going to make it 12 slides without eating.

I have this problem.  I think in Technicolor.  Even about bland things.  Blue skies when I make airline reservations.  I see the Google logo whenever I think of bubbles.  Suddenly, the vision of a fat, slobbering Dave, talking about statistical values with his mouth full while desperately trying to cram down his throat yet another one of the wet, squishy, yellowish muffins that always seem to haunt lunch plates at financial services firms struck me.  Crumbs on his chin.  Moving as he spoke.  One of them just about to fall off, hanging on for dear life to avoid the fate of his comrades, squished ignominiously into the $200 per yard carpeting in the executive conference room.

Oh my god.

I counted to ten in my head.  "Breathe," I thought.  "There's no need to vomit.  Really.  That mouth watering you are feeling is just a trick of the brain.  Breathe.  Breathe."

It pains me to even continue to relate the rest of the conversation. Suffice it to say I spent the better part of today doing their presentation for them.  That's the rub when you are the parent firm. You own them.  Even if they are a bunch of fuckups you have to carry them.  Much as you might want to, you can't fire the entire sales and marketing team.  As a result, they are almost rewarded for underperforming, particularly if you've already cut staff to the bone, because you parachute in at the last minute and pull the slack in when they trip (or are caught sleeping) on the job.  Why work?  Our wonderful parents will save the day!  Hey, does the Peninsula have in-room massages?

So here I was.  We were flying three sales boobs over just so I could do their entire presentation for them and they could blithely handle the subsequent Q&A session.  (I am due to go to Europe for a transaction today but know this is how it will turn out instead). Subsidizing mediocrity.  There is nothing closer to anti-matter to me. It is the bane of my existence.  It is time I should spend on the next deal wasted on the pits of the last one.  I know that will sound arrogant to the non-industry readers.  You industry people know exactly what I mean though.

Don't you?

On Excess

Behold the very definition of excess.

Invisible Executives

No one knows where the Sinister, LLC people are.  Apparently, they left early in the morning from the left coast to get to the Estate, but no one has their itinerary.  There's a rumor that flights are delayed because of an outage in New York's ATC radar, but no one knows what flights they took.  No one knows how they expect to get to the Estate from the airport.  No one knows if they even know where the Estate is.  No one has seen the presentation they are due to give.  No one knows if they took a projector.  Efforts to get someone else at Sinister to see if a projector was missing resulted in the answer: "Three projectors are missing."  Now there is a witch-hunt for projector thieves raging in the Sinister hallways.  To find the missing projectors, the head of IT for Sinister has been calling every employee into his office one by one and pretending he's a main character in the TV Drama Law and Order.

Unconcerned with the projectors, Armin has instead devolved into calling everyone he can get to answer the phone to grill them about the location of the missing executives.  It is Armin's habit, in circumstances such as these, to vent to me and poll me repeatedly for my opinion.  My challenge, in this circumstance, is to totally avoid rendering an opinion.  It is all downside for me, this rendering an opinion business.

If I echo his present disdain, it is just as likely as not that he will reverse his position and seem apologetic on the subject for a solid week.  (It won't stop him from just as apologetically firing someone's ass, but it makes me feel like a callous old heel).  If I counter it, then the firing he does anyhow becomes the physical manifestation of my error.  Not to mention that if I render a strong enough opinion I actually have the quite dangerous potential to spur drastic action on Armin's part.  I think two executives were the unwitting collateral damage related to my learning curve on how much power I had, inadvertently, been wielding. Of course, I could also be roped into "solving" the problem, if I gave any sign that I agree there is one.  No, it is better that I try to remain neutral.

"This is very rude, you know," he starts, standing at the doorway of the library, which is one of my sometime-unofficial workplaces at the Estate.  Uh oh.  I keep my nose buried in a stack of financials.  I resist the temptation to murmur.  It is hard to make a murmur neutral sounding.  (Try it.  No really.  No one's watching.  Try to murmur without conveying a value judgment.  Anything that sounds neutral gets mistaken for agreement with the speaker, I think you will notice).  So, I sit silently.  Trying not to even turn a page for fear it will keep his attention.

"They are guests in my home and I have no idea when or in what number to expect them," he delivers this as if he is talking about a flock of sheep, or the Wehrmacht or something.

"There are three of them."  Fuck.  I couldn’t help it.  I should have kept my mouth shut.  He sucked me right in.  Armin - 1.  EP - 0.

"What?  How do you know this?  You spoke with them?"

"Well, yes.  Yesterday.  I..."

"Do you have their schedules?  Why didn't you tell me?"

"I do not have their schedules."

"Then how do you know there are three of them," he demands, suspicious that I am hiding critical information from him.  I can hardly blame him.  He was a CEO of a Fortune 500 company in the 1980s.  I bet all his subordinates feared to give him bad news.  And since you couldn't really determine in advance what the CEO would think was bad news, it was safer to just keep your mouth shut.  Sort of like I am right now. I would be ashamed if I wasn't prone to be really vocal with respect to pending deals, negotiations and valuations.  It is just these petty daughter firms, particularly the ones that predated me, that just don't hold my interest.  It is not that I do not want them to do well, it is just that I don't have any real emotional stake in them.  I'm such a snob.

"Well, there were three of them on the conference call."

"So does that mean there are three of them coming?"

"No," I admit.  "I guess not."  For a minute I think I've escaped.  There's a long silence.

"This is outrageous."  That's it.  Now I know someone is losing their job.  "You do not behave like this.  It's entirely unprofessional." He's moved off of "angry" and into "resolved."  Someone's head is already on the floor.  The body is still twitching around.  Blood everwhere. Whoever it is, they don't even know they are dead yet.  At this very moment they are probably happily sipping wine in a leather covered business class seat trying to determine if the flight attendant will sleep with them and if so how they can swing meeting her later after the pesky meeting they have to attend in the morning.  "I want you to speak with them.  I want you to find out what the hell they think they are doing.  And then, I want you to call me."

Fuck.

Swim Team

The "fall party" was in September of 2005.  Typically, we host around 200-300 people on the estate for a day of food, wine, socializing, industry gossip, and whatever other trouble people can get in. Before the main party there is always a little party "ex ante."  Since all the outdoor tents, the tables, the liquor, and a good bit of the food are already present, Armin takes advantage of the infrastructure to entertain 30-40 people the night before.  Armin is all about extracting value.

Armin's wife had been making some changes to the landscaping around the Estate's driveway all that week.  Apparently, one has to make these particular changes before frost sets in so there is a huge demand for landscapers just before the winter months.  I have no idea if this is true, but one of the associates, who seems to regard himself as an authority on every subject that might potentially enter into a conversation, mostly I think by liberal use of bullshit, made this claim when I asked why a huge part of the hedges bordering the driveway had been removed and covered with gravel.

I wanted to catch him on his bullshit (I've been wanting to do that for a long time) but as with any of his claims, this one was impossible to verify without obtaining an advanced degree in landscape design and by the time two hours had passed I'd forgotten all about the little promise I made to myself (probably when I was a bit more sober) to look up the latest little stinking tidbit he had offered up.

As it was, I was walking into the main house for a glass of wine right around 5:00 or so.  I had just found the bottle and was starting to pour my first glass of the day when I heard the most alarming scraping sound from outside and then a loud splash.

The teenage daughter of the head of one of the largest hedge funds in the country had driven her brand new Saab straight through the gap in the hedges and right into the swimming pool.

Fluff

I really hate websites and blogs developed by someone who's written a book, or two.  Particularly if the books suck.  Nowhere is more hype expended to market more useless literary (and I use the term loosely) nonsense to larger numbers of people than in the fields of personal finance and venture capital.  Nevertheless, occasionally, you find something out there worth reading.

Compare the awful and awfully pretentious: Bona tempora volvantur
...to the understated and simply good: O'Reilly Radar

Personally, I think if you are going to adopt latin mottos you either better be a large institution with a massive endowment, or at least be able to speak latin and get the grammar right.  Aut insanit homo, aut versus facit.

-ep

2 + 2 = 5

IT Guy: "Hello?"
Equity Private: "Hi, IT Guy, it's Equity Private from [your parent company]."
IT Guy: (Guarded) "Oh, hello."
Equity Private: "I heard you are missing some projectors?"
IT Guy: "Uh, yeah."
Equity Private: "I've been asked to figure out what happened."
IT Guy: (To background) "Hey, Mike?"
Mike: (From background) "Yeah?"
IT Guy: "How many projectors are missing?"
Mike: "Uh.  Four."
IT Guy: "We are missing five projectors."
Equity Private: "He just said four."
IT Guy: "He means five."

Arrogance

Some stereotypes get to be stereotypes because they are primarily true.  That finance professionals, particularly those from certain firms or certain schools, are arrogant is, at least in my experience, true. I swore to myself when I took this job that I wouldn't go down the road of superiority in this way.  I promised that I would try to maintain perspective.  Dedicated myself to keep an open mind.  That lofty ideal lasted about 4 months.

This job breeds contempt.  Oh I love it so.

The thing about buyouts, as in sales and trading, is that your value is extracted at the expense of someone else.  Every time we buy a company we are in effect saying, "we paid less for this then we can get for it, and we can run this better than you ever could."  The difference is that in sales in trading you are saying this to some anonymous other trader with a thick skin and the protection of an anonymous terminal screen between you.

The due diligence process supports this turn of the psyche.  Due diligence primarily orbits around the concept that there is something wrong and that the current management is either unaware of it (in which case our business acumen is superior) or actively concealing it (in which case we are ethically superior).  Often, however, our suspicions are correct.  That's not to say we don't create our own problems or make different mistakes in the company once we get our hands on it.

As for investigation?  We spend our diligence time finding faults, highlighting them and exaggerating their impact and effect.  We are the arbiters of failure.  Soon it becomes easy to find fault in everything.

So much gamesmanship surrounds the process, in fact, that you grow used to thinking of other parties in the transaction as the dupes and victims of the "negotiating strategy" and "diligence tactics" you deploy.

You develop similar ideas about the employees in your portfolio firms.  (At least the ones still left after the firings you oversaw).

God forbid you went to an ivy league.  -cough-  Then you start to think the same thing about your peers in other PE firms.

Really, I think this kind of bitching is just a response to the pressures of the job.  It is a lot of really hard work.  Small things, like dry-cleaning- which drives me batty- get under your skin.  Near perfection is your metric for everything.  You are hyper-sensitive to any, even slight, waste of time.  (That's just a consequence of living in New York City).

You start to use phrases like "We can put a man on the fucking moon but no one in your marketing department can do a price elasticity regression?" with the portfolio companies.  You respond to the growing loathing the employees have for you with "I am here to get this business back on track, not to win a popularity contest."  Of course, these things are true.  You aren't in a popularity contest.  (Or you are losing it very badly).  We can put a man on the moon.  No one in the marketing department can do any kind of regression at all.  The new associate who just joined is lazy and can't be counted on to put the firm first and, goddamnit, there is just no place to get my best suit dry-cleaned.

It's Dirty

Sign in Wall Street bathroom:  "Employees must wash hands after handling money."

It's Just My Day Job

Umbrella Cart Hot Dog Vendor on Cell Phone (54th and 6th):  "You're talking about a goddamn billion dollar company here and they are just using it for a tax write off."

Not Falling for It

Sell Side Investment Banker: "That is really going to have no impact on EBITDA going forward."
Private Equity Associate: "Uh, yeah.  You know, I may have been born yesterday, but I stayed up all night."

Haemoglobin

It is true that I only grudgingly accept assignments involving the care and feeding of daughter firms, particularly when I had no part in the acquisition, but be this as it may I do take the assignments I am given quite seriously.  It is in this way that I discover the location of the Sinister team.

Quite a clever bit of detective work on my part, if I don't say so myself.  I happen to know that one of the Sinister sales team members, let's call him "Tom," is almost certainly sleeping with another Sinister employee, let's call her "Linda."  Linda has no idea I know this so I figured calling Linda at Sinister's headquarters and insisting that there was a medical lab calling with something about "test results" was a good way to find out where Tom was.

"Hi, Linda, it's Equity Private from your benevolent parent company."

"Oh. -pause- Hi, Equity."  (Linda doesn't like me very much because I delivered the news that three people in her department were getting laid off right after we bought Sinister).

"Look, this guy from Hemotest Labs, California keeps calling here asking for Tom."

"Hemotest?"

"Yeah, some kind of medical test results or something?  Anyhow, I need to reach him and I know he is traveling in New York but no one has his itinerary."

There is a long pause.  Linda doesn't even think to ask why I am calling her about Tom or why the lab would be calling me, the panic has already set in on several levels:  1.  What is this medical test result thing about?  2. Whenever the parent company calls, it's trouble.  3. I wonder if Tom will be mad if I tell Equity where he is.  4.  Does Equity know I'm bumping uglies with Tom?  5.  Does Tom's wife know I'm bumping uglies with Tom?  6.  I wonder if Tom is sleeping around.  7. Wait a minute.  He's cheating on his wife with me... why would I think he's not cheating... that bastard... I'll...

"Linda?"

"Oh.  Sorry.  Uh, why don't you give me the number for Hemotest and I'll give Tom the message."

"Oh, Linda, I wouldn't have bothered you with that sort of thing.  The Hemostat guy insists that he has to talk to Tom personally.  He won't tell me anything at all.  Apparently, it's some kind of confidential test result or something.  Heee-moe-test.  What do you think they test for?  Anyhow, I really have to reach him.  These people keep calling here and the partners are starting to ask questions."

"Uh.  Well.  I think Tom is at the Peninsula Hotel."

Duh.  Should have figured that.

"Ok, I'll try that.  Thanks Linda!"

Tom isn't the only one.  All three of them are at the hotel.  Calling their rooms is a useless endeavor.  I am sick of the hotel's scratchy, and somewhat bitchy, generic voicemail message by the third time I hear it.  I commandeer Armin's driver and head into the city.

Maybe I'm the only one, but I have to think that it would be obvious to anyone that if a VP of your parent company has to come hunting for you because no one can find you the day before a critical presentation, you might have made a career limiting move.  Apparently, it wasn't obvious to the Sinister sales team.

I tell the driver to wait nearby, copy down his cell phone number and walk up to reception.  Of course, none of the team are in, or if they are they aren't particularly disposed to answer their phone.  Getting room numbers from the suspicious and savvy staff at the Peninsula's front desk is going to effectively be an impossibility.  (I remind myself that should I ever want to have a discrete affair with someone the Peninsula is a good bet to keep the matter quiet).  Instead, I leave notes ("Medical Emergency.  Call Equity Immediately: [cell phone number]") for each of the team members and after taking a quick peek in the almost totally empty Bar at Fives I camp out in the lobby.

I should have brought a book.

On the Job Hazards

Woman Lawyer Eating a Burger:  "I hate you.  You are so thin all the time."
Woman Lawyer in size 2 Brooks Brothers suit: "Really, don't worry.  This job will fix that right up.  In a pair of years my metabolism will grind to a halt and I will put on 50 pounds overnight.  Then I will go around with some bullshit excuse like "It's a thyroid problem."

Ignore the Man Behind the Curtain

From Research in Motion on the BlackBerry nonsense:

As to the lingering question of why the patent system should allow such a bizarre set of circumstances to threaten millions of American customers in the first place, we share your concern. The good news is that this topic is currently receiving much more attention from policymakers and the Supreme Court and we hope the patent system will evolve to close the loopholes and become more balanced.

Translation: "What do you mean we failed to respond to a legitimate licensing request from a small fry and it cost us a full year's EBITDA before we could.... Hey wait!  What's that behind you?"

Don't want to pay off $615.5 million for a piece of patent litigation?  Don't spend four years with your head in the sand ignoring a patent holder who asks you politely for royalties.

Detrimental Reliance

The Peninsula is a beautiful hotel.  It does, however, feel a bit cramped.  The lobby seating foyer feels more like a little alcove.  A couch and two chairs.  The chairs are terribly uncomfortable.  The couch is the only realistic seating option if you are going to be there for a while.  I was going to be there for a while.  Then there is the little girl, probably 5 years old, running around and up and down the stairs in the throws of what can only be a major sugar high.  I am sorely tempted to hurl one of the throw pillows on the couch at her.  Instead, I try to entertain myself by doing as much business on the phone as I can. 

I toy with the idea of getting up and buying a book to read, but I know that the moment I do the entire team will walk in.  I have no idea how long it took but they eventually walked in, bright as day, pleased as punch with themselves.

Tom, the VP of sales, is their unofficial ringleader.  I've only met him once before.  Dave and Hal, on the other hand, both know me.  I walk right up to them before they even have a chance to gauge my approach.

"Gentlemen."

They freeze.

Step back for a moment and consider the scene.  There is something highly backwards about private equity when it comes to hierarchy.  Here I am, not even 30 yet, and I have more clout than the CEO of their firm.  The perception, right or wrong, is that heads roll, divisions are diminished and products eliminated at the whims of young, MBA'd upstarts like me.  If we are prone to get big heads quickly in private equity, this is why.  Here is an "experienced" sales team, terrified by the likes of me.  Or, perhaps more accurately, the power of the entity standing behind me.  I, of course, play it up whenever I can.

"We have a serious problem and the Senior Partner has asked me to come down here and speak with you."  I always say "Senior Partner," with capital letters on it when I am on a "force projection" mission for the firm.

Tom managed to collect himself, barely.

"Equity.  What a surprise!  What are you doing down here?"

"I just told you that.  The Senior Partner has sent me here to collect you and put things back on track for the meeting tomorrow."  I love the phrase "put things back on track."  There is no opportunity to argue that things never got off track.  There is only the discussion about how to put them back on track.

"Well, I think we have that in hand already," Tom begins.  I cut him off.

"The Senior Partner does not share your optimism."  I am convinced that slightly modified Darth Vader quotes are a badly under leveraged asset. I have been using them, and I think with good effect.  "This is what we are going to do.  We are going to sit down, go over the schedule and the presentation tomorrow and then I am going to decide if we need someone else to manage this process in your stead. What we are not going to do is discuss why you three are checked in at the Peninsula, or the anger of the Senior Partner's wife, who has been slaving in the kitchen all day to prepare the dinner that any moment will be slowly getting cold on the large table in the Senior Partner's dining room on 3 plates placed carefully in front of three empty seats in which your respective asses should be sitting at this very moment."

Surprisingly, and to their credit, the three of them obediently took a seat in the cramped lobby alcove and began pitching me their presentation.

It sucked.

Two hours later, it sucked less, but it still sucked.  I despaired of the debacle that would be tomorrow's presentation.  Whatever, it wasn't going to be my problem anymore.

I called Armin and gave him the long summary.  He was very quiet for a very long time after I finished speaking.  After a ten second pause that seemed an eternity I broke the silence.

"Armin, they are going to need some adult supervision tomorrow.  Left to their own devices I shudder to think what might happen."

"Good idea.  Go with them and take charge of the presentation.  I am relying on you."  -click-

Fuck.

The Bono of Cable?

The Wall Street Journal published a piece last week (WSJ Subscription required) quite critical of Charter Communications and its big-name backer, Paul Allen of Microsoft fame.  Among other criticisms the article points out:

Since leaving Microsoft two decades ago, Mr. Allen has struggled to dispel the notion that he owes his wealth solely to his prep-school camaraderie with Bill Gates. During the dot-com mania he dropped billions into the Internet, tech and telecom sectors -- in firms ranging from Priceline.com Inc. to broadband group RCN Corp. -- with little to show for it.

Now one of his biggest bets, in the cable business, has been dealt a blow. AT&T Inc.'s takeover of BellSouth Corp. raises the competitive ante for all cable operators. None are as feeble as Mr. Allen's Charter Communications Inc. Its $20 billion of debt is 50 times the market value of its stock ($409 million). Mr. Allen's 58% stake is worth $250 million, a far cry from the $7 billion-plus he spent buying Charter and Marcus Cable back in 1998.

Mr. Allen's company is in poor shape for a fight. Last year interest payments of $1.8 billion nearly matched its cash flow as measured by earnings before interest, tax, depreciation and amortization. To cope, it has refinanced debt and shed some cable assets. This financial weakness may explain why Verizon chose a Charter market in Texas to launch its TV services. Charter halved prices in response, but Verizon still nabbed a quarter of the market.

Any other company in Charter's condition would probably seek bankruptcy protection. But that would wipe out the bachelor billionaire's interest, with possible tax implications for his investment firm, Vulcan Ventures.

Is it wrong of me to be amused by these college-degreeless one trick ponies who made their billions in the tech bubble, name their investment vehicles after Star Wars and Star Trek terms and are slowly discovering that an internet baron is about as useful to business as an A-List celebrity is to a health care and foreign policy debate?

My advice?  When you hit 23 black on the roulette table on your first try and get a 35 to 1 payout, leave the casino and dump the money into t-bills.

The debt piece of this discussion is interesting.  I have commented before on the slow dilution of convenant pieces on large debt pieces in response to a booming market for debt.  Interesting then that the Wall Street Journal highlights the fact that S&P discontinued their covenant rankings product back in the 1990s.  I wonder, if they made a revival, what sort of rating would Charter get?

-ep

Never Hire a Latte Drinker

I was wrong about Sinister's sales team.  They aren't hopeless.  It is the Vice President of Sales, Tom.  He's hopeless.  The thing about some "techie" or "engineer" professionals is that there are so focused on their own fields that they are often socially maladjusted.  Social ineptitude is often, I am told, a sign of great genius.  Sinister's sales team seems to be a data point right on this regression line.

After being tasked with managing this entire sales call, as if I were a sales guru, I snagged the last hotel room at the Peninsula and hand-held the team through at least a passable presentation.  This was no easy task given the fact that I knew exactly nothing substantive about the product.  I learn quick, or at least that's what my resume says, so at the very least I could talk the talk by the next morning.

The day started off with a 20 minute panic as we waited in the hotel lobby for Tom.  I got tired of saying "Where the hell is he" after the third time and, instead, sat brooding and thinking to myself that I would rather be just about anyplace else at all.

20 minutes after our appointed departure time Tom waltzed in with a Starbucks Latte in his hand.  Not a care in the world.  "Hey guys."  I could have killed him.  Later, when I described the incident to another Sinister employee the reply was, "That guy moves like old people fuck, and if you put a latte in his hand, you have to half that speed."

We all piled into a taxi (I took the front seat) and lumbered through the city to our destination.  On the way I handed a massive bag of danish, bagels, banana bread and granola bars I had snagged from the local upscale coffee shop to the back seat.  I thought Dave's eyes were going to bug out.  He set upon the bag like a big cat on the Serengeti.  There was nothing left by the time we had traveled 2 miles.

As we got closer, I shot a cross look at Tom.  "I will do the talking today.  You need to just be a fly on the wall."  I turned around and gave him the back of my head before he could reply.  All the while, I imagined him making obscene gestures behind me and almost spilling his latte.

You know a hedge fund is bursting at the seams with money when the refrigerator that holds the soft drinks for the late working employees is a Sub Zero(tm) with digital temperature controls.  This hedge fund was clearly bursting at the seams with money because I found four such refrigerators in the short span of our visit.

The presentation was a bravado performance.  I had completely despaired of it being even mildly successful.  The presentation slides were weak.  I feared Dave would be eating the entire time.  I feared Tom would break in and offer to reduce the price of the product to half of our cost.  I feared our techies would veer off into the never-never land of tangential trajectories.  I feared the audience would see through our thin veneer of competence and confidence.  In reality, I had nothing to fear.

I am still convinced that it was the breakfast bag I had handed Dave that saved the day.  Once I made the introductions I had been prepared to lead the entire discussion, referring to Dave and Hal only when necessary and completely shutting out Tom.  Totally unnecessary.

Dave took the floor and threw himself into the presentation with full force.  He delivered succinct and effective points, highlighted the exact features of the product that the quant guys in the room wanted to have and spun any barbed questions into a triumphant outline of why the product was the best thing since the discovery of portfolio management theory.  The passion he had for the product, heretofore concealed beneath a silent and brooding exterior, hemorrhaged from him and filled the room with the sweet, oxygenated plasma of enthusiasm.

By the end the quant guys were begging for more details, looking up into their eyebrows and imagining all the time and effort they were bound to save and all the money they were going to make for the firm.

It dawned on me.  Tom was the problem.  Hal and Dave weren't sales guys.  They were the technical, Q&A and presentation guys.  Give them just a little direction, put them in front of the right people and keep them fed and fireworks would follow.  Tom, who was supposed to be the grand leader, the sales guru, was in fact useless.

I dreaded the debrief with Armin.

Small Change

I have been getting a lot of email questions.  I figured it was time for a silly frequently asked questions section in response to the many silly questions.  It is on the now recently updated about page.

Closer Than You Think

Business Suit Clad Professional Standing Directly Across from the Las Vegas Style, Billboarded Lehman Brothers Building: "Excuse me, where is the Lehman Brothers Building?"
Private Equity Associate: -pause- "Oh, you've got a ways to go.  About 5 blocks that way into Time's Square."

Testify

Having endured the Project Sinister presentation I hoped dearly to avoid Armin until a day or so passed.  Maybe he would neglect to quiz me on the team.  I feel guilty giving poor reports, a characteristic that could, in a more severe form, make me quite unsuited for this line of work.  I have no problem whatsoever doing it in the ethereal confines of my own thoughts or to someone's face.  Reporting back to the partnership, however, feels an awful lot like telling the teacher in Kindergarten that the kid who picks his nose in the back of the classroom peed in his pants when she wasn't looking.  If I just left it long enough the teacher would see the soaked pants on her own.  Why should I intervene?  Involve myself in the nastiness that followed?  Be a direct party to it?  Why get involved?

Because I wasn't given a choice.

And so, back on the estate the next morning, an elegant note written on engraved stationary laying atop my desk in the library.

"Lunch? - A."

Such a simple note in the midst of all that white space always throws me.

One didn't really reply to these notes.  It was a given that you would accept and anyhow there wasn't any clear mechanism to indicate your approval.  Like getting a card with "prière de répondre - regrets only" except there's no phone number.  Eventually, the butler would announce something like: "Mr. Armin has asked you to join him in the reception," and I would finish what I was doing and find him there, dressed for a formal business lunch.

Sometimes these kinds of invitations meant Armin took me out to eat, studiously ignoring the subject that would eventually be the focus of our lunch until we were seated and well into the main course.  Other times they meant a glass of wine while I watched him cook, he refused all offers of help, and emergence of the point in the Estate's cavernous and otherwise empty main dining room.

Each time it was a bit agonizing.  You knew it was coming.  Almost like the traditional Christmas family fight during dinner.  What would spark it this time?  Who would be the trigger this year?  My mother's soft, wistful sigh taken by my grandfather as a subtle slight to his childrearing abilities?  (So subtle, in fact, that no one else noticed it until he stiffened and grew silent).  Mention of the family dog that my mother had put down before my father returned home?  ("Everyone knows you always hated that dog!")  Discussion of the economy, leading without fail to the subject of my decision to go to business school? (My parents had wanted me to pursue a more "intellectual" career, whatever that meant).  I could only entertain myself by speculating in the hours before the line was crossed.

This time it was out to eat.  We flirted around a dozen discussions in the back of the car, over salads and bisque until he finally broached the issue in the midst of my lobster risotto.

"I understand you had an eventful meeting with Sinister's sales team." I have no idea how he would know that.  Surely, none of them would have told him.

"Well, yes."

"I suspect this was among the most important meetings Sinister will have this year.  Don't you agree?"  I was uncomfortable immediately and the tension had been bothering me.  I could almost feel the sweat on my back.

"Actually, I do."

"Tell me, Equity, do you think we put our best foot forward?"  I could see already where we were headed.  Armin was calm.  Resolved. Pensive.  Deeply calm.  He was using the sedate Britishlike accent. The one that reminds me of the Harvey Birdman, Attorney at Law Character, "Vulturo."  Tom was history.

"I am afraid not."  With this Armin acted surprised.  The briefest of eyebrow elevations.

"Oh?"  I was, unfortunately, expected to elaborate.  And so, as Armin gestured for the waiter to fill my glass with more red wine, I did.  I described the hotel fiasco, my suspicions about Linda, my ruse to find the team, the state of the presentation before and after my work at the hotel, the latte in the morning, the bag of food, Dave's performance, everything.  Several times along the way I was tempted to downplay the comedy of errors that was the Sinister sales effort, but I found that Armin's polite attention made even this kind of deception impossible for me.  He did not nod in agreement, or shake his head in bewildered horror.  He just listened.  Almost, but not quite, passively.  He always seems to receive such reports this way.  It is unnerving.  There was also the sneaking but totally irrational suspicion that he had somehow gotten the story already and the fear of the consequences that might follow my giving anything other than a faithful rendition.  So I was brutally honest instead.  It was painful.  When I finished Armin was silent only for a brief, thoughtful moment before speaking.

"I am glad I sent you, Equity."  I still don't know how he meant this, but I heard it as "I am glad I sent you, and not someone else, Equity."  I was still pondering this during the long pause that followed when he, suddenly as unconcerned as if he had not even heard the tale of woe I had just woven, caught the eye of the waiter again.

"I would like an espresso, please."

Whatever Floats Your Boat

Sub Rosa Associate: "Someone told me that they were looking at IMDB and that in American Psycho all the women on the set turned up out of the woodwork to watch Christian Bale do the shower scene."
Equity Private: "The most memorable image I have of him is running through the hallway bloody and naked except for white sneakers."
-long pause-
Equity Private: "The most memorable non-sexual image..."

Imperialist Democracy?

Martin Lipton's objections aside, the Economist seems to think little of the new "Imperialist Shareholder," and in fact argues quite strongly in an article this week (Economist subscription required) that shareholders are quite a bit less powerful than they might seem. Lipton's primary argument was one of focus. Permit shareholders to go wild, he argues, and management will be so focused on short term gains that long term planning will fall by the wayside.  Similar arguments are made to support the notion that firms shouldn't give quarterly earnings guidance, or seek to maximize quarterly earnings.

Funny that it would be Time Warner now, and Carl Icahn's siege of that firm, that prompted Mr. Lipton's outrage.  Back in 1989 a Delaware court backed Time against a hostile bid by Paramount.  (The famous "Just Say No" case resulting in the "Nancy Reagan Defense").  The case resulted in the adoption of "Poison Pills" by management all over the country and a series of takeover defense mechanisms with names like "Bankmail," "Flip-out," "Flip-in," the "Pension Parachute," the "Pac Man Defense," "White Squire," "Jonestown Defense" and the dreaded "Goodbye Kiss," all shifting the balance of power to management and from shareholders.  Poison pills had been around since 1982 (in fact there is a strong argument that Lipton actually invented them) but their sudden widespread adoption was a dramatic shift.

Of course, hedge funds are getting in on the gig and, as I've mentioned before, they look quite like the new greenmailers.

But then what does this mean for the smaller shareholder?  According to the Economist, not very much.

As Bob Monks, a shareholder activist, puts it, “the American shareholder cannot nominate directors, he cannot remove them, he cannot—except at the arbitrary pleasure of the SEC—communicate advice to them. Democracy is a cruelly misleading word to describe the situation of the American shareholder in 2006.”

Personally, the increasing heat on the management of public companies convinces me that private equity, even with the bubble like signs it has begun to show, has a long and valued place in the microcosm of Corporate America.

On the Twelfth Day of Christmas

This year is the 25th anniversary of the HP12C calculator.  Hurray!

Elevated

I am really worried about caffeine.  I am worried about it because I have started drinking far too much of it. There is a fantastic, $3,000 pump espresso machine at the estate.  In the last three weeks I have gotten in the habit of pouring myself a deep espresso whenever I walk in, particularly if its before noon.  For three weeks that meant a cup every morning.  By the second week I was having one after lunch as well.  Two cups of strong, but wonderful espresso per day.

I tried to stop last week.  I couldn't.  Seriously, I couldn't.  I would catch myself with a cup and barely remember where and when I had obtained it.  When I finally tracked my consumption I was alarmed to find that I have gotten up to 4 or 5 cups a day.

I am not a hypochondriac by even the most remote stretch of the imagination but I have no doubt at all that I can feel the effect on me.  I can feel a tightness in my chest in the afternoon.  I can feel the anxiety eating at me.  I can feel the impact on my body already.

Maybe Milosevic was drinking espresso.

I need to stop drinking caffeine.  Soon.

Unintended Globalism Consequences

The Wall Street Journal ran a piece this weekend on Carl Icahn's latest shareholder activism (read: hostile takeover) efforts at KT&G, the Korean tobacco concern.  Icahn is pressing for control of the firm which means, of course, that he believes he can extract significant value through superior management (or be annoying enough to be bought out at a premium).  He just won a board seat for an ally of his.  A nice victory (but just a single step forward) given his recent back-down from Time Warner.

KT&G's history is an interesting one.  State owned and a monopoly until 2002 when privatization (read: taking money from foreign institutions) took them public.  They have benefited greatly from foreign capital and for the longest time haven't carried any debt at all.  I will leave it to the students of finance to comment on the wisdom of that particular fiscal strategy.

As is becoming typical of such endeavors, Icahn has an ally in other activist firms overflowing with cash.  In this case, Warren Lichtenstein, who leads the hedge fund "Steel Partners II, LP."  There is a side of me that wonders if Icahn, when he sits down with the likes of Lichtenstein and plots a takeover, isn't revealing material non-public information in the process.  Certainly, that Icahn is plotting a takeover would be material, no?  Why should Lichtenstein benefit before the rest of the market?  Ah, well.

Korea is particularly closed as a capital market jurisdiction.  It is also very isolationist.  That is changing, clearly, given that the activism at KT&G is the first foreign led hostile "takeover" (I use quotes because so far they haven't committed totally to a pure takeover) in the country ever.

I found it comic that the unions picketed Icahn and that the move is spawning a great deal of hatred for foreign capital under the thin guise of nationalistic pride.  Take heed, foreign firms: You cannot have your cake and eat it too.  If you take foreign capital, enjoy the advantages thereof and then try to lock out foreign shareholders (KT&G earnings releases are in two versions, Korean and English.  Guess which is the more extensive.) then don't expect them to roll over and play dead.

Paddles Prohibited Beyond This Point

The hedge fund people suddenly have issues with the product we showed them.  Things had gone spinningly in the presentation, but now they seem to have some kind of strange set of technical issues.  There is a lot of back and forth between Armin's highly placed friend, me, Dave and the technical team at the hedge fund.

Now things don't look particularly good.

This would be a bad strike for Sinister and, if the early concerns of the hedge fund's technical team pan out, it would imply that the primary product Sinister, and therefore we, had hung its hopes on could be worthless.

It never ceases to amaze me how Ph.Ds can disagree about technical details.  These are supposed to be statistical conclusions.  We can argue forever about the conclusions themselves but being unable to agree fundamentally on the data and the calculations used to get there is like taking contrary positions on whether 2 + 2 actually equals four.  Or so it seems to me.

If the two teams cannot come to some common ground quickly it probably means one of two things:

1.  The hedge fund team is calculating something wrong, there is actual value in Sinister's product but they are looking in the wrong place for it.
2.  Our team is calculating something wrong, there is zero value in Sinister's flagship product.

Of course, option #2 would be a dire consequence for Sinister.  It also, based on my experience in these matters, is probably the more likely of the two.

This is why buyouts of tech, service and other firms whose primary value is based on intangibles are more risky and undesirable than buyouts of boring manufacturing firms.  The due diligence is just harder.  How can one possibly know if the product is real?  With manufacturing you can touch it, see the machines, watch them work, hear the click of the 900,000th washer falling into a bin of 899,999 other finished washers.  A slick technical product that was "in the final touches of development" can evaporate right in front of you like so much Windex on clear glass, taking with it any hint of the grease of your already accounted for profits and leaving you staring right through to the now clearly visible abyss beyond.  Unfortunately, however, debt payments are not soluble in Windex.

The John Lennon of the Sell Side

Sell Side Investment Banker: "I imagine that the increases in revenue will be unimaginable."

Exeunt omnes

The always excellent "The Big Picture" today leads with a column tagged "Lots of jawboning out of the Fed these days."  I find this both interesting, and alarming.  The issue of central bank transparency is not even remotely new, of course.  The trend in the last decade has been to more openness which, in the context of a free economy, seems the course most aligned with market philosophies.  (It is maybe no accident that Alan Greenspan is an Ayn Rand disciple and used to be a jazz saxophonist).  That pronouncements by any Fed Chairman can move markets is not new.  But caution is the better part of valor in this context, I think.

The grip with which the markets held the collective armrests of the movie theater chairs when Greenspan assumed the podium, however, is a more recent phenomenon.  So much so, in fact, that one can find substantial research measuring the impact of the former Chairman's pronouncements (and even the anticipation thereof) on the market.  My favorite recent work in this field is Chirinko, Curran, "Greenspan Shrugs.  Formal Pronouncements, Bond Market Volatility, and Central Bank Communication," January 2006 (183k .pdf) which, in summary, notes "the possibility that one or more aspects of [the Chairman's scheduled public statements] may be counterproductive."

What worries me, however, is that on the heels of a highly respected (even worshiped) Chairman, the incoming "younger brother" might be subject to overcompensation.  Bernanke has already fallen into the deadly trap of taking sides on spending and tax cuts when asked.

Part of Greenspan's charm was his inscrutability.  His pronouncements were delivered with such measure and pace that even a hint of bias was seized upon by the market.  Fed watchers once spent untold hours examining photos of Greenspan's briefcase as he walked into Open Market Committee meetings, the idea being that a full briefcase meant he had brought substantial supporting materials to support a target hike. CNN's Eyes on the Fed even used to run pictures of Greenspan and the case on his way into and out of the meetings.  I heard a rumor that it was a clever "Fed Watcher" who put together this little correlation and that once Greenspan found out about it he would deliberately load his case with the same quantity of irrelevant papers before entering the building.  As with everything Greenspan, the truth is probably unknowable (until the Memoirs are published- I can't wait).

All this is a way of saying that I think a Fed Chairman needs to be a bit of a showman.  Flirtatious.  Hard to get.  Coy.  Would we have the words "irrational exuberance" if Alan "If you think you understood me, it's because I misspoke" Greenspan was constantly holding court?  Would Greenspan's memoirs fetch something like $9 million if he hadn't been an inscrutable enigma for so long?  I don't know.  (He never returns my calls anymore).

Race to the Top (Bottom)

I enjoy Conglomerate Blog.  Particularly when entries like today's "Private Equity, Illinois Pensioners and Sudan?" make the page.  New contributor Bobby Bartlett pens an interesting yarn about Illinois' attempts to prevent funds of all kinds from investing in the Sudan.  The mechanism is to require from all pension funds over which Illinois has jurisdiction documentation that they have not invested in any vehicle (including hedge funds and private equity) that in turn invests in the Sudan.  The pension funds are expected to obtain this certification from the vehicles themselves.  The result is predictable and Bartlett summarizes it thus:

...private equity funds are already concerned with the additional disclosure burden of having public pension fund investors, and the Illinois legislation seems to be viewed by many private equity investors as simply one more reason to stay clear of “public” money.

Forgetting for a moment that such embargoes are probably most properly left to the Federal Government to enforce, and that Illinois means well, the entire situation is an interesting demonstration of the powerlessness of governments to influence large (or even medium sized) investment vehicles.  Switching costs have become quite low and many funds have already fled the United States to avoid regulation. Soros is a famous and prolific user of offshore jurisdictions.

Financial disclosure is, of course, key.  But I think the pendulum has swung too far.  The United States risks being marginalized when it comes to alternative assets classes by jurisdictions like Luxembourg or the Islands.  The United States is going to have to come to grips with the fact that burdensome disclosure will, first, press talent into private ventures, then if, as I suspect it will, the United States attempts to clamp down on those vehicles, those too will flee, taking with them their profits and tax revenue therefrom.  Of course, I am a fan of private equity.  There is a reason that it has become a highly preferred vehicle for high-risk, high-reward investment.  There is a reason that the balance for talent and capital has tilted in the direction of firms like the one I work for.

It would be interesting to see what a survey of entering MBA students list as their primary motivation from coming to business school is.  Then again, insofar as "interesting" means "surprising" it might be quite bland.  Hedge funds and private equity would, I strongly suspect, feature highly.  With all the whining about American educational competitiveness you'd think anything fostering the huge suction into United States' advanced degree programs would be a good thing.

We are actively shopping for our next vehicle.  The United States isn't even in the cards, even though we plan to invest here (and perhaps even manage the fund out of Manhattan offices).  And, of course, we don't touch "public money" either.  With a track record you don't have to.  There is enough sloshing around for everyone in the top quartile.

All of this might actually have an unintended effect.  If the big "private equity bubble" exists and is about to pop, Illinois might weather it well.  I doubt it, but we'll see.

Certainly Certain

Abnormal Returns is yummy.  Random question, however.  Today they quip:

...macroblog shows some movement in expectations for the Fed funds rate at the May meeting. After the (almost) certain increase to 4.75% in March the market is backing of a near certain rise to 5.00% in May.

I think it would be useful to have an ordered ranking of terms like "certain," "almost certain," "near certain," and the like.  Is "almost certain" a greater degree of certainty than "near certain"?  The ordering in the phrase above would suggest so given that the level of a May increase is dependent on the March increase and therefore the expectation of a May increase should be somewhat subject to the imperfect certainty of the March increase.  Then again, perhaps there is an inverse certainty curve?  Does this foreshadow a certainty recession?  Is our examination of certainty and the development of certainty expectations really a certainty derivative?

I'll tell you what is certain: I have too much time or too much chocolate on my hands.  Certainly one of the two.

The Bragging Wall

Colin is a Vice President at Sub Rosa.  He is pretty much what one would expect from a Vice President at a private equity firm.  Ivy league (he went to my alma mater but graduated two years earlier than I did and I didn't really know him well there).  Top business school.  Bulge Bracket Investment Banking experience.  One of the "beautiful people."  All the bells and whistles.

It was quite a while after I joined the firm before I started spending very much time in the Midtown offices.  I was afraid at first that this might breed resentment among my colleagues.  In this I was wrong.  Guarded suspicion?  Perhaps.  Resentment?  No.

My office in the Midtown space blew me away when I first saw it.  I had a wonderful view of midtown and the Chrysler building and what struck me as an overly large office with a leather topped work desk (Armin is big on leather topped desks) visitor chairs, a standing roll-top secretary desk by the window and a sofa.  When I first started spending a lot of time there I used to write at the secretary roll-top desk, until I found out it was an authentic 18th century antique.  Now I can't even touch the thing.  It just feels wrong.

I had met Colin a few times before I "moved in" to the offices in Manhattan, but I had never seen his office.  When I knocked on his door to ask him if he had or knew of anyone who had any experience for a particular industry he was on the phone but waved me in anyhow.

As one is prone to do when entering an office for the first time, I glanced around to see what secrets the office held.  I'm not sure I found any but the far wall was literally covered in dozens of framed certificates, diplomas, letters, announcements and such.  I had thought Colin only to be in his early thirties but the sheer scope of these mementos made me think again.  Was this actually his office?

I walked to the nearest framed letter, which looked to be a rather recent edition, and started reading:

Dear Coleen Soandso:

It is my pleasure to inform you that you are being considered for inclusion into the 2006/2007 Manchester Who's Who Among Executive and Professional Woman "Honors Edition" of the registry.

The 2006/2007 edition of the registry will include biographies of our country's most accomplished women.  Recognition of this kind is an honor shared by thousands of executive and professional women throughout America, each year. Inclusion is considered by many as the single highest mark of achievement.

Upon final confirmation, you will be listed among thousands of accomplished women in the Manchester Who's Who Registry.

Colin hung up.  I pointed at the letter with what must have been an amused look on my face.

"Congratulations," I said.  He laughed.

"Oh that?  Yeah."

"Executive and professional women?"

"Happens all the time.  My name confuses them."

"'Colin' confuses them?"

"Well, that's not actually my name.  It's Colen.  I use Colin just because I got tired of correcting people."

"Do you always frame these kinds of things?"

"You haven't looked at the wall yet, have you?"  I started to browse among the other framed pieces.  A letter from a Nigerian attorney, "I am most hopeful and pleased to present you with a nomination for a diplomatic post with the Nigerian Department of the Exterior."  Of course, a modest processing fee would be required.  A diploma from someplace called the "State University of Springfield."  The name of the state in which the University was organized was not listed.  Next to that was a certificate from "Paranormal University."  Then, a commission to the Texas Navy, complete with embossed seal.  The list went on and on, each framed memento sillier than the last.

"When I was in undergrad," he started to explain, "it became somehow funny for my friends to sign me up for any crazy offer or service that they found.  Of course, in college one comes across a great number of these.  I've been in the panty of the month club, the preferred customer list for battery powered assisted living scooters, the hair club for men..."  With this last I looked more carefully at his head.  If he was wearing a hairpiece it was a good one.

"If the initial offer was either free, required no credit card or was under $50 and funny enough, you could be pretty sure my friends would sign me up.  I am on so many mailing lists that here I am, a decade later, and I still get 20-30 offers a week," he sounded almost wistful.

"When I started interviewing for investment banking I saw all these managing directors with their tombstones and bragging walls. Sometimes these guys have tombstones for deals that have gone so south as to be embarrassing, but they keep them.  How'd you like to be a senior member of the lead underwriter for the last WorldCom offering? Yet that tombstone is a bragging piece right too.  It says 'We got rich on a deal that fleeced everyone else, aren't we sharp?'  The whole thing seemed pretentious and stupid to me.  So I made my own version."

We talked for a while about the industry I was interested in and when I was finished he reached into his inbox and pulled out a piece of junk mail.  "Apparently, I've been nominated for the Manchester Who's Who for overachieving women again.  This time I have two ells in my name."