Going Private

Risk Free Fees

The continuing saga of hedge fund compensation lingers on.  Reader mail continues to spill in on this topic including a recent set of missives that highlight the poison in the Kool-Aid the hedge fund crowd has been drinking.  Count on Going Private readers to ferret out such details (though this one probably should have been obvious) and wield them with cunning and elan.  Says one reader, a UBS alum:

If they are obsessed with non-correlating returns, or at least if they are so concerned with justifying their fees with such promises, then they should be happy to reduce their performance by the returns of a portfolio with beta of zero.

Reader 3 doesn't seem as smart as he thinks he is: a zero beta should return the risk free rate regardless of the index chosen. Such a portfolio should also have very low volatility, otherwise the risk/reward ratio would be very skewed.

This suggests that at a minimum gains for the purposes of calculating fees on a fund that has "uncorrelated returns" as its primary investment goal should be indexed against the risk-free rate.  Perhaps ten year treasuries or some such.  Clearly, other funds which espouse other investment purposes (outsized returns relative to the S&P 500, absolute returns, returns uncorrelated to tin futures) should probably be indexing other indexes.

In the end the only issue is investor education and fee elasticity.  There won't be any pressure downward on fees unless investors vote with their feet.  Don't worry, Polonius fans, given the lack of investor outrage at present, hedge funds don't appear to have much to worry about.

No Parole Either

The Unknown Professor over at Financial Rounds points us today to a piece on Market Watch on dual-class shareholder structures in the public equity markets.  Penned by Russ Britt, the "Los Angeles bureau chief for MarketWatch," the piece casts dual-class structures as some sort of control-tax dodge, pitting victimized shareholders against the highly unattractive demon of nepotistic media dynasties in what amounts to a thinly veiled call to arms against the practice.

"Management wants the best of both worlds," said Nell Minow, founder of the watchdog group Corporate Library. "They want the access to capital of the public markets and they want the control of the private markets, and dual-class allows them to get that."

Let's ignore for a moment that it is in fact the shareholders themselves, who willingly buy into the dual class system in the first place, and not some sort of lawyerly slight of hand which "allows [management] to get that."

The reality is that dual-class structures can serve important roles.  Their traditional purpose in the media context, the Market Watch piece grudgingly admits, has been to insulate media control from the short-term whims of the market.  Clearly, any anti-takeover provision which entrenches management will have this effect to some degree.  Stock price, however, is still a strong motivator and to the extent control is important to investors castrated shares will trade at a discount to uncut issues.  This point, apparently, needs to be highlighted for almost everyone who makes "fairness" arguments about these sorts of practices:

Either:
Investors have already managed to pick up the assets at a discount because the lack of control has already been priced in, or;
Control in the company issuing the shares is so unimportant that it hasn't impacted the shares.  One might wonder in this eventuality why there would be any need of adjustment.

In fact, to now, through legislation, regulation or fiat, force a change in that structure would unjustly enrich shareholders who knowingly paid non-control prices and have been granted a subsidy by regulators and at the expense of the company and management once control is handed to them.

Consider the S-1 of one of my least favorite companies:

Corporate Structure: We are creating a corporate structure that is designed for stability over long time horizons. By investing in Google, you are placing an unusual long-term bet on the team, especially Sergey and me, and on our innovative approach. We want Google to become an important and significant institution. That takes time, stability and independence.

We bridge the media and technology industries, both of which have experienced considerable consolidation and attempted hostile takeovers. In the transition to public ownership, we have set up a corporate structure that will make it harder for outside parties to take over or influence Google. This structure will also make it easier for our management team to follow the long term, innovative approach emphasized earlier. This structure, called a dual class voting structure, is described elsewhere in this prospectus.

The main effect of this structure is likely to leave our team, especially Sergey and me, with significant control over the company’s decisions and fate, as Google shares change hands. New investors will fully share in Google’s long term growth but will have less influence over its strategic decisions than they would at most public companies.

While this structure is unusual for technology companies, it is common in the media business and has had a profound importance there. The New York Times Company, the Washington Post Company and Dow Jones, the publisher of The Wall Street Journal, all have similar dual class ownership structures. Media observers frequently point out that dual class ownership has allowed these companies to concentrate on their core, long-term interest in serious news coverage, despite fluctuations in quarterly results.

The Berkshire Hathaway company has applied the same structure, with similar beneficial effects. From the point of view of long-term success in advancing a company’s core values, the structure has clearly been an advantage. Academic studies have shown that from a purely economic point of view, dual class structures have not harmed the share price of companies.

The shares of each of our classes have identical economic rights and differ only as to voting rights. Google has prospered as a private company. As a public company, we believe a dual class voting structure will enable us to retain many of the positive aspects of being private.

We understand some investors do not favor dual class structures. We have considered this point of view carefully, and we have not made our decision lightly. We are convinced that everyone associated with Google—including new investors—will benefit from this structure.

This brings me back to the original "have it both ways" quote:

"They want the access to capital of the public markets and they want the control of the private markets, and dual-class allows them to get that."

Yes, exactly.  Have we come to the point where a long-term corporate strategy is so antithetical to capital markets that we must abolish anything that encourages it?  It strikes me reading this again that Nell Minow is trying to strip one of the last real defenses against short-term public market forces in public equities and what I have started calling "the tyranny of the quarterlies,"  away.  Once again, markets are beginning to look like the laws of thermodynamics.  Don't let companies win.  Don't let them break even.  Don't let them get out of the game.

Adding in the changes Herb Greenberg advocates and we'll end up with a second rate capital market s system in no time.  What will we do then?  Why, drive out all the liquidity and collar private equity to prevent public shareholders from being "cheated" by unlocking value that the public markets have all but destroyed.

Moving to London looks much more appealing today.

Agendas

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

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

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

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

Would You Believe...?

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

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

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

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

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

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

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

Bird Flu

Given the news that Home Depot may well have been engaging in "backdating" "way back when," I wondered if the viral nature of backdating might have spread to other boards.  If so, which boards?  How long ago?  I don't know, but this graphic I threw together with 2004 data on the subject is fun. (Richard Grasso looks very lonely, doesn't he?)

(Graphic credit: They Rule)

Bourgeois Pigs

Always yummy Abnormal Returns calls our attention to a reaction from Michael Lewis, of all people, which throws enough heat off of his Bloomberg piece yesterday to fuse income inequality (lately a fashionable armchair socialism yarn for would be populists) with private equity returns and create a dense and opaque argument decrying what I can only brand "return inequality," a structural plague Lewis sees afflicting the market.

Why, wonders Lewis, isn't the "proletariat of Wall Street," the middle class, the "proles" permitted to participate in the private equity boom?  (Amusing to call those with wherewithal enough to invest in stock at all "the proletariat," given that even Marx's definition of bourgeoisie is those who earn their income off of ownership or trade in capital assets).  Lewis tell-tales his answer early on in his piece:

The job of the private-equity investor is -- again, speaking loosely -- to exploit the idiocy of the ordinary investor, and the corporate executives and mutual-fund managers who purport to serve him.

Ignoring, for a moment, that the job of every participant in the market is to "exploit the idiocy" of anyone else in the market dumb enough to display that idiocy in a public forum like the market, Lewis attempts to use Hertz to make the implicit case that an open auction on the most liquid market on the planet somehow perpetuated a massive fraud on the investing public and badly cheated the "ordinary investor," who willingly (even if not enthusiastically) scooped up the debt laden Hertz in one of the most successful LIPOs (from an IRR perspective) on record.  Comments Lewis on the topic:

But it's hard to see how Hertz is a riskier investment simply because it is owned by the Carlyle Group and not by Ford.

I can't speak to the risk effectively, but Lewis, in my view, over-hypes the importance here of "risk" and under-appreciates the "conglomerate discount" imposed on Hertz by Ford, a corporate owner that doesn't exactly represent the shining platinum standard of management acumen in the United States.  All it takes is a quick look to understand why private equity made out well here and, to summarize, that case includes "right place," "right time," "right checkbook balance."

A bit of history, though it has been badly neglected by Mr. Lewis, is probably useful.  Amazingly, Steven Pearlstein over at the Washington Post recently gave a much stronger summary of the Hertz case then anything I've seen in Bloomberg, marking the first time, in a dramatic role reversal, that the Post has slipped to the right of Bloomberg on matters financial.  (Then again, Bloomberg has of late been slipping badly).

Hertz found Ford as a major holder in 1987 back before Ford was rumored to be something other than a total charity case.  (I cannot confirm this rumor as I am too young to remember a time when Ford was something other than a total charity case).  Ford took the company over entirely by 1994, mostly under the thinking that if they didn't Chrysler or GM would.  (GM had, itself, owned Hertz once).  Not the best reason, perhaps, but it could have been a strong showing, handled properly.  It was not.  Partly because of the purpose that had been slated for rental car companies in the United States at this point in history.

Ford, as most of the big three had for decades, treated Hertz as a captive revenue machine (by selling, albeit for not much revenue, cars that couldn't compete in the consumer markets straight to Hertz).  Because of the nuances of "total fleet fuel efficiency laws," this also helped Ford meet fuel standards, dumping fuel efficient but undesirable sedans into Hertz while still selling guzzlers to the lucrative consumer truck and SUV market.  Decades of selling second-rate Tauruses to a captive customer who didn't much care what they looked or drove like didn't exactly prepare Ford to offer a decent car to the mainstream consumer market if something ugly were to happen to consumer tastes or (god forbid) gas prices.

While they couldn't sell well in the consumer markets, as former rental cars the sedans poured by the thousands into the used car market which meant those models had no resale value (a key metric for increasingly value oriented car buyers) compared to e.g., the Toyotas of the world.  Once on the used car market they also canibalized the higher margin new cars the big three were trying to hock.

Two and a half years after slurping it up, Ford IPOd a Hertz minority interest off and bought that interest right back (urgently and without much reason) three years after that.

The initial IPO valued Hertz at nearly 17 times earnings.  Read that last sentence again.  Go ahead.  Absorb it.  Here.  I'll give you a bit of white space.

That was the time of "irrational exuberance."  Travel businesses were on fire at the time.  All those New York investors going to board meetings for their VC interests on the Left Coast, I suppose.  The stock, which IPO'd at $24.00, hit $64.00 inside of 4 years.  Ford used a good bit of the proceeds to buy back Ford shares and attempt to buoy their flagging stock, it worked a bit, but not forever.  The party didn't last and not four years later Hertz was back to $24 and Ford wanted it back  Why, no one seems to know.  They got it by paying something like a 46% premium over the stock price before the Ford offer.  Read that sentence again too.

Moving forward, Hertz saw a 130% increase in net income from 2003-2004 (never mind that these figures were gains against the devastating travel years of 2002 and 2003, they looked sexy in offering documents) and coming off that Ford would be hard pressed not to want to divest the unit again (especially considering its own developing management issues and lackluster performance- due, not unsubstantially, to decades of short-term thinking in the form of piss-poor negotiations over what were eventually to become crushing pension and retirement benefits surrendered year after year to the UAW).

On top of this, Ford, along with the other big three, had no incentive to develop decent, fuel efficient automobiles.  Why bother?  No one cares much if a rental car is a keeper, or if it is particularly fuel efficient.  As long as it is just efficient enough to keep the fleet efficiency rating under the federal requirement by two tenths of a MPG or so.

Desperate for cash, and fending off the bond ratings folk, Ford started the IPO process for Hertz again in 2005, hoping, in typical front-running fashion, that the filing would flush out deep pocketed strategic buyers.  None appeared.  The other big three were up to their eyeballs as well.  Private equity came to "the rescue," but even from this sector there was limited interest.  Only two clubs bid.  The Clayton gang and a group including Bain, Blackstone, Texas Pacific Group and Thomas H. Lee.

Ford sold to Clayton's private equity gang for a net of $5.6 billion.  5.1 or so times earnings.  Read that last sentence again.

Ford could have held onto Hertz and collateralized the automobiles for cheap debt, but instead they sold outright.  The private equity guys and gals, seeing the demand for collateralized debt, collateralized, in turn using those assets to pick up $6 billion in very cheap debt to partially fund the transaction.  Not bad.

Holding out the disparity between the latest IPO price and Ford's selling price as some evidence of injustice ignores the role of the cash crunch Ford was in (owing to their own mismanagement and cannibalistic short-sightedness) and the outstanding timing of the private equity folks, picking up an asset from a motivated seller on the cheap just when the seller needed it gone the most, few questions asked.

There is no better example, in my view, of the absurdity of large conglomerate ownership in recent memory than the fire sales we see- the last vocalizations, as they were, the death rattles of the big three.  Their idiotic forays into the likes of consumer finance (GMAC) are coming to roost.  I, unlike Lewis, am entirely unsympathetic to their plight.

So much for the evil of private equity.  Ford's other option was a cheap IPO or to liquidate Hertz.  Private equity just happened to be the best cash available for the asset given the market's assessment of it.  I'm not crying for the market.  Nor should you.

There seems, of late, to be a revival of a kind of social justice theory based not on risk return, or the value of liquidity, smarts and timing, but the "inequality" some see as implicit whenever a clever group creates and captures value.  Green with envy, these fairness vigilantes target anyone who is written a large enough check, forgetting, time after time, that these transactions are as between willing buyers and sellers in a highly liquid and transparent market.  Ford shareholders barely made a whimper when Ford announced the sale.  Desperate, perhaps, to cash out right after the deal closed to save themselves from their own poor judgment in buying shares of Ford in the first place.

Lewis continues to lament the plight of the casual investor:

One day the private-equity markets may expand to the point where even proles are offered a little piece of the action. That will be the day the action is no longer worth having. Trust me. The ordinary investor is now and forever cast in the role of the peasant at the king's banquet. He's so happy to have any food at all that he fails to notice that bone between his teeth isn't the meal. It's the scraps.

Mr. Lewis should direct his ire towards the SEC, suggesting, perhaps, a repeal of the "accredited investor" requirement for participation in private placements.  Maybe we should let anyone who can scrape up $9.95 put it all in LBO funds.  And if they lose it there?  Lewis, in my view, must decide which evil he is prepared to endure.  Personally, I don't believe his course wise for two reasons.

First, the general public already participates in the private equity boom through the many institutions and pension funds that invest heavily in private equity, but, one hopes, with mostly prudent diversity.  CalPERS certainly has enjoyed it, and so, therefore, have the "poor" California public employees.  Unless, therefore, Lewis wants to suggest that the hopelessly poor household with joint income in the $300,000 range should be dumping all its retirement savings into Texas Pacific Group VII, L.P., he might have to admit that a good 401k or state pension plan is a better option.  Looking to improve the return of the "everyman" through that kind of concentration in LBOs seems absurd to me.  Moreover, I suspect a more measured investment by professionals who, smart or not, spend all their time investing rather than those who treat it as a pastime with financial benefits is the better option.

Second, let us not forget that the public is bathing in the bath they have themselves drawn.  Ford, trying desperately to satisfy a quarterly-report driven public market culture, and a misguided (but very trendy) focus on "all the stakeholders" rather than the owners of the company, increasingly resorted to complex revenue structuring, internal product dumping, short-sighted developmental programs, ruinous pension concessions and market cannibalizing tactics to give the public shareholders and pressure groups what they wanted: quarterlies, now.  Running factories, now.  Jobs, now.  Damn the costs tomorrow.

Moreover, there was far more than the tacit acquiescence of the public shareholders at work here.  This evil was quite active and persistent in its menace.  No manager who proposed a hard line with the UAW at the expense of a brief plant shut-down or four quarters of strong R&D expenditures would have lasted for more than a shareholder meeting cycle or two at Ford, or indeed any major public firm.  Ford's stockholders got their returns when they wanted them.  Back then.  To what extent did they enjoy them because the basic illness of the company was masked by these schemes?  Well, that's for you to decide.  One thing is sure: today the piper is collecting.  Damn that piper.  He's a right nasty bourgeois pig, he is.

(Art Credit: "Liberty Leading the People" Eugène Delacroix, 1830)

The King's English

I have heard the call of the Old World, apparently.  Visa in hand, it seems the first quarter will see me in the Land of Poisonings of Russian Dissidents.  (In an eerie twist, I've actually had drinks in the hotel where the tea cups glow).  My apprehension at the concept grows.  Certainly, London has proved poison for any number of non-English bankers before me.  My options however, find another position or join the press to the UK, leave me with little choice.

"You're the cheapest relocation in the firm," pointed out a Sub Rosa Vice President.  "And how would Armin get along without you?"

It is not clear to me what the fate of Going Private will be after the move.  I began this adventure as a way to give readers, particularly those not already in the business, a peek into the field.  Perhaps, I reasoned, they might reconsider.  Perhaps not.  Either way they might go in with their eyes more or less open.  That purpose, however, seems a little less served by a private equity diary written from London.  Nor, I believe, does that form command much of an audience.  (Not that Going Private is getting 200,000 visitors a day or anything as it is).

Going Private has been rewarding after a certain fashion.  I have turned down or failed to pursue any number of book offers, advertising requests, first dates, media interviews and invitations to cocktails.  I suppose that has been flattering.  Still, I'm not certain I have really made much of a difference in the way I wanted.  But, perhaps that's a self-serving kind of self-pity.  The kind that is pungent with the aroma of vanity.

"Going Private" felt more rewarding than will "London on $2500.00 Per Day," I think.  But, who knows, maybe my valuation is off.  Still, we have a good number of weeks to enjoy before then.

Sacrifices

One of the major advances in media in this decade surely must be the advent of "Free Exchange," the Economist Blog.  Nearly twice daily some content of value seems to spill out from the electronic pages of the venerable publication and, as is typical of the Economist, those pages are not afraid to share credit, point to important thinkings outside its own firewall borders, and otherwise lay any number of reading hours on the sacrificial altar of knowledge.

Small wonder then that hedge funds have been a topic much revisited by the Economist, and its blog.  Cause for wonder, however, that Foreign Affairs would get in on the act.  Certainly, a noble publication, but not one I would have perused this quarter absent the pointer from the Economist blog.  Any chance to read Sebastian Mallaby, (who's pieces on the World Bank, the worthy death of an intellectually dishonest movement against "Liberal Imperialism," crushing criticism for a weak executive, and, in perhaps his best known work, the case for America as an Empire, inject piercing and apt, if alarming, cases for wielding terrible powers, economic, military and political) however, is worth any temporal sacrifice.  He is, with this most recent scribing, at his usual best:

Imagine two successful companies. Both are staffed by very smart people; both are innovative; both have an impact far beyond their industry, improving the productivity of the capitalist system as a whole. But the first, based near San Francisco, is the subject of adoring newspaper profiles, whereas the second, based in the New York area, is usually vilified.

Actually, you do not have to imagine any of this, because it describes a double standard that already exists. The first company in the story is a technology firm; the second is a hedge fund. As any newspaper reader knows, technology firms are the leading edge of the U.S. knowledge economy; they made possible the productivity revolution of the past decade. But the same could just as well be said of hedge funds, which allocate the world's capital to the companies, industries, and countries that can use it most productively.

Would that the authors on Economist's blog were less modest and more apt to sign themselves to their entries, then I could sing their praises by name.

As for the topic at hand, marketing seems to me the issue entangling hedge funds.  This seems comic in the face of venture capital's reputation leaving the dot-bomb era, but there it is.  Time to hire (buy?) the top public relations firms, I suspect.

Crowds Theory

I must admit to being literally floored by the number and tenor of letters that poured into my poor inbox in the hours after I posted The King's English.  Your support is overwhelming.  Far from the drab self-serving musings I assumed everyone mostly endured in Going Private for the sake of the occasional bright spot, you draw a picture of the blog as a bright and engaging source of light.  To quote one reader/writer:

...a bright, and heartbreakingly lonely beacon of brilliant insight and observation in an otherwise dark, and endless sea of ignorance and financial mediocrity.

    -Anonymous Portfolio Manager

I thought this a bit excessive until I finished going through my inbox.  The comments continue, unabated, in this vein, twice exceeding my incoming mail quota.  Many began with the preface that the author had not, heretofore, the "courage to write to you."  This puzzles me as I always endeavor (though not always successfully) to respond to each email with at least a cursory "thank you."

I would describe for you the many other contributions, but I feel I would do them little justice in summary.  At the risk of sounding immodest and mimicking an old world era inventory of ship's stores (which would explain the amazing commonality of ocean and sea voyage references in the comments) I will merely excerpt:

...given all the deals being done in London (and beyond), your claim that your diary would serve little purpose seems hollow.

    -SM

...I've been spending a considerable amount of my time everyday savoring your take on private equity and hedge funds.

    -SR

The business, I imagine, is not without a new set of nuances when transposed into a new land. But the mechanics of the business do not change, do they? I see no reason why your diary should end after a relocation to London. It will just be a bit different. As long as the writing is as lucid, the turns of prose as hypnotic, the content as thought provoking, as they were prior to the move, all will be well.

    -K

Quite selfishly, I do hope you intend to continue Going Private on some level, as the site has become more to your readership than you may have intended or even know about. Specifically, your in depth intellectualism and pursuit of reason in an often times irrational world has led me to strive with greater passion to become more of a professional, more of an intellectual, more of a student of private equity and, in fact, finance and politics in general.  Your content and thought process is a refreshing oasis in a sandy sea of contrite and flippant blogs that are as immature as they are uninformative. I look to you daily for thought provoking wisdom and wish it to continue in perpetuity.

    -CR

...I've grown quite attached to "Going Private" over the past year-or-so. I've always appreciated your insight and wit, and I'm sure I'm not the only one. So I'll keep it short and sweet. If you must leave for the other side of the Atlantic, please don't give up this exercise.

    -MA

Your highly arrogant and dismissive style coupled with an unabashedly capitalist world view brands everything you touch with the searing scorch of "free market at any cost."  The stench of burning flesh is a constant reminder of your political leanings.  Please forward by email the RSS links to your new site as soon as they are available.

    -Anonymous SEC Attorney

Reading your blog today from here in London, which I've always enjoyed, made it seem like you'd be sent to Siberia.

    -JW

Indeed.

Well, dear readers, you have prevailed upon me and I am moved.  These are but a few of the literally dozens of emails that came sailing in, overwhelmingly positive.  (Well, except for one Harvard crank).  Thank you one, and all.  You've really made my day.  My week, even.

Now, to think of a new title....

(Photo: Love Parade, Berlin)

Wanted: Activists

If you work with or are acquainted with an activist investor or a hedge fund with an activist group, Going Private would like to hear from you.  Drop us a quick note on [email protected].

Tedious Corrections

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

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

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

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

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

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

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

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

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

D+ 

Solving the "Gift Giving Problem"

As a culture we are horribly conflicted.  We denominate value in cash, but consider it dirty and evil.  Cash is a universal storage mechanism for value, except when it comes to gift giving, where somehow, magically, the value is diminished because it is the "thought that counts."  That, by the way, is complete and utter bullshit.  Please, those relatives who are reading this but don't know it is me, I ask you this one thing: don't try to think.

To me this is the ultimate conceit of the "holiday season," that somehow you know better than I what material good I should possess that somehow I have not already thought to acquire for myself.  Yet, asking for a particular good is so frowned upon that hints, suggestions, broad and elaborate fantasies (Wedding registrations.  Third parties employed fifth-grader-passing-notes-with-"Do you like me? Yes [ ] No [ ]" -written-on-them-style to drop subtle, or not so subtle, hints to gift givers: "Ahem.  Ahem.  Well, gee, does Equity have a electric potato peeler Mr. Private?  She likes potatoes, doesn't she Mrs. Private?" Letters to "Santa," etc. etc.) are constructed to mask the process of asking for gifts.  Ignoring for a moment the issues I have with a pathologically sinister construct that spends half a decade or more lying to children about the existence of a fat communist (he is dressed in red and have you ever seen anyone pay Santa if he wasn't ringing a bell?  Get real, he isn't a capitalist, folks) who slips under cover of darkness into the residences of unwitting homeowners to leave gifts (joke is on you, kids, your parents are filthy liars! Hah Hah!) the entire thing is farcical.  But I digress.

Why giving cash is frowned upon is beyond me.  Gift cards just cost money to buy, use and often have onerous restrictions.  And this downward spiral of not-telling, guessing, and the polite white lies surrounding the holiday season (re-gifting, "Oh, I was just telling Linda that I would like to record my signing in the shower!" "No, I don't already have a Human Touch Robotic Massage Recliner(tm).") needs to end.  You and I have to break it, dear readers.  This year.  Accordingly, I am offering a solution:

Give Goldman Sachs (NYSE:GS) stock.

Goldman Sachs stock has a nice ring to it.  You can help the recipients of your present feel like they are a part of the largest bonus grant in history and, though it LOOKS thoughtful and appropriately "gift-like," it is "same as cash" at any brokerage in the land.  Throw in the annual report and a subscription to published proxy materials and you've given the gift that keeps on giving.

(Plus, I've already amassed a substantial position in GS, so as all of you run the shares up buying the issue for your relatives, I'll pocket a tidy sum, and then short it right after the holidays, when the hang-overs wear off sufficiently to allow your in-laws to pick up their phones, fire up their online brokerage accounts and sell the shares so they can go out and buy the Chia Herb Garden(tm) they originally wanted anyhow.  Consider my wonderfully immoral gains your gift to me for the season).

Happy (bah, humbug) Holidays.

Remember...

Given the time of year, it is useful to take a few moments to reflect on what is important in life.  One should ponder the, sometimes secret, urgings of the heart.  With that in mind, please accept these Seasons Greetings from Going Private (delivered today, believe it or not, from the Sub Rosa offices).

Crash and Burn

"Flyboys" Production Budget: $60,000,000
Larry Ellison's investment in "Flyboys": $30,000,000
"Flyboys" reported worldwide revenue: $14,812,244
Satisfaction of knowing 'ole Larry is a moron: Priceless