Going Private

Just Try to Get Away

Repeat offendersLoyal readers will be aware that I often see signs that regulators would like to simulate the laws of thermodynamics in capital markets (or shall we just say in business endeavors of any kind).  You know the laws:  1. "In any process the total energy pf the universe stays constant."  2. "There is no process that, operating in a circle, produces no other effect than the subtraction of a positive amount of heat from a reservoir and the production of an equal amount of work."  3. "As temperature approaches absolute zero, the entropy of a system approaches a constant."  Or, in my version (read: the version I stole from Allen Ginsberg): "You can't win, you can't break even, and you can't get out of the game."

The similarities have become so common, and I estimate they will now become even more frequent given the emerging political bias in the United States and the United Kingdom, that I have started a new category "Thermodynamics," here on Going Private, to discuss the propensity of regulators to penalize profitable businesses by shoving them towards the tugging gravity wells and, by extension, closer and closer to the event horizons of the many supermassive bureaucratic institutions that make up the governmental universe.

Little surprise, therefore, to find the increasingly massive orbital body of the United Kingdom's City minister, appropriately named Ed Balls (I couldn't make this stuff up if I doubled the rate on my morphine drip), working to drag private equity into the ravages of the third law of capitaldynamics, at least if the quote proffered by the Financial Times (subscription required) is to be believed.

My message to private equity is that coming forward with proposals for greater transparency in the way they operate would be in the interests of their industry and the UK economy more generally.

I suppose this could more clearly be translated to: "Yes, we know we've made disclosure oppressively burdensome and imposed legal and criminal liability that rivals the sorts of incarceration that one might earn for high treason.  And yes, we understand that you've fled the public markets in droves as a consequence, since these operational requirements have made it high inefficient to continue to exist as a public firm, but we have decided to cut off that escape route now too since you seem to be getting quite a bit too much work done quite a bit too well.  Oh, and just wait until you try to move your business out of the jurisdiction to escape.  Quite sorry, really, old chap.  Oh, and there is a fellow from inland revenue here to see you.  Shall I show him in?"

An Ode to The Economist

"It is because I have been kept so long in this island, and see no sign of my being able to get away. I am losing all heart; tell me, then, for you gods know everything, which of the immortals it is that is hindering me, and tell me also how I may sail the sea so as to reach my home?" "Then,' he said, 'if you would finish your voyage and get home quickly, you must offer sacrifices to Jove and to the rest of the gods before embarking."

Ah, a journey that, at last, comes to a happy end.  But indeed good things come to those who wait.  If I had, heretofore, any doubts that The Economist is among the best publications on the planet, they are now extinguished.  It is clearly, simply the best publication on the planet.

-----Original Message-----
From: Andrew Rashbass <andrewrashbass (a t) economist.com>
Sent: Thursday, March 1, 2007 17:45:29
To: Equity Private <[email protected]>
Subject: Economist Letter

Dear Equity Private

I was looking for Economist mugs on Google yesterday (don't ask!) and I came across your posting about our thermal coffee-mug and our reply.

I am the publisher of The Economist. I wonder if you would mind passing on my apologies to VP. Clearly our mug was not what VP expected and judging from their experience with it, I can well understand why. The free movement of capital and labour is, as VP implies, central to The Economist's world view. The free movement of coffee inside the supposed vacuum chamber of the mug is not. I should very much like to make amends and send them the memory stick they were after.

I enjoyed reading your blog, by the way.

Best wishes

Andrew

---------------------------------------------------------------------
Andrew Rashbass
Publisher and Managing Director
The Economist

(Quoted Text: Homer, The Odyssey.  Translated by Samuel Butler)

Thick as Thieves

Thieves.  Stolen Property. Whistleblower (yummy).

No, Really

Honestly, Mordant Economics.  Stop saying words.  Seriously, man.  Get some help.  Find a purpose, or something.

Out!

I have often puzzled over the phrase "all good things must come to an end."  Not only do I not understand the phrase- it is far too pessimistic world view for me, though admittedly I have high levels of morphine running through my veins right now- but I don't really believe it.  The absence of a black hole in our solar system is a good thing.  Is that destined to come to an end?  Well, maybe, but if that's so then that must mean the solar system will survive until it arrives.  This would mean that "the fact that the sun has not burned out yet is a good thing" will never come to an end.  See what I mean?  Silly phrase.  Still, one does have cause to wonder about inordinately good times.  They all seem to result in a reversion to the shitty mean before too long.  (Parties:Hangovers is as Good Fortune:Bad Luck).

Certainly the Wall Street Journal would have us think so.  Consider this line from Dana Cimilluca, Serena NG and Alistair MacDonald's piece this morning titled "Market Unease Casts Shadow on Deals Boom" (subscription required):

One of the main factors behind the buyout boom is an unprecedented willingness of banks and hedge funds to lend to deal makers, with fewer loan restrictions. Should the M&A market come unhinged, the culprit is likely to be an abrupt end to easy debt financing.

The risk level in today's buyouts was highlighted by the sale late last week of debt to finance the $12 billion LBO of Univision. When a group of private-equity firms completes its purchase of the company this month, it will be saddled with debt that amounts to 12 times cash flow, an extraordinarily high level compared with other deals.

The sale may have shown the first signs that investor appetite for risk is beginning to wane. Univision first offered to pay an interest rate of 9.25% to 9.5% on its new bonds but had to raise the interest rate it was offering to 9.75% to complete the sale.

Even before the transaction, some prominent deal makers were beginning to wonder how stretched the debt markets were becoming. Bill Conway, the co-founder of leveraged-buyout powerhouse Carlyle Group, told his partners in an internal memo recently that the firm's lenders are making "very risky credit decisions" and that Carlyle should start doing fewer risky deals.

Yep.

Carlyle wasn't the only one making comments even before our little blip in the road last week, but then, the media has been predicting the imminent death of private equity for nearly 4 years now.  So who do we believe?  Not the media, surely.

The reality is that even expensive debt won't kill the LBO world entirely.  People quickly forget that back in the "day" (by which I mean the Milken era) interest rates were oppressive and the risk premium on junk bonds huge.  We have been spoiled, certainly, by the easy credit and low rates of the last three years (or perhaps longer) but even if the risk-free rate were to spike to 6.50% with a hefty high-yield risk premium there are still deals that could (and would) be done.

Remember that a "pure" LBO targets downtrodden and under-appreciated firms and looks to make the lion's share of its gains through operational improvements and top line growth through highly expert management acumen.  (Cerberus started as a distressed debt shop, as did many big PE firms today).  Easy to forget that today when everything under $60 billion seems fair game.

Will credit tightening kill the LBO business?  No, it will put it back where it belongs.

Don't forget- and I am comfortable torturing religious metaphors since I'm basically an atheist- life started for the human race after the expulsion from Eden.

(Art credit: "Adam and Eve Driven Out of Eden," Gustave Dore, 1865).

Bottomless Pits

The Cleantech Investing blog apparently makes the mistake of thinking that I made the mistake of lumping "green" investing and SRI into the same slop bucket accidentally.  In reality it, should be painfully clear that the Venn Diagram for "green" investing, SRI and "substantial losses" is drawn with one circle.  If this is not obvious to you, your CFA should be revoked.

Slipping Below the Dew Point

Over the last 5 months I have seen more and more "NFD" deals.  NFD is my quick and dirty term for "Non-Financial Drivers," or, when including my likely opinion on the viability of the opportunity: "No Fucking Deal."  These include all of the "Socially Responsible" or "Green" deals that have come across our bow at Sub Rosa.  (Ethanol has been increasingly common but fuel cells, hybrid part manufacturers, hydrocarbon reclamation and solar have have been appearing with increasing frequency too).

One of the deep flaws in investing strategies like "Socially Responsible Investing" or "Green Investing" is less about an intrinsic strategic flaw (though these exist too) than the nexus between the decision to add non-financial criteria to an investment process and human nature.  The general miasma created by focusing on how "green" an investment is (or isn't) or how "socially responsible" it is (or isn't) clouds clear decision making.  This is because these criteria are political, and therefore subject to the whim of policy and public opinion.  I have, of course, discussed this before on Going Private, quoting, among others, Jon Entine who said:

The dark secret of "social investing" is that it is neither art nor science: It's image and impulse. It reflects perceptions, not performance.

Why?  Because:

The social investing community also suffers from the hubris that it can separate the good guys from the bad guys.

Taking the subjective nature of deciding what is or isn't "green," and the moving target that is the definition of "green" this week and you have a recipe for disaster.

Since joining Sub Rosa, I have had occasion to review any number of NFDs.  A common theme in major "green" or "socially responsible" projects is that when someone finally bothers to study the larger impact of the technology or product it becomes painfully obvious that the product or technology is either astonishingly impractical or has a more substantial negative impact on, e.g., the environment than the "non-Green" alternatives already in the marketplace.  If this pattern appears regular in SRI or Green projects, I believe it is because of this miasma effect.  It is, however, easy to avoid the miasma effect.  Ask what the pricing mechanism is for the product.  Is it the market, or something else that is setting pricing?

Let's take an example.  Trying to get back into the swing of work I have been researching hybrid cars, a project I began last spring related to some parts manufacturers we were considering acquisitions of.  Some interesting things came out.  Ford, for example, was at one point taking losses on every hybrid they sold.  I haven't seen recent data but I suspect not much has changed.  Consumers simply won't pay the $5,000 - $6,000 premium for a hybrid just "because," or at least not enough of them will do so to make the product even a break-even proposition.  What was Ford thinking?  Why would this be?

No matter, the savings on gasoline make up the premium cost.  Nope.  Not for a long while.  The Toyota Prius is among the fastest at returning savings to the user.  It takes 5 years and then how much can one expect?  $80.00.

Well, it's worth it.  Buying a hybrid will reduce your impact on the environment and if it takes 5 years to break even, well, that's just fine isn't it?

Sure, it would be, if that were true.  It isn't.

In fact, the major hybrids are really quite unfriendly when you use real metrics to evaluate them.  In this case, energy cost per mile over the lifetime of the vehicle.

CNW Market Research has done a comprehensive study (updated with 2006 model recently) on the "dust-to-dust" energy costs for everything from extracting and refining raw materials to manufacture, assembly, testing, delivery, driving during the life of the car and even disposal.  This is, of course, the metric that should have been used to justify hybrids in the first place (since savings on fuel costs certainly didn't make their manufacture rational).

The study is intensely detailed (a great deal of  time is spent modeling how long a vehicle remains with its first owner and how many times it changes hands before being disposed of, for instance, as each incremental transfer is additional energy expenditure).  Read the 400 page report, absorb the "energy cost per mile" figures and some interesting things emerge:

• Actual consumption of gasoline is generally less than one third of the total energy consumption in the lifetime of a vehicle
• The 2006 model hybrid with the lowest energy impact during its life cycle is the Toyota Prius that consumes $2.965 per mile during its life
• The 2006 model hybrid with the highest energy impact during its life cycle is the Ford Escape that consumes $3.540 per mile during its life
• For many hybrid vehicles 25% to 30% of the life cycle energy expenditure is consumed in raw material production and manufacture- this is much higher than in non-hybrid vehicles. For foreign built cars this means that emissions in the country of use (the United States, say) are not being eliminated, but rather transferred to the country of manufacture.  Next time a hybrid driver looks smug feel free to remind them that they are likely dumping their emissions into the second or third world.  What kind of pig subjugates the peoples of Mexico and endangers their health to look "green" for their suburban neighbors and smirks about it?
• Federal (and state) subsidies mean that this energy use and emissions transfer is part of United States monetary policy (and California is exploiting Mexico).

Remembering that the hybrids consume $2.965 - $3.540 of energy per mile during their life cycle it is interesting to consider these figures for other popular vehicles:

Ford Escape: $3.540
Porsche Boxter:  $3.388
Toyota Land Cruiser:  $3.354
Maserati An: $3.219
BMW 5 Series: $3.197
Cadillac Escalade: $3.197
Corvette: $3.196
Toyota Prius: $2.965
Lincoln Navigator: $2.943
Porsche 911 Carrera 4: $2.806
Lincoln Town Car: $2.661
Range Rover Sport: $2.602
Porsche Cayenne: $2.539
BMW X3: $2.513
Hummer H3: $2.069

Interestingly, most large SUVs have a fairly significantly lower lifetime energy impact than do any of the hybrids.

What a wonderful "Green" investment strategy.  Hybrid cars.

Hybrids are such a horrible mess because they mix all the elements required to destroy the market forces.  Subsidies, state and federal.  Green investing.  Substantial research and development to avoid spending money on gasoline, which the market has actually left quite cheap, at the expense of a more expensive product.  (Hint: use cheap resources until they are not cheap anymore).

Gas has to hit $6.00 per gallon before today's hybrids show any cost savings to their owners inside of three years.  Even the most basic sensitivity analysis would expose this.  We can only reason that the likes of Ford either expected $6.00 per gallon in the near future, or simply disregarded the economic analysis in favor of a political one.  Is it any surprise that the resulting product is more expensive in every way worth measuring than its conventional counterparts?  Shouldn't be if you were paying attention.

Accountable, To Myself

An editor at a large publishing house whose name you would certainly recognize forwarded me a quick link to a New York Times article on the rise and fall (but mostly the fall) of Henry Winterstern.  Winterstern follows a long line of outsiders with big Hollywood dreams.  The sidewalks of Hollywood are littered with the impressions of their broken bodies left in concrete sidewalks, remnants of the high-energy impact created by their massive falls from grace.  Says the Times in what should have been the article's opening sentences (subscription required unless you use bugmenot):

The 49-year-old Mr. Winterstern, who has the craggy looks and hunched-over affect of a street fighter, never claimed to have much movie experience. But convinced that distribution was the place to make money, he planned to build a studio using his talents at raising money and strategic thinking that were successful in his turnaround of the Wet Seal, a maker of clothing for teenagers, in collaboration with Prentice Capital earlier this decade.

You have to love an article that manages to work the phrase "earlier this decade" into the mix.  And, of course, the first person I would search for to lead such a project would be the former manager of "Wet Seal," fine purveyor of slutty apparel for tweenagers of all ages, the mothers of said tweenagers seeking to re-live the golden years of promiscuity and home of the "Shark Bite Halter Dress" (pictured right) priced at an ultra-reasonable 7.588 Toyota Prius miles.  (I think I will check out their Hello Kitty intimates collection when I'm done with this post).

The studio he endeavored to rebuild was First Look Pictures.  Of course, this wouldn't be a true Veritable Capital story without the dumb money.  In this case it came in the form of the hedge fund Prentice Capital that put $70 million into the project and Merrill Lynch, which issued a tasty line of credit for another $80 million.

Winterstern dove right in to the cashbusiness.  There were warning signs right away.  Like the firm's mission statement:  "First Look is a maverick. We are primarily accountable to ourselves...."  Not enough warning?  Let's hire 140 people and put $4 million into the Century City headquarters offices.  That will impress our visitors.  Yep.  It did.  Said one:

[The headquarters are] excellent, really fantastic, but you kind of go, ‘Wait, this isn’t Paramount, where you’re expecting to do a $70 million movie...'

They’re an independent, and they’ll come back and say, ‘Make it for less.’ And we’ll say, ‘The amount less you want us to spend to make the movie is what you spent on the receptionist station."

$50 million in losses (that's the rumor anyhow) didn't impress, apparently, and our hero is politely invited to leave after he argues for more acquisitions.  Now what will he do?

Asked about a rumor that he might attempt to reacquire the studio, the deposed mogul laughed and said, “Absolutely not.” Then he called back to say, “It’s possible.”

Environmentalism for the Rich and Famous

Slowness today motivated primarily by (properly dispensed) narcotics.  Plus, it is Friday, after all.  Still, what is Friday without a little irreverence?  As if I wasn't annoyed enough, a loyal reader points to Paul Kedrosky's Infectious Greed today which relays a rather upsetting account of VC Maven John Doerr.  To wit:

In what was may have been one of the strangest moments at TED in Monterey, an admittedly often strange conference, venture capitalist John Doerr apparently cried yesterday at the end of a speech about climate change. In the talk he repeatedly said "I'm afraid", and then closed by begging emotionally for people and companies to go green...

Oh, how the mighty have made asses of themselves.  Will someone please stop this madness?

Want to get everyone to "go green?"  Either make cheap solar that can compete in the marketplace (I'm talking to you Mr. Doerr) or come up with some other viable alternative.  Subsidize it with a tax break for businesses that get certified green or something if you must, but even that will fall apart eventually if the underlying economics do not hold up.

I am reminded of Bush begging people to stop hoarding gasoline on television.  Hopeless.  Carter wearing a sweater on television, hinting that 68 degrees might be a fine temperature for your home in the winter- not that I'm old enough to remember it, our micro professor played a videotape of it in class.  The market is the market.  Even more so now that the United States enjoys waning influence in global economic affairs.

Since this week has become green smearing week on Going Private, and because I hate Al Gore and all he stands for (because, to me, that looks like hypocrisy), let's examine carbon offsets.  Apparently, I'm in good company pointing the finger at this latest, torturous treatment of economics.  The Economist Blog has been running a mini-series of sorts on it as well.  Recently they quoted Arnold Kling, who was recursively citing them saying:

If you want to fight carbon emissions, then join the Pigou Club and push for taxes on bad energy. If you want to fight carbon emissions at a personal level, then act as if there were a high tax on your use of energy from carbon-emitting sources, and reduce your use of that energy. If you are not really all that worried about carbon emissions, but you get pleasure from making empty, self-righteous gestures, then do what Al Gore does -- buy carbon offsets.

The Economist Blog continues:

Carbon offsets are even more lunatic less effective as a response to flying.  "I am pouring tons of carbon into the air with my transportation needs, so I will therefore . . . increase the supply of electricity in Kansas" doesn't exactly have a fine, logical ring, does it?  In this case, it should be obvious to most readers that this does not work.  The decision to fly marginally increases demand for flying, meaning, if enough people do it, more flights and more carbon; meanwhile, the wind farms you paid to install probably haven't taken a single power plant offline.  Net effect:  more carbon.

The Kling piece in particular is worth a read, not least for its excellent discussion and application of the role of "rent seeking" in sovereign created markets.

If we add to this the knowledge that the carbon offsets Gore buys don't go directly to alternative energy production but to Generation Investment Management, LLP, that begs the question "what the hell is Generation Investment Management?"  Generation Investment Investment Management, LLP, is the investment firm Gore founded which invests in "future proof" companies.  Interesting.  More so when you read Generation's self-descriptions:

We invest in long-only, global, public equities with a concentrated portfolio of 30-50 companies. We aim to buy high quality companies at attractive prices that will deliver superior long-term investment returns. Sustainability research plays an important role in forming our views on the quality of the business, the quality of management and valuation.

Our performance fees align our interests with that of our clients by being based on long term performance.

Well, you don't have to be a genius to read between the lines here and come to a very revealing conclusion.

"We invest in long-only, global, public equities with a concentrated portfolio of 30-50 companies...."

Public equity investment.

"We aim to buy high quality companies at attractive prices that will deliver superior long-term investment returns."

Value/Growth strategy.

"Sustainability research plays an important role in forming our views on the quality of the business, the quality of management and valuation."

Non-financial drivers.

"Our performance fees align our interests with that of our clients by being based on long term performance."

20% Incentive fee.

It is actually pretty clear.  Al Gore wants you to buy carbon offsets because you aren't really buying carbon offsets.

You are investing in Al Gore's long-only hedge fund.

Except, you can't, really.  See, these are carbon offsets for the rich and famous.  Joe Sixpack, unless he's an accredited investor, probably can't invest in Generation Investment Management.  Consider:

GenerationIM is the parent company of Generation Investment Management US LLP ("GenerationUS"), and investment adviser located in Washington, DC and registered with the United States Securities and Exchange Commission under the Investment Advisers Act of 1940.

Well, let's just see what their registration says.

What types of clients do you have? Indicate the approximate percentage that each type of client comprises of your total number of clients:

(1)     Individuals (other than high net worth individuals): 0%
(2)     High net worth individuals: 0%
(3)     Banking or thrift institutions: 0%                     
(4)     Investment companies (including mutual funds): 0%                        
(5)     Pension and profit sharing plans (other than plan participants): 0%                        
(6)     Other pooled investment vehicles (e.g., hedge funds): Over 75%     
(7)     Charitable organizations: 0%
(8)     Corporations or other businesses not listed above: 0%
(9)     State or municipal government entities: 0%
(10)   Other: 0%

You are compensated for your investment services by (check all that apply):

A percentage of your assets under management [X]
Performance based fees [X]
Other (specify): NEGOTIATED FEE ARRANGEMENTS, INCLUDING SET FEES [X]

What is the amount of your assets under management and total number of accounts?

$75,000,000

And what's the minimum investment?  $3,000,000

Power to the people.

Winding Up Amaranth

We speculated quite a bit on the eventual fate of Amaranth and its many characters after its melt-down.  A hedge fund guru and loyal reader forwards me today a copy of Amaranth's Summer 2001 Offering Memorandum for Amaranth International Limited, the Bermuda entity that served as a "master feeder" fund to Amaranth's Delaware entity.  To wit:

Amaranth International Limited (the “Fund”) is a Bermuda exempted mutual fund company, incorporated on 2 January 1998, the investment objective of which is to maximize expected returns on a risk-adjusted basis. The Fund will seek to achieve its investment objective by investing, directly or indirectly, substantially all of its capital in a Delaware limited liability company (the “Master Fund”), which has an investment objective identical to that of the Fund. The Master Fund is expected to employ a diverse group of trading strategies, within which it may trade a broad range of equity and debt securities, commodities, derivatives and other financial instruments on a global basis. The Fund cannot assure any of its Shareholders that its investment objective will be achieved. The securities and strategies which the Fund and the Master Fund utilize present special and significant risks which investors should carefully consider in conjunction with their  investment, legal and tax advisors. There can be no assurance that the Fund or the Master Fund will meet its objectives (or avoid losses). See “RISK FACTORS.”

It is an older document, and many revisions could have been made in the interim, but some interesting features come out on further examination.  Join us, dear reader, in contemplating these and descring, (but for a moment) the strange world of restricted redemptions.

Of course, redemptions were an interesting point given the eventual fate of Amaranth. 

Redemptions

No Shareholder will have the right to redeem any of its Shares except as described below.

A Shareholder may request the redemption of its Shares as of the first anniversary of the last day of the month those Shares were purchased by the Shareholder and on each anniversary thereafter (each such day being a “Redemption Date”) by notifying the Administrator in writing at least 90 days prior to the Redemption Date.

Furthermore, a Shareholder may request the redemption of a portion of its Shares as of December 31 of any year (each such day also being a “Redemption Date”), up to that number of Shares held by such Shareholder as have an aggregate Net Asset Value equal to 90% of the amount estimated by the Fund to represent the cumulative net increase in the Net Asset Value per Share of that Shareholder’s Shares from the date(s) of their purchase through the last day of that calendar year (less any amounts previously so redeemed) by notifying the Administrator in writing by November 30 of the year in question.

A Shareholder may also request the redemption of all or a portion of its Shares as of the last day of each of January, April, July and October of any year (each such day also being a "Redemption Date") by notifying the Administrator in writing at least 45 days prior to the proposed Redemption Date, provided that the Fund will not permit the redemption on such basis of more than 7.5% of the 20 Net Asset Value attributable to the total Shares outstanding on any such Redemption Date, excluding any Shares being contemporaneously redeemed under either of the two preceding paragraphs on such Redemption Date. In the event that the Administrator receives aggregate redemption requests on this basis in excess of such limit, the redemption amounts will be determined by reference to the relative numbers of Shares held by those Shareholders requesting redemption, rather than by reference to the relative amounts of the redemption requests. Accordingly, the maximum dollar amount a Shareholder will be able to redeem under this paragraph will be determined by multiplying the total dollar amount available for redemption by all Shareholders under this paragraph by a fraction, the numerator of which is the total number of Shares held by such Shareholder on such Redemption Date (prior to giving effect to any redemption under this paragraph), and the denominator of which is the total number of Shares held by all Shareholders so requesting redemption under this paragraph on such Redemption Date (prior to giving effect to any redemption under this paragraph). In the event that a Shareholder has requested redemption of less than the maximum dollar amount available for redemption by such Shareholder under this paragraph, the available amount not redeemed by such Shareholder will be made available for redemption by the other Shareholders so requesting redemption on such Redemption Date, and the additional amount redeemable by any such other Shareholder will be determined by multiplying the total additional amount available for redemption by all such other Shareholders by a fraction, the numerator of which is the total number of Shares held by such other Shareholder on such Redemption Date (prior to giving effect to any redemption under this paragraph), and the denominator of which is the total number of Shares held by all such other Shareholders on such Redemption Date (prior to giving effect to any redemption under this paragraph). Quarterly redemptions under this paragraph are subject to a redemption fee of 2.5% of the redemption proceeds. All such redemption fees will be deducted from the amount withdrawn and will be retained by the Fund.

The Directors may, at their sole discretion, waive part or all of any of the above notice periods or redemption fees, if any, or agree to different Redemption Dates. Each Share will be redeemed at a price equal to the Net Asset Value per Share of the relevant Series being redeemed on the Redemption Date, subject to (i) a charge, if applicable, to be determined at the sole discretion of the Fund, for the expenses of liquidating a proportionate share of the Fund’s assets, (ii) other reserves for contingencies as the Directors, at their sole discretion, deem appropriate, and (iii) adjustments to the value of the Shares being redeemed to reflect such Shares’ proportionate share of increases and decreases in the Net Asset Value of the Fund occurring after the Redemption Date, if the Directors elect the Deferred Redemption System described below (the “Redemption Price per Share”).

The Fund has the right to require the redemption of a particular Shareholder's Shares of any Series, for any reason or no reason at any time a t the sole discretion of the Directors, upon not less than 30 days' written notice. If a Shareholder's Shares are so redeemed, the Bye- laws provide that the Redemption Price per Share payable in respect of such Shares shall be the Net Asset Value per Share of the relevant Series as of the date fixed for the redemption thereof in the notice of mandatory redemption served on the relevant Shareholder by the Fund, adjusted as described above on the same basis as the Redemption Price per Share payable in respect of a redemption requested by the Shareholder.

Redemption proceeds will be paid in cash, by check or wire transfer, or securities or both, as the Fund may at its sole discretion determine. Under normal circumstances, 90% of redemption proceeds will be paid by the Fund to a redeeming Shareholder within 30 days of the relevant Redemption Date, with the balance paid promptly after the completion of the Fund’s audit for the calendar year in which the Redemption Date falls. The amount of such balance is subject to adjustment to reflect any revision of the relevant Net Asset Value per Share between the initial 21 payment of redemption proceeds and the payment of such balance. Redemption proceeds or the part thereof which is paid in cash will be paid in U.S. Dollars, unless the Fund otherwise agrees. See “RISK FACTORS, Valuation Risk.” No interest shall be payable by the Fund with respect to any redemption proceeds.

The Fund may adopt the “Deferred Redemption System” if, as of any Redemption Date, the Fund’s funds are committed directly or indirectly to one or more trading entities that do not permit immediate withdrawal of funds or there exists a state of affairs which, in the opinion of the Fund, constitutes circumstances wherein liquidation by the Fund of its investments is not reasonable or practicable, or would be prejudicial to the Fund. If the Deferred Redemption System is adopted:

a) The Fund will attempt to withdraw from its investments, as of the earliest date on or after the relevant Redemption Date upon which the Fund is permitted to do so, the portion thereof allocable to the Shares of the Shareholder being redeemed;

b) Within 30 days following the relevant Redemption Date, the Shareholder will be entitled to receive an amount of cash, securities or both, as determined by the Fund at its sole discretion, equal to (i) the Shareholder’s proportionate share of all cash, and the fair market value of all marketable securities, held by the Fund as of the Redemption Date, less (ii) its share of the Fund's liabilities as of the Redemption Date and any reserves for contingencies;

c) Any outstanding redemption proceeds due to the redeeming Shareholder following steps (a) and (b) above will be paid within 30 days after the Fund receives the proceeds from the liquidation of Fund investments representing the redeeming Shareholder’s proportionate share thereof. The Bye-laws do not obligate the Directors, when they determine which Fund investments to liquidate in order to satisfy a Shareholder redemption request, to partially liquidate any investments allocable to the Shares being redeemed by the redeeming Shareholder. In any event, the Fund will pay at least 80% of the amount due to a redeeming Shareholder within one year following the relevant Redemption Date and will seek to pay any outstanding balance as soon as is reasonably practicable, thereafter; and

d) The value of the Shares being redeemed will be subject to a “Liquidating Adjustment” representing a credit or charge for such Shareholder’s proportionate share of any increase or decrease in the Net Asset Value of the Fund from the relevant Redemption Date through to the date upon which the Fund liquidates investments for the purpose of satisfying such Shareholder’s redemption request. Under Bermuda law, the Fund cannot redeem its Ordinary Shares if to do so would result in the issued share capital of the Fund being less than the required minimum capital of U.S. $12,000.

Suspension of Dealings

Notwithstanding anything contained herein to the contrary, either the Directors or the Trading Advisor may suspend dealings in Shares in certain circumstances as described under “GENERAL INFORMATION.” No Shares will be issued, valued or redeemed during such suspension.

Going back to the General Information reference we find:

Suspension of Valuations and Dealings

Either the Directors or the Trading Advisor may suspend Net Asset Value per Share calculations for the whole or any part of a period during which any exchange or over-the-counter market on which any significant portion of the investments of the Fund or the Master Fund are listed, traded or dealt in is closed (other than customary weekend and holiday closing) or trading on any such exchange or market is restricted; or there is a temporary operational or other communications breakdown or when circumstances exist as a result of which, in the opinion of the Directors or the Trading Advisor, the accurate valuation of the Fund’s investments (i.e., primarily its investments in the Master Fund) is not possible. No Shares shall be issued or redeemed during such suspension.  (Emphasis mine).

And if the fund, god forbid, might have to be dissolved?

Share Rights

The capital of the Fund is divided into Participating Shares and Ordinary Shares, all with a par value of U.S.$1 each. The holders of such shares shall have the following rights:

(a) The holders of Ordinary Shares and the Class B Participating Shares shall be entitled to receive notice of, to attend and to vote at general meetings of the Fund. Holders of Ordinary Shares are not entitled to a dividend or any other distribution or to any payment in a winding up that exceeds the par value thereof. The Ordinary Shares are not redeemable whether at the option of the Fund or the holder(s) thereof.

(b) In the event of a winding up or dissolution of the Fund, whether voluntary or involuntary or for the reorganization or otherwise or upon a distribution of capital, the holders of the Participating Shares will be entitled to all surplus assets of the Fund after payment of the par value of the Ordinary Shares. Furthermore, the holders of the Participating Shares will be entitled to dividends as the Directors may from time to time declare and the Shareholders will have the right to have their Shares redeemed based on their Net Asset Value per Share (see “SHARES OF THE FUND, Redemptions”). Details of the voting rights of the holders of the Shares are set out under “Voting Rights” below.

Term of the Master Fund, Dissolution, and Liquidation

The managing member may, at its sole discretion, dissolve the Master Fund at any time. In any event, the Master Fund will dissolve on December 31, 2037, or upon the withdrawal, bankruptcy, or dissolution of the last remaining managing member, unless a majority in interest of the remaining members vote to continue the Master Fund.

When the Master Fund is dissolved, the managing member will cause its assets to be liquidated (except to the extent that the managing member elects to distribute assets in-kind) and, after paying debts and expenses and establishing such reserves for contingent or potential liabilities as the managing member, at its sole discretion, deems proper, distributed to the members of the Master Fund in proportion to their respective capital accounts.

There was, as I recall, some question about liability for the Brian Hunter's of the world.  Have no fear, Brian Hunter, (absent fraud):

Indemnification

The Limited Liability Company Agreement provides that the managing member will not be liable to the Master Fund or any member thereof for claims or losses other than those occurring by reason of the managing member’s bad faith, fraud, gross negligence or reckless or intentional misconduct, or by reason of actions so found by a court of competent jurisdiction, after entry of final judgment, to have been taken by the managing member without a reasonable belief that they were properly authorized by the Limited Liability Company Agreement. The managing member will not be personally liable for the return or payment of all or any portion of the capital of or profits allocable to any member of the Master Fund, which payments will be made solely from the assets of the Master Fund.

The Limited Liability Company Agreement further provides that the Master Fund will indemnify, defend, and hold harmless the managing member, its Affiliates and, at the discretion of the managing member, the Master Fund’s agents, employees, advisors and consultants from and against any losses arising as a result of business or activities undertaken on behalf of the Master Fund, other than such losses as result from the bad faith, fraud, gross negligence or reckless or intentional misconduct of such parties, or the violation by such parties of such lesser standard of conduct as under applicable law prevents that indemnification, or as a result of actions so found by a court of competent jurisdiction, after entry of a final judgment, to have been taken without a reasonable belief that they were properly authorized by the Limited Liability Company Agreement. All such rights of indemnification shall survive the dissolution of the Master Fund.

Robbed, Again

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

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

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

Going Private Awards

Going Private is pleased to announce the First Annual Going Private Awards.  Readers are invited to submit nominations for the First Annual Going Private Awards, intended to recognize the contributions of individuals and organizations to financial and economic ignorance, the elimination of market economies and the destruction of economic efficiency everywhere.  This year's awards include:

The Enron M&A Prize
The prize is an attractive Enron stock certificate suitable for framing.  Presented to the management team responsible for the merger, acquisition, sale or divestiture causing the most extensive financial damage to equity or bond holders.

The Daniel Loeb "Chief Value Destroyer" Award
The Daniel Loeb "Chief Value Destroyer" Award is an autographed copy of Third Point's letter to Salton Inc.  (Note: Celebrity autographs may be impersonated).  Presented to the senior executive most responsible for the destruction of shareholder value.

The Maxwell Smart Prize for Mediocrity in Financial Journalism
The Maxwell Smart Prize for Mediocrity in Financial Journalism is a well worn and pungent shoe, owned by a man whose religious convictions forbade him socks and which the recipient is expected to use like a phone.  Presented to the financial journalist issuing the most sweeping generalizations, possessed of the weakest grasp of finance and most the deficient command of economics.  (Note: As the prize has already been awarded to Justin Fox of Time, only submissions for "runner up" will be accepted).

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

Nominations should include the award or prize sought, a brief description of the nominee's qualifications and any reference material the committee may find useful in evaluating the nominee's contributions.  Forward all materials to: [email protected] by August 1, 2007.

Thief of Thieves

An astute reader points me to indications that the likes of Abnormal Returns may have prematurely branded the birth of a meme.  A Paul Durman article in the Sunday Times Online dated November 2, 2003 leads with: "Private-equity firms are the new conglomerates."  My own post on the topic (which has been pillaged repeatedly) may itself have been pillaged.

(Picture Credit: Crime dramas are a guilty pleasure of mine.  Four years before "Miami Vice" and fourteen before "Heat, "Michael Mann directed the Chicago crime drama "Thief."  Even as a snobby movie buff it is hard not to call this Cann's (and Mann's) best work.  Don't miss the not-yet-stars that pepper the film either, including Willy Nelson, Tom Signorelli (the Cotton Club), and a very young looking James Belushi.  Watch it first then fire up "Heat" for a little time warp on action movies as a genre).

Tick Tock, Tick Tock

"I'm on top and just beaded with sweat."  Laura the debt bitch, who has been selfless in trying to cheer me up given all the downtime I have endured owing to a shattered wrist and who, moreover, can soften life's hard edges better than my morphine drip did, is relaying across the pond her latest carnal dalliance with some banker or another to me on one of her mornings and my afternoons.  I've long since turned off the speaker phone.

"Were on the floor in front of this huge flat-screen TV he has on his wall like its a piece of art or something above a breakfront against his wall.  You know, like that commercial?"  I do, in fact, know the commercial but I keep silent, knowing better than to interrupt her to answer her rhetorical questions.

"I've already got rug burn on my left shoulder from his carpet on the floor and I guess I must have rubbed my knees raw too because I could barely walk yesterday.  Anyhow, we arrive simultaneously..."- you have to love Laura's euphemisms- "...and make rather a lot of racket and I just collapse on top of him and we are there panting, hearts pounding, in the glow of the screen which used to have Saw III on it but now has that blank, faded blue background like it is trying to be a screen saver."  I neglect to ask the obvious question: "How exactly did the two of you get riled up watching 'Saw III'"?

"We are probably laying there for twenty seconds or something before one can hear this very peculiar ticking.  Less a 'tick... tick... tick...' than a 'fluck-ah... fluck-ah... fluck-ah...'  Strangely muted.

We are quiet for a minute before he says, 'do you hear that?'  I do, of course, and I say so.  'What is that?' he is asking me over and over again.  I have no idea.  And it is really hard to tell where it is coming from because we are on the floor.  We listen again for a minute, then I realize, it is coming from his chest.  It is his fucking heart!"

I am quiet on the phone call now.  I really don't want to be told that Laura killed a man via coitus.

"So I tell him.  I say, 'It is your fucking heart!' and he is totally silent for a minute, and we just listen to that sickening ticking, like a loose hinge flapping back and forth or something and then he just starts to freak out saying 'My god, my god,' over and over again.  I must have blown his valve or something.  My heart is pounding too and that noise is freaking me out.  We really have no idea what to do.  Call an ambulance?  Should I perform CPR?  Run?  And if run, then where are my clothes and how long will it take me to put them on and how many fingerprints would I be leaving behind?  I can just see the fucking cast from CSI Miami dusting for my vaginal secretions and David Caruso busting me with the line, 'why exactly did we find your bodily fluids all over the victim's penthouse?'  The line is bad in itself but I really hate David Caruso, you know?"

I do know, as it happens.

"This goes on for several minutes while we both run frantically around the bedroom, nude, and I'm finally looking for my cellphone to call 911 when the noise stops.  We both sit really still, I put my head to his chest and hear nothing but a thumping.  'It was probably nothing,' he says like six times.  'Probably,' I agree.  What else am I going to say?  Anyhow, he goes down to the kitchen to get a glass of water or something and I'm getting dressed because you better believe I am not staying the night at this point, what if he dies?  And when he's gone and I'm crawling around looking for my panties under the bed I hear it again, 'fluck-ah... fluck-ah... fluck-ah....'  Now I almost freak out.  Maybe it is my heart.  But it doesn't sound like it is coming from me.  I stand up, walk around the room a couple of times until I track it to the breakfront.  It is the fucking DVR thing in his cable box and the hard-drive or whatever is writing or reading or whatever the fuck it thinks it is doing.  'Fluck-ah... fluck-ah... fluck-ah....'  I almost laughed, but instead I went home."

Then I make the big mistake, I ask her: "So he must have been relieved he wasn't dying."

"What?  Oh, I didn't tell him.  What the hell would I do that for?"

Loan, Baby, Loan

Given the increasing propensity of financial journalists to cite the thriving debt markets as "a house of cards," (or at least to quote anonymous "Wall Street Bankers" as relaying the bad news) it is nice to see the Wall Street Journal's Dennis Berman asking "why, then, does it continue?" (subscription required) right along side that same paper's Serena Ng and Karen Richardson who point out (subscription required) how corporate actors are getting in on the game (even if they fail to mention the role of activist investors in the surge), and yet somehow manage to answer the question as well.  What's the verdict?

People inside the big banks are eerily candid about the credit cycle creeping to an end. They also candidly admit they don't want to get caught missing the next big deal. Their banks, and their own bonuses, might suffer. So they ply ahead.

The Going Private reader, being well versed in such matters, will recognize this as a "moral hazard" problem.  As a Vice President, why not write the big loan today that will likely blow up in 48 months?  Bonus time is only 9 months away, after all.  Absent a claw-back provision for such bonuses, why worry?  And, taking it a step further, if you are the managing director of a bank filled with Vice Presidents writing loans that may well blow up in 48 months, why not sell them to a CLO?  (A nicely done, albeit slightly old, primer on CLOs of exactly the sort that will intrigue the Going Private reader and written by Andreas Jobst can be found here and is recommended).

The answer to the moral hazard "problem" is fairly simple.  Introduce a structural compensation schema that rewards only enduring and stable loans.  The mechanisms for this are well understood, as anyone who has gotten stock options with a "cliff" will happily tell you.  But, given the ability to "lay off" the risk of these loan originations to a CLO, why be the first shop to start delaying bonus compensation for loan origination officers when you may well price yourself out of the market for top loan origination talent?  What incentive do you have to avoid risky loans when the average time such an instrument remains on your books is six months or less?  None, of course, if you have done the math and are comfortable with the aggregate exposure you are subject to with a six month window.

The Going Private reader, most likely being of the free market and capitalist ilk, will also likely wonder "where's the problem?" as CLOs tend to be sophisticated investors and certainly are (or should be) well aware of what they are buying and able to (even if they, by choice, do not bother) carefully manage the risks thereof.

Sure, there will be some blow-ups.  And some blow-ups will be quite dramatic.  But anyone who knows the CLO business will tell you that somewhere in there, perhaps in a basement cubicle of the CLO shop, there should be a little gnome computing efficiency frontiers for a blend of risky and not-so-risky loan portfolios, computing Sharpe ratios and generally minding the store so that frisky Vice Presidents of CLO groups, focused on maximizing their bonuses, don't get out of hand.

Will the Vice Presidents listen?  Will the lure of high returns induce them to "push the limit" and, when someone has to be left holding the bag, will it be they?  Will Managing Directors "bend" the rules to open the high-yield portfolios a little wider than is prudent?

The Going Private aficionado will reply, "who cares?"  If the alternative to the occasional blow-up is a paternalistic, top-down economy designed to protect sophisticated investors from themselves then the Going Private reader will prefer the blow-ups (or retire from worldly affairs to the shelter of their Lake Como estate).  Going Private readers believe in freedom, and consequences.

Plus, like wars, blow-ups are ever so fun to watch... from afar.  (Just ask Paulson & Co.)

The (Not So Paradoxical) Blackstone Paradox

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

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

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

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

Actually, the joke is on you, public markets.