Going Private

Buried Cable

A highly undesirable series of unfortunate events has led me to the task of researching "software as a service" and "online software," and the rise of the squeaky clean "Ajax."  Any number of pundits, some smart, some not so smart, have hailed the arrival of online software as everything from the death knell for Microsoft (craftily descried, but barely, lurking on Slashdot, by the always yummy Abnormal Returns) to the answer to infectious disease and immortality.  Mark my words, before long Google will be slicing your bread and brewing your coffee from a data center in Fuscha, Seattle.  (We just need enough bandwidth at the retail level to push the coffee to the customer).

Of course, Google is typically described as the chief beneficiary of these developments, and indeed, Google's "Docs and Spreadsheets," as one example, are quite cool to play with.  You will note, dear reader, that my choice of words here is quite deliberate.  For now, these applications are toys and they ignore a general mantra that the strength of a chain is only that of its weakest link or, to be a bit more pejorative, KISS (which Laura the debt bitch yesterday reminded me means "keep it simple, shithead.")

You see, to my way of thinking my data and my processing of said data belong on the machine I own.  The one sitting right in front of me and which (almost) never leaves my side.  For those of us who cannot live without our data, even for a ten minute period, mandating online access to it seems absurd.

"Oh, but with the increasingly pervasiveness of fast internet because of wireless hot-spots and broadband internet..."  Hogwash.  For years the mavens of internet providers everywhere talked about "dialtone reliability," (i.e. your internet simply works whenever you call on it.  Like picking up the phone and getting a dialtone) forgetting, naively in my view, how unreliable plain old telephone service actually was (is).  Introducing a bunch of infrastructure (and therefore more staff, maintenance, support and manufacturing resources) between me and my data (or my processes) just adds more people who reside daily on the left hand side of the bell curve to the critical path between me and the stuff I need to get to in order to get my work done.  (Read: Cost in every sense of the word).

We went through this with Oracle and the "dumb terminal" game.  Once the lines go dark, your terminal is (by definition) dumb.  That means you, dependent on the terminal and lacking even a slide-rule or an abacus since the Oracle sales guy gave you everything you needed with the dumb terminal and a network connection, are also dumb when the lines are dark.  Even if you are very smart you are still dumb because even a human computer like you (yes, you in the basement at 85 Broad, with the 800 GMAT score) is pretty useless without the data.

Haven't we been down this road before?  Back then they were called "big iron," or "mainframes," no?  Yes, I'm sure of it.  I'm sure of it because I've written about it before.

So is Microsoft dying?  Yes.  But Google isn't killing it because "software as a service" (which is merely a clever way to charge you monthly for something you should be able to own in perpetuity because of the strong downward pressure on software costs) is going to destroy Microsoft.  Microsoft is destroying (has destroyed) Microsoft because it has become an uncreative tumor, growth unchecked, resource hungry and greedy without really providing much of the useful functionality that clever, more nimble firms still consider instrumental to the technology industry.  (This should, crystal ball like, give one a glimpse of Google's not-so-distant future, I think).

Still, every time I hear someone sing the praises of software as service revenue I roll my eyes and picture "Ralph," the union back-hoe operator pulling up a fiber optic main, writing a blog post with my e-mail client while sitting on an unconnected airplane, or imagine myself working diligently on my laptop, finishing by candle light a spreadsheet during one of the summer's increasingly common blackouts caused by increasing strain on decades old and barely adequate power infrastructure.

Call me a Luddite, but I think I'll invest in utilities with aggressive grid growth reinvestment policies instead.

(Lack of) Business Intelligence

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

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

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

The Blackberry Monologues

On the shelf of its plateau, following the major marketing climax surrounding the unit, I watched a woman in a restaurant fondle her Blackberry Pearl for minutes on end, totally oblivious to her surroundings.  It was shocking, but at the same time, oddly alluring.  The sort of strangely pornographic short film that you aren't sure is supposed to be arousing.  It was the sex scene that had to be pruned to calm the MPAA down enough to agree to keep the "R" rating.  Highly suggestive, oddly carnal.  The sort of scene that makes you uncomfortable, but which you cannot, for the life of you, tear your eyes from.  As if your mother was in the theater too, or maybe your kid sister.  You don't want to admit it gets to you, but neither do you want anyone to know you are watching.  It was just before I left for Europe and, judging by the suit and the resigned look of a shattered social life she wore like a blood soaked glove, she might have been a frustrated banker, or an attorney.

Some time before that, irony of ironies, a close colleague of mine in the LBO world (and sometime adviser to Going Private on activism) found a female M&A attorney's Pearl in a Chicago taxi.  Calling her (and resisting the temptation to read her deal related email) he arranged to have her pick it up at the concierge desk at the Grand Hyatt.  In return she left him a box of chocolates and a thank you note that invited him to dinner at Coco Pazzo.  He, having already dated a sufficient number of female attorneys to recognize a deadly trap when presented with one, politely declined the invitation.  "The sex is great the first several times because of all the pent up frustration, but they have short tempers and really go for the jugular when angered," he observed.  I can't comment on that, but it is safe to say that professional women have a very intense and personal relationship with their Pearls, I think.

I, mercifully, have managed to avoid redirecting sexual frustration to a glowing, hooded bead at the top of a Blackberry keyboard.  It may be more a resentment for Research in Motion in general than anything else.  The studied Going Private reader will recall that my distaste for the firm goes back quite some time.  I do wish the stock would get the stuffing kicked out of it again so that someone could mount an LBO.  Imagine my disappointment that today's outage (subscription required) didn't punish RIM more.  Still, the prospects for the future don't seem all that dim, really.

At its current price of around $133 per share it is a bit expensive for an LBO (with trailing twelve month PE ratio of almost 40 in a industry where PEs sit at 25 or so, a price to sales ratio of something like 8 and a price to tangible book of over 10) but the stock has been very volatile (its beta approaches 3 and the 52 week low for the stock is something like $61 per share and that was 9 months ago).  Even hitting the $80s again would give it a forward P/E of 16-17.

The other thing that strikes me about RIM is that most of its problems seem to stem from management issues.  Service outages like yesterday and todays just aren't excusable in the telecom business when your product's only purpose is universal connectivity.  It frustrates the female lawyers, and let my LBO colleague tell you, that is just asking for trouble.  Add to this the kind of arrogance that gets you in patent disputes with the likes of NTP (and near suffering an injunction to boot- who does that besides Vonage?) challenged margins and the entry of the likes of Apple and I think there might be room for a good bit of change at the top.

Perhaps it would make a better activist project?  $2 billion in cash equivalents on the books.  But probably not.  It's a huge growth stock and more than three quarters of the shareholders are institutionals and they are showing a 30% return on equity right now.  Hard to imagine shareholders are that mad, or impatient.

Alas, I think we are stuck with them "as is" for awhile and we probably have to expect the introduction of the Blackberry "Rosebud" any day now.  Still, I can dream.

One More Activist (To Be)

Warmest congratulations to close friend of Going Private and close friend to friends of Going Private, "Activist Junkie" on the latest edition to his family.  Look out, activist targets, underperformers and subprime lenders, there's another activist to be waiting in the wings.

Down the Tubes, Slow But Sure

Yet another socially responsible fund (in the form of a fund of funds) hits the market, giving investors yet another way to pour money down the drain while feeling (nonsensically) good about themselves (albeit without the formal tax deduction).  According to HedgeWorld (subscription required), Kenmar Global Eco Fund SPC Ltd was introduced this week.  Why?  Far be it from me to editorialize.  Let's just get it from the horse's mouth (i.e. from Ken Shewer, co-chief executive and co-chief investment officer- thank the maker they have two) shall we?

"An Inconvenient Truth" helped inspire the idea for the fund, as the film "has done quite a bit to bring environmental issues to the fore...."

No, seriously.

The fund, set to launch July 1, primarily will invest with asset management companies whose underlying investments are considered economically sustainable as well as eco-friendly. "Our goal is—with the merger of Wall Street and environmental concerns—to have a fund that is environmentally friendly but also profitable...."

Accordingly, Going Private would like to announce the introduction of the "Spider Global Technology Fund SPC Ltd."   Says Co-Multi-Founder and Co-Joint-Secondary Portfolio Manager Equity Private:

"The success of the Spider Man franchise helped inspire the idea for the fund as the film has done quite a bit to bring 'Spidey Sense' and Spidey Technology issues to the fore....  Our goal is- with the merger of Wall Street and Spider concerns- to have a fund that utilizes Spidey Technology but also be profitable."

"The fund, set to launch July 1, primarily will invest with asset management companies whose underlying investments are focused on new technologies related to Spidey Technology, webs, advanced adhesives,  superhero law enforcement and security, gymnastics and silk twine technology."

The Spider fund will, reportedly, issue statements on April 10th of every year so that the most exact loss figures will be available to investors for Tax Day.

Reader Mail (Again)

As Going Private readers know, the number of times I reply publicly to reader mail is small, but finite.  However, occasionally I am motivated (usually by the lack of any semblance of an idea for a "real" post) to post and reply to reader mail.  It can generally be assumed that if I am doing this it is because I am feeling guilty about neglecting readers.  Of course, I used to use the "Overheard" section for this purpose, but it was so transparent a cloak for my lack of industry that I have since abandoned the practice.  Alas, I fear today is "Reader Mail" day again.

From:  Daniel Loeb <xxx@xxx.xxx>
To:  equityprivate@hushmail.com

To say that I am honored that such an award has been created in my name
is an understatement.  God Bless You.

Daniel S. Loeb
CEO
Third Point LLC

(In response to the Going Private Awards, which include The Daniel Loeb "Chief Value Destroyer" Award).  Do please note that we are still accepting entries for the awards.

"I'm not sure how you've managed to keep up the level of wit and insight in your posts for so long..."

Boredom and plenty of absurd material.

"Are you ambulatory?"

(In reference to my recent injury). Yes.  And I have a huge supply of the most kick-ass recreati... er... therapeutic painkillers.

"Do you have a sweet cane with a skull and a hidden retractable dagger?"

(Also in reference to my recent injury).  No, but the cool stainless steel pins that are sticking out of my hand are quite intimidating during negotiating sessions. I've been nicknamed "Equity Sissorhands."  When I take off the brace on my hand and type (which I am not supposed to do) the pins describe interesting patterns in the air.

"Care to comment on the latest BS from Guy Kawasaki?"

In a fit of mental self-preservation, I now do my very best to ignore that moron.  And, thank you VERY much for breaking my important therapy regimen.

"...the art department just called. They were wondering whether you would sit for a picture?"

(From one of the rare breed of competent media professionals I granted an interview).  No.

"It appears you're well on the way to mending, when sexual allusions appear in a financial blog...."

(Referring to "The Blackberry Monologues").  What sexual allusions?

"By the way, I think [Portfolio Magazine] has noticed your contempt: GP does not make Felix Salmon's blogroll.  I am sure you are pleased."

Intensely.

"You are a Luddite."

(In reference to my piece on "software as a service.")

"Fuck Google. Those are the motherfuckers sitting in Seattle Starbucks trying not to spill shit on their baby macs. But doubting web applications is failing to recognize blatantly obvious trends and efficiencies that have yet to be exploited because of personal biases."

(In response to the same post- lots of pundits disliked my irreverent treatment of this "important technology,"- one so much so that they sent me a bibliography- and my suggestion that if the emailer really loved "software as a service" they should invest in Google and see how that works out).

"Hello Friend, This mail might come to you as a surprise and the temptation to ignore it as unserious could come into your mind; but please consider it a divine wish and accept it with a deep sense of humility, It is indeed my pleasure to write you..."

(One of dozens of similar scams I get daily).

"I read your blog quite a bit....I think we share the same kind of humor."

God, I hope not.

"What do you think of Richard Dawkins?"

One has to be impressed with a guy who marries the reincarnation of Romana.

"Being social, for the most part most of humankind wants to be liked, loved and have friends."

This fails, utterly, to explain the Debt Bitch.

"Just wanted to say that I've read every article you've posted now and find everything you write extremely entertaining."

You haven't finished this one yet.

"Durka durka durka, jihad."

(In an email containing no other text).

Polonius is (Posthumously) Avenged

The astute Going Private reader will recognize, on behalf of the private equity audience at the Shakespearian play of the marketplace, the character of Polonius.  Loud, distracting, full of unsolicited advice that issues forth almost constantly from his mouth no matter the circumstance, often appearing in places he is decidedly not wanted, always determined to become the center of the stage, usually bearing evil tidings, typically meddling in the affairs of the other characters and, just occasionally, hiding behind the wrong draperies at exactly the wrong time.  So tedious does his intrusive toiling become that it is not long before the audience wishes him a speedy, and preferably painful, exit.  For the private equity world Poloious is, of course, the activist investor.

Increasingly, activists and private equity have become at odds.  This is particularly so in going private transactions.  Activists have begun to ask serious questions about auction processes as well as the prices being paid for publicly held firms.  "Why," the question goes, "should we sell you this firm cheaply today so you and your private equity partners can make hundreds of millions later when you re-offer it publicly?  We are leaving a lot of value on the table.  We, and the other public shareholders," (activism can be a highly populist pursuit, but only when the institutional shares are already a tight proxy race) "are being cheated."

While I am generally sympathetic with the activist cause and I believe shareholder activism serves important (nay, critical) purposes in the public and private capital markets, this argument is about as compelling as Martin Short playing in the role of Stalin.

A close friend of Going Private and activism manager at a fund with activist tendencies points to the latest Clear Channel spat as a case in point.  Bain Capital and Thomas H. Lee Partners have posted a $39.00 per share bid for Clear Channel, up from their original bid of $37.60 per share.  ISS opposed the original bid as have a number of large shareholders, of which Fidelity seems the be the loudest.

Clear Channel makes an attractive target for a bit of modern day greenmail.  Under Texas law two thirds of the shareholders must approve the transaction.  Distinguish this from two thirds of the votes cast.  Uncast votes will cut against the merger.  This gives minority holders a strong position and makes for a particularly retail-oriented campaign.

The problem with these kinds of battles, however, is more about risk than price.  Or, rather, while price is the public face of the issue, the more important and latent issue is risk.  In order to pay $40 per share (the rumored "magic number" for Clear Channel) Bain and Thomas H. Lee will have to pile on more debt.  This being the fourth serious bid for the company, one might imagine that a lot of pencil sharpening has already gone between the debt capital markets guys and whoever the Debt Bitch over at Bain is.  (Hope she doesn't have rug burns yet).  As should be obvious, default risk increases as the debt load gets higher.  Bets on the company's future performance are, in effect, being leveraged to pay current shareholders.

Let's go back, for a moment, to the basic scenario.  Public shareholders lose confidence in a company, let's call it "Opaque Channel."  Opaque Channel (not to be confused with "The OC"), a communications company and once great purveyor of obscure, Kafkaesque commentary, Byzantine news analysis and spin of such magnitude that the headquarters (gyroscope like) slowly wobble about their central axis, has had a difficult run recently.  Over the course of a year, the shareholders bid the stock, which was sitting at $25 a share a year ago, down to $10 per share.  It doesn't really matter why.  Perhaps they don't believe in management anymore.  Perhaps they believe the market for the company's twisted informational products is shrinking amid the increasing stupidity of media consumers and the consummate boost in demand for short, shallow news and commentary.  (CNN.com has deftly avoided this problem by leading their stories with a prominent, red colored "Story Highlights" section with the 4-6 bullet points that summarize their already curt 500 word articles).  Perhaps margins are low.  Perhaps the company has issued depressing guidance.  Whatever the case, the market does not believe in the prospects for the company.  The market has set the price for the firm at $10.

Now, some guys and gals who think they are pretty smart (the private equity locusts) do their homework and decide that, with some changes, they can make some money by buying the company in a leveraged deal, holding it for a period of time, improving the operations, and, perhaps, eventually reissuing it to the public market for substantial profits.  Let us pause for a second and reflect upon what this really means.

The private equity locusts are willing to take the company private, forgo any real liquidity (and therefore opportunity to exit the investment easily if things go south) and, further, will add debt such that there is little room for error.  They are, in effect, signing a contract to hold the company for 5 years even if it sinks down the tubes the entire time.  Their only early exit would be to find another buyer eariler.  Either the public, or another private firm that sees the value in deeply miasmal content providers.

Not only this, but the private equity locusts who think they are smart, have also managed to convince some debt market leeches (who also think themselves smart) that they are smart, and that their plan for the resurrection of Opaque Communications can work.

Moreover, the private equity locusts are willing to provide the public shareholders with a premium to do so.  They put their money where their mouth is.  They bid $11.50 per share.  15% over the company's currently trading price.  This is pure surprise and purely found money for the public shareholders, who, two days ago and as a group, couldn't imagine the company was presently worth more than $10.

A couple of shareholders, and it is not clear if they are new or old shareholders, but this really doesn't matter as share certificates are not wine, nor are they cheese, and therefore do not somehow gain nobility with age, start making noise.

"How can you expect us to sit here and let you take this company private and make hundreds of millions of dollars and not cut us in on it.  You are cheating us."

Consider the assumptions being made here by the complaining shareholders.

1.  That a 15% premium over the value that the shareholders themselves have set is somehow unfair.
2.  That, de facto, the private equity guys and gals will make hundreds of millions of dollars.
2.  That, if left to its own devices, Opaque Channel could make shareholders hundreds of millions of dollars if only left on the public markets long enough.  Management, about to be out of a job, doubtlessly feeds these delusions eagerly.  "We need just a few more quarters for our strategic obfuscated media product to catch hold in the market place."
2a.  Note the inconsistency in 2 above.  Namely that, if shareholders believed in management and felt that Opaque was only a few quarters away from greatness, why isn't their confidence reflected in the stock price?  This is an important attitude to look for.  The hope for a windfall which is not backed up by the resolve to pay more for the stock in the first place is quite telling.
3.  That the shareholders today should enjoy the potential future benefits of the LBO today (undiscounted) and without assuming the risks (liquidity, default risks, time frame) that the private equity locusts assume.

Consider point 3 carefully.  This is the essence of the "we are being cheated" argument.  Please note that "We are being cheated," really boils down to "We want you to pay us for the right to take a risk with this company.  And, actually, we want to boost the risk you take after you finally buy us off.  We want you to be paid less for more risk because we, deserving public citizens, are being cheated of our entitlement to a windfall of more than 15%."

In this connection, consider a subtle nuance of point 2.  By definition, what I will call a "pure" going private LBO (one that relies on actual top line and operational improvement to drive return rather than just clever debt loads) is a contrarian investment.  Private equity groups plan to make money by finding value that others have forsaken, and taking risks on these investment theses.  That's the point.  If you doubt this, all you have to do is watch what happens when an buyout firm withdraws the only bid from a public firm.  Anyone in risk arbitrage will tell you that the stock price quickly descends back to its original level in the absence of bidders.  Once again, the public shareholders show their colors.  The shareprice sinks back to $10.  The stock is worth $10 to them in the absence of a cash bid for their shares.  How can it be anything other than obvious to the impartial observer that the "entitlement" to more for these fickle shareholders is a fantasy?

Of course, in the political and economic climate that is the United States today, these fantasies are drawn as reality.  Giving someone 25% of what they ever imagined it was worth, and in the process piling additional risk onto the purchaser, is somehow transformed into "fraud."  Pretending that capital markets are anything but broken for these firms, and that therefore some enterprising group trying to unlock value is some kind of con job, seems to be a hobby.

So what are buyout groups to do?  Certainly, as prices are driven up by purely political (and I include both legislative and capital markets politics here) pressures they will have to, increasingly, bow out of otherwise useful and value-creating transactions.  They cannot, in good faith to their limited partners, assume the risks associated with these sorts of price elevations.

So how does one quiet unruly shareholders to consummate these transactions?  KKR and Goldman Sachs Capital Partners may have the answer in the structure we find attached to their purchase of Harmon International.

Here, KKR and Goldman give existing, public shareholders the option to convert up to 12.5% of the firm into 27.0% of the new.  The new firm will be registered under the Securities Exchange Act of 1934, and therefore, while not listed, will issue financial statements but trade over the counter only.  That keeps out the retail investors but gives institutional the opportunity to play along.

Consider the many problems this solves for the private equity buyers:

1.  Noisy public shareholders are (we assume) silenced because they can participate in the LBO and its subsequent success (or failure).
2.  The short term pressure of "the mob" and the "tyranny of the quarterlies" is suppressed.
3.  The populist argument against the transaction is (mostly) neutralized.
4.  The above are accomplished without the addition of more risk (debt).

Consider the problems it creates for the rest of the market:

1.  Specious, populist arguments against going private transactions are bolstered.
2.  Going private transactions (which I believe act as a "do-over" for firms which the public markets are not mature enough to serve) will see reduced returns and, accordingly, this particular public market safety valve for value will be damaged.

What is, at least from my perspective, sad, is that the reason buyout shops are resorting to this sort of tactic is because they have not been able to convincingly make the anti-populist case in their going private transactions.  This is probably because private equity as an industry is PR brain dead.  This, in turn, is because private equity is dominated by massive and myopic egos.  Private equity is about as accomplished at PR as Larry Ellison when separated from his handlers.

Activists will continue to make these arguments, because they make money by doing so, as they will, quite rightly, criticize poorly run auctions and conflicts of interest in "sweetheart deal" buyout transactions with the tacit complicity of management.  This latest development, however, is a sad reaction to overreaching by public shareholders.

The King is Recovered

In past, I have been pretty tough on Burger King's LIPO in the past and its management plan for expansion and growth.  Burger King was a pretty easy target after Texas Pacific Group, Bain and Goldman Sachs all took a fat special dividend paid for in debt immediately prior to the IPO.  Interesting, therefore, that the Wall Street Journal, which, in one breath, wonders after (subscription required) the poor state of the restaurant industry...

Activist shareholders and private-equity firms are reshaping the restaurant industry as it retrenches after years of overbuilding and struggles to lure cash-strapped diners, with Applebee's the latest chain to respond to a big shareholder.

...elsewhere (subscription required) in the same edition outlines Burger King's new-found good fortune owed to exactly the thing that others in the industry are being skewered for.

Burger King Holdings Inc., benefiting from aggressive restaurant expansion and the rollout of a breakfast value menu, reversed a year-earlier loss and posted better-than-expected fiscal third-quarter earnings Friday.

The world's second-largest hamburger chain said it expects to beat its revenue goal for the fiscal year, which ends in June. Revenue is forecast to increase 6%-7% and adjusted net income more than 20%.

[...]

Burger King said its strong free cash flow allowed it to pay down debt to historically low levels in recent months.

Pretty impressive, actually, considering what seemed, at least to me, to be a rather rudderless forward-looking strategy and the general state of the industry.

Personally, I noticed that Burger King's LIPO left a bad taste in my mouth.  I wouldn't have bought the stock in the IPO, or since.  However, some pundits used the LIPO as an excuse to decry the private equity world and name 2007 the "year of private equity crisis."  Never mind that the investors who bought into the Burger King IPO did so with open eyes, well aware of the company's debt load.  (And the patient ones seem, for now, to have done moderately well).  Even unpopular LIPOs seem to have a place in the private equity schema.

Wouldn't it be ironic if some activists, noting the historically low debt load on Burger King now, decided to pile in and demand a dividend recap?

Experimental Feedback

I committed myself long ago to avoiding public comments on Going Private.  It is not that I do not love my readers (though sometimes I don't) but rather that comments seem to have a certain mass that weighs them down towards a very low common denominator.  Limiting feedback to reader mail solves much of the "open mic" problem I see elsewhere on blogs with comments open.  Just because, (the high quality of most reader mail being one reason) I have decided to experiment gently with comments.  Accordingly, heavily moderated comments are open for my last two posts.  Depending on how this goes I may selectively open other posts for comments (or I may not). Enjoy.  Behave.