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Saturday, April 28, 2007

Comments

Angry investor

I agree that private equity firms should not be disparaged for trying to buy companies at attractive prices, improving them, and then reselling them. As you point out, they are taking on risk and deserve to be rewarded for that risk if they do their jobs correctly.

However, I disagree with your comment, "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." Public shareholders would not (or should not, at least) own shares in a company that they think is fairly valued. The act of owning the shares implies that they think the shares are worth more than where they are currently trading. Similar to private equity, many shareholders buy stock in companies that are temporarily out of favor in the hope that fundamentals/appearances will improve over time. The fact that a stock is trading at $10 does not mean that the company will not be worth significantly more in the future, even without the Midas touch of a private equity firm.

Public equity holders resent having stocks that they believe are worth $20 in a few years being taken out for $12.50 now. Sure, the $12.50 beats $10, but I'd rather get my $20 down the line. There's no guarantee I'll get it, but that's the risk an investor takes. I'm not saying private equity buyers are committing "fraud," to quote your piece, but many times a takeout is not a desirable outcome for a public shareholder and they have a right to voice their displeasure in such circumstances.

miami

As the convergence of PE and Hedge Funds continue, how do you think these types of battles will be resolved as these investing styles [say, shorter v longer] intersect more often?

Will PE be able to co-op Hedge Funds? Will enough Hedge Funds open private 'side pockets' that they will co-opt themselves?

Will activist HF managers start to incur a penalty as less LBOs occur in their holdings?

Unknown Professor

I think you're right that you'll have increasingly more cases of buyout offers being withdrawn. Following this, we'll see continued increases in do-it-themself recaps.

Of course, if this doesn't work (and I doubt they'll have near the appetite for risk that the PE firms have), we'll have some very unhappy shareholders looking for CEO scalps.

Alternately, they'll demonize the recalcitrant buyers. And then, hopefully (but I doubt it) they'll realize they've just engaged in an autoscrewing.

Like we learn in Finance 101: it's return AND RISK.

In any case, it'll make for good financial drama (and a case or two for my corp fin classes).

BTW - a short and very unscientific poll of my friends concludes you need more stories about the Debt Bitch. We're just sayin...

dc

The grant of additional equity seems a particularly expensive way to buy the cooperation of a minority shareholders, given the historically strong performance of KKR's and GS's acquisitions (as measured by fund gross returns).

Maybe Goldman and KKR are trying to keep the constant escalation of acquisition premia out of the mainstream press/public domain by using sleight-of-hand in deal structuring. If deal-specific returns are the only criteria for the structure, there should be some cheaper, simpler way to make the deal go through (an elevated -- yet less damaging to sponsor IRR than the equity grant -- acquisition premium for example)

Efficient Market

I don't understand the comments from "Angry Investor". If the intrinsic value of these shares is $20 in the future, that will be reflected in the current price. If a $20 stock is trading at $10, why wouldn't investors keep buying it until it is bid up to $20 (or PV of $20 discounted back "a few years")? Or if it was so clear that the stock is undervalued, why would the majority of investors vote for a buyout that undervalues their shares?

Clearly the PE shops are adding some value and they deserve to enjoy the gains. They are paying a premium to current market price, so current shareholders should stop crying about being ripped off.

Equity Private

"The grant of additional equity seems a particularly expensive way to buy the cooperation of a minority shareholders, given the historically strong performance of KKR's and GS's acquisitions (as measured by fund gross returns)."

Yes, perhaps, but it does pull risk out of the deal in that you minimize debt. How expensive is using the debt to pay a higher price going to look if the company defaults?

"I don't understand the comments from "Angry Investor". If the intrinsic value of these shares is $20 in the future, that will be reflected in the current price. If a $20 stock is trading at $10, why wouldn't investors keep buying it until it is bid up to $20 (or PV of $20 discounted back "a few years")? Or if it was so clear that the stock is undervalued, why would the majority of investors vote for a buyout that undervalues their shares?"

Of course, what is at work here is the HOPE of a windfall versus a committed position on price (by bidding the stock up). Hope of gains that isn't reflected in the stock price is, of course, irrelevant. If we are going to use "hope" as a metric to determine what is "fair" to give existing shareholders than what limits our scope to a 15% or a 20% premium? Do we doubt that existing investors hope for 500% premiums? Clearly, as a group, they could not have believed the shares worth more because the marginal investors have not bid up the stock.

Angry investor

You may choose to call the difference between a $10 share price and $20 intrinsic value “hope.” I call it time arbitrage. Unlike what is taught in business schools, the market is not perfectly efficient. To paraphrase Ben Graham, in the short run the market is a voting machine, in the long term it’s a weighing machine.

Many investors focus far too much on near term results and not nearly enough on the long term, what you may call “intrinsic,” value of a company. It is common for a stock to trade for far below its intrinsic value for temporary reasons. Maybe it’s an industry downturn, maybe a stock option scandal, maybe value is obscured because of a complex operating structure. Sometimes value is recognized but investors aren’t patient enough to wait for it to unfold (the phrase “dead money” is often heard in these situations). Whatever the problem, it’s often clear that the problems will pass. However, investors overlook the long term value of a company because they are worried about what will happen in the near term. That’s how you get a chance to buy $20 worth of future value for $10.

Why would an investor approve a 15% premium when he/she thinks it’s worth $20? Not all investors have the same time horizon. Hedge funds that get paid bonuses on annual (or even quarterly) performance, are going to be much more interested in the near term premium from a private equity buyer than a long term investor patient enough to wait for the true value to be revealed and then recognized by the market. Other investors may not have the stomach or the incentive to wage a proxy battle. They take the near term pop and move on. The recent success of activists has changed things so that now more investors are likely to fight a take out they think is unfair.

Owning a company that is trading at a discount to its intrinsic value isn’t “hope” to me--it’s value investing. I’m not hoping for a pie in the sky 500% premium as you suggest. I want fair value, or at least my best guess at what fair value is. When private equity comes along and tries to take advantage of near term issues to buy a company at a discount to that value I get unhappy. Telling me that I should stop crying because I got a 15% premium to a depressed stock price is insulting. If you think the market price of a stock is its true value then there’s really no reason to invest in publicly traded stocks. In that case, we’ll just have to agree to disagree because my whole investment process is based on taking advantage of short term issues to buy stocks at a discount to their intrinsic value. The “group” may be voting that the stock is worth $10 now, but that doesn’t mean that true value isn’t $20.

Equity Private

Angry Investor Says: "Unlike what is taught in business schools, the market is not perfectly efficient."

And that, ladies and gentlemen, concludes Going Private's experiment with comments.

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