Tuesday, June 05, 2007

Imminent Death of Private Equity Predicted II

behold the destroyer More than a year ago I wondered after the ego inflating effect the private equity world was having on me.  I noted the increasing propensity to regard with a calculated disdain the business practices of Sub Rosa's daughter firms, and mused that the increasing dissatisfaction with life in general might not be a consequence of the newly found quest to deliver crushing blows to mediocrity everywhere.  Back then I said:

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

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

A few months later, I bemoaned the many dunkels who seemed convinced that the "private equity bubble" was on the verge of a large and wet "pop."

Death of the industry?  Hardly.  Not any more than the demise of Drexel was the death of the industry.  There's a ton of equity overhang still sitting around.  Even if the LIBOR pops up 2.5% we are still in very healthy debt markets.  The business isn't going away any time soon.  Maybe the headlines will, but that would be fine with me, and most of the people at Sub Rosa and the hundreds of firms like us that daily go quietly about the business of buying and, more importantly, improving companies.  That mostly orderly cycles and seasons in private equity would come to pass should surprise no one.

A flight to quality is certainly in the cards.  I can't wait.

I still feel the same way, but a new element, a new dynamic has come to my attention that complicates the analysis.  That element is concentrated in and personified with absolutely painful clarity by Natasha Mitra, first brought to my attention by last month's DealBreaker "write offs" pointer to the profile of young Natasha, an Associate at Carlyle, in New York Magazine's "Look Book" feature.

But before discussing Natasha's revival (and significant personal advancement) of the "culture of excess," I want to pass on a bit of Sub Rosa daughter firm lore.

Project Deadline, once just a twinkle in Armin's eye, is now a Sub Rosa daughter firm.  I worked extensively on the acquisition and the subsequent (and ongoing) transformation of the firm.

An essential department of the firm that rhymes with (and resembles) "hugest quarter horses" was populated almost exclusively by women.  (One young man of decidedly ambiguous sexual preference also haunted the group).  Five women in the department had been with the firm for five years, had started the same month and lorded over the department (and the firm) with a reign of terror that, owing to the critical nature of the work, penetrated every orifice of Deadline, Inc. with dozens of fear-slime covered tentacles.  The sole young man endured the machinations of the department with good humor (having a highly compatible catlike disposition- and I refer here not to his dexterity but rather the frequency and venom of his easily prompted, cutting remarks about co-workers).

New to the department was a younger (and considerably thinner) woman who I will call "Jill."  Jill was overeducated for the position, holding a master's degree on top of everything else, but approached the job with, if not good humor, a strong "work hard, finish early, start something new" attitude.  She was unlikely to endure any distraction, she kept focused and, consequently, was intolerant of any laziness.  She was "goal oriented" in the true sense of the word and always had good insights into the flaws within the department as well as their best cures.  These delightfully refreshing attributes made her the most productive, effective and beneficial member of the team and, of course, also doomed her to total and utter ostracization and consequent career failure in the firm.  But I am getting ahead of myself.

The department, like most of the firm, had long since fallen into a lax and complacent set of business practices driven primarily by avarice and apathy.  The chief goal of most of the group was to avoid taking any shade of responsibility, ownership or initiative (all of which were punished quickly, brutally and reliably with more and more responsibility, career advancement and managerial opportunity- horrific consequences for a group that strove to coast as long as possible without so much as a toe on the gas pedal, as if carbohydrate-petrol was at $5.50 a gallon).

When I first met her, it became totally clear to me that she was exactly what the department needed to get itself in shape, its current state being at least partially responsible for the low price (and therefore the motivation to buy the firm) we paid in the acquisition.  This, of course, is the point of private equity.  Or at least, I think it is.  We are supposed to shake up daft and purge dead weight (or excessively heavy live weight) departments, cull them of drag and the elements that create drag and profit through a combination of our operational improvements and the leverage we have applied.  We are supposed to do this quietly, efficiently and without regard for politics and the like.  Our job is to get the company running, not to be popular.  Popular, in fact, is the mortal enemy of efficiency.

Before I even met Jill, the denizens of the Department of Dead Weight had already aligned against her.  They had, quite rightly, identified her as someone who would increase the burden of their daily recreation work routine and, upon revealing the "hidden" potential of the group in productivity, and thereby exposing the current and totally artificial lack thereof, condemn them to a life of fear of dismissal and/or the far worse fate of doing hard work on occasion.  Already, they had begun to marginalize her and proceeded to administer the "death of a thousand paper cuts," secretly assigning her "below average" ratings in their secret performance reviews of her, the most tragically comic of which I discovered a month or two after the acquisition and that indicated that Jill "lacked initiative and reduced the efficiency of the department overall."  I almost laughed out loud, and likely would have, had the situation not been so sad.

Because Jill's performance reviews were done both by her peers and her superiors, all of whom where now conspiring against her, the picture on paper was a classic projection of the reviewers.  Jill would appear to any less diligent acquirer or review group to be a shiftless, lazy, unmotivated and unresponsive bit of driftwood.  A blocking troublemaker.  She had been passed up for merit increases twice.

Amazingly, she hung on, convinced that one or another of her memos (one I discovered identified an accounting error that had the company overpaying salaries for executives which, in turn, inflated payroll by over $1,000,000 per year, another pointed out that a criminal background check on an employee had been ignored though it indicated the employee was wanted for fraud in another state- the employee was a friend of an existing member of the department) would finally be read carefully and her worth would be recognized.

After an acquisition, Sub Rosa, like most private equity firms, develops a personnel plan (that we pejoratively call the "hit list") that outlines the new form of the organization (and therefore who will be invited to leave the firm and under what terms).  These plans have particular guidelines.  Usually, to streamline payroll, to use outsourcing when cost effective to replace expensive payroll slots, and to form a plan that "aligns the employee base with the future needs and resources of the firm."  An unwritten goal of these plans has always been to break up the empires and defuse long running office political campaigns.  Sub Rosa believes, correctly in my view, these cults of personality to be extremely hostile to productivity.

I was responsible for developing the sub plan to "harmonize" the Department of Dead Weight.  My plan was painfully simple and brutally efficient.  This was how we had been taught to develop such plans.  This was my third.  I proposed to eliminate 75% of the group, outsource many of its functions it to a vendor I had already identified (and with whom we had worked successfully before) and put Jill in charge of the transition.

My presentation was nakedly forward about the problems the politics in the department, its vindictive attitude towards the only element within its ranks that was producing anything, and pointed out that Jill's many memos had already identified over $1.5 million in annual savings on top of these changes (savings we had, as it happened, not expected in our initial analysis).  I also pointed out that one of the group's employees was wanted for an out of state felony while another may well be liable for harboring the first, that Jill had discovered this months ago and that this might have severe consequences for the firm.

"We are not kindergarten teachers, Equity," I was once told early on in my career with Sub Rosa when going soft on a daughter firm's finances.  "There is no nap-time, there are no time-outs, we do not have parent-teacher conferences where we discuss developmental needs.  We are here to fix the problems that threw this company in our arms in the first place.  We are here to do it mercilessly.  Pity is not a useful emotion for us or for our daughter firms.  The company is most likely in our clutches now because of pity and forgiveness on the part of former management.  We are not needlessly cruel, but we are, of necessity, brutal.  We hack off rotting limbs without anesthetic and therefore we must saw quickly and move on."  That visual stays with me still.

I learned my lesson on this point, this part of the transformation process.  Zealously identify flaws.  Expose them.  Propose and execute corrective action swiftly.  It is the later generation of management , brought in a year or so after the acquisition and the subsequent "transformation," that possesses the softer touch.  The surgeons fade away, the anger at their swift and heartless action, one hopes, fades too.  New management is given a clean slate, and appears much kinder and gentler.  How could they not?  Then Esprit de Corps can be built again.  The survivors will bond together with them nicely.  Very "Imperial Rome," really.

And so I expected I had done what was asked of me.  That it would be accepted without issue.  I was quite wrong.

"Why are we eliminating Lance?"  Lance is the Department of Dead Weight's sole male of "catlike disposition."  The question is from a Principal, Chris, who is fairly new to Sub Rosa.  Chris comes from a "public relations" background and is part of Sub Rosa's new "image conscious" focus.  I have not had much contact with him before this meeting, fortunately.

"Lance is a major part of the murderous political cabal in the department," (my prior slide in the presentation was entitled "the murderous political cabal," bore the likeness of Charles II and included a time-line that outlined the department's systematic, and baseless in my view, elimination of six employees in eighteen months who had fallen out of the department's favor.  Three of these employees have since instituted wrongful termination suits one of which was going against Deadline, Inc.) and in the 5 weeks I have been poking around it has become clear to me that he not only produces little himself but, more importantly, he is a significant drain on productivity."

"How can we fire him?"  I feel I have not heard the question properly.  There is a long pause as everyone looks at Chris.  "Won't we be looking at a lawsuit?"  I am even more puzzled, lawsuits have never worried us before, but, amazingly, a few nods from the audience now.  "I mean it is discriminatory.  Because, you know, of his... status."  More nods.  Finally I catch on.  Chris means because Lance might be gay.  I play dumb.

"I'm sorry, what status do you mean exactly?"  There is an uncomfortable silence.  No one wants to speak it out loud.

"Carrie warned me about this."  Carrie is a member of the Department of Dead Weight.  I wonder to myself how Chris knows her first name and when/why he had been talking with her.  "Well, you can't just eliminate people because we feel they might be a drain on productivity."  Now I am close to shock.  Who are these people and what have they done with the Sub Rosa employees?

"Actually, that's my fucking job," I want to say, but I stay silent.

"Let's get a group together to review the personnel plan for the Department of Dead Weight," Chris suggests.  Murmurs of agreement.  That's code for "Death by Committee," for my plan, which is now, clearly, out of my hands.

And this is what I mean when I wonder after the future of private equity.  Suddenly, cost savings, efficiency and the like are secondary considerations.  Now public relations is the focus.  And why not?  There is enough cheap debt to use leverage to give us the returns, at least its cheap right now.  Why do the hard and unpopular work of improving efficiency?  Lance's feelings might, after all, be wounded.

And, dear reader, this is why I point to dear Natasha Mitra.  Natasha "I love to consume.  Consuming is my specialty!" Mitra, who totally works with "this woman at Louis Vuitton" to pick out just the right $3,500 accessory that looks like a broken rope bridge from some civilizationless jungle with cannibals still running about.  What missionary got eaten to provide you with that broken rope bridge of a purse, Natasha?  Natasha who thinks the oversized and overpriced Six-Flags theme park glasses are "wild and crazy and different."  She's not alone.  The male Natasha is our friend Joshua Butler, of recent DealBreaker and Fortune fame bent on "merging" with KPMG, which understands his needs and expects his commitment.

This could well be the beginning of the end for private equity.  This side effect of the public relations focus.  It is a vicious spiral really.  More puff pieces about private equity.  Showing the human side of the business.  Putting a kinder face on the process.  Hiring "finance professionals," whos finance degree is in public relations.  Putting the spotlight on the players, and pulling it from the game.  This is the new face of things.  This is the attitude that creates Natashas and Joshuas scores at a time.  And the more Natashas there are, the more consumption is their specialty (rather than cost cutting) the more resentment is bred via their painfully obvious excess, and, in turn, the more public relations and the more player focused the business will become.

Oh, and Jill?  She was the only one fired in the department.  So far, none of the errors or cost cuts she identified in her tenure at Project Deadline have been acted on.  Oh, and I have good reason to believe that Chris is sleeping with Carrie.

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