Tuesday, February 13, 2007

A Simple Request

In the course of an investment banking career spanning almost two decades, I have yet to meet a private equity professional who is wracked with doubt, paralyzed with uncertainty, or unsure about his or her own brilliance and effectiveness in the realm of investing. Perhaps this perception is not a true reflection of these peoples' character and beliefs, but rather just a pose they all adopt when meeting an investment banker, one of those low and despicable intermediaries who are only out to skim a fee and who never put their own capital at risk in any deal. I do not know.

This also seems to be a common attitude among those refugees and recruits from Corporate America who join financial sponsor firms as operating, adjunct, or advisory partners. I still remember a series of meetings a few years ago when a Senior Operating Partner at A Very Prestigious Private Equity Firm argued strenuously in one meeting that Portfolio Company XYZ absolutely needed to be characterized as an Industry A-type company in order to sell it in an IPO and just as strenuously argued that it was without question an Industry B-type company in a meeting two months later. Never mind that the company in question couldn't find its way out of an Industry A- or an Industry B-type paper bag with a map and a blowtorch. The only consistent attitude this partner had in both meetings was a complete and uttter disrespect for the (relatively well-informed) opinions of Yours Truly, Scum of the Investment Banking World. (And, having been a Divisional Vice President at A Very Prestigious Public Corporation, I can assure you that this person was not widely regarded as A Complete Idiot.)

Now, I do not know whether this uniform attitude of arrogant superiority and absolute certainty is a genetic prerequisite for anyone aspiring to join the ranks of private equity, or rather a protective carapace which an individual necessarily develops in the course of pursuing a successful career in the industry. My guess is that it is a mix, said guess being entirely based upon my personal knowledge of a small and non-representative sample of formerly nice, smart young investment bankers I have known who have subsequently been recruited to the Dark Side of the Force.

All that being said, I can appreciate why PE professionals display such traits. After all, the feat of buying a largely unknown entity with a fundamentally untested management team on a highly leveraged basis and then being required to hand-hold, prod, scream, and yell at various constituencies over a period of up to seven years in order to deliver a saleable entity whose exit value will be almost entirely at the mercy of forces completely out of your control does require a certain confidence in either fate or your own abilities. And if you do have any doubts, I am sure you learn to suppress them into nonexistence the first time you are required to defend your investment thesis in front of the sponsor's Investment Committee. After all, one does not draw attention to a nosebleed when one is immersed in a shark tank.

So, let's just agree that a—shall we say—robust ego is a necessary and appropriate prerequisite to being a successful private equity professional. So what? Well, I can see two risks.

The first, of course, is internal: hubris. Self-confident or not, any self-respecting PE professional has to admit there has been a terrific tailwind at his or her back for the last several years: abundant, cheap debt (with minimal or no covenants); strategic buyers frozen in the headlights like rabbits; and chunky realized returns boosted by relatively depressed entry multiples from the 2001 – 2003 investment period. In other words, you cannot realistically take credit for all of the success you have enjoyed. You may indeed be Good, but do not underestimate the fact that you have also been Lucky.

The second risk is external. Private equity has gotten so prominent in today's society and economy (vide The Carlyle Group's recent apothoesis on the cover of BusinessWeek and the dust up surrounding Steve Schwarzman's 60th birthday bash), that attention is being directed from many quarters at an industry that has not made a practice of justifying itself in public. And, let me tell you, you need a little justification, notwithstanding all your good work.

Think about what that old chestnut of behavioral economics, the Ultimatum Game, tells us. When they have a veto power, most people will punish someone who attempts to take "too much" of the pie by guaranteeing that no-one gets any pie. This is not "rational," in a strictly economic or game theoretic sense, but it is an observable behavior trait across many different societies and cultures. And kid yourself not, veto power is exactly what many of the social, political, and investment constituencies beginning to question the value of private equity have. How would you like to have the tax deductibility of corporate interest expense limited for highly levered transactions in this country, as has been mooted in a few corners? I didn't think so.

So, for your own good—and the good of the economy to which you contribute so meaningfully—do us all a favor: Make nice.

© 2007 The Epicurean Dealmaker. All rights reserved.

Monday, February 12, 2007

L'État, c'est moi

Dan Primack of peHub has recently weighed in with a jeremiad against Steve Schwarzman's upcoming 60th birthday bash in Manhattan, scheduled for tomorrow evening.

In it, Dan bewails the fact that such a high profile, posh affair as is apparently being planned is coming at exactly the wrong time, what with increased scrutiny of the private equity juggernaut in the press, Washington, and among public company shareholders:
The New York society pages estimate that the bash will cost in excess of $4 million, and I’m told that Schwarzman [is] a bit miffed that the details are being scrutinized as if it were a taxpayer-funded event. But this party presents Schwarzman with a much bigger problem than personal pique—it will be just another reason for public company shareholders to reject leveraged buyout offers (or at least to drive them up). In other words, this party is bad for business.

I agree with Mr. Primack that there is almost nothing about this bacchanal that will be good for the private equity business, whether at Blackstone itself or at any number of its competitors. Fairly or not, news of this little romp is guaranteed to stiffen the spine of the wimpiest Special Committee director and sharpen the teeth of the most passive pension fund investor. The net result cannot help but be a marginal increase in premiums paid to public company shareholders by buyout firms, plus a likely increase in the number of offers withdrawn. It will also do nothing to endear Mr. Schwarzman and his fellow PE plutocrats to the hoi polloi on The Hill or in the street. Call it the Steve S Effect.

Mr. Schwarzman is reportedly too intelligent to be unaware of this outcome. What I think Mr. Primack fails to grasp, however, is that Steve really doesn't care. If his 60th birthday party causes adverse economic externalities to his firm and his industry, so what? Steve has already made himself "a billionaire several times over," in the classic coinage of the New York Times. A little extra headwind won't bother him in the slightest, and it may have a nicely detrimental effect on his competitors. Take that, Henry Kravis!

By focusing on the economic effects on the PE industry, Mr. Primack completely misses the point of Mr. Schwarzman's to-do. So, in a different way, does the NYT, by focusing on the apparent extravagance and conspicuous consumption of the arrangements. This party is not about money, and it is not about business. It is a coronation.

Mr. Schwarzman is doing no less than crowning himself the King of New York, and as publicly as possible, too. The $4 million price tag and the bargefuls of exotic flowers destined to adorn the Park Avenue Armory this Tuesday are nothing compared to the conspicuous display of power and influence that Mr. Schwarzman and his wife are putting on. According to reports, every bigwig on Wall Street has been invited to pay homage—as befits the kowtowing due your biggest customer—as have prominent personalities in politics, the arts, and society. For anyone dense enough to miss the point, someone has apparently made sure that those who cannot or will not attend have recorded video tributes and written remembrances of the Great Man which will no doubt be shown to all the Grandees who do show up.

(Those lucky enough to sit at Mr. Schwarzman's table during the festivities better don protective eye wear, because I predict he will burst several buttons as he laps up the real and forced adulation from his audience.)

That is why it is preposterous that Mr. Schwarzman should be "miffed" about the attention his party is attracting. Attracting the attention of New York Society was the entire point. If he really wanted just another lavish birthday party for himself and a few hundred friends, he could have flown everybody to Sardinia, like his former fellow society doyen, Dennis Kozlowski. (I hear the mold for the David ice sculpture centerpiece can be had for a knockdown price.) No, I smell a virtual army of publicists beavering away in the press to get the highest profile possible for this affair.

Now don't get me wrong. Mr. Schwarzman is undeniably a successful man, and I have no doubt that he has many admirable qualities. Why shouldn't he have a big blowout, especially since he is paying for it himself? Just don't confuse people like Mr. Schwarzman with Homo Economicus. I would wager it has been a long time since Steve has looked at money as anything other than a particularly effective method—especially in this city—of keeping score. And this party is all about keeping score.

The King is dead. Long live the King.

© 2007 The Epicurean Dealmaker. All rights reserved.

Thursday, February 8, 2007

Lucky Fool

Dear Readers — It appears I have been failing you, my only constituency. I have received several e-mails along the following lines:
Yo, T.E.D. —

You write too much. Don't you have a job?

Anyway, don't you know that no-one visits a blog about Wall Street and M&A to read about corporate governance, CEO pay, or any of that other [stuff]? We want to know how to get RICH.

Now, are you gonna deliver, or do I have to go to richdadpoordad.com?

Sincerely,
Vinnie S.
Brooklyn, NY

Herewith, I share my response:

Dear Vinnie — You are right. I'm sorry. I have gotten a little carried away with blogorrhea, but my doctor assures me it comes from my newness to the medium, and it will pass. I do have a job, but I have been able to post so much because my partners believe I am busy financing a high speed rail link in Somalia.

You're also right about the lack of wealth-building pointers. I thought there already were enough blogs out there dispensing investment advice, but I guess there's always room for one more.

In lieu of specific stock tips, I will pay for my shortcomings this time by sharing with you the best advice on how to get rich that I have ever received, courtesy of my friends and investment advisers at Long or Short Capital. It is a little article entitled "Four Simple Steps to Becoming a Billionaire," penned by my pal, Johnny Debacle. Enjoy.

Cordially yours,
T.E.D.

Nassim Taleb would be proud.

© 2007 The Epicurean Dealmaker. All rights reserved.

Whoa, Nellie!

Business.view at Economist.com (cute use of dots, btw) writes—rather hysterically, in our view—that the "[the] backlash against the private-equity boom is becoming a tad hysterical." As evidence, they cite recent opinion pieces by John Gapper in The Financial Times and Ben Stein in The New York Times.

As is typical of many apologias for our current system of capitalism found in The Economist, there is a lot of apparent even-handedness ("still," "on the other hand"), but at the end of the day what caps it for B.v is that 1) "many private-equity firms are paying over the odds for their acquisitions" and 2) "the shareholders of [the] firm must approve any sale." We shall dispatch each of these arguments in turn.

First, I think few would dispute that all acquirors, private equity and strategic, are paying lots of moolah for their acquisitions nowadays. Money is cheap and plentiful, and most businesses are relatively healthy, so acquisition multiples have been climbing relentlessly. No-one disagrees that the market is swamped with drunken sailors wearing Hermes ties flinging buckets of cash at anyone who has the sense to tack the initials "LLC" to his door. However, it is not obvious that public company shareholders always get enough value for their shares. Pointing out triumphantly that a boat's keel is floating six inches above the high tide mark is not a particularly compelling argument to someone sitting knee deep in water because a surge tide is lapping over the gunwales. The ancillary point—also true—that PE firms are competing vigorously for acquisitions does not by itself guarantee that shareholders are getting full value, either, for no PE firm worth its Park Avenue address competes to pay full value for its purchases. It pays enough to win.

The second argument B.v puts forward—that shareholders can always vote down any deal they do not like—is almost laughable in its naivete. Since when, in this country, do public company shareholders take any meaningful supervisory governance role over their portfolio companies? Even when they do, a shareholder vote is almost exactly like closing the barn door after the horse has escaped: all the important decisions, like which deal, who, and how much, have already been made by management and the Board of Directors. It is a pretty crude and clumsy tool, when all you can do as an owner of a company is vote "yes" or "no." No wonder most shareholders take the money and run.

No, as Mr. Gapper points out, the problem with management-led buyouts is a structural one. Once a senior management team has made the emotional, financial, and often contractual decision to sign up with a particular buyout firm, they become advocates of a deal and, in fact, their particular deal. Management holds all the best inside information and has umpteen ways of encouraging or discouraging their own or other bidding teams from putting forth effective competing offers. The only ones guarding the cookie jar at that point are the independent directors of the Special Committee, who have the unenviable task of jumping into the shark tank covered in sheep's blood wearing a sign saying "Bite me."

I am sure many independent directors at many public companies are in fact independent, even though recent corporate history in this country does give me pause. I am also sure that most of these fine men and women are full of integrity and seek to execute their fiduciary duties as fully as possible, if for no other reason than the watchful circling of the Plaintiff's Bar. But I am also certain that most of these independent directors are hopelessly outgunned in high-pressure negotiations with the deal partners of buyout firms, who buy companies like theirs for a living. And their golf buddy Joe, the Chairman and CEO, who brought them onto XYZ Company's board and got them into Baltusrol, is now on the other side of the table, smoking a 12-inch Cohiba and chatting amiably with some Private Equity Grandee out of New York who eats small children for breakfast. Who would you put your money on?

Of course, as Business.view points out, not all public company buyouts pan out this way. The frenzied auction for Equity Office Properties Trust, in which EOP's Board was able to squeeze another $3 billion out of the bloodless turnips at Blackstone, is a shining example of a buyout done right for shareholders. But guess who drove that bus. Not CEO Richard Kincaid or his senior management team, who may or may not end up salaried partners of Blackstone going forward, but mean, sneaky Chairman Sam Zell, who had approximately one fifth of his pro forma net worth riding on the deal outcome as a shareholder himself (talk about alignment of interest!) and who has been reliably reported to eat Private Equity Grandees for breakfast. Especially after this outcome, I do not think Steve Schwarzman will be inviting Sam onto his advisory board.

Say, there's a thought. Perhaps we can persuade old Sam to drop his bid for the Tribune and become sort of a Lead Independent Director for hire, one we can airlift into boardroom negotiations for public corporations whenever the need arises. You know, sort of like a spine transplant when the CEO and his team jump over to the Dark Side. I'd pay real money to see that.

© 2007 The Epicurean Dealmaker. All rights reserved.

Wednesday, February 7, 2007

The Fat Lady Sings

Well, it's over.

It appears that Steve Schwarzman and The Blackstone Group have won the bidding war for Equity Office Properties Trust today, as EOP shareholders approved the $39 billion deal in the biggest LBO ever. I guess I am happy for Steve and his colleagues, but I suspect there are a lot of unhappy people out there.

First, of course, must be Steve Roth, Chairman and CEO of competing bidder Vornado, who has missed out on yet another juicy whale of a target after bemoaning all the previous whoppers that got away. He must be feeling a little like Rodney Dangerfield, since the equity component of his bid never did get any respect. I suppose he can take some consolation from the fact that his stock is up over 15% since Blackstone announced their original deal with EOP, and Vornado shareholders seem to be drowning their sorrows in Cristal champagne by bidding up VNO shares over $1.3 billion today alone. He may also get several smaller bites at the same apple, now that Blackstone will be scouring EOP's portfolio for properties to dispose of to reduce the buyout's crushing debt burden.

Second, I imagine Blackstone's investment bankers are beginning to break into a flop sweat of epic proportions, now that they face the prospect of raising eleventy-three billion smackeroos in third party debt and equity to make sure Blackstone's check doesn't bounce. But, really people, who cares what happens to investment bankers anyway, other than New York magazine and The Daily Deal? Besides, we all know that it must have been quite a brawl among the bankers in Blackstone's locker room shower over who got to bend over and pick up the soap first, n'est-ce pas?

Third, I imagine there might be a little queasiness among Blackstone's limited partners now that it has won the deal after boosting the equity component of its bid by over 14%. Everyone is old enough to remember (or clued in enough to have read Barbarians at the Gate) what happened to the returns earned by the last "biggest buyout of all time," RJR Nabisco. Nevertheless, these are many of the same LPs who are writing checks by the bundle to buyout groups like Blackstone that are setting up funds to invest in infrastructure, of all things. You know: assets that are lucky to earn mid-teens equity returns after having been leveraged 95% or more.

I am sure there are other unhappy campers, too. All I can say is that I am relieved that Blackstone will be able to consummate its undying passion for EOP in the end. I don't think I could have taken another media circus like the Psycho Astronaut Kidnapping Drama in one week. I mean, the image of Steve Schwarzman, disguised in a fright wig and trenchcoat, driving across country in diapers to confront Steve Roth in Vornado's parking lot with an air gun and pepper spray just gives me the shivers.

Wait a minute . . . Vornado and Blackstone are both headquartered in Manhattan, so Steve wouldn't have needed a diaper to cross town in his Lincoln Towncar anyway. Whew.

Say, do you think the fact that Schwarzman and Roth both work in the same town and probably both go to the same black tie charity events had anything to do with the ferocity of the bidding war over EOP?

No prizes for the correct answer.

© 2007 The Epicurean Dealmaker. All rights reserved.

Saturday, February 3, 2007

A Modest Proposal

FOR PREVENTING THE CHIEF EXECUTIVE OFFICERS
OF PUBLIC CORPORATIONS
FROM BEING A BURDEN TO THEIR SHAREHOLDERS OR COUNTRY,
AND FOR MAKING THEM
BENEFICIAL TO THE PUBLIC 1

IT IS a melancholy object to those who walk through this great town or travel in the country, when they see the streets, the roads, and expensive restaurants, crowded with former Chief Executive Officers of public companies, followed by three, four, or six hangers-on, consisting of PR flacks, personal trainers and bodyguards, and second or third wives, all in furs and importuning passersby for the location of Charlie Rose’s studio. These ex-CEOs, instead of being able to work for their honest livelihood, are forced to employ all their time in playing the 100 Best Golf Courses in the World, yachting in the New Hebrides, and giving interviews on “Larry King Live.” Worse, they are routinely compelled by their straitened circumstances to author self-exculpatory autobiographies and tendentious management screeds (with the assistance of ghostwriters or third wives) and to promote same on nationwide speaking tours.

I think it is agreed by all parties that this prodigious number of former CEOs is in the present deplorable state of the nation a very great additional grievance; and, therefore, whoever could find out a fair, cheap, and easy method of making these individuals sound, useful members of the commonwealth, would deserve so well of the public as to have his statue set up for a preserver of the nation.

But my intention is very far from being confined to provide only for former CEOs; it is of much greater extent, and shall take in the whole number of current and former Chief Executive Officers of publicly traded corporations in this country and, by extension, the world.

The number of public company CEOs in this nation being usually reckoned five thousand, of these I calculate that there may be about fifteen hundred of consequence. The latest research by eminent scholars of executive pay indicates that these CEOs were paid an average of $4.9 million a-piece per annum in wages, benefits, and emoluments, thereby imposing upon the nation and upon the common shareholders of their employer companies an aggregate burden of $7.4 billion per annum. And yet this is not the worst of the imposition upon the population, since it is common for such CEOs to take with them substantial multiples of their current pay and benefits upon their retirement, voluntary or otherwise, from the post. A respected gentleman of my acquaintance, who himself is of the most unimpeachable character and honesty, even asserts that there have been some knaves and scoundrels among the ranks of former CEOs who have managed to depart their employers with amounts in excess of $200 million, although I can scarce credit such outlandish reports.

I shall now therefore humbly propose my own thoughts, which I hope will not be liable to the least objection.

I have been assured by a very knowing Frenchman of my acquaintance in New York, that a vigorous healthy CEO well compensated is at three years old a most delicious, nourishing, and wholesome food, whether stewed, roasted, baked, or boiled; and I make no doubt that it will equally serve in a fricassee or a ragout.

I do therefore humbly offer it to public consideration that of the fifteen hundred current CEOs already computed, those five hundred CEOs in their first year and those five hundred in their second year of service may be reserved for ongoing management, and five hundred CEO designates be identified for promotion to the post. The remaining five hundred currently in office may, upon the third anniversary of their employment as CEO, be offered in sale to the persons of quality and fortune though the nation; always advising the shareholders to let them suck plentifully at the corporate teat in the last fiscal quarter, so as to render them plump and fat for a good table. A CEO will make at least six dishes at a lavish entertainment for friends; and when the family dines alone, the fore or hind quarter will make a reasonable dish, and seasoned with a little pepper or salt will be very good boiled on the fourth day, especially in winter. I have reckoned upon a medium that a CEO newly appointed will weigh 190 pounds, and in three solar years, if tolerably remunerated with salary, options, restricted stock, and perquisites, increaseth to 260 pounds.

I grant this food will be somewhat dear, and therefore very proper for private equity partners, who, as they have already devoured most of the public corporations, seem to have the best title to the CEOs.

CEO’s flesh will be in season throughout the year, but more plentiful in February, and a little before and after; for we are told by a grave author, an eminent Equity Research Analyst, that public company shareholders are most willing to part with their CEOs during earnings season, when they are wont to preannounce bad news and disappoint earnings expectations.

Some persons of a desponding spirit are in great concern about that vast number of former CEOs, who clog our commwealth and push up the price of vacation homes on St. Kitts, and I have been desired to employ my thoughts what course may be taken to ease the nation of so grievous an encumbrance. But I am not in the least pain upon that matter, because it is very well known that they are every day dying and rotting by overeating and boredom, and tax audits and Senate probes, as fast as can be reasonably expected. Besides, any attempt to include these numerous former CEOs in the aforementioned sales to the rich would be certain to roil the market, and unnaturally depress the prices which public company shareholders could otherwise reasonably expect to earn from the sale of their own former executives.

I think the advantages by the proposal which I have made are obvious and many, as well as of the highest importance. For first, as I have already observed, it would greatly lessen the number of autobiographies, memoirs, and noxious how-to guides penned by former CEOs, with which we are yearly overrun. Secondly, public company shareholders will have something valuable of their own, which they may use to satisfy their personal obligations, their dividends being already seized, and capital gains a thing unknown. Thirdly, whereas the severance package of a public company CEO, from his third anniversary of service and upward, cannot be computed at less than $25 million a-piece, and twenty to thirty percent of all CEOs are now fired or retire every year, the nation's stock will be thereby increased by $7.5 to $11.3 billion per annum, besides the profit of a new dish introduced to the tables of all gentlemen of fortune in the nation who have any refinement in taste. And the money will circulate among ourselves, the goods being entirely of our own growth and manufacture.

Many other advantages might be enumerated. For instance, the addition of some hundreds of carcasses in our exportation of cattle, and the great reduction of sushi and other imported take-out foodstuffs, too frequent at our tables; which are in no way comparable in taste or magnificence to a well-nourished, fat, mature CEO, which roasted whole will make a considerable figure at a mayoral feast or any other public entertainment. But this and many others I omit, being studious of brevity.

Supposing that four hundred private equity families in this city, would be constant customers for CEO’s flesh, besides others who might have it at merry meetings, particularly at office holiday parties and closing dinners, I compute that New York City would take off annually about three hundred and fifty carcasses; and the rest of the country (where probably they will be sold somewhat cheaper) the remainder.

I can think of no one objection, that will possibly be raised against this proposal, unless it should be urged, that the number of second and third trophy wives will be thereby much lessened in the nation. This I freely own, and ’twas indeed one principal design in offering it to the world. For who among us can complain that we have not enough experience of Ivana, Pia, Wendy, Suzy, and their ilk? A very worthy person, a true lover of his country, and whose virtues I highly esteem, was lately pleased to suggest that an admixture of sauteed trophy wife might enliven roast haunch of CEO at table, and this author is not one to quibble with a culinary suggestion which seems so eminently reasonable.

I am not so violently bent upon my own opinion as to reject any competing suggestions proposed by wise men, which shall be found equally innocent, cheap, easy, and effectual. I profess, in the sincerity of my heart, that I have not the least personal interest in endeavoring to promote this necessary work, having no other motive than the public good of my country, by advancing our trade, providing for corporate executives, relieving the public company shareholder, and giving some pleasure to the private equity rich. I have no CEOs by which I can propose to get a single penny; my investments being in index funds, and my restricted stock unvested.

THE END


1 With apologies to Jonathan Swift.

© 2007 The Epicurean Dealmaker. All rights reserved.