Two ideas at the heart of modern financial economics are the efficient markets hypothesis, which says that investing doesn’t work, and the Modigliani-Miller theorem, which says that corporate finance doesn’t work.1 Also there is a financial industry which is pretty much organized around ignoring those ideas. Hahaha how stupid of David Einhorn to think that he could make Apple more valuable just by issuing some preferred stock! But also how stupid of David Einhorn to think he should invest in Apple rather than a market-cap weighted index of all the companies! I mean, stock picking, so last century, just index.
Management buyouts are one place where those two efficiency hypotheses break down in obvious ways. Of course management knows more about a company’s prospects than public shareholders do, and so will be able to buy when the company is undervalued.2 And of course adding giant gobs of debt to the balance sheet, with the attendant tax benefits, will make the stock more valuable. This doesn’t always work out – managements have their own problems estimating their company’s prospects, and leverage is risky – but it’s a perfectly plausible theory.
Or so I think but I come from a corporate finance background. Neil Irwin is an economics guy so he is puzzled: Read more »
I’m just some guy, but two entities of which I have become aware in my travels are (1) Apollo Global Management and (2) CalPERS. I don’t want to endorse 100% of what either of them does – CalPERS tend to be governance-scoldy, and I’ve seen with my own eyes the withered husks of formerly personable M&A lawyers who’ve spent too much time on Apollo due diligence – but I don’t think it’d be too controversial for me to say that they’re both acknowledged leaders in their fields, those fields being respectively (1) running private equity funds and (2) investing great gobs of pension money in, among other things, private equity funds. To the point that, (1) if Apollo came to me and asked “who should we ask to invest in our new private equity fund?,” CalPERS would probably be high on my list, and (2) if CalPERS came to me and asked “what private equity funds should we invest in?,” Apollo would probably be high on that list.
So where is my $20 million?
Today former CalPERS CEO Federico Buenrostro and former independent placement agent Alfred Villalobos were indicted for fraudulently funneling $20 million of placement-agent fees from Apollo to Villalobos. The case is bonkers for reasons well summed up by Dan Primack a year ago when the SEC brought a related civil case. The gist of it seems to be: Read more »
Lynnley Browning has an interesting article in DealBook about “supercharged IPOs” today. The gist is that some private equity portfolio companies go public, but keep in place agreements requiring them to pay over 85% of certain tax benefits that they receive to their former IPO owners. This, or so the argument goes, is both unfairsies – why do private equity firms get that money rather than the current shareholders? – and also, y’know, opaque secretive financial engineering etc. Viz.:
Now, buyout specialists are increasingly collecting continuing payouts from their former portfolio companies. The strategy, known as an income tax receivable agreement, has been quietly employed in dozens of recent offerings backed by private equity …
While relatively rare, the strategy, referred to as a supercharged I.P.O., has proved to be controversial. To some tax experts, the technique amounts to financial engineering, depriving the companies of cash. Berry Plastics, for example, has to make payments to its one-time private equity owners, Apollo Global Management and Graham Partners, through 2016.
“It drains money out of the company that could be used for purposes that benefit all the shareholders,” said Robert Willens, a corporate tax and accounting expert in New York who coined the term “supercharged I.P.O.” …
Another potential issue is that sophisticated investors do not necessarily understand the deals, either. The agreements typically warrant just a few paragraphs in a company’s I.P.O. filings.
So that last part, meh. The prospectus for Berry Plastics – the main example DealBook cites – describes its income tax receivable agreement in several places and pretty clearly. It explains what’s going on – “we’re funneling 85% of our tax savings from current NOLs to our pre-IPO shareholders” – and even gives some numbers, estimating that the payments will total $310 to $350 million and mostly be paid by 2016.1 It’s not really all that tricky. Read more »
“Hedge funds and private equity funds are secretive pools of capital blah blah blah,” people always say, and there’s some truth to that. But it’s partly true partly because a certain discretion is required by law. Banging on publicly about how awesome your hedge fund is could be taken as a “general solicitation” for investors, which was (and still is!) verboten, though nobody at CNBC takes that risk particularly seriously. But now that’s changing, sort of, sometime, with the JOBS Act, which will eventually allow hedge funds and private equity funds to advertise to the many though still only sell to the few.
Carlyle Group is now selling to the slightly-more-few via a Central Park Advisers feeder fund called CPG Carlyle Private Equity Fund, with a minimum of just $50,000. In keeping with no-general-solicitation rules, the Confidential Memorandum describing the CPGCPEF “is intended solely for the use of the person to whom it has been delivered for the purpose of evaluating a possible investment by the recipient in the Units of the Fund described herein, and is not to be reproduced or distributed to any other persons,” but it is also filed with the SEC. It’s super secret! It’s only available to anyone with a computer!
The memo, and today’s Journal article about the Central Park fund, are fascinating reading. But also so, so sad. Here’s the Journal: Read more »
The saddest part of this job is discovering a beautiful thing that someone has created as a way around financial regulation, and then watching philistine regulators destroy it. But the happiest part is dreaming up a come-on-that-could-never-work ploy to get around some financial regulation, and then finding out that someone’s actually doing it. Extra points if the someone is Goldman Sachs.
Two weeks ago I thought I’d concocted a way around the Volcker Rule’s porous and silly restrictions on banks running private equity funds. My solution involved (1) having a merchant banking business that took no outside investors (which the Volcker Rule does not restrict), (2) having a private equity fund that took no bank money (since the Volcker Rule limits banks to owning 3% of such funds), and (3) having your merchant bank and your private equity arm co-invest in deals. Since that doesn’t quite work,1 I later modified it a bit to have the outside investors co-invest directly, rather than through a private equity fund, and give the bank its management fee in the form of better economics to the merchant bank in each investment.
Today Reuters has this: Read more »
Reuters has a delightful story today about Wells Fargo’s merchant banking business, Norwest Equity Partners, which owns among other things the quite horribly named rifle maker Savage Sports. I can’t get too worked up about the likelihood that a fifty-year-old, smallish ($3.7bn), carefully managed, moderately gun-toting, otherwise wholesome private equity business will bring down the global financial system, but then I’m not Sheila Bair:
“Is that really what you want institutions that have safety net support doing? Is that an appropriate use for a government backstop?” she told Reuters.
I dunno, Sheila. Who is “you”? What do you want institutions doing? Something, right?
The point of the Reuters story is mainly that the Volcker Rule is expected to limit banks’ ability to invest in private equity funds, but that Norwest’s business is likely to be exempt because it runs only Wells’ own money. If you put bank money in a separate PE fund with outside investors it’s caught up in the Volcker Rule, but if you just make private-equity-type investments on your own it is not. This is no way to run a railroad: Read more »
The new hotness appears to be large cash-rich companies directly providing subordinated financing for big LBOs. Microsoft bound itself to Dell via sub debt in its LBO, and now Warren Buffett’s Berkshire Hathaway is doing a very odd LBO of H.J. Heinz with Brazilian private equity firm 3G Capital. Heinz’s announcement of the merger is brief and dull, but Buffett has filed his commitment letter and disclosed that he will “invest $12.12 billion to acquire a package of equity securities consisting of preferred and common stock and warrants issued by Holding. The preferred stock will have a liquidation preference of $8 billion, will pay or accrue a 9% dividend, and will be redeemable at the request of Holding or Berkshire in certain circumstances.” So he’s providing $4bn of common equity and $8bn of preferred leverage. The remaining $11-ish billion of the $23-ish billion purchase price will come from 3G (equity) and from a JPM/WFC-led debt financing.
There’s a basic tactical explanation for the structure, which is that it solves for this equation:
- Berkshire is an unlevered1 equity investor,
- 3G is an LBO shop,
- it’s 3G’s deal – they sourced it, they’ll operate it, they did the press conference – so 3G needs to own more than 50% of the equity,2
- but they’re not gonna put up, like, $12 billion in equity.
Read more »
One way in which my deep personal laziness manifests itself is my fascination with ways of getting paid not to do things.1 Contested M&A deals turn out to be full of such opportunities, from greenmail to don’t-work-for-a-hostile-bidder law-firm retainers. Break-up fees are a favorite of mine, and a place where I really feel mystified by the financial world. I have seen people lose out on a deal to a topping bid, putting them in line for an eight-figure break-up fee, and I have seen the look on their faces and: they were sad. Sad! To get paid tens of millions of dollars to stop working on the deal! I had to keep working on the deal, and no one was giving me millions of dollars.
At some intellectual level I understand this. So, in the Dell deal for instance, Silver Lake want to put $1.4 billion into Dell today and exit in five years and make 5x their money, I get it. But: that’s hard! You have to, like, manage Dell. Seems like a big company, has some problems. Your $1.4 billion is at risk, you have debt covenants to worry about, and, I dunno, wristwatch computers or something to make. Or someone can just write you a check for $450 million and you can not do any of that.2 I mean: go ahead, write me a check for $450 million, and I will happily not manage Dell. 450 dollars, really. Buy me a drink and I will spend as long as you want not running Dell. I’d be at least as good at it as Silver Lake.
On the other hand, if you’re a Dell shareholder, what do you win if you vote down the buyout deal? Read more »
It’s always a little awkward for a company to issue a statement saying “we’re not really that good a company,” but Dell’s Special Committee did a decent job of it today:
In the course of its deliberations, the Special Committee of Dell’s Board considered an array of strategic alternatives. In addition to working through financial and capital allocation issues with its independent financial advisors, the Committee retained a prominent management consultant to help it assess the Company’s strategic position. Based on that work, the Board concluded that the proposed all-cash transaction is in the best interests of stockholders. The transaction offers an attractive and immediate premium for stockholders and shifts the risks facing the business to the buyer group.
I think that this says that the board hired McKinsey1 to figure out how to improve Dell’s business, and they looked around and said: “It’s hopeless, burn the place down, or take whatever you can get for it.” And they did, agreeing to an LBO led by Michael Dell and Silver Lake at $13.65 a share, which some shareholders find a bit light.
One question you might ask is: who knows Dell’s strategic position better, Michael Dell or McKinsey (or whoever)? I don’t know that there’s an obvious answer. You could very reasonably take the view that Michael Dell, chairman and CEO and founder and namesake of the company, really is stealing it away from shareholders at a low valuation and taking all of the upside for himself and his private equity sponsors. On this view the board has no particular choice but to sell to him – he’s offering a premium and no other buyer is likely to compete with the CEO and founder’s offer – and so has brought in McKinsey to provide litigation-friendly rubber-stamping for that decision. This fits nicely with the notion that management buyouts always sort of screw public shareholders, as well as with the notion that management consulting is always just a highly-credentialed rubber stamp for whatever an executive was planning to do anyway. Read more »
Today Southeastern Asset Management, which is Dell’s biggest shareholder that doesn’t share a name with it, expressed its displeasure with the company’s $13.65-a-share LBO today in the form of a letter to the board patiently explaining that:
- Dell is worth $23.72 a share, and
- Dell could pay $11.86 a share in cash in the form of a special dividend and still be a decent standalone company with over $1.14 of FCF per share, and
- Can’t we work something out?
Southeastern appears to have a basis in Dell north of $20, so, y’know, they would say that Dell is worth more than $13.65.1 But: who cares? Southeastern gets a vote like everyone else does; the merger agreement requires a majority of the non-Michael-Dell shareholders to approve the deal but preliminary nose-counting suggests that, between index funds and merger arbs and others not anchored in the $20s, they’ll probably get there.
What is Southeastern up to? Their proposed dividend-recap solution, in which a standalone Dell would increase its shareholder value through the magic of financial engineering, may or may not work,2 but that’s mostly irrelevant: it’s hard to imagine the board changing its mind now and deciding that standalone engineering is superior to this LBO. For one thing: that is the sort of thing that boards obviously consider before agreeing to an LBO, so presumably they had a reason for rejecting it. For another: if Dell decides now, as opposed to last week, that a dividend recap is the way to go, it’ll owe Silver Lake $450mm in termination fees. That’s the sort of expensive change of heart that makes a board look really bad – and that alone is reason enough to be pretty sure that idea will never fly.
Which is not to say Southeastern doesn’t score some good points. I was moved by this: Read more »
Perhaps, you thought, that the day Vikram Pandit was abruptly and unceremoniously fired from Citigroup was the end. That we’d lost him for good. That he’d retreat to the his Upper West Side manse and spend his days beefing up his Odd Couple memorabilia collection, or work on that novel about a love that dare not speak its name between a bank CEO and the analyst who only acted like she hated him, or build that Zen garden he’d always wanted that the fucks at Citi never let him have. That he was finished with Wall Street. Well fret not. Uncle Vik wouldn’t never do that to you. Read more »