A Good Private Equity Blog

Thanks to Analyst Forum (one of my regular stops), I just came across a pretty good blog on Private Equity called The Private Equiteer. It has a lot of posts that go through the basics of the private equity world (here's a list of many of them).

I'm adding it to the blogroll.

I Didn't Know Godzilla Managed A Private Equity Fund

You're gotta love an ad that uses old Godzilla footage to slam PE firms - if just for the sheer shlock factor (say that three times fast...).

I was curious about the McCain reference in the video (it seemed to come out of nowhere). Then I checked and found out that the ad was paid for by the Service Employees International Union. Like most other unions, they're big Obama supporters. In fact, they were just mentioned in Wednesday's Wall Street Journal (unfortunately, I can't find a link to the piece just yet).

It's a pretty interesting mishmash of messages with a populist slant. It starts off with the obligatory gas pump picture (the economy is hard, and it's the fault of the eeeeeevil buyout firms) , and then shifts to say that there's a group of people who make millions and slash jobs. And worse yet, /sarcasm on/ they get tax breaks for doing it! /sarcasm off/

So, I guess the message to take from this is that gas prices are high, the economy is tanking, and it's all the fault of buyout firms with tax breaks.

But at least it was educational - I didn't realize John McCain and people at PE firms could breathe fire. That alone would be enough to get them my vote (if just for the coolness factor). Hey - if the Presidential campaign doesn't work out and McCain gets tired of the Senate, he could get a job in commercials.

Do PE Firms Manage Portfolio Firms, or Just Manipulate Balance Sheets?

PE firms often are described as nothing more than financial engineers - according to their detractors, they buy firm, load them up with debt, pay out recapitalization dividends, and leave lifeless, over levered shells.

Or do they?

A couple of reports by accounting firm Ernst & Young over the last two years give some indications otherwise. According to a summary of last year's report published in the Wall Street Journal's Deal Journal:

Ernst & Young found that the average enterprise value of the companies studied in both Europe and U.S. jumped more than 80% from the time they were acquired. The growth in enterprise value was driven in part by the fact that private-equity-owned companies achieved faster profit growth, two-thirds of which came from business expansion — while a third in Europe — and 23% came from cost reductions.

What does that mean for jobs? The study found that employment was at the same or higher level at the time of exit in 80% of U.S. buyouts and 60% of European buyouts. In the United Kingdom, France and Germany, where fears that the industry will slash jobs has spurred strong opposition and scathing criticism, employment at businesses owned by private-equity firms rose 5% annually. That compares to 3% for equivalent publicly traded companies.

And, in a summary of this year's E&Y report (again in Deal Journal):

...companies being sold off by private-equity firms increased in enterprise value at an annual compound rate of 24% during the time they were in a PE firm’s portfolio, double the rate of comparable publicly traded companies. Buyout firms also increased the earnings before interest, taxes, depreciation and amortization of these portfolio companies 33% faster than their publicly traded counterparts did. Finally, these companies had productivity levels 33% higher than publicly traded company benchmarks.

The out performance wasn’t confined to a specific geographic region or particular industry. Private-equity-owned businesses outperformed their publicly traded counterparts in almost every sector and market as well.

I'd take the result with at least a little grain of salt, though. One reason is that the report was done on "successful" PE deals - those companies taken private that were eventually brought public again in a subsequent IPO. These are likely to be the ones with the biggest increases in market value, and the ones that had the best overall performance (unsuccessful portfolio companies don't get taken back public down the road). So, the results most likely overstate the performance of LBO firms.

Second, there's a big agency problem inherent with the report. E&Y did this report for the PE industry. Since they get a significant amount of fees from doing transactions advisory work (due diligence, forensic accounting, etc...), they have a vested interest in keeping their client companies (i.e. the PE firms) happy. So, there are some biases that could be present in the report (What, the accounting firm could be biased, I'm shocked. Shocked, I say!).

Read Deal Journal's article on last year's report here and on this year's report here.

So what does this mean? That in at least SOME cases, PE firms create value by making substantive operational changes that increase the quality of the portfolio company's business. In other words, they're not "just" restructuring the right hand side of the balance sheet.

Looks like another piece for class...

Sunday Link Dump - More on PE and Hedge Funds

The semester continues its march to the last day of classes (I have a total of 7 teaching days left until finals). So, I'm in my office on a Sunday getting ready for the final push. I leave for the Eastern Finance Association Meetings in New Orleans Wednesday after class, so I have to get a bit ahead of things (I still haven't written my quiz for my sub, or finished my presentation, or even started on my discussants comments).

So while I toil away, here are three links (again, on hedge funds and PE firms - I seem to be in a rut) to keep you busy:

All About Alpha interviews Tom Schneeweis of UMASS on hedge funds, alpha, and risk. Here's the money quote: "I really do believe that most hedge fund managers want to believe they are wizards. When in reality, all they are doing is accepting certain types of risk. "

According to this Fortune magazine article on the distribution of PE firms, the majority of PE funds are well under$1 Billion in size - in fact, the average fund (once the top ten are excluded) has an average size of $180 million, if you don't count the top 10 firms.

Here's an overview of hedge funds (in PDF format), compliments of Michael Covel.

Enough blogging - my grading beckons.

Thursday Link Dump

The last couple of posts have been humorous (or at least, in some cases, tasteless), so I guess it's time for a link dump.

Private Equity & Hedge Funds
First off, there are a troika of pieces on PE-bond relationships: Accrued Interest breaks down the implications of takeovers for bondholders, Floyd Norris at NY Times discusses how debt is used to fund payouts in PE deals, and Marketwatch relates the woes of bondholders in LBOs.

Via FT Alphaville: activist hedge funds are using the Web to convince shareholders to their way of thinking.

According to this Financial Times piece, Hedge Funds are taking positions in bankrupt firms.

Curious about who the big dogs are in the PE worked? LBO wire reports.

Investments
Felix Salmon discusses "Debt arbitrage". He's been writing some great pieces lately - time to update my links.

Mark Hurlbert at presents the latest insider buy/sell ratios - they're still mildly bullish.

New York Magazine has a (fairly typical) piece on how top executives are making TOOOO MUUUCCCHHH MONEY (both coming and going).

MarketBeat reports on "accelerated share repurchases.

Barry Ritholtz at The Big Picture presents a bit of a history lesson and examines Historical Bear Market Contractions

CXO Advisory Group reports on some interesting pieces. One describes historical patterns of the value premium (the additional return earned by high book/market firms over their low book/market peers), and another examines factor models and finds that "A model combining market return, liquidity and coskewness ... explains individual stock returns in 35 out of 40 years.

Humor
Joe Carter has his latest installment of the Yak Shaving Razor series up at Evangelical Outpost.

Craig Newmark links to a corporate finance version of the old "you have two cows" joke.

Enough blogging - I've cleared out my bloglines account, and it's time to get back to something productive.

Friday/Spring Break Link Dump

It's the last day at Unknown University before Spring Break. I have one class to teach at 11, but it's a minimal prep, since it's on Modern Portfolio Theory, a topic that takes little prep (I've taught it many times). In addition, it's snowing outside to beat the band, so the over-and-under bet for attendance in today's class (it's at 11, so the little darlings can sleep in) is about at 50%.

I realized I haven't been doing as many Link Dumps as usual lately, so here's one to keep you busy while I get something productive done:

Private Equity:

Equity Private at Going Private gives a response to the folks who are predicting the imminent demise of the PE party. The link's about a week old, but since the same story keeps popping up, you an just reread it periodically.

And in a somewhat related piece, Business Week highlights some smaller PE shops that don't generate the same publicity as the big boys. They nevertheless make very nice returns for their investors by focusing on smaller deals.

Investing & Markets:

Barry Ritholtz of The Big Picture and Davig Gaffen of MarketBeat comment on the role buybacks play in market returns.

CXO Advisory Group highlights three studies by Keith Anderson and Chris Brooks on approaches to adjusting P/E ratios. They find that the value-growth premium ( the amount by which low P/E outperform high P/E stocks) widens when they sort by adjusted P/E ratios rather than by "raw" ones.

10B-1 plans are intended to be essentially "insider stock sales on autopilot." They're a way for insiders to sell shares on a prearranged schedule and thereby avoid the taint of "informed trading". BusinessWeek reports on a recent study by Stanford Accounting Professor Alan Jagolinzer that provides evidence that insiders use these plans to exploit private information after all. It seems the SEC is now investigating these plans.

Brad Setser at REG Monitor links to a primer on some of the CDO and CDS (i.e. collateralized debt securities) products.

Trader Mike provides a list of short/inverse ETF's. For the uninitiated, these are essentially short (and sometime) leveraged bets on common indexes.

Miscellaneous:

It's always great when you can find a freeware program that's useful. But navigating some freeware sites can be a pain. Sound Money Tips links to a couple of helpful and well organized sites.

Craig Newmark found a link that provides origins of the names of rock bands.

Enough bloggery for now. It's back to editing a paper. We hope to get it done and submitted this weekend. Then it's on to newer projects. In particular, I've got loads of analyst forecast data to torture.

It's like Torquemada said: "Give me an hour with a man in a room and I can make him confess to anything".

Update: Unknown University just cancelled classes because of the snow. Woo Hoo!

Friday Link Dump

It's been an interesting day at Unknown University. We had a huge storm blow through, and there was flooding in many buildings around campus. Unfortunately, one of the buildings housed the university servers, and they had to shut down before there were short circuits that could really mess things up. As a result, they cancelled afternoon classes, and I've had no internet access all day. In any event, there have been a few interesting things that came across my bloglines account, so I thought I'd post a Link Dump before I turned in for the night.

At the Super Returns PE conference, someone asked a number of PE bigwigs what keeps you up at night worrying. Dealbook reports their answers.

Barry Ritholtz at The Big Picture put up some very nice analysis of of issues surrounding Tuesday's big stock market decline. And in a related piece, he presents the Top Ten Myths of Tuesday's Correction.

Greg Mankiw's top-selling economics principles text is centered around Ten Principles of Economics. Yoram Bauman (the world's only "stand-up economist") gives the unofficial, humorous version in this video.

The Wall Street Journal (online subscription required) reports on a large insider-trading scheme involving over a dozen individuals at investment banking firm UBS AG and several hedge funds.

That's all for now, folks.

The Private Equity and Academic Research Link Dump

It's been a while since I did a proper link dump, so it's time to clean out the buffer. I teach CFA again tonight, so I have to leave shortly and prepare. But in the meanwhile, here are some links for your reading pleasure. As usual, they're heavy on Private Equity and Academic research:

Hedge Fund and Private Equity
Mark Hulbert discusses the effectiveness of hedge fund activism in the New York Times (online subscription required).

In a related piece, Equity Private at Going Private is blogging on the relations between Private Equity and Shareholder Activists. The Cliff Notes version (but definitely read the whole thing) is that the two groups have a lot of overlap, but also provide different mechanisms for resolving agency problems.

Texas Pacific Group's founding partner David Bonderman made some opening comments at today’s Super Return 2007 private equity conference in Frankfurt

Academic Research
Green, Jegadeesh, and Tang (three finance profs at Emory University) examine the performance of men vs. women analysts in Gender and Job Performance: Evidence from Wall Street. Dang - another piece I wish I'd written.

Fama and French have just written another interesting piece on the size and market-to-book effects titled "Migration. They study ..."how migration of firms across size and value portfolios contributes to the size and value premiums in average stock returns. The size premium is almost entirely due to the small stocks that earn extreme positive returns and as a result become big stocks. The value premium has three sources: (i) value stocks that improve in type either because they are acquired by other firms or because they earn high returns and so migrate to a neutral or growth portfolio; (ii) growth stocks that earn low returns and as a result move to a neutral or value portfolio; and (iii) slightly higher returns on value stocks that remain in the same portfolio compared to growth stocks that do not migrate." HT: Jim Mahar at Financeprofessor.com

Finally, Boudoukh, Michaely, Richardson, and Roberts have a forthcoming Journal of Finance piece titled "On the Importance of Payout Yield". They find that "...the widely documented decline in the predictive power of dividends for excess stock returns is due largely to the omission of alternative channels by which firms distribute and receive cash from shareholders. Statistically and economically significant predictability is found in the time series when payout (dividends plus repurchases) and net payout (dividends plus repurchases minus equity issuances) yields are used instead of dividend yield."

That should keep ya busy. Time to catch my train.

You can pick your frends, you can pick your nose, and you can PIK your bonds

Wednesday's WSJ had a very interesting piece on "PIK " or "Payment In Kind" bonds, titled "What's Aiding Buyout Boom: Toggle Notes." It's perfect to bring into the classroom if you're teaching about capital structure, M&A, financial engineering, or derivatives.

For the unitiated, a payment in kind toggle (I'll just call them PIK bonds from here on out) bond gives the issuer the option of not paying coupon payments. If they exercise the option (i.e. "flip the toggle"), the liability for the missed payments payments accrues (at an interest rate higher than the coupon rate) and is repaid at maturity. The article notes the recent PIK bond issued in the takeover of Neiman-Marcus - it has a 9% coupon, and a 75 basis point higher (i.e. 9.75%) rate on "toggled" payments.

In a Miller and Modigliani 1958 world, there aren't any costs to financial distress. In the real world, there are serious consequences to missing a coupon payment. Even more, actions taken to avoid this eventuality can cause distortions in firms investment and disclosure activities. So PIK bonds are a creative financial engineering solution to the problem.

It's not surprising that PIK toggle bonds have been seen mostly in the PE world. These deals end up highly leveraged. So, there's a significant risk that a target firm could get driven under by an external shock completely out of their control (the article uses 9-11 as an example). And the "insurance" seems pretty cheap at 75 basis points.

It's also interesting in terms of how you'd price the option. Since the option would be exercised if the firm was underwater on its debt payments, it's actually an option on the cash flows of the firm rather than on a traded security. Since the issuing firm has a much better feel for those numbers than the credit markets do, there should be a significant adverse selection problem with these securities. My guess is that the insurance (the 75 b.p. spread on the toggled payments) will turn out to be way too low.

There's some good commentary on the topic from the usual suspects: Abnormal Returns has a nice roundup of PE/credit related posts, and Going Private analyzes the effects of PIK financing on the PE firms equity returns.

And if you have no clue about what a PE firm is and does, here's a pretty good video primer on Private Equity from CNNMoney.com

Thursday Link Dump

It's been a good week. I'm slowly getting over the creeping crud in my lungs, my classes are on track, and some exciting things are happening at Unknown University. A number of my undergrads are interested in forming a self-study group in the fall to work towards taking the CFA Level 1 exam in December. The dean has agreed to provide funding for both the required reading AND a set of the self-instructional materials from one of the major vendors --we're in the process of redesigning our finance curriculum to bring it more in line with the CFA program, and this fits perfectly. So, I may end up the unofficial advisor to the newest student organization in the college.

In the meanwhile, here are a few links to keep you busy and off the streets (bedsides -- it's too damn cold up here to go outside):

Flexo at Consumerism Commentary posted about a guy who's made some money suing telemarketers in small claims court. I love the idea.

Dealbook questions whether initial PE buyout bids are being raised or not. And in a related piece, BusinessWeek.com notes that competing bids seem to be on the rise.

The math department at Polytechnic University has some great advice on how to solve problems. They're right on the money for finance students as well as for math students. (HT: Craig Newmark).

Given that I finally have some energy, I decided not to waste any more of it today on blogging. So enough blogging - time to do some research.

Tuesday Link Dump - The Merger and Private Equity Edition

I've been a little lax in blogging lately, but I'm still on the mend from the pneumonia. I'm still not anywhere near back to full capacity (and from what I've heard, I won't be for a while), but at least I'm on the mend. I now only have coughing fits mostly in the morning and late evening.
From what I've heard, this thing can take 4-6 weeks to completely beat.

For some reason, the articles that have caught my eye lately have been mostly related to M&A and PE topics. So, I'll just call this the M&A and PE edition of the Link Dump:

TheStreet.com has some interesting stock filters. In one, they screen for takeover candidates - firms with high price/cash flow multiples and low debt ratios.

A recent WSJ article chronicles how bondholders are bargaining more intensely for a bigger piece of the premiums in PE transactions in Bondholders Fight Back

In another PE-story, CNNMoney.com asks if there's a "private equity backlash".

James Altucher at TheStreet.com has a very nice primer on merger arbitrage (HT: Abnormal Returns)

Finally, the NY Times Online asks the question "Should You Buy When the Smart Money Sells?". The piece discusses the returns investors have historically made from "seasoned" IPOs - IPOs of companies that were taken private and then subsequently taken public a while later.

Time to get back to work - I've got a lot of catching up to do since I got almost nothing done last week.

A Review of Sarbanes Oxley

Financeprofessor.com recently highlighted this article in Financial Engineering Today titled "Sox It To Them.

It first lists many of the new requirements under the law, such as increased auditor independence, bans on auditors doing certain types of other work for audit clients, CEO & CFO certification of financial reports, accelerated reporting of insider trades, and so on.

However, the most interesting part of the article is its questioning of the commonly held belief that SOX imposed excessive implementation costs on companies.

There is some evidence that going-private transactions increased in the post-SOX period. For example, see this piece by Engel, Hayes, and Wang, titled"The Sarbanes-Oxley Act and Going Private Transactions."