Forbes reports that two private equity firms, Silver Lake and TPG Capital, have agreed to purchase Avaya. While the purchase price of $8.2 billion or $17.50 per share isn't much of a premium to that market price of approximately $17.00, Avaya has been a lackluster business for several years now. The communications equipment maker has been cited as a potential takeover target due to an attractive balance sheet with lots of cash and little debt. Of course the business has struggled to actually make any money since Lucent Technologies blew a gasket at the end of the Dot Bomb.
Communications equipment makers are in a highly cyclical business. As a technology spending cycle waxes and businesses build capacity, high profits flow to almost anyone in the sector. Yet the inevitable waning the follows can destroy the profits of even industry leaders. The tremendous oversupply of communications bandwidth that built up over the course of the last technology boom is only now being fully utilized. Key industry figures see the new media trend toward serving video over the Internet as a sufficiently bandwidth intensive offering to justify building out a new generation of infrastructure.
Private equity players typically aren't investing solely to build upon the businesses they purchase. Avaya's relatively unleveraged balance sheet offers any buyer willing to use significant debt a guaranteed profit.
Like in the case of many other deals initiated by private equity firms, investors in Avaya are concerned that Silver Lake and TPG Capital are underpaying for the company, so the deal has a clause that allows Avaya to solicit competing proposals for the next fifty days.
While there is no evidence of collusion among private equity firms to avoid bidding wars and potentially save billions, even a highly informal understanding to avoid such risky bidding would serve the interests of private equity very well indeed.
Showing posts with label Private Equity. Show all posts
Showing posts with label Private Equity. Show all posts
Wednesday, June 6, 2007
Saturday, May 26, 2007
China Shortchanges Its Poor
The IHT reports that while China is expected to continue its unprecedented streak of double digit economic growth, the communist nation has neglected vital social programs. The Organization for Economic Cooperation and Development issued a report that noted China's surging tax revenues have been outrunning growth in social spending. In particular, China has been engaging in a significant arms buildup aimed at Taiwan that has diverted tremendous resources from the rural poor.
The OECD predicts that China's surging exports will create an even larger trade surplus next year than its current record levels. This has enormous implications in the form of China's massive foreign reserves. Because the country has been sopping up excess liquidity by building foreign exchange reserves to prevent foreign direct investment from creating inflation, China has more than $1.2 trillion in foreign exchange.
China has recently committed itself to investing $3 billion in a US private equity group and talks about creating a national investment firm to invest its foreign exchange abroad in order to acchieve a higher rate of return.
China is an emerging economy with tremendous monetary resources. Nonetheless, in a country with hundreds of millions of people barely above subsistence levels, China could surely direct those resources more profitably toward its own citizens.
The OECD predicts that China's surging exports will create an even larger trade surplus next year than its current record levels. This has enormous implications in the form of China's massive foreign reserves. Because the country has been sopping up excess liquidity by building foreign exchange reserves to prevent foreign direct investment from creating inflation, China has more than $1.2 trillion in foreign exchange.
China has recently committed itself to investing $3 billion in a US private equity group and talks about creating a national investment firm to invest its foreign exchange abroad in order to acchieve a higher rate of return.
China is an emerging economy with tremendous monetary resources. Nonetheless, in a country with hundreds of millions of people barely above subsistence levels, China could surely direct those resources more profitably toward its own citizens.
Friday, May 18, 2007
DaimlerChrysler Deleveraging as Private Equity Ramps Up
Reuters reports that DaimlerChrysler's CFO Bodo Uebber has announced that the company will significantly reduce its use of corporate debt. At a time when private equity group Cerberus is using enormous debt to leverage its commitments to Chrysler, DaimlerChrysler is moving in the exact opposite direction.
Just how much does DaimerChrysler plan to reduce its reliance on commercial paper? Almost completely. The company will not issue bonds "in the quarters ahead". Daimler AG, as the company will be known once the Chrysler sale is complete, is making a strange decision.
The price of corporate debt is quite low and doesn't appear to be rising in the near term. Companies that engage in leveraged buyouts, like Cerberus and KKR, are on a tear making investments in otherwise uninspiring companies based almost entirely on their observation that those companies are under-leveraged.
MBA students around the world have long learned how to calculate the appropriate balance between equity and debt that maximizes the profits of shareholders, yet companies have consistently been far more financially conservative than those calculations suggest they should be. Of course, their are other costs associated with taking on excessive debt that cannot be expressed in purely financial terms. Many wealthy individuals are uncomfortable with taking on significantly more risk by increasing the debt of their businesses.
Still, the rewards of leverage remain clearly visible in the new leveraged buyout firms that are remaking the business world. DaimlerChrysler is making a decision to reduce its risk profile at a time when much of the smart money is betting in the opposite direction. Only time will tell who is right.
Just how much does DaimerChrysler plan to reduce its reliance on commercial paper? Almost completely. The company will not issue bonds "in the quarters ahead". Daimler AG, as the company will be known once the Chrysler sale is complete, is making a strange decision.
The price of corporate debt is quite low and doesn't appear to be rising in the near term. Companies that engage in leveraged buyouts, like Cerberus and KKR, are on a tear making investments in otherwise uninspiring companies based almost entirely on their observation that those companies are under-leveraged.
MBA students around the world have long learned how to calculate the appropriate balance between equity and debt that maximizes the profits of shareholders, yet companies have consistently been far more financially conservative than those calculations suggest they should be. Of course, their are other costs associated with taking on excessive debt that cannot be expressed in purely financial terms. Many wealthy individuals are uncomfortable with taking on significantly more risk by increasing the debt of their businesses.
Still, the rewards of leverage remain clearly visible in the new leveraged buyout firms that are remaking the business world. DaimlerChrysler is making a decision to reduce its risk profile at a time when much of the smart money is betting in the opposite direction. Only time will tell who is right.
Sunday, May 13, 2007
Chrysler Buyout Saga Continues
Reuters reports that private equity firm Cerberus Capital Management LP is now DaimlerChrysler AG's preferred buyer for its Chrysler assets. This significant information, from people willing to talk to the Detroit News, suggests a shift in interest from the formerly preferred Magna International, a Canadian auto parts maker. The shift is significant because until recently, one of the primary differences between the competing bids was that Cerberus was willing to give the current management and employees a large ownership stake in the firm. Yet just on Thursday, Magna indicated that it was also willing to make similar concessions.
Since no official announcement has been made, this shift might be only the outward reflection of negotiations that occurred quite a while ago or even a complete fabrication designed to somehow influence the strength of the competing bids.
Nonetheless, one unmistakable view of the shift away from the traditional auto business buyer to a private equity concern is that DaimlerChrysler is responding to the continuing weakness of the American automakers. Private equity has recently taken on the role of buyer of last resort in the larger equity markets, snapping up companies that otherwise look sickly to industry insiders. If the Germans have come to the conclusion that management is sufficiently unable to right the ship at Chrysler, they must see the ability of private equity concerns to create additional value by dramatically increasing the leverage of Chrysler as a big plus.
The important thing to remember is that private equity concerns like Cerberus lack the industry specific knowledge of players like Magna have. They also tend to adopt a decidedly mid-term view, planning to sell the company in about five years. Running an organization the size of Chrysler is less akin to driving a lawnmower and more akin to driving a battleship in terms of its turning radius. It might take five years to turn the business around under the best of circumstances.
Last quarter Chrysler was the only major American automaker to keep its head above water. Ford and GM are in free fall and Toyota is seemingly unstoppable. Yet just a recently as 2005, Toyota recalled more vehicles than it sold. The American auto consumer is a fickle beast and winning today is no guarantee of winning tomorrow.
Since no official announcement has been made, this shift might be only the outward reflection of negotiations that occurred quite a while ago or even a complete fabrication designed to somehow influence the strength of the competing bids.
Nonetheless, one unmistakable view of the shift away from the traditional auto business buyer to a private equity concern is that DaimlerChrysler is responding to the continuing weakness of the American automakers. Private equity has recently taken on the role of buyer of last resort in the larger equity markets, snapping up companies that otherwise look sickly to industry insiders. If the Germans have come to the conclusion that management is sufficiently unable to right the ship at Chrysler, they must see the ability of private equity concerns to create additional value by dramatically increasing the leverage of Chrysler as a big plus.
The important thing to remember is that private equity concerns like Cerberus lack the industry specific knowledge of players like Magna have. They also tend to adopt a decidedly mid-term view, planning to sell the company in about five years. Running an organization the size of Chrysler is less akin to driving a lawnmower and more akin to driving a battleship in terms of its turning radius. It might take five years to turn the business around under the best of circumstances.
Last quarter Chrysler was the only major American automaker to keep its head above water. Ford and GM are in free fall and Toyota is seemingly unstoppable. Yet just a recently as 2005, Toyota recalled more vehicles than it sold. The American auto consumer is a fickle beast and winning today is no guarantee of winning tomorrow.
Wednesday, May 9, 2007
Venture Alliance Partners - A New Force in Private Equity
Private equity has been on a roll recently, but navigating this sector requires exceptional management. The tremendous growth of hedge funds and other "alternative investments" has driven large amounts of capital toward many obvious investments, driving valuations out of the range of profitable acquisition.
Venture Alliance Partners is a company with a strong commitment to the values that initially attracted so much capital to this sector in the first place. With an emphasis on exit strategy and knowing how to monetize the next great idea, the company is poised to grow going forward.
Silicon Valley is starting to regain some of its luster, but the giddy days of endless profits are over. Intelligent investors would favor an alternative that recognizes the danger of fads and knows how to avoid the pitfalls. Venture Alliance Partners is ready to ride the trend without following anyone else off the cliff.
Venture Alliance Partners is a company with a strong commitment to the values that initially attracted so much capital to this sector in the first place. With an emphasis on exit strategy and knowing how to monetize the next great idea, the company is poised to grow going forward.
Silicon Valley is starting to regain some of its luster, but the giddy days of endless profits are over. Intelligent investors would favor an alternative that recognizes the danger of fads and knows how to avoid the pitfalls. Venture Alliance Partners is ready to ride the trend without following anyone else off the cliff.
Monday, May 7, 2007
Excess Liquidity and the Leveraged Buyout Boom
The IHT reports that some of the private equity firms which depend on access to cheap credit with few strings are complaining about an excess of liquidity. While precise measures of liquidity are prone to error, it is clear that the amount of liquidity has been increasing rapidly. The Bank of England estimates that liquidity has doubled in the last four years.
The high price of oil, which shifts enormous resources away from the developed world to oil sheiks in the Middle East, has further exacerbated the liquidity troubles. And at least until now, China's trade surplus has gone largely uninvested. When China decides to mobilize its capital in the global markets, this will further spread liquidity.
Liquidity by itself is not a bad thing. Quite the reverse, many good investments in the past have gone unmade because of a lack of liquidity. But as the subprime mortgage market recently demonstrated, easy money leads to loose credit practices. The mortgage market is unique in its general low level of risk, but capital investments and leveraged buyouts can be very high risk. When cheap credit is extended largely without conditions, many more loans are extended than would be accepted otherwise.
Even the private equity firms themselves are concerned about the easy credit markets because competitors are encouraged to step in and bid up the price of acquisitions. These more expensive, more heavily leveraged investments then become much more risky and investors become less likely to profit.
Ironically, the Fed's chairman Ben Bernanke is currently receiving public pressure to lower interest rates in order to spur growth during a period of excess liquidity. In this environment, Bernanke is likely to leave interest rates alone for the seventh straight meeting. This will probably leave him looking indecisive and reduce his credibility in the short term, but the alternative is even worse. Bernanke can't give in to market pressures even if he will be praised in the short term.
Leveraged buyouts are fueling much of the mergers and acquisitions activity driving the stock market higher these days. The leverage is cheaper than ever thanks to excess liquidity. The liquidity would be fine in isolation, but unfortunately it is accompanied by loosened lending standards. Interest rates aren't likely to resolve the problem anytime soon, in spite of the housing bust. Hopefully the private equity gurus will have the intelligence to proceed cautiously. But don't hold your breath.
The high price of oil, which shifts enormous resources away from the developed world to oil sheiks in the Middle East, has further exacerbated the liquidity troubles. And at least until now, China's trade surplus has gone largely uninvested. When China decides to mobilize its capital in the global markets, this will further spread liquidity.
Liquidity by itself is not a bad thing. Quite the reverse, many good investments in the past have gone unmade because of a lack of liquidity. But as the subprime mortgage market recently demonstrated, easy money leads to loose credit practices. The mortgage market is unique in its general low level of risk, but capital investments and leveraged buyouts can be very high risk. When cheap credit is extended largely without conditions, many more loans are extended than would be accepted otherwise.
Even the private equity firms themselves are concerned about the easy credit markets because competitors are encouraged to step in and bid up the price of acquisitions. These more expensive, more heavily leveraged investments then become much more risky and investors become less likely to profit.
Ironically, the Fed's chairman Ben Bernanke is currently receiving public pressure to lower interest rates in order to spur growth during a period of excess liquidity. In this environment, Bernanke is likely to leave interest rates alone for the seventh straight meeting. This will probably leave him looking indecisive and reduce his credibility in the short term, but the alternative is even worse. Bernanke can't give in to market pressures even if he will be praised in the short term.
Leveraged buyouts are fueling much of the mergers and acquisitions activity driving the stock market higher these days. The leverage is cheaper than ever thanks to excess liquidity. The liquidity would be fine in isolation, but unfortunately it is accompanied by loosened lending standards. Interest rates aren't likely to resolve the problem anytime soon, in spite of the housing bust. Hopefully the private equity gurus will have the intelligence to proceed cautiously. But don't hold your breath.
Sunday, May 6, 2007
Private Equity Pursuing Music Giant EMI
Reuters reports that three American private equity firms, namely Fortress, Cerberus, and One Equity, are all interested in paying something in the vicinity of $6 billion for the British music group EMI. The entry of significant private equity dollars indicates a major shift from as recently as March, when EMI rejected a $4.2 billion bid from Warner Music.
EMI is one of the world's largest music companies but the industry has faced difficulties adjusting to the presence of digital distribution and the resulting ease of stealing its product. While Napster has been vanquished and reincarnated within just a few years as a legitimate distribution channel, the development of countless clones with technology designed to avoid legal challenges indicates the ultimate weakness of the business.
Downloading music illegally is getting easier all the time, and the potential to download higher value products like movies is increasing the returns to mounting this diminishing learning curve. The music industry's attempts at digital rights management, or DRM, have been a titanic failure. In addition to failing to prevent any reasonably dedicated teenager from getting a hold of music, the whole process has had the effect of creating an adversarial relationship with customers.
EMI has been underperforming its industry over the past few years and has actually lost money in the last quarter. Given the profitability of the rest of the industry, even as it struggles with change, this indicates EMI's management is not up to the task of answering the digital challenge.
All of this clearly begs the question: "Why is EMI suddenly worth so much money?" The better question is: "Why would private equity firms be willing to pay significantly more than music industry insiders for the company?" The answer seems to be that music industry insiders are focusing on the unique value proposition of the underlying business while private equity gurus are more concerned with the balance sheet.
The music business may not be what it once was, but significant revenues are a certainty for the foreseeable future. At the same time, the recent spate of private equity firms engaging in leveraged buyouts across numerous industries with widely different businesses and risk profiles seems to indicate that relative to the price of capital, most publicly traded companies are insufficiently leveraged. EMI is a giant business that has lost its way. The company is losing ground, but that actually makes it a more compelling takeover target.
By taking a company with essentially no debt and leveraging it to the maximum, the Americans plan to take value stored in the enterprise itself and cash out quickly. EMI is slowly sinking, but it isn't drowning. A quick turnaround could net substantial returns on resale in five years when the company has returned to profitability.
Experts know their area of expertise and not much more. Music industry insiders see a floundering giant, but private equity sees untapped potential. Only time will tell if the money that private equity can squeeze out of a leveraged buyout will outweigh the loses at EMI's main business.
EMI is one of the world's largest music companies but the industry has faced difficulties adjusting to the presence of digital distribution and the resulting ease of stealing its product. While Napster has been vanquished and reincarnated within just a few years as a legitimate distribution channel, the development of countless clones with technology designed to avoid legal challenges indicates the ultimate weakness of the business.
Downloading music illegally is getting easier all the time, and the potential to download higher value products like movies is increasing the returns to mounting this diminishing learning curve. The music industry's attempts at digital rights management, or DRM, have been a titanic failure. In addition to failing to prevent any reasonably dedicated teenager from getting a hold of music, the whole process has had the effect of creating an adversarial relationship with customers.
EMI has been underperforming its industry over the past few years and has actually lost money in the last quarter. Given the profitability of the rest of the industry, even as it struggles with change, this indicates EMI's management is not up to the task of answering the digital challenge.
All of this clearly begs the question: "Why is EMI suddenly worth so much money?" The better question is: "Why would private equity firms be willing to pay significantly more than music industry insiders for the company?" The answer seems to be that music industry insiders are focusing on the unique value proposition of the underlying business while private equity gurus are more concerned with the balance sheet.
The music business may not be what it once was, but significant revenues are a certainty for the foreseeable future. At the same time, the recent spate of private equity firms engaging in leveraged buyouts across numerous industries with widely different businesses and risk profiles seems to indicate that relative to the price of capital, most publicly traded companies are insufficiently leveraged. EMI is a giant business that has lost its way. The company is losing ground, but that actually makes it a more compelling takeover target.
By taking a company with essentially no debt and leveraging it to the maximum, the Americans plan to take value stored in the enterprise itself and cash out quickly. EMI is slowly sinking, but it isn't drowning. A quick turnaround could net substantial returns on resale in five years when the company has returned to profitability.
Experts know their area of expertise and not much more. Music industry insiders see a floundering giant, but private equity sees untapped potential. Only time will tell if the money that private equity can squeeze out of a leveraged buyout will outweigh the loses at EMI's main business.
Thursday, May 3, 2007
Murdoch Bids for Dow Jones and the Wall Street Journal
Businessweek reports that Rupert Murdoch's News Corp. has offered a hostile bid for control of Dow Jones and Co., the financial information powerhouse, with a massive 66% premium. Most analysts covering Dow Jones business empire, which includes the Wall Street Journal, were previously under the impression that the company was fully valued at its old price of just $36 per share. That Murdoch was willing to offer $60 a share for a company firmly entrenched in the dwindling print media is astonishing.
Murdoch's high offer for the company will likely prevent most private equity companies from offering competing bids because even with the use of extensive leverage, it seems unlikely that the company could be flipped within a decade at a substantial profit. The beauty of Murdoch's bid is that the prospect of integrating the Wall Street Journal with his existing media assets at Fox and his upcoming Fox Business channel makes the company worth substantially more to him that to any other conceivable rival. The only competitor with the deep pockets necessary to fight back in a bidding war is GE/NBC which could engage in purely defensive bidding to try to protect its valuable CNBC franchise. Not very many people watch business news on CNBC, but the wealthy audience is an advertiser's dream and the resultant profits make it one of NBC's more valuable properties.
The only thing standing in the way of Rupert Murdoch is the family with a controlling share of ownership in Dow Jones and Co. The Bancroft family has made use of their two-tier ownership structure to resist many previous bids for control of the company. The company is structured in such a way that while the family does not own the majority of the company, their shares have extra voting power which makes their acceptance of any deal crucial. Nonetheless, not all of the Bancroft family is opposed to the bid and the prospect of an increased bid seems likely to convince enough younger family members to sell. The sale has provoked intense interest across the media because of its implications for the value of many other media properties. With print circulation in free-fall, if Murdoch can find a web-based strategy to leverage the "old media" into the future, he could save the fourth estate.
Of course, whether or not Murdoch succeeds in purchasing the Wall Street Journal is beside the point. The print media is dying as society simultaneously loses interest and moves online. The old subscription model of payment which enriched the newspaper business for so long must give way to a solely advertisement based system. In an era where information is free, eyeballs are still worth a fortune to advertisers.
Murdoch's high offer for the company will likely prevent most private equity companies from offering competing bids because even with the use of extensive leverage, it seems unlikely that the company could be flipped within a decade at a substantial profit. The beauty of Murdoch's bid is that the prospect of integrating the Wall Street Journal with his existing media assets at Fox and his upcoming Fox Business channel makes the company worth substantially more to him that to any other conceivable rival. The only competitor with the deep pockets necessary to fight back in a bidding war is GE/NBC which could engage in purely defensive bidding to try to protect its valuable CNBC franchise. Not very many people watch business news on CNBC, but the wealthy audience is an advertiser's dream and the resultant profits make it one of NBC's more valuable properties.
The only thing standing in the way of Rupert Murdoch is the family with a controlling share of ownership in Dow Jones and Co. The Bancroft family has made use of their two-tier ownership structure to resist many previous bids for control of the company. The company is structured in such a way that while the family does not own the majority of the company, their shares have extra voting power which makes their acceptance of any deal crucial. Nonetheless, not all of the Bancroft family is opposed to the bid and the prospect of an increased bid seems likely to convince enough younger family members to sell. The sale has provoked intense interest across the media because of its implications for the value of many other media properties. With print circulation in free-fall, if Murdoch can find a web-based strategy to leverage the "old media" into the future, he could save the fourth estate.
Of course, whether or not Murdoch succeeds in purchasing the Wall Street Journal is beside the point. The print media is dying as society simultaneously loses interest and moves online. The old subscription model of payment which enriched the newspaper business for so long must give way to a solely advertisement based system. In an era where information is free, eyeballs are still worth a fortune to advertisers.
Wednesday, April 25, 2007
The Private Equity Boom Continues
The IHT reports that private equity giant Kohlberg Kravis Roberts and an inside investor have outbid their competitors and secured Alliance Boots, Britain's largest drugstore, for $22.2 billion. This enormous price represents a 40% premium on the market price. The largest leveraged buyout ever in Britain, the purchase gives KKR control over 3100 stores.
KKR has been extremely busy this year, having spent $109 billion on three buyouts including $44 billion for TXU, a Texas power utility. Merger mania seems to have hit Wall Street in general and private equity in particular has been constantly in the news.
Analysts predict that the intense bidding over Alliance Boots, which saw KKR raise its bid three times, indicates that other British companies will soon be targeted. Retailers like Carrefour, a titan in Britain, are the subject of speculation.
The question many average investors are asking is: "What prompted this frenzy of activity?" The answer is much more complicated than any one factor, but perhaps the leading reason for the burst of activity is the surge in investment capital being put to aggressive use from major pensions and private universities. There is no global shortage of capital and savvy investors chasing alpha are becoming much more prominent.
Private equity represents the latest fad on Wall Street for creating out-sized returns. Giants like Goldman Sachs are rebuilding their operations around more aggressive use of capital in order to emulate the success of upstarts like KKR.
Private equity seems to have a particular advantage in companies under public scrutiny because executive compensation and other issues don't have to be reported like at most public corporations.
The boom shows no signs of slowing as the careful managers of private equity firms have yet to ridiculously overbid for worthless assets. But the increasing competition for companies like Alliance Boots demonstrates the declining returns that private equity will be able to squeeze out of the market.
KKR has been extremely busy this year, having spent $109 billion on three buyouts including $44 billion for TXU, a Texas power utility. Merger mania seems to have hit Wall Street in general and private equity in particular has been constantly in the news.
Analysts predict that the intense bidding over Alliance Boots, which saw KKR raise its bid three times, indicates that other British companies will soon be targeted. Retailers like Carrefour, a titan in Britain, are the subject of speculation.
The question many average investors are asking is: "What prompted this frenzy of activity?" The answer is much more complicated than any one factor, but perhaps the leading reason for the burst of activity is the surge in investment capital being put to aggressive use from major pensions and private universities. There is no global shortage of capital and savvy investors chasing alpha are becoming much more prominent.
Private equity represents the latest fad on Wall Street for creating out-sized returns. Giants like Goldman Sachs are rebuilding their operations around more aggressive use of capital in order to emulate the success of upstarts like KKR.
Private equity seems to have a particular advantage in companies under public scrutiny because executive compensation and other issues don't have to be reported like at most public corporations.
The boom shows no signs of slowing as the careful managers of private equity firms have yet to ridiculously overbid for worthless assets. But the increasing competition for companies like Alliance Boots demonstrates the declining returns that private equity will be able to squeeze out of the market.
Monday, April 16, 2007
Google Turns Evil
The IHT reports that Google has purchased DoubleClick, quite possibly the most evil company in the history of the Internet (yes, it's worse than Microsoft). Google won what was apparently a bidding war with Microsoft over leverage in the Internet advertising business.
Google spent $3.1 billion in cold, hard cash for DoubleClick, significantly more than the $1.65 billion it spent on Youtube.
DoubleClick is a very valuable company to anyone who wants to know what you've been doing on the Internet. Advertisers are obviously interested, but so are privacy activists. DoubleClick is probably responsible for 1/2 of the spyware currently on the Internet. Basically, the company's business model is built around tracking what users do on the Internet, largely without their knowledge.
Most realists recognized that Google couldn't remain forever the perfect company, able to mix phenomenal products with high margins and social goodness. But this acquisition, literally beating Microsoft at its own game, just signals the extent to which Google has changed. One of the great criticisms of Microsoft is that it doesn't develop anything in house, but rather acquires smaller, more innovative companies and milks their products for revenue. Google is at least still paying lip service to its core competency by concentrating on advertising, but the writing is on the wall.
An intriguing side note is that private equity has infiltrated another giant deal. The connection this time is a San Francisco private equity firm Hellman & Friedman, which bought DoubleClick for $1.1 billion in 2005. Not a bad return for such a short investment. Watch for other private equity firms to develop companies with the express purpose of selling them to Google for a big profit. As long as Google retains control over the Internet through its search dominance, Google will have lots of cash from advertising to invest in other businesses.
Ironically, in much the same way that Microsoft used its dominance on the desktop to crush Netscape, Google is poised to use its search dominance to muscle into other areas.
Google spent $3.1 billion in cold, hard cash for DoubleClick, significantly more than the $1.65 billion it spent on Youtube.
DoubleClick is a very valuable company to anyone who wants to know what you've been doing on the Internet. Advertisers are obviously interested, but so are privacy activists. DoubleClick is probably responsible for 1/2 of the spyware currently on the Internet. Basically, the company's business model is built around tracking what users do on the Internet, largely without their knowledge.
Most realists recognized that Google couldn't remain forever the perfect company, able to mix phenomenal products with high margins and social goodness. But this acquisition, literally beating Microsoft at its own game, just signals the extent to which Google has changed. One of the great criticisms of Microsoft is that it doesn't develop anything in house, but rather acquires smaller, more innovative companies and milks their products for revenue. Google is at least still paying lip service to its core competency by concentrating on advertising, but the writing is on the wall.
An intriguing side note is that private equity has infiltrated another giant deal. The connection this time is a San Francisco private equity firm Hellman & Friedman, which bought DoubleClick for $1.1 billion in 2005. Not a bad return for such a short investment. Watch for other private equity firms to develop companies with the express purpose of selling them to Google for a big profit. As long as Google retains control over the Internet through its search dominance, Google will have lots of cash from advertising to invest in other businesses.
Ironically, in much the same way that Microsoft used its dominance on the desktop to crush Netscape, Google is poised to use its search dominance to muscle into other areas.
Wednesday, April 11, 2007
Private Equity: NOT A Risk to Financial Stability
Forbes reported that the IMF has warned investors to pay attention to "areas of risk which could cause a disorderly correction in financial markets". First came a discussion of the carry trade in the Japanese yen that could have occurred at any time in the past decade with precisely the same arguments and exactly the same amount of evidence - none. Financial analysts at the IMF have noted the potential trouble emanating from Japan's ultra-low interest rates, but they aren't paying attention to the fact that the Japanese are also aware of the situation and are highly unlikely to wreck the global financial system since that would immediately destroy their own export dependent economy as well.
The new area of risk that the IMF wants investors to watch is private equity. The problem is that every time a buyout occurs, the acquired firm takes on a great deal of debt that could make the business more vulnerable to a downturn. While it is certainly true that taking on debt up to your eyeballs is a risky financial strategy, the greater reality is that not leveraging your business is itself a decision to hold back and retain your flexibility to ignore the needs of your customers. All businesses are going to end up taking on lots of debt before they go belly up, simply because they can. If companies already have a significant debt load, they can't slowly fade away over the course of decades. While it might be more psychologically satisfying to give everyone years and years to get used to the fact that a given company isn't producing any value, the economy is better off when resources flow to their most efficient uses.
At any rate, the geniuses behind private equity are constrained in their ability to take on excessive debt both by their bankers, who rightly fear default, and their own profit motive, because a failed company is never in the interest of its owner.
If this is the new risk facing the world economy, the next few years should witness some impressive growth.
The new area of risk that the IMF wants investors to watch is private equity. The problem is that every time a buyout occurs, the acquired firm takes on a great deal of debt that could make the business more vulnerable to a downturn. While it is certainly true that taking on debt up to your eyeballs is a risky financial strategy, the greater reality is that not leveraging your business is itself a decision to hold back and retain your flexibility to ignore the needs of your customers. All businesses are going to end up taking on lots of debt before they go belly up, simply because they can. If companies already have a significant debt load, they can't slowly fade away over the course of decades. While it might be more psychologically satisfying to give everyone years and years to get used to the fact that a given company isn't producing any value, the economy is better off when resources flow to their most efficient uses.
At any rate, the geniuses behind private equity are constrained in their ability to take on excessive debt both by their bankers, who rightly fear default, and their own profit motive, because a failed company is never in the interest of its owner.
If this is the new risk facing the world economy, the next few years should witness some impressive growth.
Tuesday, April 10, 2007
Are More Nuclear Power Plants in Our Future?
CNN reports that TXU, a utility company acquired by two private equity firms earlier this year, is working to build the largest nuclear power plants in the country. Something big must be under way in Texas, because the Wall Street Journal suggests that at least three other utilities are considering building nuclear power plants in Texas.
No new nuclear power plants have been built in the United States in decades, but TXU has apparently been consulting with Mitsubishi Heavy Industries of Japan who would build the reactors, so there might actually be fire at the bottom of all this smoke.
The global warming debate has cast nuclear power into a sudden environmentally friendly light. If people are really more worried about global warming than nuclear accidents or terrorism, then the country might follow the French model which derives the vast majority of electrical power from nuclear energy.
The more capitalistic angle on this renewed interest in nuclear power questions what impact private equity has had on TXU's priorities. If private equity's ability to focus on long-term profits has allowed TXU to finally act on long simmering plans, this could have major repercussions for the economy as a whole. In a world where private equity is capable of even considering spending $50 billion for Dow Chemical, no public company is safe.
Greater willingness to take on spectacular risks will undoubtedly result in higher eventual payoffs for everyone in society, but the financial disasters will be larger too. Society just needs to make sure that the risks remain purely financial and not allow private business to avoid appropriate technological safeguards.
No new nuclear power plants have been built in the United States in decades, but TXU has apparently been consulting with Mitsubishi Heavy Industries of Japan who would build the reactors, so there might actually be fire at the bottom of all this smoke.
The global warming debate has cast nuclear power into a sudden environmentally friendly light. If people are really more worried about global warming than nuclear accidents or terrorism, then the country might follow the French model which derives the vast majority of electrical power from nuclear energy.
The more capitalistic angle on this renewed interest in nuclear power questions what impact private equity has had on TXU's priorities. If private equity's ability to focus on long-term profits has allowed TXU to finally act on long simmering plans, this could have major repercussions for the economy as a whole. In a world where private equity is capable of even considering spending $50 billion for Dow Chemical, no public company is safe.
Greater willingness to take on spectacular risks will undoubtedly result in higher eventual payoffs for everyone in society, but the financial disasters will be larger too. Society just needs to make sure that the risks remain purely financial and not allow private business to avoid appropriate technological safeguards.
Wednesday, April 4, 2007
Is a Chrysler Buyout in the Cards?
Bloomberg reports that at least two serious bids have been made for DaimlerChrysler AG's Chrysler unit. One of the bids is from Canada's largest auto-parts supplier and the other is a joint bid by private equity giants Blackstone Group LP and Centerbridge Capital Partners LLC.
Nobody close to the deal is saying what the likely price will be, but $6 billion is a number that has been tossed around by analysts. That's a lot of money considering Chrysler lost $1.5 billion last year. Its market share is also in freefall, dropping to 12.9 percent.
The real story here seems to be that the nine-year-old merger between DaimlerBenz AG and Chrysler Corp has been an unmitigated failure. The Germans were unable to take a struggling Chrysler back to its former glory, in spite of the fact that in most regards Chrysler has been the most vigorous of the Big Three Detroit automakers. This failure is particularly galling in view of the concommittent rise of Toyota. None of the Detroit automakers has been able to avoid enormous losses and even most foreign automakers like Honda are really just treading water. Only Toyota has moved to significantly increase its marketshare while remaining profitable.
The global auto industry is definitely a growth business worldwide over the next few decades. None of the Detroit automakers looks particularly well leveraged to take advantage of the rise of a new consumer class around the world. American management has failed spectacularly to lead the way and our German friends likewise appear stumped. Canada's largest auto-parts supplier looks to be doubling down and maybe that's their only hope to keep their jobs, but if I were one of those private equity concerns I'd rather invest in the only auto company worldwide with proven leadership - Toyota.
Tuesday, April 3, 2007
Private Equity Strikes Again!
According to the IHT, one of the largest private equity firms in the world has just signed a deal to buy First Data, the credit card payment processor, for over $25 billion. First Data has been a money machine for years, growing along with the credit card industry to become a true behemoth.
But while the underlying business at First Data is clearly sound, overpaying for a great company can still result in poor returns. The private equity firm KKR will pay a 26 percent premium to the market value of the company and assume over $3 billion in debt. That works out to 27 times estimated earnings per share.
You don't even need to resort to back of the envelope calculations to see that such a large premium is only justified by impressive future growth. It's certainly possible that growth like that is going to happen, and only a fool would bet on the company actually shrinking, but it takes good management to maximize growth and First Data looks like its about to lose its leadership.
Henry Duques, the chief executive of First Data, is 63 and looking for a way to get out. He's already tried this in the past - he turned the company over once before in 2002, but now he's back in control because his first hand-picked successor couldn't cut it.
I don't think buying First Data is a bad decision by any means, but KKR is going to need to demonstrate impressive management over a business that hasn't really done that on it's own in order to make this investment a winner.
KKR has access to lots of cheap debt right now, and I'll bet that makes all of KKR's calculations look much more tractible, but at the end of the day the underlying business needs to perform. Credit cards aren't going to leave our society tomorrow, but if Dave Ramsey has his way, their impressive growth will stall.
But while the underlying business at First Data is clearly sound, overpaying for a great company can still result in poor returns. The private equity firm KKR will pay a 26 percent premium to the market value of the company and assume over $3 billion in debt. That works out to 27 times estimated earnings per share.
You don't even need to resort to back of the envelope calculations to see that such a large premium is only justified by impressive future growth. It's certainly possible that growth like that is going to happen, and only a fool would bet on the company actually shrinking, but it takes good management to maximize growth and First Data looks like its about to lose its leadership.
Henry Duques, the chief executive of First Data, is 63 and looking for a way to get out. He's already tried this in the past - he turned the company over once before in 2002, but now he's back in control because his first hand-picked successor couldn't cut it.
I don't think buying First Data is a bad decision by any means, but KKR is going to need to demonstrate impressive management over a business that hasn't really done that on it's own in order to make this investment a winner.
KKR has access to lots of cheap debt right now, and I'll bet that makes all of KKR's calculations look much more tractible, but at the end of the day the underlying business needs to perform. Credit cards aren't going to leave our society tomorrow, but if Dave Ramsey has his way, their impressive growth will stall.
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