Private Equity Not Showing Signs of Weakness

In raising only 3% short of its figure for the first half of 2007, private equity firms are proving that there is still plenty of liquidity available for the right deals. Savvy investors, no doubt, are preparing to take advantage of the down-cycle with a spate of buyouts, mergers and IPOs in time for when the economy rebounds.

$132.7 billion; that's the figure American private equity firms raised in the first half of this year - just 3% shy of the figure for last year, which, by the way, was a record year. The news gets even better when you focus in on venture capital specifically. VC firms raised $11.5 billion in the first half of '08 - a full 15% improvement over the $10 billion they raised last year. All this points to a great deal of future deals. While IPO numbers are down to historic lows, the money being raised among the alternative financing segment of the capital markets suggests that that slowdown will be short-lived, which, of course, points to a stronger outlook for the economy as a whole. Timing, of course, is anyone's guess.

Slowest IPO Quarter In Recorded History

First, I'll be clear that recorded history, as far as VC-backed IPOs are concerned, goes back only about 30-years. That said, June 2008 will go down as the slowest month with zero, that right, zero, IPOs backed by private equity firms. Compared to the same quarter last year, there were 101 IPOs; this quarter that number is 49 in the U.S. Of course, Wall Street is trying to read between the lines and come to some sort of conclusion about the viability of the private equity industry as a whole, which I feel is simply unjustified.

Of course, I shouldn't be too surprised. The media is only doing what it always does: take a story and sensationalize it to grab viewers' attention and sell a few more ads. The reality is that the private equity business is a business like any another and responds to market conditions like any other. The slow-down in IPOs does not necessarily mean that there are fewer firms prepared to go public, but rather that there are few firms that VC firms are prepared to sell in this particular market. The folks behind these firms are pretty smart; they'll exit their investments when they believe they can get the greatest return on their buck. This market, not surprisingly, does not appear to offer the kind of deals that they're looking for. End of story.

Mergers & Acquisitions Are Up! Really!

The media is quoting a decline in mergers & acquisitions of about 35% in the past year, but the numbers can be deceiving. The total value of the deals is down, but the number of deals is actually up - up by 11% in fact. Does this represent a sign of life in the markets?

What makes this even more interesting is the size of the premiums - they're not only higher than the same period a year ago, but they're at the highest levels in nearly 6-years. With premiums of as much as 25% above the market price four-weeks prior to the deal. The question is, what does this information mean? In 1999, the number of deals, and deal premiums, were at all-time highs as well and we all know what followed.

BCE Buyout Dead; Is Telus its Only Hope?

The biggest proposed buyout is dead after a ruling by the Canadian courts. Bond holders in Bell Canada Enterprises (BCE) appear to have won against the syndicate of private equity firms that were looking to buy the monolith for a total of $51.8 billion dollars - making it the largest LBO ever - at least it would have been. With the 5% decline in it's stock price following the request of financing banks to renegotiate the terms of the loans, the market appeared to have seen what lay ahead, but now what?

The fact that BCE is in dire straights has not changed. Almost as soon as the PE deal collapsed, talk of Telus, the largest telecommunications provider in Western Canada, may step-in to save the day. Telus had considered BCE about a year-back, but walked away when it wasn't granted access to internal financial records. Even if it does choose to give this deal a second look, there's no doubt that there would be competition concerns with the entire Canadian market being essentially divided between only these two firms and Rogers Communications.

Bell has said that it will appeal the decision to the nation's Supreme Court, but there's no way of knowing whether the court will even hear the case - the decision, at least according to the appeals court - is consistent with previous decisions. Bond holders, for the time being, appear to have won their case and have kept the company from assuming even greater debt and increasing its financial risk, but will their interests be ultimately served if the company can't meet those existing obligations?

VC Firms Fighting Over Twitter? Really?

Twitter, the so-called micro-blogging service, is the subject of quite a lot of venture capital interest these days. The bidding war that is apparently developing over the financing of its next round will leave it with a valuation of about $70 million. Really? $70 million?

Ok, I realize that it's managed to attract quite a following and eyeballs do mean advertising revenue bucks, but I just don't get the appeal. Are there really that many people interested in following every move their friends make?

If you're not already aware of it, or god-forbid a user, Twitter allows you to track the minute-by-minute moves your friends make. Their website explains it as follows:

Twitter is a service for friends, family, and co–workers to communicate and stay connected through the exchange of quick, frequent answers to one simple question: What are you doing?

I'll admit that it's an original, if not interesting, idea. But a business? It really makes you wonder sometimes about how many better business ideas lost-out on financing because the money went to ventures such as Twitter. Am I being too harsh? Do I just not get it?

Disney Seeks Another $200 million for its Third Steamboat Fund

Just as the headline says, Disney is sourcing $200 million to fill-up its third fund as part of its Steamboat Ventures venture capital arm. Focused on the European market with specific interest in digital media companies, it's a fun VC firm to watch. Ranging from social networking start-ups to mobile services, Steamboat concentrates its investments on those, not surprisingly, that leverage its parent company's empire. C'mon; admit it. You love their logo too.

Energy Fund's Public Offering Less Than Well Received

Eric Sprott's Sprott Inc. went public late last week at a price of $10 per share on an issue of about 16% of the total equity in the firm and proceeded to dip by as much as $0.50 and ended the week (before the Canadian long weekend) down $0.23. Having raised $200 million, this gives Mr. Sprott's firm a valuation of approximately $1.5 billion, which is great, but also leaves Mr. Sprott scratching his head as to the cause of the dip.

Mr. Sprott said, in an interview with the Globe and Mail newspaper, that he believed the less-than-stellar result in the companies first public showing to be the result of short-sellers betting against his company. What's surprising about this, however, is that even a freshman finance student knows that that's quite unlikely to be the case with any IPO. Short-selling requires a stock to be borrowed and then sold in order to profit from any decline in the stock's price. However, an IPO means that the stock is just entering the market and is unlikely to be available in brokerage accounts for any borrowing to take place. Consequently, many believe that the true cause of the fall in Sprott Inc.'s stock price is due to its fundamentals.

As a hedge fund betting on metals and energy, Sprott Inc. is certainly in the industries making the news these days. That said, they're making the news because their prices are constantly breaking record highs and many are questioning for how much longer this trend can continue. Ask Mr. Sprott and you're sure to get the answer that you'd expect, but apparently the market sees things differently and are valuing the fund at less than what Mr. Sprott had anticipated. Beyond the impact to Sprott Inc., this result has interesting implications for the economy as a whole; what is happening with the energy industry and how much longer can this go on. Is it, in fact, time to go short or do you believe some reports that gasoline may soon see double-digit prices per gallon at the pumps?

When Debt is In Doubt

Aquiline Capital Partners, the private equity firm run by former Marsh & McClennan chief, Jeffrey Greenbert, has spun off a new commercial financing arm to put some of its capital to use. Tygris Commercial Finance Group, will launch with two deals already on its books in the form of to all-equity-financed buyouts of a leasing company and a healthcare equipment manufacturer.

This is a great example of why everyone looks at PE firms with awe; they're motivated to come-up with deals no matter what the economy is doing. With reports of the largest leveraged buyout deal (BCE here in Canada) put on hold with banks wanting to renegotiate their lending rates, you have firms like Aquiline refusing to squabble over spare change and putting $1.75 billion of capital raised via equity commitments to work.

Search Engine with No Website Gets ANOTHER $3 Million

No website (or logo, as a matter of fact), but that hasn't stopped all the original investors in Blekko from putting-up yet another $3 million dollars for the would-be challeger to Google. By all accounts, Rich Skrenta, is very media savvy and isn't giving-up any details about their technology beyond criticizing Google's invention of Page Rank and confirmation that they aren't following suit.

With backing from the likes of former Google executives, Netscape's Marc Andreesen as well as Venture Capital firms of the like of Baseline Ventures, SoftTech VC and Western Technology Investments, they must have something pretty good up their sleeves. Except for SoftTech and Western Technology Investments, everyone investing in this round also invested in their seed round that raised $2 million for the 6-person team working out of their garage in true-start-up style!

They aren't alone, of course, with many other challengers to Google waiting in the wings to reveal their secret sauce. The only notable thing about this story, really, is Skrenta's ability to apparently convince sophisticated investors that he's got something worthwhile. Maybe more than that, his ability to get folks like me to write about it without having anything to actually look at until their expected launch sometime in 2009. Any who said an idea, unto itself, isn't worth anything?

Carlyle Group Goes Back to its Roots in D.C.

The Carlyle Group, one of the largest private equity firms and probably one of the most criticized, is purchasing the government consulting arm of Booz Allen Hamilton in a deal worth $2.5 billion. With its history as a Washington insider, this may represent a move back to what it knows in light of tighter credit and fewer LBO deals available for its managers to stay occupied.

Known for placing politicians on the boards of its companies and having the likes of former President George Bush on its payroll have made The Carlyle Group a favorite target for many who undercut its financial prowess to make good deals favoring, instead, to use its influence to be in the right place at the right time. Whether admitting to this or not, it certainly seemed as though they took note of their image and made strides to polish-it-up.

In the past few years it has asked the Bin-Laden family to divest from its firm (yes, those Bin-Ladens), has removed both former President Bush and former Prime Minister John Major of the UK from its payroll as well as reduced its stake in military and aerospace projects from a high of 20% to a current 6% of its total portfolio. So what does its purchase of a government consulting firm mean for its future?

Based on its spokesperson, the deal just makes business sense - pure and simple - and has nothing to do with its prior or current corporate image. On a more down-to-earth note, however, it's likely going back to its roots in light of a drought in the capital markets making new leveraged buyout deals more difficult to come by - at least the 'leveraged' part, anyway.

Public Private Equity?

When does a company go public? The simple answer is whenever its private owners feel that they can get the most for their shares. Elaborating a little further, you might also time it such that it precedes a decline in the value of those shares. Well, private equity firms are no different.

Coming off of a great run starting shortly after the dot-com bubble burst earlier this decade, private equity firms are lining-up at the SEC to file their registrations for public offering. The Blackstone Group already went public and now KKR and Apollo are set to go next. There is no doubt that the partners behind these firms know exactly what they're doing, but there is a something to be said for the dilution of those firms' mission statements that follows their IPOs.

Harvard Business School professor Josh Lerner said it well in a Fortune magazine article this month. Going public necessarily means that the firm's management must now begin to focus on what it never had to consider in the past: the quarterly reports. While benign unto themselves, the implications are profound.

Quarterly reports, as we all know, are scrutinzed to no end. Markets rise and fall with the slightest deviation from expectations. Consequently, management does all that it can to meet or exceed those expecations. However, it must do so in consideration of the fact that it must repeat that same feat only 3-months later all over again. The result, as you might expect, is a steadying of the earnings to ensure consistent returns and profits. While this is, of course, a sound business practice, this does seem to go against the general reasons for which people seek venture capital as part of their investment portfolios in the first place. If we wanted steady returns and lower-risk, then wouldn't we go elsewhere?

In the end, this is likely just an example of the life cycle of any company. While it may leave us private equity fans just a little saddened, it's probably only fair to not suggest that these firms should behave any differently than any other. It's just that private equity firms are our heroes. They do the deals that make headlines and form the basis of great books, magazine articles and sometimes movies. When is the last time you watched a movie about a bank lending some money? Exactly.

Never a Bad Time to Invest

When the stock market is hot, everyone seems to be making money. When it's down, on the other hand, it seems everyone is telling you that now is the time to invest so as to make a bundle as soon as things pick-up again. Is it ever a bad time to invest?

According to buyout firms, the answer appears to be no. Moreover, history seems to back-up their claims showing that returns on these private equity funds return far superior rates beginning from the year of the bubble and over the following two-years. Remember the popping bubble in 2000? Well, would you be surprised to hear that 2001 through 2002 resulted in returns of 33%, 29% and 31% in each year respectively?

I read a great little two-liner about how private equity firms view the market - regardless of its position in the business cycle. If a company is worth more in private hands than it is in public hands, then there's money to be made in performing a buyout. If the reverse is true and a company is worth more as a public entity, then there's money to be made in going-public. No matter what, you see, there's always money to be made.

Double Cropping - A Second Bite At The Apple

It will come as no surprise to many people that banks make money in every market - regardless of whether its up or down. Venture capitalists are no different, but they may very well be more innovative.

Let's assume that you're a venture capitalist that has plenty of money floating around, but you can't seem to find anything worthwhile in which to invest. You still need to satisfy all those investors with the same, or similarly, high returns, so what options do you have? The answer, at least today, is double cropping.

Double cropping is the practice of lending back the money you just borrowed, at higher rates of course, backed by the same underlying assets. Remember that bank that lent you all that cash for your last buyout? Those banks had planned to sell your loan to other financial institutions, but when the credit crunch arrived, they found themselves holding the bag. Still wanting to unload the loans, they're now offering them at below face value. That's right, you can send the money that the banks just gave you right back into their pockets, but at less than it originally cost you in the first place. There is a catch, but it's a good one - if you're the VC, that is.

To avoid all the complications resulting from legal paperwork and taxes, you don't actually buy the debt, but rather engage in a swap; a Total Return Swap to be more precise. This is the act of paying a small portion of the total face value now and agreeing to pay some rate of return on the balance of the below-face-value asset (our own loan). In exchange, we'll get back the interest and principle promised on the original loan - yes, that's the interest and principle that we're paying them... until now! The end result is cheaper money as well as less risk.

Why less risk? The asset, the loan in our case, is backed by the venture for which the bank originally made the deal. If those loans turn out to be worthless, then it's still the bank that's on the hook for the full amount. The only thing to which we've committed is the payments on the balance of the below-face-value loan.

A great example of just such a case is Citibanks 'sale' of $12 billion of buyout loans back to Apollo, TPG and Blackstone. The firms put-up $3 billion cash and then agreed to pay a ridiculously low rate of 1% on the balance of $7.8 billion - yes, that's only a total of $10.8 billion for something with a face value of $12 billion. Can you say easy money?