Friendly Article about Publicly Traded PE Firms

The WSJ takes an benign view of publicly traded buyout funds with a focus on foreign publicly traded management companies, primarily 3i (UK) and Onex (Canada). Still, the Blackstone structure provides weaker protection to public shareholders and is probably coming at close to a cyclical peak...we will see...

Full article here (registration required).

One of the largest of the publicly traded private-equity firms, London-based 3i Group PLC, says it is buying companies at a record clip. "We've been growing our investment levels and getting into new business lines," Chief Executive Philip Yea said in an interview. Being publicly traded enables 3i to use its own balance sheet to start new businesses quickly or buy minority stakes in other companies, he added.

Beginning as a government agency to finance start-ups in the aftermath of World War II, 3i dates back about 60 years and has had shares publicly traded since 1994. The company's shares are up 67% over the past two years on the London Stock Exchange. On Thursday, 3i said it will return an additional £800 million ($1.57 billion) to shareholders after windfall gains from selling companies it had taken over and restructured. On Friday, its shares closed at £11.36, down four pence.

"Their core business areas across buyouts, growth capital and venture capital continue to perform strongly," said Simon Haines, a fund manager at Threadneedle Investments, one of the largest 3i shareholders, with more than 3% of the company. The recent payment to shareholders "underlines their success."

Going public has several advantages for firms in an industry dominated by private partnerships. The ones that have made the leap say it can make them appear more reputable and enduring than rivals that operate funds that typically exist for no more than 10 years. It also can help them raise money from the stock market for a variety of uses, cash that is better suited to more long-term investments because it doesn't need to be paid back like money raised from institutional investors and the wealthy. (Blackstone and Fortress Investment Group LLC, a hedge fund and private-equity firm that recently went public, are selling stock in their management companies, not in the funds they use to buy companies, so public stockholders won't own a direct stake in the firms' buyouts.)

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Canada's Onex Corp. was founded in 1984 with money from rich individuals and institutions. Three years later, Gerald Schwartz, the former Wall Street banker and founder of Onex, realized a permanent pile of capital was needed to fund his long-term acquisition ambitions as private-equity shops specializing in leveraged buyouts were still a novelty to Canadian investors. Going public has produced "a very steady and regularly increasing amount of capital for us to invest," said Mr. Schwartz, Onex's chief executive.

Since raising 240 million Canadian dollars (US$207.9 million) in its 1987 initial public offering on the Toronto Stock Exchange, Onex now has C$4 billion in capital, which it invests along with private money it raises from outside investors, known as limited partners. In total, it has C$7.5 billion in assets under management and has made some high-profile acquisitions. The firm is part of a consortium that recently launched a buyout offer for Australia's Quantas Airways.

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Onex shares have climbed an average of 18% each year since it went public. Friday, Onex shares closed down 1.4%, or 44 Canadian cents, to C$32.06, up about 13% this year.

Older People and Gaming

Gaming will remain a growth industry for a long time... Full article from the New York Times.

CHATAWA, Miss. — For 133 years the School Sisters of Notre Dame have lived here in a thick forest just up the hill from the Tangipahoa River. In a modest but stately compound called St. Mary of the Pines, 52 retired members of this Roman Catholic order spend much of their time as the order’s members have since the 19th century. They read and garden, fish and sew. They pray five times a day.

But many also have a new hobby, one they credit for keeping their hands steady and minds sharp. They play video games. Every day residents go to the seven-terminal “Computer Cove” to click furiously on colorful, nonviolent, relatively simple games like Bejeweled, Bookworm and Chuzzle.

Though they live in a remote grove, the women of St. Mary are actually part of a vast and growing community of video-game-playing baby boomers and their parents, especially women.

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It turns out that older users not only play video games more often than their younger counterparts but also spend more time playing per session. Pogo.com is a Web site that offers “casual” games, easy to play and generally less complicated than the war, sports and strategy games favored by hard-core gamers. According to Electronic Arts, the game publisher that runs the site, people 50 and older were 28 percent of the visitors in February but accounted for more than 40 percent of total time spent on the site. On average women spent 35 percent longer on the site each day than men.

“Baby boomers and up are definitely our fastest-growing demographic, and it is because the fear factor is diminishing,” said Beatrice Spaine, the Pogo.com marketing director. “Women come for the games, but they stay for the community. Women like to chat, and these games online are a way to do that. It’s kind of a MySpace for seniors.”

Military Builds Robotic Insects

Those of you who have heard my "robots are coming" speech know that I expect intelligent and highly capable machines within a generation. The first generation of these robots are here now.

See this article below about robotic insects with attack capabilities. Just imagine how dangerous and scary these things are in 3-4 generations with some emergent intelligence.

Full article from Wired here.

If you feel something crawling on your neck, it might be a wasp or a bee. Or it might be something much more dangerous.

Israel is developing a robot the size of a hornet to attack terrorists. And although the prototype will not fly for three years, killer Micro Air Vehicles, or MAVs, are much closer than that.

British Special Forces already use 6-inch MAV aircraft called WASPs for reconnaissance in Afghanistan. The $3,000 WASP is operated with a Gameboy-style controller and is nearly silent, so it can get very close without being detected. A new development will reportedly see the WASP fitted with a C4 explosive warhead for kamikaze attacks on snipers. One newspaper dubbed it "The Talibanator."

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This means preventing the target from carrying out its mission, rather than destroying it, Davis says. A truck, for example, can be put out of action by destroying its tires; a MAV can do this by squirting them with few milliliters of a catalytic de-polymerization agent, causing them to disintegrate rapidly.

Predictions 2007-2008

Background My rule of thumb is that I have about 1 good macro-level idea per year.

I tend to think that my predictive accuracy is pretty good, but it is also possible that there is some historical revisionism happening where I remember my correct predictions and forget my incorrect predictions. In fact all research into human psychology suggests that would be the expected case.

I have sometimes been too early in my prior predictions which makes it very fortunate that I did not had enough capital to short dot coms in 1999! “The market can remain irrational longer than you can remain solvent.” (Keynes) is one of the wisest statements in investing.

The Test So the only way to test if these predictions are accurate is to write them down, preferably publicly, so here they are.

Comments, contributions and your own predictions are very welcome! I will put a permanent link on the right hand side so we can find this post and review how we do.

This post will be updated at least once a quarter, if not more often, but new entries will be time-stamped.

This is the first post, at end of Q1 2007.

This by no means should be construed as investment advice

PREDICTIONS COMPLETE SO FAR

1. Subprime underwriting bubble and drop in underwriting standards exposed as unsustainable.

STATUS: Correct. March 2007. This one is complete

2. Complex distribution of risk in subprime mortgages through financial instruments like CDOs does very little to protect against stupid credit / underwriting risks. The thought that slicing and dicing the risk makes it somehow less risky is false.

STATUS: Correct. March 2007. This one is complete

3. Stand-alone subprime mortgage originators have a 1998-style industry shake-out with tremendous drops in valuation and bankruptcies.

STATUS: Correct. March 2007. This one is complete

Now in subprime I was a bit advantaged because I have been following the space since just before the 1998 credit crunch and subsequent collapse of most subprime originators. We'll see about broader trends...

PREDICTIONS STILL OUTSTANDING

A. Mortgage

1. Subprime MBS continue to underperform through 2007 and Q2 2008. We have not seen the worst of things yet.

2. Alt-A MBS underperform from now Q2 2007 to late 2008. The concept that this is an issue contained to subprime is put to rest by the end of Q3 2007. Keep an eye on Indy Mac as a bellweather.

3. Housing prices fall by 20%+ in certain regions as the appraisal cycle starts to work in reverse. In other words, lower appraised values push more homeowners into low/no equity situations, leading to more foreclosures, lower sales prices and lower appraised values. Values start falling in 2007 through mid 2008.

4. Investment banking investments in subprime origination platforms in 2006 turn out to have been terrible investments at the peak of the market. Note this has already happened, it is just not fully disclosed yet.

B. Buyouts

1. Multiple LBO funds IPO in 2007 after Blackstone. Let's say at least 3 in total but no more than 6.

2. High-yield credit tightens from late 07 to late 08. Spreads and covenants start to return to historical norms.

3. First higher-than-expected losses to the junior (CDO) tranches of high-yield issuances in 2008.

4. More regulatory pressure by 2008, either regarding tax rates or fees earned by the senior MDs, particularly of the publicly traded vehicles.

5. At least one very visible PE-backed company blow-up from Q2 08 to Q2 09.

6. 2008-2010 are tougher years for the PE industry as a) ability to lever deteriorates, b) revenue growth at companies slows, c) public markets are less accomodating to leveraged IPOs, d) competition for deals does not ease. Holding times increase and more time is spent on operations.

7. Overall, 2006-2007 vintage funds underperform. 2009-2010 vintage funds perform well as markets and valuations correct or over-correct. I have no opinion about 2008 vintage.

2007-2008 vintage distressed debt funds do well also.

#7 is a long-range prediction so if I am off by a year, I am still claiming victory!

C. Overall:

1. Economy weakens substantially in 2008 into a growth recession or actual recession. I am less sure of this than of my other predictions but think it is more likely than not. If this happens at the wrong time relative to the coming housing/mortgage bust, it severely aggravates issues in housing and the two cycles self-reinforce.

2. Dollar crosses 1.40 against the Euro at some point in 07/08.

3. All forms of credit tighten by late 2007 to mid 2008 and yield spreads start to return to historical norms

4. New President in Q4 2008 inherits a weak and vulnerable economy.

Once again:

This by no means should be construed as investment advice