FINspeak

It is no secret that many investors right now are struggling to gain traction against this mostly bearish market that has taken to whipsawing dramatically as of late. However, I still found the recent comments of David Rubenstein, the co-founder of the mega fund Carlyle Group, very surprising. While speaking at the Emerging Markets Private Equity Forum in New York, Mr. Rubenstein made a remark in regards to investments made in the last three years that

“Returning your capital may make you a top-quartile performer, if not top-decile performer.”

(courtesy WSJ Private Equity Beat http://blogs.wsj.com/privateequity/2009/03/26/top-returns-may-not-be-top-notch/)

When simply returning the money invested in a historically high performing asset class constitutes excellence, we have some serious problems. My comment was not a slight to Mr. Rubenstein since I appreciate his candor; it is more in regards to the systemic issues facing us all. These issues affect Private Equity more greatly due to the impact on their leverage model which accentuates the downward pull when growth stagnates or drops due to the debt service requirements. To see this effect, PEHub reported that Q1 bankruptcies for Private Equity-backed holdings are already over half the total from all of last year (http://www.pehub.com/35819/lbo-backed-bankruptcy-list-24-total-no-mega-busts-in-q1/). It is interesting to note that there were no large holding bankruptcies in that total which can be credited to the ability to complete debt exchanges or restructuring. Much has been written this type of debt restructuring in the press lately regarding efforts at Harrah’s Entertainment and Realogy (to name two large PE-backed holdings). At Infosys, we try to proactively partner with our clients to create solutions that will help them weather this current economic climate and avoid value destruction from bankruptcy. With innovative risk sharing models, we try to assure mutual benefits for both companies while we navigate the global downturn. No solutions are ever perfect, but we strive to enable our client’s strategic initiatives within the bounds of this economic duress. I would be interested in hearing about examples that you may have seen during your own experiences.

Posted by Jeremy Kloubec at 03:18 PM | Permalink | Comments (0) | TrackBacks (0)

This will be the first in an ongoing series of interviews with members of the Private Equity industry. My hope is to offer insights besides my own in the blog. Today I will cover aspects of the role of the COO for Private Equity firms, which a topic I have addressed in a previous blog entry.

Gary Weinstein, the COO of Providence Equity Partners, was gracious enough to spend some time with me and will be the participant in today’s interview. Just to provide some background on Gary, prior to joining Providence in 2008, he was the Managing Director and Global Chief Administrative Officer of investment banking at Lehman Brothers in addition to other leading roles in that firm. He also served as the CEO of Thermotrex Corporation from 1996 to 1999. Providence Equity Partners is the leading global private equity firm specializing in equity investments in media, entertainment, communications and information companies around the world. The firm has approximately $22 billion in equity commitments and has invested in more than 100 companies operating in over 20 countries since its inception in 1989.

Since role of the COO is newer for most Private Equity firms, how has your transition been to the role?
(GW): The transition itself was relatively seamless due to having similar responsibilities, reporting lines and employee backgrounds as when I was with Lehman Brothers. The biggest difference would be the size of the organization, with Providence Equity being much smaller than the Lehman Brothers organization. The interesting thing though is the close culture Providence Equity has been able to develop due to its smaller size. You make it easier, not 100% foolproof, to match your candidates to that culture when you are hiring on a smaller scale.

How was your introductory period at Providence Equity?
(GW): As with any change, I was met with resistance and relief.  The resistance was from those who were worried about flexibility and access in the organization. Relief was felt by those who saw the need for common processes and centralized operational support.

The difficult part for me personally was the desire to immediately start putting my 20+ years of experience into practice, but I received some great advice and support from the Founders who wanted me to learn the organization and people before implementing changes. Because they had the patience and a longer term view, it allowed me a longer runway to understand the group which will help me be more successful.

Can you comment on the organizational complexities you faced when you started?
(GW): The biggest issue is that this is an entrepreneurial organization that needs to move in a nimble fashion. Because of that, bureaucracies were avoided as individual groups worked in isolation to solve their own problems. I had to establish a foundation in which the constituencies could trust a repeatable, centralized process that would be responsive to their needs.

Do you have an opinion as to the size at which PE firms should be before incorporating the COO role?
(GW): First you need to have some pain that needs to be addressed; it could be finance and accounting, reporting, systems, whatever such that the change imperative exists. My guess that is that there is some minimum number of staff between 50-100 to consider a dedicated position, it also depends on the geographic dispersion as well. However, even with smaller firm, a Senior Managing Director may want to focus elsewhere, which would create a role for an operations person. You would then match the seniority required to appropriately manage the role. It is a mix of experience and needs.

Do you have any suggestions for other COOs at Private Equity firms?
(GW): At the end of the day, it is not just a capital business, it is a people business. You must understand the need and goals of the organization in order to be successful.

Posted by Jeremy Kloubec at 06:54 PM | Permalink | Comments (0) | TrackBacks (0)

With a global slump affecting many industries in a dramatic fashion, Private Equity is also undergoing many changes. The pressure first started to show last year when many firms announced asset write downs as portfolio valuations started to fall. This was then followed by personnel cuts (considered a significant event too many in the industry) affecting upwards of 10% of the employee base in some firms. Announcements were then made allowing reductions in Limited Partner investment commitments (it is next to impossible to back out of a LP commitment) and more recently changes in the fee structure itself. While this is not an indictment of a flaw in the Private Equity model, it is simply a sign of PE evolving with the market.

This evolution is also evident from recent COO placements made by PE firms, the most recent being Henry Silverman at Apollo. This COO trend may be restricted to the larger funds since they have the resources to support the position, but it shows how PE is looking to get leaner and operate more efficiently regardless of the firm size. They are demonstrating the same rigor internally as with their portfolio holding investments. In trying to support this transition, Infosys has created customized offerings for research, knowledge management and financial/accounting services to address the unique needs of Private Equity. These services address the full Private Equity value chain from initial market scans to due diligence support through to portfolio tracking or divestment services in addition to back office functions such as fund and carry accounting. These services help PE firms support current operations or even enter new markets in a low cost and low risk manner. One thing is for sure, the leading PE firms will not remain static and I am betting that they come out of the current market slightly shaken, but not flattened. What are your thoughts?

Posted by Jeremy Kloubec at 03:30 PM | Permalink | Comments (2) | TrackBacks (0)

Don’t just take my word that Private Equity is retrenching with an operational focus, David Rubenstein, the co-founder of Carlyle Group and key figure in the Private Equity industry recently stated “Private equity firms will spend 70 per cent of their time shoring up their investments, 20 per cent of their time shoring up their investor base, 5 per cent trying to raise new money and 5 per cent trying to do new deals”. While part of that 70% will also involve financial restructuring, the bulk of that effort will be in creating value for that portfolio investment via new revenue generation or cost reduction.

While I have previously posted in an earlier entry referencing a WEF report that PE drives better management practices and worker productivity in their investment portfolio companies, There is still a theoretical upper limit for that improvement using the current internal resources. I am not queuing music for “March of the Consultants”, but I am saying there are many functions that can benefit from outsourcing services that support 12 month return on investments and free up significant working capital. This approach is not constrained to simple internal cost cutting, but also creating business models in new markets that had not been previously considered for entry. An example would be new shared services models across current competitors who previously had a desire to keep “it all inside the four walls” but now are looking at all options to keep ride out the current market. Private Equity is able to take long views with their holdings and consider aggressive value creation. It is this willingness to make bold moves which will help drive their portfolio holding companies.

While some can point to examples of “pass the parcel” investments (courtesy of Guy Hands, Chairman of Terra Firma) which create value only on a sale to the next buyer, the vast majority of PE investments are longer bets that create value for the workers and overall economy.  Lagging companies create economic drag and inefficiencies which require shock treatment to increase competitiveness. It is refreshing for Mr. Rubenstein to highlight this point so directly. What are your thoughts?

Posted by Jeremy Kloubec at 03:26 PM | Permalink | Comments (0) | TrackBacks (0)

April 2009 is promising to be a watershed month for Banking Regulations. Regulations and guidelines are being revisited regarding asset valuations, scenarios to consider while arriving at the capital adequacy and definition of the bank capital itself!

With clear directions from Congress, FASB is aggressively revisiting the mark to market rule esp for illiquid assets. Most of the banks are likely to see marked positive impact with any relaxation in mark to market rule. The Stress Test (Capital Assessment Program) is taking very sobering baseline and adverse scenarios while arriving at the health of the bank:

		2009	2010
Real GDP	Baseline Scenario	-2.0	2.1
	Adverse scenario	- 3.3	0.5
Civilian unemployment rate	Baseline	8.4	8.8
	Adverse	8.9	10.3
House prices	Baseline	-14	-4
	Adverse	-22	- 7

These tests will mandatorily evaluate bank holding companies (BHC) with assets more than USD 100 bn, roughly covering two thirds of US BHC assets. In addition, many smaller banks may also choose to undergo similar test in order to gain access to funding. Last, increasingly Tangible Common Equity (TCE) is replacing Tier 1 capital as the indicator of banks stability.

While it is too early to arrive at the net results of these changes, some outcomes are more likely then others -  Banks will need and get funding possibly beyond remaining funds under TARP, Banks will raise TCE either through new issue or conversion of “hybrid” capital into TCE and US Government stake will go up in relatively weaker banks while stronger banks may choose to raise private capital in order to avoid restrictions. In any case, next few weeks will keep the adrenaline rushing.

Posted by Neeraj Kumar Jindal at 03:45 AM | Permalink | Comments (0) | TrackBacks (0)

In my last post, I discussed the need for government mandates to stimulate the use and production of green energy.  As I reported, President Obama has taken the necessary steps to move forward with renewable energy by mandating 10% of the energy portfolio in the US to be of renewable sources.  However, the US—even with a solid renewable energy policy written into the Economic Stimulus Package—is not a global leader in renewable energy.  Instead, it’s Europe leading the way with progressive and innovative renewable energy policies.

In Europe, government policy does not stop at mandating the use of renewable sources.  Policies are in place providing incentives for homeowners and businesses to generate renewable energy.  Using a “feed in tariff” system, a utility company will pay four times the rate of coal energy—vastly above the market price—for the renewable energy produced by private citizens.

A “feed in tariff” system not only shifts the weight of subsidizing the production of renewable energy away from the taxpayer to a utility company but also provides a guaranteed return on investment for homeowners and business owners who install solar panels or wind turbines.

Like mandates, incentives will be a key driver in transforming the electrical grid around the world.  I’m happy to see such innovative policymaking drive the prominence of renewable energy in Europe.  Now, let’s wait and see if other regions follow the lead of European countries.

To learn more about the “feed in tariff” program, read this New York Times article.

Posted by Jitin Goyal at 09:57 PM | Permalink | Comments (0) | TrackBacks (0)

Thomson Reuters reflected a 70% drop in total funding from the previous year in their Jan 2009 Venture Capital survey (thanks to PEHub for posting the data http://www.pehub.com/32973/vc-investment-pace-gets-even-worse/) . You could chalk this up to a monthly blip due to the current economic crisis, but total VC investments have been trending downward for a while now. Through no fault of the Venture community, they are holding onto their money due to market uncertainty and issues from being able to raise new capital. While many people may not shed a tear for VCs, this unfortunately creates many problems for the intellectual economy.

First, we risk the health and incubation of current startups that will be restricted from reaching critical growth. Maybe resource cuts, inability to hire new talent or simple default will delay the maturity of many startups looking to make the leap in their business model that allows them to scale with their new product offering. This creates a dead zone for fledgling companies 1-2 years out. Secondly, many new start ups will not receive initial funding and maybe never launch. This adds to the dead zone but on a longer time period out. This represents lost jobs, lost intellectual property and lost advantage in the global marketplace right after we are “supposed” to be coming out of this recession/depression. This simply creates a further weakening for any recovery. However, I doubt this is only a problem in the US so start ups around the world are probably suffering a similar fate. What are you seeing in your markets?

Posted by Jeremy Kloubec at 02:02 PM | Permalink | Comments (4) | TrackBacks (0)

The World Economic Forum* recently published a research report, Globalization of Alternative Investments- Global Impact of Private Equity 2009, which covered the effect of Private Equity (PE) investment on their portfolio holding companies. The research board is made of academics with some PE advisory participation, so I would tend to believe the results were not skewed. The scope of the report was fairly broad, but I will focus on two areas which are Management Practices and Labor Productivity. The Management Practices study covered 4000 PE owned companies in the US, Europe and Asia which completed double blind surveys in the 2006 timeframe. A few things came out that are worth mentioning. First, these portfolio investment companies are better managed and have stronger operational processes than other peer companies. There was also a lack of a “long tail” of laggards for PE investment companies. This could be attributed to the fact that PE firms typically hire very experienced people to address those issues to ensure that their investment “performs”. While PE can sometimes be vilified by the press, they do create value with the companies that are purchased.
Based on the results of the first study, you could assume that Labor Productivity would increase as well. The analysis covered a different data set of US-based manufacturing PE investments from 1980-2005. The researchers found that in the first three years after acquisition, jobs were shed at a faster rate than peer companies, but jobs were added at a faster rate thereafter. This was termed “creative destruction” where the investment company shed resources in order to improve performance with better resources. The productivity bump happens in the first two years and is 72% attributed to stronger management practices. They also found that PE was also willing to make tough choices to sell underperforming assets which added to productivity increases.
What is interesting to me in regards to these results is that they missed the final PE flurry of 2007 and do not include data points from the current economic malaise we are in. Because the use of debt creates significant value on the upside and pulls harder on the downside, I would suspect some of these results could swing back to the median. Either way, I am a firm believer in developing management excellence and having the ability to objectively evaluate resources. It is not always easy to enact a program for both from the inside which is why PE steps in to help make those choices that result in a net positive impact for the global economy. What are your thoughts?

 

(*In full disclosure, Infosys is involved in WEF activities)

Posted by Jeremy Kloubec at 03:42 PM | Permalink | Comments (0) | TrackBacks (0)