FINspeak

Since September 15th 2008, we’ve witnessed banks fail, banks be bailed out by the government, banks de-leverage, and banks promise to avoid bad investments.  As the banking world has become increasingly scrutinized, all business decisions and investments have been well publicized and well criticized by the media, government, and citizens alike.  In this push to return to more sustainable levels of leverage, banks have cut budgets, eliminated bonuses, and apprehensively made new investments.

However, I recently discovered that a handful of banks are making very smart investments—investments in green, sustainable technology to reduce their carbon footprint and energy costs.  Just last month, the Bank of New York Mellon installed a 76 Kilowatt solar panel system at its office in Massachusetts.  The bank hopes to reduce its energy costs by $15,000 per year while significantly diminishing the environmental impact of its office. Clearly, the solar panel system, with the potential for a positive ROI, is a safe environmental investment.

Joining the Bank of New York Mellon is HSBC who installed 617 square meters of photovoltaic panels at its office in Canary Wharf, London. Next time I am near a window at my office in Canary Wharf, I will have to take a peek and see if I can notice the shimmer of solar panels at the HSBC Tower. 

I’m happy to see that banks are beginning to make investments in green technology to reduce their own carbon footprint.  While financial institutions certainly are drivers of the economy, I can’t wait until they are the drivers of green technology as well.

To learn more about solar panel projects, check out the article about HSBC and the article about the Bank of New York Mellon.

Posted by Jitin Goyal at 02:24 PM | Permalink | Comments (2) | TrackBacks (0)

Paul Peterson is currently a Principal at Wind Point Partners with an investment focus in Engineered Industrial Products, Chemicals/Plastics and Building Products.  Paul has worked on numerous leveraged buyouts and currently is the lead investor and sits on the board of directors of Citadel Plastics.  Wind Point Partners is a Private Equity investment firm that acquires middle market businesses with growth potential and a clear path to value creation. Wind Point manages $2B in commitments and has invested in more than 80 companies since 1984. I am very appreciative of Paul taking time out of his day to discuss mid-market Private Equity.

(PP):  It is slower as it would be in the wider market. Through Q3 things were holding up with the broad based decline hitting in Q4 carrying over into Q1 of this year which along with liquidity issues has really stunted transaction volume. There are some exceptions in health care, food or education which are fairly recession resistant. The problem affecting Private Equity in particular was the use of peak leverage in 2006-2008 where some of those deals started to unwind within a few bad quarters due to the leverage multiples being too far out of balance. We started to see companies worth less than the debt on their balance sheet. Interestingly enough, the mid-market, in most cases, was not able to really push the extreme leverage multiples as much with the banks and benefitted from that fact now that we have hit this downturn.

(PP): To generate deals in this environment, you will need a strategic angle or existing platform where you own a company that can support complimentary acquisitions. This is where having a deep network in a segment of a market gives you the edge into what are now tight processes  because sellers are not widely sending out books to 100 PE firms like they could have done in the boom time. Before, you could get away with a broadcast sale since there was a higher chance of the deal getting done. Now, sellers don’t want a high profile process and having increased risk of the deal falling apart. A failed deal creates stress on the employees, suppliers and customers at a time when bad news is not welcome in the market. With these sorts of obstacles, mid-market private equity is at a slight disadvantage just from the sheer number of connections needed to drive volumes, so you need to be smart in your network building. You also need to be a credible buyer with a firm view on your financing to be a player.

(PP): That is a tricky question to answer. There is still quality in the market from some firms that simply need cash for corporate orphans or owners needing to exit. The flip side is that you are more likely to find bad or lower quality assets on the market at this time. The reason for this is that a seller will not get a premium sale price in this current environment so why would they sell their prime asset? There is actually a backlog of sellers in the mid-market who are waiting since the multiples are so low and the uncertainty of deal closing is so high.  It tells you something when Bankers, who earn their money on transaction fees, are advising their clients not to sell in many instances.

(PP): It is hard to draw generalizations for all banks, but many banks are not providing leveraged lending, others simply don’t exist any longer and most are very reluctant to underwrite or finance “storied” credits. We are no longer seeing banks taking the risk as the single provider of funds or holding a large portion of the transaction financing. This adds complexity to the process as you need to coordinate terms across all the lenders which create a “Least Common Denominator” effect where if I have to change terms with one bank, I need to change terms with all banks in the consortium. You try to minimize this upfront, but sometimes it is unavoidable. It is just a more time consuming process to coordinate.

[For more on the lending climate http://blogs.wsj.com/privateequity/2009/04/03/1q-lbos-buyers-and-sellers-but-no-lenders/ ]

(PP): I have really not seen many new structures out there. We talked earlier about all equity options, but you are really limited there to rare circumstances where you have a low purchase price with an extremely high growth potential. Our firm also does not make investments in PIPEs [ed note- Private Investment in Public Equity] since we would not have significant ownership control. Really, any sort of minority investment or financing structure would really need to be examined closely because you really need that control to ensure that you meet your investment goals. One area that many see some creativity would be with earn out structures due to tighter financing.

[Click here for mid-market earn out definition http://orioncg.wordpress.com/2008/03/15/part-ii-how-an-earn-out-works-and-the-advantages-and-disadvantages-of-using-an-earn-out/]

Posted by Jeremy Kloubec at 01:57 AM | Permalink | Comments (0) | TrackBacks (0)

Posted by Jeremy Kloubec at 02:29 AM | Permalink | Comments (0) | TrackBacks (0)

Charles Bauer serves as Vice President – Investor Relations for HM Capital. Mr. Bauer spent the first 11 years of his career in public service serving as Chief of Staff for a United States Congressman with a special focus on fundraising and donor relations for the Congressman’s campaign. HM Capital Partners is a sector-focused private equity firm that primarily makes control investments in the energy, food and media industries, where the Firm has extensive experience, expertise, relationships and access to differentiated deal flow.  Since inception, the Firm has completed more than 150 transactions in these sectors for a total transaction value in excess of $26 billion. I would like to thank Chuck for providing his insight into this aspect of the Private Equity value chain and educating me on some of its nuances. I hope you enjoy the interview.

Once your firm establishes a target fund size, how do you start the fund raising process?

(CB):   When determining a fund size, you evaluate a number of factors including the amount of capital your firm can effectively invest over the course of an investment period (typically five years), the market opportunity for your particular investment strategy and the state of the fundraising market in terms of available capital in the marketplace.  

(CB): The timelines and plans for the actual fundraising are fairly straight forward.  In today’s environment, I think most firms have increased their proactive marketing to prospective limited partners during periods when they aren’t raising a specific fund.  Utilizing these periods to continue to build relationships and educate the LP community on investment activity, the macro-environment for your investment strategy and keeping them better appraised of your return to market timing.

Most firms will start fundraising with pre-marketing activity where they will spend time with the existing investors of the current fund, determine the status of their investment program, available capital to deploy in a given year and willingness to support a new fund.  During this period, the firm is soft-circling commitments from existing LPs and beginning to determine how much “new capital” will need to be raised in order to achieve the target goal for the fundraise.  During this pre-marketing period, firms will also engage new relationships they have established to alert them that the firm expects to come to market in the next 6-9 months.  This is important because most institutional investors will maintain a forward calendar and will base their investment pacing and resource allocation on what they know is going to happen in a particular calendar year, so it is best to always provide institutions with as much lead time as possible to identify when your particular fund might fit in that particular calendar year’s workload.  As an example, some funds may only have quarterly board meetings and if you engage an institution in February, with a hope of holding a final close in May, you may have automatically eliminated an opportunity for a commitment because the institution has a full agenda for the March meeting and you won’t be open for their June meeting.

Most institutions will have a third party advisory group / consultant that assists them with asset allocation models, diligence on funds and in some cases can have discretionary authority to make commitments.  The fund will also engage the consultant community during this period to determine what type of information that particular consultant would like to receive to begin an evaluation of a particular fund and where this fund might fit within their client base.

[ed note- Advisory Consultants in this instance provide advice to large or institutional investors who place money in Private Equity. These advisors may conduct due diligence and be in initial screen for the investor. They are sometimes, but not always present for investment decisions.]

Official fundraising begins when the Firm distributes the Private Placement Memorandum (PPM).  .   The PPM is an executive summary of the fund consisting of items such as the target fund size, investment strategy, market conditions, prior experience and track record, biographies of key principals, and your legal terms.  Based upon a successful pre-marketing, the Firm will begin collecting commitments and once they have achieved a scale amount of commitments towards their fundraising goal, they will hold a first close, whereby they can begin making investments from the fund with that capital.   Typically, the fund’s legal agreement negotiated between the General Partner and the Limited Partners will provide the Fund 12 months from the date of the first close to hold its final close.

(CB): Due to the timing issues mentioned above, it is possible that as you approach the final close of the Fund, it may become apparent that some Limited Partners may require additional time to get final approval or finalize the legal documents.  In this situation, the Fund will request an extension from its Limited Partners to extend the final close date for some period of time.  Most Limited Partners will ask for a list of the LPs that require additional time and only those LPs would be allowed to be admitted to the fund during this extension period.

(CB): First of all you are truly looking for partner that will participate in long term investing with your firm. Ideally it is someone that can bring market knowledge and has a consistency dedicated to the asset class so they will participate in multiple funds. A good LP will also possess a certain amount of flexibility as well to help the fund achieve its goals.  As an example, some General Partners will put value of Limited Partners that will have active co-investment programs and can participate in deals alongside the fund if the required equity to close a transaction is larger than the equity the fund can commitment to any one given deal (most Fund legal documents will place a concentration limit on the percentage of equity that can be deployed in any given underlying portfolio company).

(CB): I am currently between fund raisings, but we see a significant impact to the fund raising market now.  Two main issues are driving the slowdown in the fundraising market, the denominator effect and the slower pace of distributions from GPs back to LPs.

The steep decline of the public markets has created something called “the denominator effect” for many institutions whereby the overall value of their investment portfolios has dropped putting pressure on their asset allocations. This can be explained as follows: a portfolio (valued at $1000) has a Private Equity investment allocation percentage of 10% ($100). Now if the portfolio value drops 30% ($700), the investor has a smaller investment amount to work with for private equity ($70) affecting their ability to make current and future commitments.  The second issue is that as the credit market has dried up, the ability and the attractiveness of selling assets in this environment has become increasingly more difficult and there is downward pressure on purchase multiples, so those investors that do not have to sell assets in this market are choosing to hold on to their portfolio assets until a time that the market restores itself.  Because there is very little sell side activity going on, the amount of distributions LPs are receiving has declined dramatically over the past 18 months and most institutions model out a certain level of distributions for fund future fund commitments in their alternative asset program.

[Additional material on the state of PE fund raising http://blogs.wsj.com/privateequity/2009/04/03/pe-fund-raising-plummets-in-1q/ ]

[For more on the Denominator Effect http://scorebrokers.blogspot.com/2008/06/denominator-effect.html ]

(CB): The secondary market for the private equity market continues to mature and provides a form of liquidity to LPs that are looking to rebalance portfolios, reduce their number of overall fund commitments or need to create liquidity for their institution.  Based on what we discussed earlier about the state of the fundraising market, activity in the secondary market has increased and there has been a significant amount of time spent discussing the secondary market in the press and trade journals.

Typically, if we have a LP that needs to access the secondary market to sell one of our fund positions, we will work with secondary firms to help them better understand the portfolio, the existing companies, our expectations for those companies and timing for exit, so they can form some type of value judgment about what they would pay for that asset.  During fundraising, we might work with a secondary firm to create a “staple transaction” whereby we partner with the secondary firm to purchase an existing fund asset from a Limited Partner that has chosen not to recommit to the new fund and the secondary fund will commit to making a primary commitment to the Firm’s new fund.  This is advantageous to the secondary firm because they typically will be able to use distributions from the secondary fund purchase to fund the primary commitment for the new fund.

[For more information on staple transactions and secondary markets http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=8554 ]

Posted by Jeremy Kloubec at 01:12 PM | Permalink | Comments (0) | TrackBacks (0)

There are many fixes for the financial industry being bandied about Congress and from experts in the field. While not all will be implemented, it is a safe bet that regulatory powers will be increased just from the fact that financial firms have been at ground zero in this current economic crisis. Obviously, the mention of additional regulation creates significant concern and histrionics for some, but I feel that this is a turn in the right direction. Before I start on my defense of additional regulatory powers, I would like to state I am in favor of financial innovation. I just draw the line when that innovation creates systemic risk to our broader economy. 
 

First, the current regulatory bodies are everything and nothing at all. I find it a waste of resources having a myriad of governmental entities that cannot act as a cohesive unit. It makes more sense to combine and scale their efforts to provide swift action in a crisis or even proactive assistance. Second, while we have a process for managing our banking system, we do not have a way to affect financial services firms that exist outside of the banks but have significant exposure with the financial system. As evident by the AIG meltdown, the Government needs the ability to step in to fix the problem instead of only being able to lob money at the problem from afar. Last, the Federal Reserve has needed updating for quite some time due to the rapid changes in financial services. We avoided a major financial failure with Long Term Capital Management in the late ‘90s (http://www.erisk.com/Learning/CaseStudies/Long-TermCapitalManagemen.asp), but yet failed to enact any real regulatory change to avoid the issues created from having massive counter party risk backed by a single entity. It is unfortunate that we had to fall off the cliff completely for taking action (I hope).

Posted by Jeremy Kloubec at 02:17 AM | Permalink | Comments (0) | TrackBacks (0)

Today in the next set of interviews with Private Equity, I will be providing the text from a conversation with an investment lead at what is considered to be one of the mega Private Equity funds. I will not be able to provide specific information on the interviewee or the firm name due to the fact that approvals from their PR department would be quite lengthy, so I decided on anonymity, speed and content over names. I assume you will find it useful none the less and I am very appreciative of my interviewee for the taking time to answer some questions.

Private Equity has been undergoing pressures, just like other sectors in the economy, what are some of your biggest concerns?

(A): The macro environment is the biggest concern for us and everyone else out there. Demand is weak, which weakens pricing and causes profits to erode. Declining profitability is a particular concern for a Private Equity firm since we built our leverage models on growing and not declining earnings. If we thought earnings would decline, we would have never completed the purchase in the first place. The effect on the leverage model on declining earnings is more severe since it inhibits your ability to service debt. Because that is not in the investment thesis, it makes the debt more ominous. Of course, on the upside, the use of debt is what enhances returns for our investment. You just need to be careful in your investment model.

What steps are you taking to address these issues?

(A): Obviously, there are only so many things you can do in a down economy. However, you can take the opportunity to enact long term beneficial changes within your holding company or make decisions aggressively capture market share from the competition which may be distracted in this challenging climate. A down market is a good time to examine these and other tough decision since it is often hard to enact change in good times due to a higher level of resistance (if it’s not broke don’t fix it). The key is not remaining paralyzed in any market.

Being Private, we also have the benefit of not having to answer to the street in the short term. This allows our people who have expertise operating in leveraged environments to implement long term plans to create long term value for our investment. We manage the short term earnings to service debt requirements and reduce distress. Another lever we use is to align management incentives to a larger degree with this approach. While our portfolio management teams may benefit on the upside, they share the risk on the downside so we tend to have very close alignment of goals when we set our corporate expectations and strategy. This is different from many managers of public companies who may benefit with positive or negative corporate performance.  [ed note- see current news stories and furor regarding Wall Street bonuses]

Lately there has been more talk of Equity Buy Outs (EBOs), what are your thoughts on a model without leverage?

(A): That option is always on the table and I can see where it could become more popular due to current lending issues. I see it as more of an option for small add-on purchases to complete a market need for roll up strategy than for other types of acquisitions unless it is just a drastically under performing asset that you feel you can turn around quickly.

[For more reading on EBOs http://www.bloggingstocks.com/tag/EBO/ ]

Have you changed your investment strategy? What are you looking for in a target company?

(A): In my opinion, the $30-40B buyouts have passed us for a while. They may eventually come back, but it will take a significant amount of time and those types of transactions will be as a result of corporate mergers. Right now, deal flow is very limited across the board, I think we will get it going, but buyer and seller expectations have not yet merged.  We will see more creative corporate partnerships due to financing restrictions, but there are not many great examples out there just yet. We will need to sharpen our pencils on any new transaction.

I am spending over closer to 90% of time on the portfolio holdings conducting strategic and analytical support in addition to planting seeds to meet companies and build relationships when the turnaround happens. With very little new deal execution, this is your only options right now.

My guess is that one area of opportunity open up in the near term would be corporate carve outs where companies are running into financial distress and wish to shed non-core assets in pre- or post-bankruptcy. These assets may not have made as much sense to sell in an up market, but, for example, can go from dilutive to accretive once multiples have dropped from 8-9x to a 5x range in a down market because that 6x offer now really looks much better.

Speaking of financial distress, have you seen any “vulture” activity with your holdings?

(A): There are vulture positions made in every part of the market, so they are not unexpected. What you see now are positions being taken to establish a “loan to own” structure where those large debt positions become convertible to equity if the company fails. On the upside, those notes simply get paid out. You are starting to see some coercive debt exchanges where this is a concern and restructuring is required. The PE firm can swap junior for a senior notes or a better rate to get a lien on the assets. The bottom line is that you just need to ensure your investment company performs for reasons beyond these types of debt positions. 

[For a definition of vulture investing http://www.gsb.stanford.edu/news/bmag/sbsm0211/trends.shtml ]

Posted by Jeremy Kloubec at 02:17 AM | Permalink | Comments (0) | TrackBacks (0)