Vertical Pulse

Societe Generale Trader

The saga of Jerome Kerviel causing $7.2 billion in losses for his employer, Societe Generale, is a timely reminder of the enormous shocks that small sparks can set. According to The Wall Street Journal, Mr. Kerviel was so low on the bank's totem pole that some bank executives didn't consider him a trader at all. Nevertheless, Mr. Kerviel persistence in squaring his books and never making big profits or losses eventually caused Societe Generale losses to greatly exceed those sustained by Barings Bank when rouge trader Nick Leeson caused $1.3 billion in losses in 1995.

These are some of the kinds of episodes that are discussed in our new book, The Power of Incremental Advantage: How Incremental Improvements Produce Dramatically Disproportionate Results.

The Power of Incremental Advantage documents how one bullet, one vote, one second, one word, and one inch have shaped history and changed the world.

The Power of Incremental Advantage is replete with strategies, tactics and practical leadership lessons to help you stay one step ahead of your closest competitors. These leadership lessons are supported by well-researched historical examples.

Current Trends in Reverse Break-Up Fees

Traditional break-up fees are paid to suitors when a target withdraws from an acquisition. Reverse break-up fees are paid when an acquirer backs out of a deal. Financial sponsors are becoming more conservative in their deal making. This is evidenced by the low reverse breakup fees they are writing into deals. For example, when Cerebus Capital Management withdrew its buyout of United Rentals, Cerebus' breakup fee was just 2.5% of the deals value. When J.C. Flowers & Co. withdrew from its deal to acquire SLM Corp., their payment to SLM was less than 4% of the $25 billion transaction.

These are some of the issues discussed at IncreMental Advantage's Mergers & Acquisitions Due Diligence Conference Series. More information is available at www.incrementaladvantage.com or by contacting neomi@incrementaladvantage.com.

There is Still Plenty of Buying Power

We believe mergers and acquisitions activity will remain strong. It is true that private equity players are hampered by an overhang of unsold LBO debt and that the credit markets have deteriorated substantially. However, there is as much as $250 billion in the private equity sector's war chests. Also, larger companies have accumulated some $800 billion of cash on their balance sheets--which is equal to 10%  of their market cap. Further, the more lax anti-trust environment is conducive to more corporate combinations.

Deals are more rationally priced today than they were seven or eight years ago: According to research conducted by UBS, most deals in 2000 were for stock, and the price paid above actual market capitalization was 35% on average. In the first three quarters of 2007, premiums held below 25%, according to Thompson Financial. The heightened corporate governance and activism by hedge funds has contributed to this greater scrutiny.

These are some of the issues discussed at IncreMental Advantage's Mergers & Acquisitions Due Diligence Conferences. For more information, visit www.incrementaladvantage.com or email neomi@incrementaladvantage.com.

Blackstone Shakes Off Credit Crunch For A Day

Don't tell Blackstone there is a credit crunch on. Today The Wall Street Journal reports that Performance Food Group Co. agreed to be acquired by an affiliate of the Blackstone Group and Wellspring Capital Management in a deal valued at about $1.3 billion. Performance Food will continue to look for better bids over the next 50 days.

At a time when raising debt is very expensive, Blackstone and Wellspring offered shareholders $34.50 in cash for each outstanding share they hold, a 43% premium to Thursday's closing price of $24.19. The combined efforts between Blackstone and Wellspring, via their affiliate, are perhaps why the two were able to navigate the troubled debt markets.

Performance Food will be merged with Blackstone's VISTAR Corporation, a Denver-based food distributor, which the private equity firm took a controlling stake in sometime in July 2007 for $421 million. Blackstone also owns other companies in the food business, including Pinnacle Foods ($2.27 billion), United Biscuits ($3.19 billion), Tragus (£2.71 billion), and Orangina SAS ($2.30 billion).

Evercore Group L.L.C. is acting as financial advisor and Bass, Berry & Sims PLC is acting as legal advisor to Performance Food. Wachovia, Goldman Sachs, and Credit Suisse are acting as financial advisors and Simpson Thacher & Bartlett LLP is acting as legal advisor to Blackstone and Wellspring.

144a Securities Boom

Washington regulators have come up with another way to marginalize the ordinary retail investor by precluding them from participating in some of the more lucrative equity and bond markets. Under present market conditions people may scoff at the notion of investing in the stock or bond market, but no matter how the media plays it up with scenarios of dooms-day recessions, it is only temporary. A bull market will return one day. But JoeSixpack and his IRA or 401K may miss some of the better performing companies that go "semipublic" when the markets return to their glory of just even a few months ago.

Securities & Exchange Commission Rule 144a allows companies to raise capital without having to comply with certain regulations (some of them stupid, i.e., Sarbanes-Oxley). The downside for us simple folk is the securities can be sold only to sophisticated investors, such as hedge funds and investment advisers, who have to have a required minimum of $100 million under management.

"Through the first nine months of 2007 companies raised $300 billion in 144a equity, compared with $215 billion for public markets," reports Forbes, which ran a story on the 144a rule in its Jan. 7 edition. Most of these deals were done by companies that were already public, but there is a provision in the rule that allows for PIPO (Pre-Initial Public Offering). Forbes also found that two years before the useless Sarbox legislation went into effect in 2002, there were only two PIPO deals. Since then there have been 83, raising an average $282 million.

To learn more about 144a securities the Forbes story and SEC link are good places to start. In the coming months the semipublic sector will be getting assistance from Nasdaq, which will supply price information to buyers and sellers of 144a shares.

The Link Between Chinese Demand and Urbanization

Anyone who follows the news can tell you that commodity prices have surged because of demand in China, India, and other emerging markets. Other factors figure into why commodities have boomed the last couple of years, but let us focus on the fundamentals for today. Let's look at demand in China.

In "China Shakes the World," by James Kynge, he states in the beginning of his 240-page book about the economic giant that demand will grow as long as the Chinese landscape continues to urbanize. He uses statistics that find 400 million Chinese currently live in towns and cities, but is expected to rise between 600 and 700 million to a total of 1 billion or 1.1 billion people. "Even at that level, China may be only slightly more than 70 percent urbanized, compared with prevailing rates of around 90 percent for the United Kingdom and the United States, just over 80 percent for France and Germany, and 77 percent for Japan."

"The investment required to settle so many people in an urban environment is impossible to calculate with any accuracy, but it is clear that worldwide demand for steel, aluminum, copper nickel, iron ore, oil, gas, coal, and many other basic metals and resources may remain strong for as long as cities in China expand at a rapid clip."

The Business Development Academy, an affiliate of IncreMental Advantage, organizes seminars around the U.S. and will be hosting its "Managing Transactions in China" on Jan. 29 in Boston, March 18 in New York City, and March 31 in Washington D.C. For more information please click on previous link.

Selling Your Business

There was an interesting article in The Wall Street Journal today dealing with the long sales-cycle of selling a small business. Some advisors contend that sellers should begin the process of preparing their companies for sale seven years before they intend to exit their business. During this time, the right kind of paper trail - including financial records and business plans - should be kept in sound order. Much more due diligence is being conducted and the credit markets are making it harder to fund deals.

These are some of the issues that are discussed at The Business Development Academy's Mergers & Acquisitions seminars.  Please visit www.bdacademy.com.

Price Stability

Just to continue with Friday's theme of this country's questionable monetary policy of the last 30 years I found an interesting passage in Alan Greenspan's book, "Age of Turbulence." The former Fed chairman  briefly discusses the heyday of the gold standard when price stability, for the most part, was pretty consistent until the world abandoned it during the Great Depression.

"I have always harbored a nostalgia for the gold standard's inherent price stability ... But, I've long since acquiesced in the fact that the gold standard does not readily accommodate the widely accepted current view of the appropriate function of government - in particular the need for government to provide a social safety net. The propensity of Congress to create benefits for constituents without specifying the means by which they are to be funded has led to deficit spending in every fiscal year since 1970 ... For the most part, the American people have tolerated the inflation bias as an acceptable cost of the modern welfare state. There is no support for the gold standard today, and I see no likelihood of its return."

Never say never.

Now, I will put on my undergraduate college cap to paraphrase Adam Smith, who said a neutral currency is vital in a capitalist system. Perhaps one day, our economic system will find another price stabilizing force, may be in the form of an electronic medium.

Commodity Prices Continue Surge

Huckabee wins Iowa and my faith in the GOP as the vanguard of limited government and fiscal restraint has been destroyed. The only one talking any kind of sense in economic terms is Ron Paul. But the average voter has no idea about monetary policy and therefore can't make heads or tails of what the populist Libertarian/Republican is talking about. Come to think about it, the lack of understanding about free market economics among voters is appalling.

Commodity prices know no bounds. Oil briefly hit the century mark twice in this new year. Fuel oil per gallon has increased from 0.97 cents in Nov. 1997 to $3.17 in Nov. 2007. Time to go long on oil, gold, wheat, raw materials, and short everything else.

"Since 2001 the dollar price of oil and gold have run in almost perfect tandem. The gold price has risen 239% since 2001, while the oil price has risen 267%. This means that if the dollar had remained 'as good as gold' since 2001, oil today would be selling at about $30 a barrel, not $99. Gold has traditionally been a rough proxy for the price level, so the decline of the dollar against gold and oil suggests a U.S. monetary that is supplying too many dollars," a Wall Street Journal editorial states.

The price of wheat and soybeans increased 3.4% and 2.8%, respectively, which follows a 75% increase in their price in 2007. I know demand has grown in India and China causing these commodities to rise in price, but that goes only so far. Such increases also follow the fall in value of the dollar very closely.

I am no monetary expert, but it appears the Nixon Administration's decision to take the dollar off the gold standard on Aug. 15, 1971 based on run-away inflation seems flawed. An expensive war in Vietnam, government spending, and bad Fed policy led to inflation. It seems that Ron Paul understands this based on his campaign planks of ending military adventurism, reducing government by 60% to 70%, and abolishing the Federal Reserve System. Too bad he won't be president.

The day Nixon switched to a floating currency Ron Paul was quoted in the Texas Monthly saying, "After that day, all money would be political money rather than money of real value. I was astounded." Soon after Mr. Paul decided to run for Congress.

On related matter, Ron Rimkus of BB&T Asset Management was on Bloomberg this morning arguing that the U.S. economy was already in a recession. He added to his argument that job numbers would catch up with this reality soon and that part of the blame should be placed on the Fed for acting to slowly to the credit crisis.

These are some of the issues that are discussed at IncreMental Advantage's conferences. For more information, please visit www.incrementaladvantage.com.

My Worry For 2008

My New Years Eve bubble-induced hangover did not help me forget the many worries I have for 2008. High oil prices (record $100 today), talk of recession, a return of populist politics, housing market crash, a weak dollar, a credit crunch, social unrest in Pakistan (Middle East region in general), and other issues have me walking on egg shells.

However, with the exception of social unrest and recession, the most important concern I have for 2008 is inflation. "A change in inflation expectations [could] send the Federal Reserve into a severe monetary policy tightening campaign that would take the U.S. economy into a recessionary path," wrote Wells Fargo Senior Economist Eugenio Aleman.

That comment came on the heels of Mr. Aleman's analysis that the ongoing credit crunch should bring U.S. economic growth back within a trajectory of a mature economcy - not an emerging market's rate of growth. Also, the negative savings rate and current account deficit would not weigh on the economy like in the past.