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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.

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.

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.

CDO Doom

The bad news continues for collateralized debt obligations. According to the Financial Times' Alphaville, "As of December 3, 33 CDOs have reported events of default to S&P." One CDO, named Adams Square I, was liquidated recently at less than 25% of par value. The FT is reporting that note holders received nothing. "AAA notes? Nothing. Not a penny."

"Proceeds from the Adams Square I liquidation weren’t even sufficient to cover the termination payments to the CDS counterparty (Adams Square is, or was, a hybrid CDO, containing straightforward ABS and also CDS on ABS). Unable to meet its CDS payments, Adams Square had to draw down the balance from the super-senior swap counterparty. Thus there was no money left to pay the actual owners of the CDO - the bondholders. Adams Square, which was arranged by Credit Suisse, had 79 per cent of its total RMBS collateral downgraded by the rating agencies in October," Alphaville reporter Sam Jones writes.

E*Trade's portfolio of ABS was valued at 27 cents on the dollar by rescue hedge fund Citadel. More and more information is hitting the street of CDOs and mortgage backed securities from liquidation events and sales, which will give everyone an idea of these securities values. Doesn't look good.

Rick Bookstaber writes about "mark to value versus mark to liquidity during market crises" issues that gets at the heart of most these issues. Its a good read and worth your time.

Also worth reading is Brian Wesbury's editorial in today's Wall Street Journal where he explores how a "desire for government intervention to fix problems that grown adults have created for themselves is dangerous." He focuses on government's handling of the sub-prime mortgage mess, which to say is probably more politically, than economically, motivated.

LBOs To Mirror Sub-Prime Sorrow?

For the last few months this blog's authors have stated deep concerns about the good possibility of a downturn in the LBO market in the near future. What everyone has seen in the tumbling housing market, and subsequently in the mortgage-backed securities meltdown, could be replicated in the leveraged buyout debt market. The Wall Street Journal and Barron's ran stories this week about how paper tied to businesses buried under LBO debt is selling at steep discounts in light of an economic slowdown or recession.

"Many LBO-linked senior loans are trading for as low as 90 cents on the dollar," the Journal reports. This does not bode well for private equity fund investors who may see their returns dry up in the coming months as portfolio companies struggle just to pay off interest on their debt. For instance, Apollo-owned Realogy, its "annual cash flow, which topped $1 billion in 2005, could drop to $700 million this year, meaning the company is barely covering its interest costs of $650 million. Next year could be even worse," reports Barron's.

The Journal's punch line: "Of course, private-equity firms have the luxury of waiting out bad markets, and the terms of their debt packages were excessively forgiving. It's a long stretch to say that overpaying for a company leads to bankruptcy. But it can destroy the lifeblood of the private-equity industry: returns. 'Their returns are less likely to be double digit,' said Jake Newman, a media analyst at research firm CreditSights Ltd. 'They won't be able to get out [of investments] as soon as they want. And there will be some that fail.'"

Some of the currently souring LBO deals both publications report on include:

• Univision's first-lien paper is trading at 91.6 cents of par
• Freescale Semiconductor's term loan is changing hands at 93.2 cents
• Realogy's 10 1/2% senior unsecured notes due in 2014 trade around 75 cents on the dollar and yield 17%, while the 12 1/2% subordinated notes due in 2015 trade for 62 and yield 23%. They were issued at about 98
• Linens 'n Things' debt now trades at about 55 cents on the dollar
• Swift Transportation 12 1/2% bonds were fetching just 52 cents on the dollar last week, for a 26% yield to maturity
• Bonds issued by Columbia Sussex (which acquired casino operator Aztar) were trading last week at 68 cents on the dollar, to yield 17%
• Claire's Stores subordinated 10 1/2% bonds of 2017 trade for 62, for a 19% yield
• Dollar General's subordinated 11 7/8% debt due in 2017 has fallen to about 80 from par of 100 when it was sold in late June, and now yields 16%.

For vulture funds and some hedge funds, I'm sure they will be making unusually small loans to ailing private businesses, who are desperate for cash infusions, in order to monitor their financial health. When the timing is right, these funds will swoop in and pick apart the carcasses.

Back In The Red

It appears that our January hedge fund strategies conference will be held in a nick-of-time. November results for hedge funds bare out troubled times for the hedgies that should persist for awhile. The Wall Street Journal reported today that "average returns look likely to be back in negative territory for the first time since August, judging by the performance of listed closed-end funds. More worrying, those average returns conceal big dispersions not just between strategies but within strategies, with performances varying from as much as 10% down to 5% up, according to prime brokers."

When I was reviewing some of the hedge fund indexes a month or so ago, I noticed that some hedge fund strategies vary by a 15% difference. Quite a gap. Such volatility does not bode well for the industry, considering investors are sold on the idea that hedge fund managers maintain risk-adjusted returns in their strategies. "That will worry prime brokers, too. Most include material-adverse-change clauses in their contracts allowing them to withdraw financing -- and, if necessary, seize assets -- from funds that suffer major drawdowns," the Journal reports.

Speaking of brokerages, major banks have a lot to worry about too obviously from the ongoing debt market problems. Peter Hahn, a fellow at the Sir John Cass Business School in London, wrote an interesting editorial in the Journal's commentary section today, partly blaming weak bank boards for the current mess. It's worth the time to read.

"But November's figures are likely to trigger some soul-searching by investors, who will now have had several months to see how funds perform under pressure. Weak performers are likely to be jettisoned. Given that most hedge-fund investment these days is locked up for three months, the bulk of redemptions won't take place until the first quarter of next year. That could be when the credit crunch catches up with hedge funds," the article states.

For more information about IncreMental Advantage's Jan. 22 hedge fund strategies conference, please visit www.incrementaladvantage.com.

Anti-Growth Politicians

Corporate America along with every man, woman, and child better be prepared to live under a much costlier tax regime within the next few years, especially if a Democrat wins the White House in 2008. Every day it seems the Democrats (and some Republicans) are calling for new and higher taxes on everything and anything. Don't be surprised if they implement a tax on the air you breathe.

For example, the House Ways and Means Committee just last week passed a proposed bill that would change the tax status of "carried interest" - part of the compensation the general partner receives in various partnership structures. If made law, income would be taxed as ordinary income rather than capital gains - 35% versus 15%.

In a recent study released by the Real Estate Roundtable, there are some 2.5 million partnerships in the United States managing $13.6 trillion dollars in assets, changing the tax treatment of carried interest would result in a tax increase of $13 billion annually.

I don't know if it's arrogance or greed, but politicians must be kidding themselves if they think the law will bring that much revenue into government coffers. It will only change investors', particularly those who acted as general partners, behavior by participating in other parts of the economy. Real estate, private equity, hedge funds, and other entities that use partnership structures will no doubt be impacted and probably move overseas, taking jobs and capital with them.

Let's hear it for Washington D.C.!!!

Go Alternative!

In times of rocky equity and bond markets, institutional investors and high net worth individuals will increasingly turn to "alternative assets" to beat traditional investment returns. In a study of 790 individuals by Barclays Wealth, "Some 15% of respondents said they planned to invest in private equity funds, up from 11% over the past three years, while 21% said they expected to invest in hedge funds, up from 20%. But fewer than half of the respondents expressed confidence in their knowledge of such investment vehicles, with hedge funds and private equity the least understood. Just 27% understood the former 36% the latter." This is Money, a British financial website, covered the study's findings.

Troubled times in the U.K. and U.S. markets are most evident by the study's other findings. "The survey shows that fewer people expect to invest in equities in the next three years, 48%, compared with the past three years, 64%. Investors also plan to cut back their bond exposure, with just 20% saying they will put money into fixed interest in the next three years, down from 26%."

As most of you know private equity funds, hedge funds, venture capital funds, REITs, and other investment vehicles are popular money managers that are considered part of the alternative investment class. Such vehicles, in order to produce "absolute returns," invest in among other things: commodities, oil and gas, infrastructure, real estate, structured finance, and private companies.

IncreMental Advantage will be hosting an "Alternative Investment Due Diligence" conference in Chicago on April 9 to help people better understand the alternative investment universe. In the following weeks visit www.incrementaladvantage.com for more information.

In other news, Forbes ran a story that quoted George Littell, partner at Groppe, Long & Littell, that oil prices will be falling to around $60 per barrel in about two months. His reason, in March 2006 Saudi Arabian "petrocrats thought demand would slacken at the same time that oil production rose from outside the (OPEC) nations." They are only now increasing oil production to bring prices to around $60 per barrel. Also, China's growing demand for oil is overrated for causing prices to increase. "Forty-percent of that country's oil is burned in so-called stationary uses like electric plants ... which will be shifted to less expensive fuels if oil prices stay high. Most industrialized countries made that shift decades ago."