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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.

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.

Patience Is A Virtue

The much talked about era of distressed funds has yet to arrive. Don't get too impatient. Many analysts  expect a slowdown in corporate profits over the next 12 months, which means debt-laden companies could struggle and eventually become crippled by a slowdown in the global economy.

"A net 60 percent of fund managers now expects corporate profits to deteriorate in the next 12 months — the most pessimistic response in almost a decade — while a net 62 percent expects the global economy to weaken," a Wednesday Merrill Lynch press release states. If this prognosis is correct, distressed debt funds and vulture investors will shine in late 2008 and throughout 2009.

"Investors' love affair with emerging markets continues despite a sharp rise in the number of fund managers expecting a slowdown in China's economic growth. A net 25 percent of respondents expect the Chinese economy to weaken in 2008. Only 4 percent in took this view in November," Merrill analysts found.

I would imagine distressed debt managers will wait for bond valuation to come more in line with market conditions. The Merrill poll found that a net 13% think equities are undervalued while a net 43% believe bonds are overvalued.

These are some of the issues that are discussed at IncreMental Advantage's conferences. For more information please click here.

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.

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."

Reason For Hard Times

So, here we are again. At the beginning of a bust period in the typical boom/bust economic cycle. Lots of ordinary people are fretting if they can continue to pay the mortgage. Workers are concerned about their jobs if a recession does indeed come. Economists are worried about the ever weakening dollar and the many effects it will have around the world. Everybody is concerned about oil and other commodities maintaining their skyward cost projections, which in part stems from the weak dollar. The struggling dollar was made weaker by the recent Fed rate cut, which Mr. Bernanke decided to do in an attempt to resuscitate financial markets after they took a pounding from the sub-prime crisis. Lots to worry about. In such times politicians pounce on the opportunity to spew populist rhetoric to win votes. With the elections next year, this economic bust probably came at the worst possible time.

While there are many culprits for the recent financial and economic downturn, perhaps the biggest suspects are Wall Street and those who implement public policy. Ray Carey, former CEO of ADT, Inc., and author, wrote about Wall Street speculators and finance law in his book, "Democratic Capitalism." In parts of his book he examines the Wall Street machine that lends hefty amounts of money to hedge funds and other "leveraged speculators," which in conjunction with flawed public policies (volatile currencies and derivatives to name a few), are the agents of boom and bust economic cycles. He wrote:

"Adam Smith specified that the success of free markets depends on money that is ample, low-cost, non-volatile, and patient. Smith also warned that speculators would deflect capital away from growth, and make money scarce, high-cost, volatile, and impatient. Smith defined the mission of finance capitalism as helping companies grow, offering advice, and lending money that meets Smith's criterion of neutrality while avoiding damage from speculators."

Mr. Carey continues about flaws in Wall Street's short term outlooks and public policy:

"The ultra-capitalistic distribution of surplus for short-term personal gain is stock buy-backs and non-strategic acquisitions. Why, then, do tax laws favor stock buy-backs and non-strategic acquisitions? Too many hints have already been provided: The answer is that public policy is determined not for the general welfare but based on the lobby power of Wall Street."

"The United States government ... escalated the traditional impediment of wealth concentration into a dominant influence that damages both economic and social opportunities. An extraordinary volatility in international currency and interest rates resulted from the American government's floating the dollar in 1971 without an alternative stabilizing mechanism or control of speculation with borrowed money. This was followed in 1974 by a further U.S. government action that coupled the excessive volatility with excessive liquidity. A new law, ERISA, required present funding of future pension benefits and effectively took about $100 billion a year out of the economy and delivered most of it to the stock market with only a part of that sum recycled into the economy. In addition to the volatile and impatient money that these mistakes caused, the government in the last quarter of the 20th century compounded the problem by deregulating finance capitalism at the same time it was abrogating the market disciplines upon which free markets depend."

I don't mean to attack hedge funds, private equity, or other financiers, that is not my intention. However, government and business leaders need to take a hard look at current laws, taxes, and regulation that impact people's daily lives. To point the finger at someone else or turn a blind eye to the problem means one is unfit for duty.

Nardelli Back In The News

Robert Nardelli resurfaced in the news this week after a seven month hiatus when he left Home Depot as its chief executive in January amid criticism that his $210 million severance package was absurd. As we all know by now Mr. Nardelli will be taking the helm at Chrysler LLC to turnaround the ailing American auto-maker. Several months ago hedge fund Cerberus Capital Management acquired Chrysler through a classic private equity buyout deal. For the last several years executives have been leaving public companies (and the criticism that comes with it) to work for quieter, less noticeable private companies.

Shortly after Mr. Nardelli left Home Depot I wrote up a report for IncreMental Advantage that delved into the contentious issue of executive compensation. It explored some of the regulatory proposals aimed at executive compensation and why some executives were heading to privately-held companies. "As overall regulation and criticism mount, the media has reported on CEOs and other executives leaving public companies (or taking public companies private) for privately held organizations, and especially, private equity firms in the pursuit of making hefty sums of money without bearing public scrutiny. All of our sources who agreed to go on record said compensation and pay were of course a big factor in CEOs decisions for heading to private companies," the report states, which you can read in its entirety here.

Mr. Nardelli proved to be no exception to the trend. For months Mr. Nardelli had worked on the Chrysler deal for Cerberus, which has retained other big names like former U.S. Treasury Secretary John Snow, who serves as the firm's chairman. The Wall Street Journal today ran a story today about what Mr. Nardelli will bring to Chrysler, how the job may redeem his reputation, Chrysler's corporate strategy, and other issues surrounding the car-maker and its new boss.

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

A Cause Of Good

As we all know state pension funds are significant investors in hedge funds and private equity funds. For the last few years alternative asset classes have yielded good returns for pension funds, which represent hundreds of thousands of state and municipal workers who depend on their pension plans for a comfortable retirement. It has been reported in the immediate past that the success of hedge funds and private equity funds has nearly closed the funding gap between politicians' promises and financial shortfalls.

The state that needs the most help from the alternative asset class in financing state workers' retirement plans is New Jersey. In yesterday's New York Times it was reported that the Garden State will experience a $58 billion shortfall, the amount needed to provide all the health care its politicians have promised current and future state worker retirees. The state stopped placing money in a fund to pay for health care for its retired public workers in 1994 under Republican Governor Christine Todd Whitman.

"That’s nearly twice the state budget and nearly twice the amount of its outstanding debt. And because of the step it took in 1994, the state has virtually no money in reserve to cover those costs," the Times reported. The newspaper went on to spin that a national health care plan would be the solution to New Jersey's woes. However, for those of us who know better, realize that this would be only a short-term solution and would end up costing taxpayers even more of their hard earned money while destroying innovation in the medical industry. 

I will not go on to pretend that I know the solution, but among all the state's politicians' possible options, one should be to take some the money earmarked for the pension plan and invest it in a vehicle of the alternative asset class. Also, members of unions should suggest to their top leaders that private equity and hedge funds are a cause of good (yes, they do fire union workers, but experts have argued that such employers would collapse if it were not for outside investors' cash infusion) and spare them from losing their jobs. Also, voters, especially the ones in New Jersey, should tell their representatives in Congress to drop all proposals that would raise taxes on organizations that are partnerships (i.e., hedge funds, private equity, venture capital, REITs, etc.).

Forbes Magazine CEO and President Steve Forbes wrote in The Wall Street Journal yesterday that increasing taxes on private equity is "an ill-conceived idea that will ultimately affect all of us, and not for the better."

Indeed.

Subprime Summer

The tempestuous debt market is making it difficult for Chrysler to raise $20 billion - money that would maintain its operations once sold off from its parent company, DaimlerChrysler AG. "Low interest rates and plentiful capital are the key enablers to Detroit's restructuring," John Casesa, managing partner of the Casesa Shapiro Group, told The Wall Street Journal yesterday. Daimler decided to sell its North American automaker unit to Cerberus Capital Management, a New York-based hedge fund, several months ago.

For the last couple of years debt has been cheap for private equity firms and hedge funds looking to take companies private, which allows them to turn their acquistions' operations around, and then sell them for a profit. However, recent troubles in the sub-prime sector have made many debt investors nervous, who are now calling for more protections when lending money. This has increased interest rates and terms to loan covenants.

Several hedge funds have imploded recently because their sub-prime holdings have suffered a dramatic decline in value since the winter. It appears the sub-prime bug knows no bounds. In Sydney, Australia where Basis Capital, a popular hedge fund manager, recently alerted investors in its Basis Yield Fund that the value in the fund’s illiquid securities has been reduced by more than half. What is being labeled as the "Sub-prime Summer," people are divided on how it will affect the overall market over the next several months.

Hedgeworld.com reported today that "Economists and bond market participants are divided into two camps on the relationship between the subprime/credit headlines and the dollar. Some believe that the effect of the U.S. subprime crisis will be limited and that the economy is in growing mode. They tend to anticipate that the Federal Reserve Board will lean toward a tightening policy this year, either because they see that U.S. growth can't be sustained without a serious risk of inflation or because they already worry about price increases. The other camp believes that the subprime 'disease' is spreading across the credit market, the economy and the dollar. Their view is that the Fed is likely this year to postpone rate hikes or may even ease up, because they see the housing and credit markets as having the potential to slow down the U.S. economy."

The sub-prime issue will be discussed at IncreMental Advantage's Oct. 16 Hedge Fund Due Diligence Conference in NYC. For more information please visit www.incrementaladvantage.com.