Partnership from Hell

StockJockey discusses Private Equity firms, regression to normal conditions, partnering with the government, risks and agendas. – Ilene

Partnership from Hell: Private Equity and Paulson

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Courtesy of StockJockey, at 1440 WallStreet

The media fell under the spell of Private Equity in early 2007; CNBC’s breathless coverage of the Blackstone IPO pretty much marked the top.

But I was more in Dan Loeb’s camp – he does not hold them in such high regard, and unloaded on the industry at one of its very own confabs (roughly 20 months ago):

During an informal question-and-answer session, hedge fund manager Daniel Loeb—seated in the audience—began to criticize private equity firms for hoarding profits that rightly belong to public shareholders. While some attendees may have agreed privately with Loeb, those dinner guests well accustomed to the sanguine navel-gazing of business conferences were taken aback. In the pantheon of audacious acts, Loeb’s behavior was akin to wearing an NRA T-shirt to a peace rally.

But it was clear by the summer of that the salad days of PE were over. Every two-bit blogger jumps on Jeremy Grantham pronouncements now, but few did 18 months ago when he stuck a fork in the industry:

August 2007
What has been almost completely missed, though, is the degree to which dazzling results have been enabled by rising global profit margins and leverage on easy terms……But the history of finance makes one point very clear: near-perfect conditions, although intrinsically very rare, are almost invariably extrapolated by market participants. Yet they almost invariably regress to more normal conditions.

When this regression happens to today’s record profit margins, all but a handful of private equity deals will lose money and many will lose it all. FT

Yes, it was a good time to short Andrew Ross Sorkin, and his rapidly shrinking rolodex.

Financial firms have been perhaps the worst investments for the PE gang. TPG’s loss in Washington Mutual was the largest in the history of the industry.

It is worth noting that clever contracts can save bundles…Corsair actually escaped the National City deal with a small profit. But they are none to happy with Hank Paulson’s meddling in the markets:

Corsair’s contemporaneous investment in Nat City, meanwhile, tacks a disturbing addendum on to the lesson of WaMu: Namely, sometimes even a liberal infusion of capital that seemingly exceeds a target bank’s possible write-offs won’t suffice. A person familiar with Corsair’s investment notes that the $7 billion Nat City received was $2 billion more than Corsair’s financial models showed was needed. The $2 billion “cushion” effectively “derisked the deal from [Corsair’s] perspective,” the source says. The Deal

Nevertheless, justifiably or not, Nat City fell prey to a run on deposits the way WaMu had—a run touched off in part by speculation that Nat City was under intense government pressure to sell itself to a financially sounder rival. The rumors were true, and on Oct. 24, the bank disclosed it would be sold to PNC Financial Services Group Inc. for $5.6 billion. Even though the $2.23 a share PNC said it would pay for Nat City was less than half Corsair’s investment cost, the firm escaped with a modest profit on its own $850 million slice of the $7 billion, thanks to downside protections built into its Nat City investment contract.

Whether Nat City could have survived on its own is open to debate. After all, depositor runs can doom even an amply capitalized bank. Although Corsair declined to discuss Nat City, the firms’ partners, sources say, firmly believe that the government’s own maneuvers exacerbated Nat City’s plight and made necessary a sale that might have been avoided.

Hank Paulson and Sheila Bair have set off many unintended consequences, and doing business with them is not so palatable to folks left standing. Paulson’s November 12th call for the private sector to join the government in recapitalizing the financial sector apparently set off guffaws on Wall Street.

And watching KKR get spanked on their investment in Legg Mason, Goldman in First Mablehead, and Warburg Pincus in MBIA has not exactly inspired confidence.

Valuations continue to rachet downward, and PE shops still in the game seem to be biding their time. Will the long rumored sale of Neuberger Berman (which I thought would have bought Dick Fuld some precious time – oops) finally get done? The “Power Trio” at Clayton, Dubilier wisely walked away, but other suitors are circling, and rumors persist that a deal will get done.

But Grantham’s predictions were spot on. For now the Masters of the Universe are kicking back, collecting their 2% fees, and praying for better days.

To be fair, it was hard to see 18 months ago that Hank Paulson, and the government, would be “here to help.” But, believe it or not, Private Equity professionals are debating the helping hand:

There is considerable disagreement in private equity circles over one key matter: whether Paulson’s plan for TARP and for private capital sources to join forces holds any appeal at all. Some contend that partnering with government always carries risks. “As Paulson’s policy shifts over the last six months show, governments are not stable and predictable partners,” says a partner at a well-known private equity firm. “They have agendas that are driven by more than just financial returns.”