Izzy Math

Back in the day, no one in Brooklyn had air
conditioning.  Now, we could deal with that, but the real killer was
that far too many people had plastic slipcovers on their furniture.  Hot apartments and vinyl seats: a deadly combo! 

a eighteen innings of stickball out in the summer swelter, we'd all
rumble-tumble over to someone's house for video games, lemonade, and,
if we were lucky (or unlucky depending on whose mom was cooking,)
dinner.  Always in a big hurry to sit down and start playing games, we
paid little mind to the inevitable pain of getting up once our
leg-sweat had bonded our skin to the infernal plastic.

the most bittersweet place to visit was the DiPietro place.  There, the
plastic slipcover found its most profligate use: the faux-rococo decor
lay beneath two layers of 4-mil thick clear vinyl . . . that
stuff was everywhere, even on the lampshades!  But it was all worth it:
the always-elegant Mrs. D was an outstanding cook and my buddy owned
the only Intellivision on a block of Ataris.  And besides, the amiable malevolence Mr. and Mrs. D directed at each other lent a sitcom air to the apartment.

I'll never forget one particularly goofy exchange.  Mrs. D had just brought a dress home from Gimbels and proudly announced to us that she'd saved 20% by buying off the clearance rack.  Mr. D practically spit his Ballantine all over the yellow shag and bellowed, "Izzy, just 'cause ya got twenny poicent off don't mean ya saved anyting.  Fer cryinoutloud, ya still spent money, maybe twenny poicent less than ya would've, but still more than you should've."  

recently, I've been having  lot of flashbacks to those long-lost
languorous afternoons at the DiPietro's.  At least four (remember, I
don't blog until I get more than three data points so as to keep
confidentiality) LBO-sters raising funds have said to me recently that
they were seeing "great deals" again: companies that were previously
selling for X times EBITDA were now selling for X minus 1 or X minus
1.5 times. 

Guys: just because something
is cheaper than it was, doesn't mean it's cheap.  As my buddy, Du,
says, elegantly updating Mr D, "twenty percent off is still eighty
percent on."

Now I've been spared the
"things are suddenly cheap" reasoning by my own managers; I like to
think that all the weekend ice fishing on Lake Wobegon clears the
head.  But I do worry there's a lot of rationalization out there right
now.  And it all starts with the poster-child rationalization: the
assertion that downturns are the best time to invest.  I'm not saying
that they aren't, I'm just a bit suspicious of the data that people
cite.  Inevitably, someone whips out a spiffy chart that overlays
vintage year returns on GDP growth figures.  The line goes down, the
bar goes up.  Beautiful.

But on further
review, the number of recessions that have taken place during the
mature years of the private equity "business" can be counted on about
half of one hand.  Not exactly what one would call a robust data set. 
It's just confirmation bias; people look for data that proves their
hypothesis, no matter how meager that data.

remember, it wasn't all that long ago that people were saying that
seven was the new five, in terms of multiples one could pay for a
business.  But if prices have come down two turns of EBITDA, does that
mean that the old five is the new seven?  That just seems like a return
to normal pricing.  And normal just isn't good enough right now. 
Things have to get a whole lot cheaper.  After all, the public markets
are on sale and the opportunity costs of capital are extremely high. 
Moreover, people are assigning an incredible amount of utility to
liquidity.  Drawing capital today for a new investment means that deal
has to be an absolute screamer.

And if
folks focus on screaming deals, not just places to dump some dollars,
we'll hopefully be able to say in retrospect that this turned out to
be another recession during which it was a good time to invest.  I just
hope that when we say that, it will be because people invested in great
companies at good prices, not because we're seeking confirming data and
confusing correlation with causation.

5 thoughts on “Izzy Math

  1. In the buy-out business you hear of cheap assets for sale. In the venture world, ‘capital efficiency’ is the mantra that describes the Company environment a fund finds entrepreneurs touting….and playing back for LP’s.
    It’s basically the same denominator math. Today, the PE market does not have a challenging environment finding investments that appear ‘cheap’ to build, or ‘cheap’ to buy, when compared to yesterday’s metrics. The challenge is around building intrinsic value, and having the wherewithal, and patience, to choose a proper exit time.


  2. Great post Chris. I think there are two basic reasons to be raising a fund right now. Either 1) you think there are screaming deals and it will be another decade before we see anything remotely attractive like this or 2) you have to. I have no problem with number one (albeit I agree with you Chris, there should be some prudence), but I don’t want to give any money to number two. Becasue if you HAVE to be in the market it’s because you need management fees from those commitments. How can you tell? If their previous fund is only 50% invested or less. And I see TONS of that.
    Since money isn’t coming back to G.P.’s in the form of realizations many have to scamble to come up with capital. The easiest way is to come back to your L.P.’s before results from your previous fund can be verified and play the old “recessions are better” card.


  3. EBITDA multiples on historical performance work great in rising tides as they represent a discount to your forward value. In receding tides, they represent a premium. The urgent wishfulness all of the unemployed or soon-to-be-unemployed investment professionals speaks more to their situation than the fact that the economy is on the brink of a turn-around. Why doesn’t anyone talk about the “7 years of down 2%” scenario? It’s as possible as anything else out there…
    The truth is that no one talks about it because to do so is to succumb to a fate that isn’t in our DNA, and for good reason. If we were a more “rational” society, like say Germany or Japan, then considered skepticism would be a part of our tool chest. However, the great thing about America is that we have a bias for growth. Yes, sometimes it borders on maniacal, but sometimes it saves our collective asses. The downtick rule, the short-seller gauche, what-have-you — all indications that the only winning team for any extended period of time in the good ol’ US of A is growth.
    It will be interesting to see when and where this mindset reemerges.


  4. Sir – Are we now saying that LPs are now the new (and superior) GPs? Armed with little more than derring-do and moral (though less-liquid) authority, the masters now lecture the GP-serfs about the markets and deals. If so, I’d be happy to fuse Older Ivy and Beantown Jesuit together to pursue direct deals on our own – lucre and fame surely will follow.


  5. Jake Kaldenbaugh

    FYI – people are starting to come around to the idea that we may malaise in a multi-year negative growth scenario. See this critique of Geithner’s stress-test models:


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