Now, I'm usually focused on multiple-of-cash returns. After all, you can't eat IRR, or so they tell me. (Actually, I think the hedgies have us PE cats whipped when it comes to glib phrases; how can you beat: "Miller Motorcars doesn't accept relative return as a form of payment."?)
That said, if anyone can point me to the place from which this piece of recently-spotted equipment came, I'd be much obliged! What they're sellin', I'm buyin'!
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!
After
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.
And
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."
And
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.
And
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.
All Politics Is Local . . . Maybe Investing Should be Too?
[Ok, ok . . . I've been slow on my long-promised post about out-years risk, but I started writing it last night and the post got unruly. Back to the drawing board on that one . . .]
In the meantime, I've got another quick thought about this whole Madoff mess: I'm amazed – but unsurprised – by how international the roster of victims has been. (Harry Markopolis, the man who tried to alert the SEC, suspected that half to three quarters of Madoff's capital came from overseas). As you read through the list, you can almost imagine Ricardo Montalban or Catherine Deneuve reading off the foreign names with crisp and precise diction (while heavily accenting the American ones: Ferh-feeeld Ghreenesh Ehdvisors . . . Tree-Mon Groope . . .) It's a far-flung group that now shares a common shame.
And that got me thinking about how we, as investors, do diligence. I mean, information is the raw material of investing, right? I'm not talking a Gordon Gekko/Bud Fox sort of information ("Blue Horseshoe loves Anacot Steel.") What I'm talking about is knowledge. Do you have a view? Is your opinion the product of a dialectic? How was the tension in your thinking resolved? What data tipped the scales in favor of one route, but not another? After all, we're just intelligent switches and network nodes, gathering and processing information.
And if information is our sustenance, how often do we outrun our supply lines? I've been thinking a lot about the epistemology of investing lately: how do we know what we know? Is it harder to triangulate information when investing across the country? Across the world? How frequently do we not speak the same language (literally or metaphorically) as the people with the insights? How frequently do we not even know who those people might be?
And fund of funds have it even worse. At least the primary investors are buying assets with (hopefully) some intrinsic value or growth potential. FOFs make investments in the people who buy those assets, placing at center stage the most pernicious irritant in all of finance: the Principal-Agent Problem. Don't get me wrong: I'm not kicking any of the cats who lost money. I'm sure they're all smart, well-intentioned people who somehow wandered beyond the frontiers of their expertise or suspended their disbelief. It reminds me of the exchange in Leo DiCaprio's Magnum Opus Catch Me If You Can:
Frank Abagnale, Sr.: You know why the Yankees always win, Frank?
Frank Abagnale, Jr.: 'Cause they have Mickey Mantle?
Frank Abagnale, Sr.: No, it's 'cause the other teams can't stop staring at those damn pinstripes.
Now I don't want to sound provincial. Investing is a global discipline and we need to seek out the best risk-adjusted returns wherever they might be. My fear is that we've systemically underestimated the amount of risk in going increasingly far afield.
In people businesses, it's actually really valuable to see people firsthand, to look them in the eye, to know where and how they live, to bump into them at the grocery store, to interact with them closely in hopes of building a sense of mutual obligation. That's the genesis of trust. And in finance – just as in a democracy – someone must be trusted. And, indeed, trust is always at a premium, it's just that today trust is also in extremely short supply.
Gratitude
A quick detour from Private Equity, if you'll indulge me (I'll be back on the PE train later in the week with a post on out-years risk).
In college, I won a roshambo to attend a cocktail party honoring William F Buckley. Time with Bill was always part symposium on the evils of statism, part english lesson, and part comedy hour. We kiddos around the room may not have agreed with all (or, in some cases, much) of what Bill said that evening, but we could all agree that WFB was a renaissance man and a gentleman.
Anyhow, Bill had just published a book on the topic of mandatory national service, Gratitude: Reflections on What We Owe to Our Country. His call to service was based not only on a sense of responsibility, a sense of duty, but also on a belief in the soul-nourishing benefits of contributing to something larger: "Materialistic democracy
beckons every man to make himself a king; republican
citizenship incites every man to be a knight." Service to
one's society summons forth "the better angels within our
nature." (quotes cribbed from Ted Sorensen's NY Times review).
WFB believed that a mandatory year of service would help shape a national ethos, a sense of solidarity, an appreciation of common cause, an affirmation of civic pride; service was about community.
Yet in the two decades since the book's publication, society has become much more disparate and far-flung. For many today, "community" comprises a hodge-podge of fellow-travelers in the digital ether; some spend too much time on their "social networks" that they ignore the old-school social network: those who live around them, in their neighborhood, their city, their state. Sure, virtual communities are communities of interest, but your IRL (ahem, In Real Life) community really needs you to help make things better. That's why I'm so supportive of President (elect) Obama's USA Service Initiative (and here). Who knew that WFB and BHO who be so sympatico? I'd love to see the idea of service made compulsory.
Serving together, working shoulder to shoulder with a fellow countryman, this is the essence of citizenship; it's intimate, it's loving. Service and love are inseparable and they're part of the Promise of America. As always, Whitman nailed it:
COME, I will make the continent indissoluble;
I will make the most splendid race the sun ever yet shone upon;
I will make divine magnetic lands,
With the love of comrades,
With the life-long love of comrades.
I will plant companionship thick as trees along all the rivers of
America, and along the shores of the great lakes, and all over
the prairies;
I will make inseparable cities, with their arms about each other's
necks;
By the love of comrades,
By the manly love of comrades.
For you these, from me, O Democracy, to serve you, ma femme!
For you! for you, I am trilling these songs,
In the love of comrades,
In the high-towering love of comrades.
Crime and Punishment
In high school, I tried to get a summer job across the river
in Manhattan. A bull market raged in the summer of 1987 and
Duran Duran was on the soundtrack. I’ll
never forget the morning of my interview, walking down McDonald Avenue toward the F train wearing
a fresh-pressed suit and spiffy-shined shoes.
It was still early yet and Mrs. Pulaski was sweeping off her stoop, as
she did each summer morning, with an ancient straw broom that looked like she’d
brought it over from the Old Country.
Seeing me coming, she offered me a banana and some advice: “little
Chris, always remember: the gangsters and thugs may live in Brooklyn,
but the real crooks work in the City.”
Of course, Brooklyn’s convicted get all-expense paid stays
in places with foreboding names like Attica,
Dannemora, Rikers, and The Tombs. The
City’s crooks, on the other hand, get to wear that fashion accessory of the
once-rich and now infamous: the ankle bracelet.
And boy, do they get to wear those bracelets in some fancy
places. Look at this (do I need to say,
“alleged?”) scoundrel, Madoff. Where’s
he serving his house arrest? The Upper East Side? Maybe
Montauk? But hey, those December winds
howl on Eastern Long Island. I mean, that place may be fancy in-season,
but in the winter it’s positively hard time.
Just dreadful, Lovey!
Anyhow, I got to thinking about a lecture I’d heard in
college about the transformation of punishment in America . Since the earliest colonists focused on
community above all else, crimes and deviations from norms were seen affronts
to society and punishment took the form of publicly-assigned shame. Think pillories, stocks, scarlet letters.
During the industrial revolution, society became more
mobile, more dynamic Family supplanted the community and the primary
unit of organization. Punishment became
more guilt-oriented, more inwardly-focused; guilt, after all, is a matter of
conscience while shame is a matter of reputation. Guilt seeks forgiveness while shame seeks
concealment from view. As we became more
guilt-focused as a society, shame lost it sting. We’ve literally and figuratively become shameless
(Exhibit A: Hilton, Paris.)
So what does this have to do with PE? I’ve often said that managers who are
intrinsically motivated to build portfolio companies are the ones I want to
hire; ones for whom the pride of building something greater trumps it all. If they fail, it'll hopefully be because of poor execution or bad luck, not because of mislaigned interest. Of course, it’s very tough to test for that
mindset, but that’s the essence of the voodoo I try to do.
As for Madoff, let’s find some suitable public punishment
once he’s found “guilty” in a court of law.
In the markets, as in a democracy, there must be trust. And Madoff’s (ahem, alleged) fraud makes him
the poster child for this era’s breakdown in trust. Since punishments should fit crimes, maybe he
should also become the poster child for a return to shaming? Let’s set up some pillories in Times Square and have the people come with buckets of
slop, entrails and dung to hurl his way. Sure, I’ll line up to huck a tomato or two,
but I’m guessing I’d be near the end of a very long line.
And I think the whole thing could be cathartic, a sloppy
capstone to an era whose closing headlines were all provided by grifters and slicksters. And who knows? If people started again worrying about being
shamed, worrying about the effect of their actions on the community, maybe the next scalawag might think twice before messing with our
trust.
Super LP 
