Tuesday, July 31, 2007

Spring Cleaning

Attentive readers who are not trying to view this blog on a laptop in the glaring sun of the Hamptons or the Côte d'Azur will notice that I have made a few subtle changes to the design of this site. Chief among those is the replacement of the original background color to a nice, unobjectionable white, which should reduce (but probably not eliminate) the peevish cavilling from certain quarters about my aesthetic sensibilities.

I was actually rather fond of my original color scheme, which appeared to nice effect on my high-quality monitor through the lens of a secure, robust web browser. However, I do understand that most of you—through either your own misguided choice or the evil tyranny of corporate IT departments—have been reduced to squinting at the World Wide Web through the unlucky combination of Microsoft web browsers and Dell computer monitors. I have been reliably informed that my original background color appeared as a rather noxious "lemon-lime" in such contexts, which was rather more bilious and rather less subtle than was my intent. So, notwithstanding my unshakeable faith that Steve Ballmer and Michael Dell are perfectly capable of screwing up the display of black text on a white background, I herewith bequeath you the New and Improved Version of TED.

By the way, you should also thank me for keeping the other aspects of my site up to date. I have noticed than many of my blogging peers seem to have last checked and updated their blog rolls when Spiro Agnew was broadcasting live from the Cities of the Plain. Tsk-tsk.

© 2007 The Epicurean Dealmaker. All rights reserved.

Monday, July 30, 2007

Wild Strawberries

Ingmar Bergman has gone to his long home.

Long after the last bond indenture and purchase agreement has moldered away, he will be remembered.
“I want to be one of the artists of the cathedral that rises on the plain,” he said. “I want to occupy myself by carving out of stone the head of a dragon, an angel or a demon, or perhaps a saint; it doesn’t matter; I will find the same joy in any case. Whether I am a believer or an unbeliever, Christian or pagan, I work with all the world to build a cathedral because I am artist and artisan, and because I have learned to draw faces, limbs, and bodies out of stone. I will never worry about the judgment of posterity or of my contemporaries; my name is carved nowhere and will disappear with me. But a little part of myself will survive in the anonymous and triumphant totality. A dragon or a demon, or perhaps a saint, it doesn’t matter!”

And missed.

In 1982, Mr. Bergman announced that he had just made his last theatrical film — it was “Fanny and Alexander,” a look at high society in a Swedish town early in the last century that was in part inspired by his own childhood.

“Making ‘Fanny and Alexander’ was such a joy that I thought that feeling will never come back,” he told Ms. Kakutani. “I will try to explain: When I was at university many years ago, we were all in love with this extremely beautiful girl. She said no to all of us, and we didn’t understand. She had had a love affair with a prince from Egypt and, for her, everything after this love affair had to be a failure. So she rejected all our proposals. I would like to say the same thing. The time with ‘Fanny and Alexander’ was so wonderful that I decided it was time to stop. I have had my prince of Egypt.”

Farewell, prince. Safe travels.

© 2007 The Epicurean Dealmaker. All rights reserved.

Sunday, July 29, 2007


Watching the little islands of green stock tickers flash feebly against the sea of red on my Bloomberg monitor last Friday somehow got me thinking about art. (It is too early for Christmas, and the way things are going there may be no presents exchanged in Manhattan this year anyway.) Fortunately, DealBook ran a little piece that provided an interesting distraction from the screams of leveraged finance bankers plunging to their deaths from the office buildings surrounding me.

In it, DealBook profiled the list of the top ten art collectors published in the recent issue of ARTnews. Apparently "Budweiser" Ken Griffin of Citadel Investments, the most boring seriously weird rich dude on the profile circuit, has "elbowed his way" into the top 10 to join his competitor and chubby fleece-wearer Steve Cohen of SAC Capital on the list which leading art dealers use as a masturbatory aid. Steve, of course, has already proved his art world bona fides by loaning Damien Hirst's tiger shark floating in formaldehyde to the Metropolitan Museum of Art. (Perhaps SAC's limited partners were beginning to complain about the smell in the hedge fund's waiting room. Given the current state of the market, Cohen probably decided it was not a good idea to let LPs think the smell of rotting flesh was coming from anywhere near SAC's portfolio.)

Now the cynics among you (surely not among my readers?) might sigh and shift impatiently in your seats, expecting some hackneyed jeremiad about conspicuous consumption, invidious consumption, and fine art as a Veblen good. But no, my hackneyed jeremiad will address one or two far more interesting subtleties which I perceive (or am willing to invent) as characterizing the current phenomenon of hedge fund barons spending their ill-gotten gains on art.

First, I think most people would acknowledge that nouveau riches of all stripes have often felt compelled to buy their way into proper society by contributing to the right charities, belonging to the right clubs, and furnishing their palatial digs with the right furniture and expensive accessories, including works of art. Back in the day when the division between old and new money was clearer and more easily traced—usually by a quick lookup in Burke's Peerage or the local parish register—that's usually where it ended. New money was worthy of suspicion and requiring of acceptance simply by virtue of its being new. Nowadays, when any college student can earn umpty gazillion dollars by stringing two websites together and broadcasting grainy videos of Britney Spears snorting Drano off the chest of Hervé Villechaize, people have become much more sensitive to how a particular nouveau riche earns his or her money.

And this is where hedge funds come into play. For—unlike purveyors of trashy celebrity pornography, whom they embrace unreservedly—most Americans view people who seem to make money too easily or too quickly as having done something vaguely naughty or despicable. Therefore, in addition to the usual social baggage of being nouveau, a socially ambitious hedge fund manager (or his wife) has the added burden of being about as welcome at a charity ball as a Russian oil tycoon or Michael Moore. Spending money on art—a lot of money—can be seen in this context as a form of psychic money laundering, through which the pasha in question can exchange a passel of tainted simoleons—and a good-sized chunk of social guilt—for a highly marketable commodity which even Mrs. Badgley Whittington the Third will recognize as respectable, even if it is not to her taste.

Now arrivistes were buying their way into the Knickerbocker Club with Impressionist and Postimpressionist art long before Al Gore invented the internet, so what makes this any different for hedgies? Well, I have been struck not only by the sheer number of hedge fund honchos milling about the high end of the art world, but also by the simply ludicrous amounts of money some of them seem to be throwing at second- and third-rate art. I mean, eighty million bucks for the half-baked Jasper Johns at the top of this post?! It's not even a cultural icon, for chrissake. Whatever else they are, hedge fund guys are supposed to be excellent judges of value and canny buyers, but the prices some of these guys pay and the money they throw around at Sotheby's and Christies make them look totally unhinged.

DealBook attributes much of the hedgies' collecting fervor to their competitive juices, and there does seem to be quite a bit of the old "mine is bigger than yours" dynamic at play. But this has always been true of the über-wealthy, no matter what the provenance of their squintillions. What makes the hedge fund guys act like the new Japanese, who back in the 1980s seemed to take perverse pride in paying three weeks of revenue at Sony Corporation for a dusty old painting destined to sit in a vault in Tokyo? Is it the case that the new hedge fund collectors are not really collecting art, but rather symbols of their own wealth?

If so, this is the kind of meta-trend that floats a thousand art history PhDs and makes the editors over at Social Text have wet dreams. It also brings me to my second assertion, that, knowingly or unknowingly, these hedge fund collectors are creating an entirely new category of art: fine art as kitsch. As philosopher and critic of art Denis Dutton points out,
Kitsch (from German, pretentious trash, < dialect, kitschen, to smear, verkitschen, to make cheaply, to cheapen)

is usually defined as poor quality, "pseudo-art ... whose essential function is to flatter, soothe, and reassure its viewer and consumer."

Kitsch includes what advertising blurbs might call “original hand-painted reproductions of fine works of art,” mass-produced tourist curios in imitation of honest folk styles, most cinematic versions of famous composers’ lives, much patriotic art, the funerary sculpture of California’s Forest Lawn Cemetery, and all manner of religious reproductions and souvenirs. The kitsch object declares itself “beautiful,” “profound,” “important,” or “moving,” but such values are not internally achieved; they derive merely from the kitsch object’s subject-matter or connotations. According to Tomas Kulka, the standard kitsch work must be instantly identifiable as depicting “an object or theme which is generally considered to be beautiful or highly charged with stock emotions.” Moreover, kitsch “does not substantially enrich our associations related to the depicted subject.” The impact of kitsch is limited to reminding the viewer of great works of art, deep emotions, or grand philosophic, religious, or patriotic sentiments.

Whether you like it or not, most modern and contemporary art—the general period of preference for hedge fund collectors—cannot be classified as kitsch under this definition. But look more closely at the function and purpose of kitsch:

A major function of kitsch in the present century is to reassure its consumers of their status and position, hence its association with the ever-nervous middle classes. Just as an ostentatious set of “great works of literature bound in hand-crafted buckram” is not intended to be read, but to confirm the literacy and wealth of its owner, so works of self-consciously “fine” art may appear in domestic surroundings as emblems of status and good taste.

Clearly, a leather-bound set of Franklin Library classics or a Thomas Kinkade print "hand-highlighted under the supervision of the artist" is not going to cut the mustard in the 10021 zip code, but what about a Jasper Johns painting, or a Damien Hirst sculpture? Just the ticket "to confirm the [cultural] literacy and wealth of its owner," no?

Even better if you and everyone you invite to your Park Avenue coop knows that you paid $80 million for the thing. For no-one can remain unaffected by such knowledge when they attempt to appreciate or understand a work of art. In this context, "money is no object" guarantees that money becomes the object, a kind of meta-haze that any halfway conscious viewer must struggle to see the original piece through. In fact, Ken Griffin's very public purchase of the Johns piece becomes itself a kind of commentary on wealth, art, and social status in this day and age—a performance piece or work of conceptual art in its own right, which could be entitled "Ken Griffin Buys Johns Painting and Gets Himself Written Up About It," or "$80 Million Doesn't Buy You That Much Anymore." It would be less subtle, but he could create much the same effect by stencilling the price he paid onto the original painting.

And here is the capper: I can sense no irony whatsoever, no "poking fun at high art idolatry" in the behavior of Griffin or any of his hedge fund peers in the art world. They take this stuff completely seriously.

Solemnity and a complete absence of irony also mark kitsch: this distinguishes sharply the presentation of a bearded Mona Lisa in Marcel Duchamp’s L.H.O.O.Q (1919) from the kitsch appearance of Leonardo’s painting on the top of a jewelry box.

Or, I might add, a preserved shark in a tank at the Met.

Now, if only someone could stuff Paris Hilton and the Jasper Johns canvas into the tank with the shark, we might have a real masterpiece on our hands. We would only have to worry that the Chinese would flood the market with knock-offs for other hedge fund collectors.

Like forgery, kitsch is an inevitable feature of an art world in which money and desire are spread more widely than taste and knowledge.

* * *

Correction: Felix Salmon has correctly observed that I incorrectly described Mr. Hirst's shark-in-a-tank as "bisected" in the original version of this post, twice. Whether two mentions of half a shark add up to one whole one, I leave to you Dear Readers and any conceptual artists in residence to decide. Notwithstanding Felix's other remarks, I stand by the rest of my commentary as-is. See my comments on Felix's site for any required clarification.

© 2007 The Epicurean Dealmaker. All rights reserved.

Thursday, July 26, 2007

The Wine Dark Sea

So which is it, Boys and Girls? Market meltdown, or liquidity freeze? Armageddon, or The Big Chill?

After today's nasty swoon, reflected in both the equity markets and the credit markets, I will venture a modest prediction that the financial and mainstream media will be ransacking their Financial Markets Metaphor Departments tonight for punchy phrases and blistering bon mots to describe the pile-up. Tomorrow's articles should be downright Homeric in tone.

I wish I could say that I care, but I do not have a dog in this fight. (To be more precise, I have so many dogs on so many sides of this fight that I do not care which one(s) have their throats ripped out.) Whether today's little disturbance—it didn't even trigger the circuit breakers, people, really—turns out to be another pause that refreshes, like this past February, or the start of a long and painful slide, Your Faithful Correspondent expects to land on his well-shod feet quite nicely. Sure, the M&A market will slow down a little—maybe even shut for a while—but all will turn out well. It takes more than a little nuclear war to kill all the cockroaches, and likewise it will take more than another Black Monday to wipe out the M&A bankers.

But for those of you who do care, I feel your pain. Accordingly, I will leave you with the following meditation, courtesy of a wise man who nonetheless never shorted the Nikkei or played yield arbitrage with CDOs and REMICs.
Some say the world will end in fire,
Some say in ice.
From what I've tasted of desire
I hold with those who favor fire.
But if it had to perish twice,
I think I know enough of hate
To say that for destruction ice
Is also great
And would suffice.

— Robert Frost, "Fire and Ice"

Happy reading!

© 2007 The Epicurean Dealmaker. All rights reserved.

Wednesday, July 25, 2007


If you haven't got anything nice to say about anybody, come sit next to me.

— Alice Roosevelt Longworth

Well, Cerberus Capital Management just exercised the Chrysler Put.

News broke this morning that it has abandoned the attempt to sell $12 billion of loans to help finance the purchase of the perennially troubled automaker. Apparently it couldn't negotiate acceptable terms with potential investors, because would-be lenders kept projectile vomiting all over the draft indentures. Instead, along with DaimlerChrysler it will pony up some spare change ($2 billion) and collect the rest from its committed financing banks, JPMorgan Chase, Citigroup, Goldman Sachs, Bear Stearns, and Morgan Stanley. The deal to buy out Chrysler will close as scheduled on August 3rd.

Senior bankers from Cerberus's debt bitches new best friends couldn't be reached for further comment, as they were all nursing painful dog bites on their derrieres from their three-headed client. Chief Financial Officers at the five banks were likewise incommunicado, as they were busy preparing massive reversals to the accrued bonus pools to cover expected loan losses and simultaneously polishing their resumes. Staff at all five banks' leveraged finance groups were put on suicide watch.

Not everyone was unhappy, though. PIMCO's Bill Gross, who yesterday released another broadside against loose morals and excess promiscuity in the credit markets—as well as identifying the Chrysler buyout financing as the coal mine canary to watch—was observed Irish clog dancing down Wall Street with Michael Flatley. Members of the 85 Broad Street cell of Al Qaeda issued a communiqué declaring a cessation of hostilities against Goldman Sachs employees, stating that "the infidels have been punished enough."

Finally, acquisitive corporate chieftains everywhere giggled in delight and temporarily put away their Steve Schwarzman voodoo dolls, as the prospect of reduced liquidity in the lending market summarily shaved a point and a half off EBITDA multiples required to clear the market for strategic takeovers. Their secretaries began dusting off bulge bracket investment banker Rolodex cards and practicing their best brush-off routines, in anticipation of a surge of incoming calls from bankers desperate to reestablish "relationships" with corporate buyers abandoned in the last few years of worshiping at the altar of private equity.

In fact, the only person involved who isn't particularly excited about the situation is Stephen Feinberg, head of Cerberus. He is probably much more concerned about how he can turn his newly-purchased LeBaron into a Maserati.

© 2007 The Epicurean Dealmaker. All rights reserved.

Tuesday, July 17, 2007

Like I Said

Those crack financial reporters over at the New York Post have proved my point again this morning, twice.

First, they have shown that they work as a sort of in-town wire service for The New York Times, speaking to all those hedge fund managers and financial market sources too Republican or too greasy to admit of regular dialogue with the Gray Lady. I have made this point before, to general disbelief and disregard among the chattering classes. CC, you stand corrected.

Second, the Post bloodhounds have turned up evidence that the margin leverage screw tightening I recently identified as an almost guaranteed outcome and potential accelerant of the developing subprime mortgage meltdown is indeed underway:
Big Wall Street firms' love affair with lending cash to hedge funds specializing in trading mortgage-backed securities is officially over as margin requirements are getting tougher, making an already brutal market even more costly.

For the past five years, hedge funds specializing in trading mortgage- and asset-backed bonds have borrowed as much as 15 times their capital base, making their positions - and profits - larger.

It was a symbiotic relationship: the hedge funds got easy funding on generous terms and the investment banks guaranteed themselves plenty of new-issue business and order flow for their trading desks.

Portfolio managers at three New York mortgage hedge funds told The Post that over the past week, however, large investment banks like Lehman Brothers, Merrill Lynch and Bear Stearns ended the party.

A few weeks ago, when the story broke that Bear Stearn's subprime-focused hedge funds were on the ropes, there were those who pooh-poohed my contention that Wall Street banks and other prime brokers would quickly tighten the screws on lending to participants in the subprime sector. Among other things, they remained sanguine that these lenders would behave as they and their analogues did during the sovereign debt crisis of the 80s, simply shutting underperforming loans in the vault and whistling loudly whenever the bank regulators asked to see the portfolio. In response, I expressed my doubts that the high priests and temples of Mammon on earth would show such altruistic restraint in the face of pressures to their own capital base.

It should surprise none of my Faithful Readers that I have been proved correct, once again. The Post continues:

A partner of an $850 million mortgage arbitrage fund said he received a demand for almost $50 million of additional collateral from Lehman and Bear Stearns early last week.

"To keep my existing positions I had to come up with that much within 48 hours. None of the positions were in trouble, either in price or with respect to underlying collateral. [But] they should know, [Lehman and Bear] structured and sold me the deals," the manager said.

When an investment bank demands additional collateral to keep a loan - known as a repo or repurchase agreement - afloat, the hedge fund manager is faced with stark choices. The manager can avoid the demand by quickly selling the position - in all likelihood booking a loss in the current market.

He also can raise cash by selling other positions. Or the fund can inject its own capital to meet the call.
A manager of a smaller $50 million start-up hedge fund confirmed that banks are tightening lending standards across the board.

"The dealers want more collateral for every kind of trade," he said, describing the situation as particularly acute with respect to the funds that trade in so-called structured product bonds like collateralized debt obligations or bonds made from other sub-prime mortgage bonds.

"Whereas [investment banks] used to loan out 95 to 98 cents on the dollar for CDOs they originated, they are now only willing to loan out a maximum of 85 cents now," the hedge fund manager said.

Let's see: margin requirements gapping out three to seven-plus times, causing forced liquidations into an illiquid market and putting continued downward pressure on asset prices. Sounds like just the sort of train wreck I predicted. Perhaps a slow-motion train wreck, but a train wreck nevertheless.

Let's just hope the train goes off the rails somewhere outside of Omaha and that it isn't carrying nerve gas.

© 2007 The Epicurean Dealmaker. All rights reserved.

Monday, July 16, 2007

Duh duh ... Duh duh

There is nothing like the rumor of a monster deal to enliven the dog days of summer.

FT Alphaville reports this morning that UK cell phone giant Vodafone may be considering a $160 billion bid for US fixed-line and cell phone giant Verizon. Apparently it's all very early days yet, and nothing may yet come to fruition, but it does make me want to add an extra shot of expresso to my morning latte.

Alphaville quotes "well placed financiers" who reveal that deal structures Vodafone has contemplated include potentially spinning off Verizon's fixed-line business to private equity, issuing tracking stock in Vodafone to US investors to fund the takeover, and gleefully "flummoxing critics" by floating provocative rumors of mega-deals in the UK financial press. The numbers involved, at the top end, would indeed be staggering. A merged entity is posited by Alphaville to have a market capitalization of around $300 billion, and a PE-financed spinoff of the fixed-line hamster and baling wire business would weigh in at around $90 billion, of which $75 billion would need to be financed by debt. If true, I guess it will be easier to get dinner reservations at East Hampton hotspots over the next several weeks, and tanker trucks full of midnight oil should be expected to clog the streets of the financial districts in both London and New York.

Given what I know of such deals—and past experience—this story itself is part of a carefully orchestrated plan by Vodafone's bankers to test equity and credit markets for their receptivity to such a deal. The sheer magnitude of such a transaction, and the vast number of moving parts any such deal has, is the clearest illustration of why investment bankers will not disappear from the markets anytime soon. No in-house corporate M&A department or individual private equity team—no matter how smart—can possibly weigh its alternatives in an sensible manner without the market intelligence i-bankers provide. After all, a deal like this tests the art of what is possible—at least from a funding perspective—and only those investment banks poised precariously on the pointy fence separating the Buy Side of the markets from the Sell Side can possibly collect enough information from the potential buyers of deal paper to tell Vodafone what is even within reason. Of course, as part of their information collection, the bankers also spend a lot of time and energy persuading the buy side that what they initially think is impossible is in fact the most reasonable thing in the world (and with no covenants, either).

This also explains why investment banks are gleefully flogging the idea that "sovereign wealth funds," or currency reserves held by nation states after they have budgeted for their weekly purchases of guns and butter, could comprise the next wave of liquidity in the global markets. Alphaville reports in a separate post today that Morgan Stanley's currency strategist is estimating that a wall of money in the neighborhood of $2.5 to $3 trillion could be invested by newly risk-seeking governments in something other than US Treasury bonds. Whether it comes to market in time to fund the Vodafone-Verizon deal is anybody's guess.

Who will win this titanic smack down between the global tsunami of money and the ravening maw of merger-frenzied buyers? I don't know, but I am betting against the naked girl just out for a swim.

© 2007 The Epicurean Dealmaker. All rights reserved.

Friday, July 13, 2007

B(ogus Ta)X

Percy Walker must be in a bad mood today.

After proclaiming himself "satisfied" yesterday with the outcome of initial hearings in Congress on the carried interest tax issue, the Greensboro billionaire and self-proclaimed "world's foremost authority on the proper tax treatment of carried interest" must be less than thrilled with today's developments. Chief among these, of course, was the incendiary page one article in the billionaire-baiting New York Times entitled "Tax Loopholes Sweeten a Deal for Blackstone."

This is just the sort of headline that forces even campaign donation whores Democratic Senators from New York like Chuck Schumer to splutter darkly about "restoring fairness to the tax code." The contents of the article were no less inflammatory, asserting that not only will Steve Schwarzman and his partners recover all of the capital gains taxes they paid on the proceeds of Blackstone's recent IPO, but the government may in fact kick in an additional $200 million as a consolation prize for having given up their private status as founding members of the Star Chamber. I can just imagine how the phone lines into Congressmens' offices lit up this morning as constituents digested that bit of news along with their morning coffee.

Surprising no-one, an unidentified ninja assassin spokesperson for Blackstone dismissed the Times article as "utter codswallop treasonous bullshit totally flawed." And, to be fair, the article did have its weaknesses. For one thing, it identified the depreciable assets being transferred in the offering as goodwill, whereas in fact they are a combination of existing partnership interests in the underlying portfolio companies' tangible and intangible assets. Established partnership taxation allows partners to deduct their pass-through share of the depreciation and amortization of the assets underlying any partnership. The Section 754 election which Blackstone undertook allows the new partners in the underlying funds to deduct taxes based on the depreciation and amortization of the written-up value of the underlying assets when partnership shares are transferred. The IPO triggered that transfer, since (essentially) the IPO partnership (trading as BX) bought the existing owners' partnership shares with the proceeds of the offering. This ongoing tax shield is valuable to the new partner buying in, to the extent it has current income to offset the deductions.

But the unitholders who bought into the BX offering will enjoy no more than a fraction of the associated tax shield from this election, because prior to the offering Blackstone's partners crafted a "tax receivable agreement" to kick back 85% of the value of this future tax shield to the selling partners in cash. According to the IPO prospectus, this will reduce the future cash flows which public shareholders of BX are entitled to, to a substantial degree:
We expect that as a result of the size of the increases in the tax basis of the tangible and intangible assets of Blackstone Holdings, the payments that we may make under the tax receivable agreement will be substantial. Assuming no material changes in the relevant tax law and that we earn sufficient taxable income to realize the full tax benefit of the increased amortization of our assets, we expect that future payments under the tax receivable agreement in respect of the purchase will aggregate $896.6 million and range from approximately $36.9 million to $80.3 million per year over the next 15 years (or $1,030.4 million and range from approximately $42.4 million to $92.2 million per year over the next 15 years if the underwriters exercise in full their option to purchase additional common units [which did happen]). [p. 209; emphasis mine]

The Times also waved its hands a bit too much in coming up with the $200 million figure as the present value of the net tax benefits available to Little Stevie and his pals under this agreement. To get it, they used the IRS approved discount rate of around 5% on a lump sum payment to come to a total cash value of $751 million, or $198 million more than the 15% capital gains taxes they ascribe to the $3.7 billion gain on sale of the underlying partnership assets. Now, the Times acknowledges that which discount rate to use is a matter of argument, and they cite a hedge fund source which claims a higher rate of 15% (and hence lower net present value) is more appropriate. Further, recapturing this tax shield is not riskless, since it depends entirely on whether BX is able to generate enough income from its ongoing activities to capture the deduction. (The purchasers of the IPO certainly hope so.) Then again, we can probably safely assume that the debtor—the United States Treasury—is good for it. (Or can we?) In any case, it is uncontroversial to say that—almost regardless of discount rate—almost anyone would feel better off if they had a reasonably certain cash flow stream over the next 15 years which totalled over a billion dollars.

Oh, and by the way, the tax receivable agreement between Blackstone's partners and BX requires cash repayments of 85% of the recaptured tax shield for all future exchanges of partnership interests by Blackstone partners for BX units, as well. Given that Blackstone's Senior Managing Directors and "other existing owners" still own 76.4% of the original underlying partnership shares after the IPO, this could amount to a tidy sum of cash for BX to pay out over the next few decades.

Future payments under the tax receivable agreement in respect of subsequent exchanges would be in addition to these amounts and are expected to be substantial. The payments under the tax receivable agreement are not conditioned upon our existing owners' continued ownership of us. [p. 209]

Well, even if BX shares turn out to be a crap investment, I am sure unitholders will take comfort in the fact that they are keeping the Schwarzmans in (almost tax-free) fresh flowers and croque monsieurs.

This little donnybrook will no doubt continue to play out in Congress and elsewhere over the next few days and weeks. It will provide an amusing counterpoint to the specious pontificating about threats to "risk taking" and "competitiveness" and the "attack on wealth" which private equity and its apologists are spewing forth.

Although, come to think of it, there is one area in which the US could indeed suffer a tremendous drop in international competitiveness, should a wholesale rewrite of tax treatment for private equity dramatically simplify the code. We could be at real risk of losing our leading global position in the employment of tax lawyers.

© 2007 The Epicurean Dealmaker. All rights reserved.

Thursday, July 12, 2007

Corrections & Amplifications

Some people seem to have felt I was a little harsh on Whole Foods CEO John Mackey the other day, when I lambasted him for goading the generally toothless Federal Trade Commission into trying to block Whole Foods' merger with fellow soymilk ice cream flogger Wild Oats Markets. Sure, what Mackey did—leaving a digital paper trail a mile wide boasting how the proposed merger would permanently remove Whole Foods' only credible competitor and relieve pricing pressure in its markets—was exactly analogous to Donald Rumsfeld walking through Sadr City alone at night wearing a t-shirt reading "Moqtada is a pork-eating pussy," but I admit I did not pull any punches.

Among other provocative adjectives, I variously called Mr. Mackey an idiot, a moron, a fool, and a doofus. Now, however, after reading the latest revelations of Mr. Mackey's extracurricular activities on the internet, I feel I owe you Dear Readers a clarification:

John Mackey is a putz.

* * *

Note to Whole Foods' (absentee?) Board of Directors: As all sailors used to know, it is not wise to allow a loose cannon to carom about a ship in motion, as it tends to have rather destructive effects on those boat parts and human limbs with which it comes into contact. The best solution, if you cannot tie the cannon down, is to toss it overboard. Need I say more?

© 2007 The Epicurean Dealmaker. All rights reserved.

Wednesday, July 11, 2007

The Taxman Cometh

Henry Kravis and his peers are underwhelming me once again.

That bastion of private equity haters The New York Times writes today on the steady stream of Gulfstream Jets and Bentley limousines trundling into the Beltway to man the barricades against restless politicos gunning for private equity tax dollars. While one should ingest the financial reporting of the Gray Lady with several shakers of salt close at hand, a close reading of the piece seems to indicate that the PE bigs are continuing to get their Kiton-clad asses kicked.

I begin to despair of private equity's ability to do anything in public without stumbling over their own appendages. What kind of lobbying strategy are these yokels following? From the looks of it, they have not developed any sort of compelling public campaign at all, but seem to be just showing up on Capitol Hill in their expensive suits with their expensive lobbyists in order to dangle potential campaign contributions in front of the supposedly desperate and stupid members of Congress.

Perhaps they are so convinced of their innate brilliance and suavity that they think they can handle the bumptious rubes charged with filling our nation's coffers just like Jeffrey Skilling did a couple of years ago: just show up and intimidate them with four syllable words. Hmm ... that didn't work out too well for Jeffy Boy, now did it? Whatever you may think of politicians in general, it has been reliably proven by research that businessmen underestimate them as testosterone-addled idiots at their own peril.
Meeting two weeks ago with Representative Sander M. Levin, a senior Democrat who is proposing to more than double the amount of tax that Mr. Kravis now pays, the buyout titan mustered his best arguments. He said that firms like Kohlberg Kravis Roberts play a central role in the economy, participants recalled, citing the example of how his firm had produced many jobs in Mr. Levin’s home state when it turned around a troubled electricity company in Michigan. He asserted that the lower tax rate benefited all Americans. And he said that an increase in tax rates would harm American competitiveness abroad.

Mr. Levin and his staff were unswayed. One aide asked Mr. Kravis to explain whether the measure would hurt workers and middle-income families by lowering the returns for pension funds that invest in Kohlberg Kravis funds, two aides at the meeting recalled. They said Mr. Kravis agreed with an answer by a partner that the proposal would not hurt returns, and the meeting ended soon afterward.

(An adviser to Kohlberg Kravis on Tuesday described the meeting slightly differently and said that Mr. Kravis said he believed the legislation could have an adverse effect on pension fund returns.)

Really? How's that, Hank? Given that the standard 15% capital gains tax rate applicable to KKR's limited partners' return on investment in your funds is not contemplated to change—except perhaps by the lunatic fringe of the AFL-CIO—I find it difficult to understand how their returns would be depressed. Is it your view that being forced to pay standard income taxes like the rest of us working stiffs would chase away all the brilliant minds in the PE industry, leaving Yale University's PE fund allocation in the trembling hands of inexperienced investment managers who would be incapable of delivering the stellar returns you and your brethren have generated for so long? (Where would all of you go? St. Tropez?) Or is it just that KKR would go into a sulk and double the fees and carried interest percentage on their funds to cover your and your partners' increased personal tax bills? I would pay good money to hear what David Swensen would say at that meeting.

Let's be clear here. The people and institutions who put up somewhere around 95% of the actual capital invested in private equity—Yale, pension funds, insurance companies, etc.—benefit from standard capital gains treatment on their investments, like everyone else who actually invests money for longer than a year. While there is nothing written in the firmament saying that preferential tax treatment for returns to capital (versus those to labor; i.e., income) is a given, I happen to believe it is a good policy. At the margin, it has the socially beneficial effect of encouraging saving and investment, which is something this country of profligate consumers desperately needs. You get the 15% long-term capital gains treatment whether you are Yale investing in KKR XXVI or Joe Sixpack investing in Berkshire Hathaway. This is a good thing.

And, notwithstanding the pathetic scaremongering of PE's Gucci Gulch flacks, I have heard no credible reports that Congress is seriously considering eliminating the special tax treatment for all capital gains. What is under threat is the current preferential tax treatment which private equity investment professionals receive for their carried interest in their funds' investment returns. In outline, they contribute somewhere between 0 and 5% of the capital to the fund (often in the form of forgone annual management fees, and sometimes in the additional form of actual spending money), receive 20% of the realized gains, and pay 15% capital gains taxes on the result. While whatever current income they may forgo and real Benjamins they may invest alongside their LPs is truly at risk—PE deals do fail, believe it or not—there is no doubt that on an economic basis the bulk of carried interest returns earned by PE pros is due to their "sweat equity," or labor. Labor taxed like capital. Sweet, huh?

There is a long history to this sweet deal, but the original policy intent was simple and clear. Congress wanted to incentivize the creation of new businesses by giving special tax treatment to the sweat equity of business founders and simultaneously not penalize the moneymen by making them pay taxes on any economic transfer of partnership equity at the start. Okay, fair enough. I could argue that it is still a good policy, given how important start-up businesses and small businesses in general have been and continue to be to the US economy.

But why do we need to maintain this special tax deal for private equity professionals anymore? In case you haven't noticed, PE is almost literally taking over the world. It is a resounding success, and rightfully so. No-one in their right mind can argue with a straight face that PE managers need ongoing tax incentives to join or continue in the business, can they? I mean, the last time I looked, it seemed like 543% of Harvard Business School's graduating MBAs listed "carrying Steve Schwarzman's luggage" as their highest career goal in the next five years. And unless someone can make a coherent and compelling argument that "fairing up" (sorry, Equity Private, the term is apt) the personal income tax treatment of an immensely wealthy, privileged, and tiny fraction of the professional investing community to levels paid by the rest of their peers would have a measureable and sustained negative effect on the returns earned by investors in private equity, you have no case.

In fact, someone might be able to make the opposite argument that raising effective personal tax rates on PE professionals would raise returns to private equity investors. One of the notable features of the recent private equity boom has been the proliferation of hundreds if not thousands of PE firms. As these firms have flooded in, competition for buyout properties has soared, along with prices paid, and average returns to the asset class have been declining steadily from highs a few decades ago. In fact, it seems that the only place you can consistently make PE-like returns from private equity is by investing with the top quartile of fund managers, who consist of the usual suspects. The other three quarters of PE funds apparently struggle to match the returns of the general listed equity market, with much less liquidity and far more volatility. This sounds like a classic case of oversupply to me.

I know! Why don't we raise taxes and chase a few of the latecomers, wannabes, and fat old cats too lazy to work anymore out of the industry. I bet returns would rise nicely.

Oh, and another thing. If any of you PE knuckleheads piss off Congress so much with your lame and pathetic special pleading that they decide to eliminate capital gains tax treatment altogether, you'd better find a deep, dark hole to run and hide in. 'Cause David Swensen and I will be coming for you, and he is much nastier than I am.

* * *

Correction: A helpful reader has reminded me that college endowments and pension funds, which comprise a very large portion of the institutions which invest in private equity, are in fact tax exempt. Therefore, they do not worry about which tax treatment applies to any gains they book from their PE investments. (Not all investors in PE are so favored, however.) Does this fact change my argument in any respect? Hmmm ... let me think ... Nope.

© 2007 The Epicurean Dealmaker. All rights reserved.

Tuesday, July 10, 2007

Monsieur ... Qui?

As if we needed further proof that life is simply not just, news comes from across the pond that the French—of all people—have no respect for money.

The crack financial investigators from Page Six of the New York Post sadly report today that the toast of toute New York, Steve and Christine Schwarzman, apparently could not get the time of day from the locals, tourists, and wannabes at the hoppin' jive joint Club 55 in beautiful downtown St. Tropez.

To top this vile humiliation off, it appears that the celebutant hoovering up all the oxygen in the room was none other than another miniscule Gothamite, Tommy Hilfiger. The nerve! As if Steve couldn't buy that Ralph Lauren wannabe twenty-seven times over. (And I have it on good authority that Steve wore newly-purchased Vilebrequin swimming shorts, to boot.)

No doubt on the advice of the Schwarzmans' publicist, who travels with them to both incite and document the fawning adulation of would-be mini-moguls everywhere, the Post writers put a brave face on the fiasco by venturing that the Schwarzmans probably preferred to be left in relative obscurity next to the kitchen entrance. But let me tell you, Dear Reader—one girl to another—absolutely nobody goes to Club 55 in search of peace and a quiet Croque Monsieur. Il faut faire un coup d'éclat, comprenez-vous?

And this, no doubt, was Steve and Christine's intention. What better way to goose the old ego after slaughtering gazillions of simoleons on the altar of not-so-private equity and escape the looming prospect of actually having to file a tax return next year than to jet over to the Gold Coast and accept the groveling admiration of legions of skimpily clad demimondaines and fashionistas? After all, surely the mere presence of a man and woman to whom most New Yorkers would sacrifice their first born child's guaranteed slot at The Episcopal School in order to get on their mailing list would reduce the charming but oh-so-much-poorer Continentals to a similar state of drooling incontinence?

Alas, it was not to be. Someone, I fear, forgot to flag the Cultural Idiosyncrasies chapter of The Squillionaire's Guide to All Things French for the happy couple. Had they read it, I am sure they would not have put themselves in harm's way by going to a society hot spot expecting to be recognized, much less celebrated.

There it is, plain as day, on page 22, among the Chief Principles of French Society and Culture:

"Money is BORING."


© 2007 The Epicurean Dealmaker. All rights reserved.