Thursday, November 29, 2012

The Rules

Living the Dream
Certain friends and acquaintances of mine have informed me on occasion of the existence of a website dedicated to codifying and promoting the rules of a secret society of bicyclists known as the Velominati. The Rules, as they describe them, are an interesting attempt to lay down a code of behavior for its members based upon honor, discipline, and a slightly suspect penchant for tight black riding shorts.

It occurred to me recently that a few of you among my regular readers might appreciate a similar codification of the rules of behavior for corporate finance and M&A investment bankers, minus the Spandex fetish.1 Accordingly, here they are. Use them wisely, and with moderation.

* * *

Rule #1 — Obey The Rules.

Rule #2 — Lead by example.
It is forbidden for someone familiar with The Rules to knowingly breach The Rules or assist another person to breach them.

Rule #3 — Guide the uninitiated.
Investment banking is an apprenticeship business. Whether your charge is McKinley C. Higginbotham IV, scion of a long line of hoary investment bankers stretching back to the founding of Dillon Read at the dawn of the Pleistocene, or Mahindra P. Parametheswamenameran, fresh off the Tuesday boat from Mumbai with an I.Q. of 215, rest assured he or she knows absolutely jack shit about what to do with a client, a deal, or even a spreadsheet. Teach them, or consign your sorry, underleveraged ass to an early “retirement.”

Rule #4 — It’s all about the money.
It is absolutely, without question, unequivocally about the money. Anyone who says otherwise is a liar, a regulator, an MBA career counselor, or Matt Taibbi.2

Rule #5 — Harden The Fuck Up.
If you forget every other rule, remember this one.

Rule #6 — Free your mind, and your career will follow.
You are not paid to think. You are not that fucking smart. You are paid to do what the client wants you to do. Go do it. The time to add real insight, to offer careful, considered judgment, is before you get hired. Then, and only then, can you tell the client what you think they should do.3 After they hire you, they own your sorry ass. Apply your overwhelming intellect to how and when to achieve their objectives, not why.

Rule #7 — Dress like a professional, not like a clown.
Wear a suit. Buy good shoes. Own more than six ties. I don’t care what your clients wear, they expect you to look the part of a slick, overeducated, hyperaggressive, insanely successful mercenary. Bulletin: the clients who wear blue jeans and sneakers expect their bankers to be dressed to the nines, too, not like themselves, because they instinctively know the difference between an entrepreneur and a professional servant. You are a servant. Dress like one. Oh, and one thing more: no two-tone shirts, banker collars, suspenders, or bowties, unless you are God, a bajillionaire, or Felix Rohatyn. Or all of the above. Nobody wants to hire a fop.

Rule #8 — Investment banking travel is for badasses. Period.
Unless you are a management consultant or a senior petroleum engineer for a global integrated oil company,4 you have no idea what high stakes business travel really is. It’s getting up at 4:30 in the morning to catch a flight across three time zones to meet with some asshole client who’d as soon as piss on you as take a meeting. It’s getting a call at your Milan hotel in the middle of a weeklong business trip to catch the next flight to Beijing for a two hour meeting with a bunch of government officials you’ve never even met. It’s traveling to some of the most famous and exotic destinations on the planet, only to have them all look the same: airport—>taxi—>hotel room—>taxi—>conference room—> taxi—>airport. It’s learning to become a connoisseur of hotel room service, a Jedi Master of airport Starbucks. Forget about private planes. Those are for clients and the senior executives at the top of your firm. Forget about first class. The only time you’ll get to the front of the plane is when you pay for it with your own money or the umpty billion upgrades you’ve earned by traveling to Hell and back a bajillion times this month alone. So travel like you mean it. Don’t fuck around: Rollerboards are for pussies. Checking luggage is for young families on vacation and old ladies. Neck pillows are for moral degenerates. When in doubt, see Rule #5.

Rule #9 — It never gets easier, you just make more money.
Investment banking is hard. It stays hard. The more success you have, the higher your clients’, managers’, and shareholders’ expectations rise. You’re only as good as your last trade or your last deal. Last year was last year, asshole: what have you done for me lately? Furthermore, the higher you rise in the pyramid, the closer you come to the clients, managers, and shareholders and their unrelenting, unreasonable, unjustifiable demands. Sur la Plaque, fucktards. See Rule #5.

Rule #10 — Don’t be a scumbag.
The pressure, the money, and the prestige will tempt you to cut corners. To steal credit. To stab colleagues and subordinates in the back. To gutlessly steamroll brighteyed young acolytes in the name of shareholder returns or your own personal compensation. Resist this. Don’t be a fucktard. Don’t be a gutless pussy. The life of an investment banker is nasty, brutish, and short. But if you can manage to avoid succumbing to the myriad base temptations to screw people over the profession offers you, you will earn a reputation as a... as a...

Oh, screw it. You won’t earn any reputation at all, except maybe among a few hundred of your professional colleagues. The general public won’t ever know or care about you at all.

But since when did you care what the general public thinks? Matt Taibbi sure doesn’t think you do.

1 There are only two rules for my colleagues on the other side of the house, in Sales and Trading: 1) Don’t get caught; and 2) Don’t eat more than two onion cheeseburgers before 8:30 am every morning.
2 Regardless of what Matt Taibbi says, of course, it’s not all about the money. But let’s level set, shall we? Matt Taibbi’s not as stupid as he sounds.
3 If you have the balls. And senior management’s support.
4 And if you are, why the fuck do you travel like me while getting paid a fraction of what I do? You’re smarter than that.

© 2012 The Epicurean Dealmaker. All rights reserved.

Thursday, November 22, 2012

Thanksgiving Day

Claude Monet, Water Lilies (The Clouds), 1903
When in disgrace with fortune and men’s eyes
I all alone beweep my outcast state,
And trouble deaf heaven with my bootless cries,
And look upon myself, and curse my fate,
Wishing me like to one more rich in hope,
Featur’d like him, like him with friends possess’d,
Desiring this man’s art, and that man’s scope,
With what I most enjoy contented least;
Yet in these thoughts my self almost despising,
Haply I think on thee,—and then my state,
Like to the lark at break of day arising
From sullen earth, sings hymns at heaven’s gate;

For thy sweet love remember’d such wealth brings
That then I scorn to change my state with kings.

— William Shakespeare, Sonnet 29

Lay aside your discontent, your envy, and your unhappiness today. Think not on your wealth, your possessions, your station in life, or the lack thereof. Think instead on the love which makes your brief journey here worthwhile: family, friends, life itself.

And smile.

Happy Thanksgiving.

© 2012 The Epicurean Dealmaker. All rights reserved.

Wednesday, November 21, 2012

Goodwill Hunting

Just shoot me
I try to maintain my equanimity, O Dearly Beloved. I really do.

I make every effort to exercise regularly, eat healthy food, and maintain my legendary composure by adhering to a strict drug and alcohol regimen sketched out on a bar napkin in 1962 by Hunter S. Thompson himself. But every so often, some ill-advised knucklehead will publish, under the aegis of a purportedly respected publication, such toxic, ridiculous, and misleading nonsense that I simply must respond with decisive and overwhelming force.

Today’s example hails from the eponymous financial newssite of Gotham City’s favorite sesquibillionaire mayor and short-man-about-town, Mike Bloomberg. In it, the award-winning [sic] financial journalist Jonathan Weil ventures the following thesis for the entertainment and edification of his hapless readers:
Here’s the problem with Hewlett-Packard Co.’s explanation today for why it took an $8.8 billion writedown related to its purchase of Autonomy Corp.: The numbers don’t make sense.
He then spends the next nine paragraphs making sure the numbers don’t make any sense and befuddling the naive and inexperienced among his audience into a state of utter confusion matched only by his own apparent cluelessness. Chief among his complaints seems to be that he doesn’t understand how HP can write down over $5 billion of value due to allegedly dodgy accounting associated with Autonomy when the latter had pre-acquisition assets totalling only $3.5 billion. He also seems very suspicious of the $6.6 (later $6.9) billion of goodwill Hewlett-Packard recorded when it purchased Autonomy, writing that
HP recorded the goodwill because it knew Autonomy’s identifiable assets were worth much less than it paid.
The implication being, of course, that HP actually knew it was “overpaying” for Autonomy at the time and that the current writedown is really just HP acknowledging the inevitable.

Call me crazy, but I have to believe there are some among you who might agree with me that it seems reasonable a journalist tasked with covering financial markets, stocks, and corporate finance should have at least some basic understanding of public accounting rules and merger math. Or at least the time, resources, and ambition to find out. Apparently we would be wrong.

So, in the interest of trying to rescue some of the well-meaning ignoramuses who have been happily educated into insensibility by Mr. Weil’s folly, I will try to provide a mini-primer on purchase accounting. In the course of this, I believe I can demonstrate that, indeed, Hewlett-Packard’s recent accounting writedowns make perfect sense.

* * *

Chief among the conceptual foundations of merger math which we must address is the distinction between enterprise value and book value, or true value and accounting. Most mergers and acquisitions are done to acquire operating businesses, not merely a laundry list of assets. Just like the real value of Apple Computer cannot be reduced to its Cupertino real estate, the inventory in its factories and stores, and the office supplies in its employees’ desks, the real value of an operating business lies in the way its management and employees use those assets, their knowledge, and their company’s brand and reputation to earn income. That is what a business acquirer will pay for.

How much an acquirer will pay for a business is determined in the course of merger negotiations by reference to comparable companies trading in the public markets, comparable M&A transactions, and the projected discounted future cash flows of the target business, overlaid by the competitive dynamic of the sale process. At the end of the day, the acquirer pays what it decides owning the target business and its associated cash flows would be worth to it, moderated by what it has to and can afford to pay. The book value of assets on the target company’s balance sheet has nothing to do with it.

Once the ink has dried on the purchase agreement and the checks have cleared, however, the accountants move in to memorialize (or embalm) the transaction in their own special way. They review the balance sheet assets and liabilities of the target company to determine their fair market value at the time, which more often than not is different from their recorded book values.1 Tangible assets like receivables, inventory, real estate, fixtures, and office supplies are valued at replacement cost or nearest appropriate market value and recorded in the opening balance sheet. Then the gnomes attempt to quantify the value of discrete and identifiable intangible assets like patents, customer lists, brands, and other intellectual property: all the assets you cannot put your finger on but you know are essential to generating the ongoing revenues and cash flows of the business. Add these together, and you have all the tangible and intangible assets which can show up on a balance sheet. Subtract that total (less the fair value of operating liabilities like accounts payable) from the amount of money you paid for the business and, presto, you get goodwill: the accountants’ remainder account where they memorialize the premium to the target’s net tangible and intangible assets the acquirer paid for the business. Goodwill can be seen as the difference between the full operating value of a business—as paid at one point in time by a third party buyer in a specific arms length transaction—and the fair value of the net operating assets its managers and employees use to run it.

So when Hewlett-Packard decided to write down the value of its investment in Autonomy, it did not inventory paper clips. It revalued the remaining intangible assets on its balance sheet acquired from Autonomy, based on their newly-determined earning power, and it revalued the goodwill of the total business based on its revised understanding of its overall cash generating capability. If Autonomy did indeed misrepresent the earning power of its business as HP alleges, goodwill would be the exact account where you would expect to see writedowns.

Autonomy misrepresented its gross profit margin and also falsely created or miscategorized more than $200 million in revenue over a two-year period starting in 2009, John Schultz, Hewlett-Packard’s general counsel, said in an interview. Autonomy was reselling Dell Inc. computers and counting those sales as software revenue, he said. Some sales were also fabricated through resellers.
When your view of the value of a business or collection of assets changes, accounting rules compel you to revise any associated goodwill account to reflect this new information. This is not that difficult a concept to grasp or convey.2

I just wish our financial press corps was better at educating the public about such things, rather than muddying the water because they’re too lazy to figure it out beforehand.

* * *

UPDATE November 21, 2012: Ugh. Apparently Jonathan Weil has not heard of the Law of Holes:

When you find yourself in a hole with a shovel in your hand, stop digging.
He has released another post today in which he throws about random balance sheet, income statement, and market value numbers from Hewlett-Packard’s accounts without the least apparent understanding of what any of them mean or their most basic interrelationships. He is trying to make the argument that HP massively overpaid for Autonomy in the first place, and that the admittedly skimpy numbers which the former has released in connection with its writedown announcement do not seem to disprove his thesis. He may be right, for all I know. I do not know and I do not care.

But when he spews forth idiotic, misleading dreck like this, my ears begin to smoke:
HP finished the fiscal third quarter with $32 billion of shareholder equity. Its balance sheet showed $36.8 billion of goodwill (which isn’t a saleable asset) and $8 billion of other intangible assets. By comparison, HP finished the fiscal fourth quarter on Oct. 31 with a stock-market value of $27.2 billion.

In other words, on paper, HP’s goodwill supposedly was worth more than the company as a whole
[emphasis mine]. The market knew big writedowns were necessary. Investors saw that Autonomy was a disaster. They were just quicker to acknowledge the reality than HP was.
No, no, no, no, NO. No, you numbnuts. Goodwill is a balance sheet account, based on historic book value with periodic testing to check that it is still valid. It bears no direct relation to what the company is worth at all.

And the worth of the company is not equal to the market value of its common equity, except in the most trivial of cases. The company’s worth, or value—known among people who actually work with this concept for a living, like me and, oh, a billion other non-idiots as total enterprise value—consists of the market value of common equity plus the market (or book) value of debt and other capital liabilities less cash on hand. In HP’s case, at the end of its 2012 fiscal third quarter, this was $27.2 billion + $29.7 billion – $9.5 billion, or $47.4 billion. At July 31, 2012, Hewlett-Packard as a whole was worth $47.4 billion. This, just to help Mr. Weil in case he runs out of fingers, is clearly more than $36.8 billion in goodwill. Which, by the way, doesn’t mean anything, just in case you were wondering.

You might argue that with my carping I am overreacting to Mr. Weil’s sloppy writing and thinking and missing his larger, potentially valid point about the poor rationale for HP’s purchase of Autonomy. But I am traditional enough to believe that a person who puts himself out there as a financial journalist who writes about M&A and corporate accounting issues for an international financial publication should fucking know a little about goddamn basic accounting.

Go ahead, call me cranky and unreasonable. I’ve been called worse by worse people.

And someone, please, buy Jonathan Weil a basic accounting textbook and make him read it before he writes again. My blood pressure will thank you.

1 Goodwill already on the target company’s balance sheet from prior acquisitions of its own, like the $1.5 billion in Autonomy’s pre-deal accounts, is written off at once. Of the remaining $1.9 billion of Autonomy’s pre-deal assets, over $700 million was cash and $600 million was other intangibles. Hewlett-Packard acquired very few tangible operating assets of any kind when it bought Autonomy.
2 I don’t have an opinion, by the way, as to whether HP’s allegation of accounting shenanigans is true or not. Autonomy’s former management disputes it. All I will say is valuation of intangible assets either in a sale transaction or on an interim basis and valuation of the long-term earnings power of a business where there is no concrete, objective reference point like a deal value to point to can be awfully squishy, subjective stuff. This, naturally, raises the question as to whether HP might be sandbagging its goodwill writedown to make future results look better. I have no special insight here, other than to note such an occurrence has happened many times before.

© 2012 The Epicurean Dealmaker. All rights reserved.

Monday, November 5, 2012

Get Up Offa That Thing

You know what to do
To VOTE tomorrow.


It is rational.

Not only is it rational, under certain circumstances it can be morally virtuous.

And, notwithstanding the preceding perspectives, it is a civic duty1 which is entirely reasonable and rational for the democratic society to which you putatively belong to expect you to perform. It is a voluntary, non-monetary tax, if you will, a donation of your time and inconvenience toward the common good from which you and the rest of your fellow citizens daily benefit.

Finally, regardless of your political or ideological affiliation, you must appreciate that the more people like you vote, the less likely our polity will be hijacked by the whackos, the unhinged, and the mentally and morally bankrupt members of the opposition.

Unless, of course, you are a member of said whackos, unhinged, etc. In which case I suggest you vote Thursday.

Happy Citizenship Day!

1 I am well aware, O Dearest and Most Indulgent of Readers, that duty is an unpopular word (and concept) in our current culture and society. I remain unapologetic in its use, and consider its unpopularity to be a stain upon the society which undervalues it, rather than a valid critique of the concept itself. Call me anachronistic if you will. I’ve been called worse.

© 2012 The Epicurean Dealmaker. All rights reserved.