Dance, Monkeys, Dance

From the Arts&LEISURE Section:*

*One in an occasional series of posts with little or no relation to the financial markets, the world economy, or the spending habits of Blackstone partners and their spouses

Like many of you, Dear Readers, I have a number of e-mail accounts for both work and home, in addition to the ultrasecret one connected with these pages. I have noticed that for some reason, the spam filters connected with one or more of these accounts seem to lose their efficacy over the weekend, and my inboxes become clogged with more junk e-mails than normal during the working week. I do not mind, however, because this phenomenon allows me to better enjoy what I have come to appreciate as the sheer beauty and poetry of the internet.

Take, for example, the subject and sender fields from two e-mails which graced my inbox this morning:

"Or primordial so leggy," from Kwept Debug; and

"That my everything," from Ifwainscot Mockingbird.

Admittedly, these were the only two among many unblinkered by mundane concern for the terms of my mortgage or the state of what I shall translate euphemistically as my love life. (At least I have no reason to think otherwise: like you, Dear Reader, I practice safe internetry by not opening e-mails from unknown senders, no matter how alluring.) Upon seeing them, my pulse quickened and my mind raced.

To whom, or what, could Mr. Debug be referring? Could it be some prehistoric Giselle Bundchen, or perhaps the first spider-like creature to crawl from the ocean onto the rocky shore? In contrast, my mind could not even begin to divine the meaning behind Mr. Mockingbird's missive, but could only marvel at its apparent genius: "That my everything." How true that is.

And the senders' names. I want to meet these people. Just think what glorious conversation we three could have over absinthe and croques monsieur at Les Deux Magots, what humbling epiphanies and playful badinage we could share. It would be another Algonquin Round Table, another Plato's Academy.

Such is the beauty of the culture garden known prosaically as the internet, where serendipity and random word generators combine daily—even hourly—to add shining jewels to our civilization's canon. Cogito, ergo spam.

However, when my attention turns to that festering plot of weeds known as the blogosphere, my brow clouds and my eyes darken. My mind cries out, "My kingdom for an editor!" The dreck, bombast, and self-indulgent twaddle fomented by legions of knuckleheaded morons—Yours Truly, and the authors on my blog roll, of course, fully excepted—is truly overwhelming. Sometimes I feel like I am drowning in a sea of half-baked ideas, ludicrous opinions, and poorly written position statements.

And don't get me started on personal "blogs." My throat begins to choke with bile whenever I stumble across blogs about babies, family vacations, kitty cats—"My kitty Milo has his own blog!"—or the author's thoughts on viewing the umpteenth rerun of the UNC basketball game. The colors! The pathetic graphic design! The clotted prose! The horror!!

But, upon calmer reflection, I realize that blogs are the exact analogue of spam. Just as those rare and precious jewels by authors such as Messrs. Debug and Mockingbird float in a veritable sea of tacky and useless e-mails selling Viagra and teaser rates, so too do a few beacons of intelligent, reasoned thought and lucid prose stand out from the millions of blogs in futile search of a reason to exist.

I guess it should not surprise me that this is so. After all, after careful research I have come to the conclusion that the entire internet is a very clever social experiment jointly initiated and funded by the Department of Psychology and the Department of Literary Theory at Harvard University to test, once and for all, the validity of the Infinite Monkey Theorem. You know: the theory that postulates that if you put enough monkeys and enough typewriters in a room—and you give them enough time—eventually they will produce the entire corpus of William Shakespeare. The way we are going, and the speed at which new blogs sprout into existence every day, leads me to believe we are not far from having a definitive answer.

In my darkest moments, however, I begin to wonder whether spouting any opinion on the internet—no matter how well-reasoned or -written—is a fool's exercise in futility. Then again, I guess you could classify much of intellectual history in the same bucket.

Some of the monkeys think
that they have it all worked out.
Some of the monkeys read Nietzsche
The monkeys argue about Nietzsche
without giving any consideration to the fact
that Nietzsche
was just another fucking monkey.¹

Exactly.

¹ Ernest Cline, "Dance, Monkeys, Dance." Text here. Spoken word by Mr. Cline, with animation added by Paulo Ang here. You might want to close your office door, if you have one, before you listen to this.

© 2007 The Epicurean Dealmaker. All rights reserved.

Jabberwocky, Part 2

Market Poetry has posted a concise summary of the Business section of the Blackstone IPO registration statement, which in the original extends for some 38 pages. It clears up a great many questions which I—and, by extension, I imagine you, Dear Readers—have had concerning the offering.

We are in MP's debt. Send them money.

"And, has thou slain the Jabberwock?
Come to my arms, my beamish boy!
O frabjous day! Callooh! Callay!"
He chortled in his joy. — Lewis Carroll

© 2007 The Epicurean Dealmaker. All rights reserved.

Jabberwocky

"Beware the Jabberwock, my son!
The jaws that bite, the claws that catch!
Beware the Jubjub bird, and shun
The frumious Bandersnatch!" — Lewis Carroll

Well, that's a relief.

Blackstone finally filed the initial registration statement for its IPO yesterday, and the financial and mainstream media are frantically earning their keep by turning the shiny object over in their hands as fast as they can. I will not provide any links to articles about the filing, Dear Reader, because you would have to be fly fishing in Kazakhstan with Blackstone #2 Tony James and TPG honcho David Bonderman (q.v. the WSJ, page C1) to have missed it. (No offense to my loyal readers in Kazakhstan.)

The statement itself (courtesy of peHub) can be interesting reading, if you like having your head swathed in cotton gauze and bacon grease and being pushed through a warehouse full of foam packing peanuts. I would expect no less from my friends at Simpson Thacher and Skadden Arps. I imagine that it has been some time since so many downloaded a weblink with such fevered anticipation—soft music, candlelight, and personal lubricant at the ready—only to be completely frustrated. The Victoria's Secret Fashion Show web video comes to mind.

The juicy tidbits I am sure you already know, courtesy of the Peanut Gallery (aka the financial press), so I will not bore you with them here. We have learned some interesting things, however.

First, Steve Schwarzman is surprisingly not rich, unlike our and everyody's prior impression. The poor fellow will only collect a salary of $350,000 going forward, which we all know won't even pay the monthly maintenance charge on his co-op at 740 Park Avenue. And, where we expected to find evidence of his purported great wealth—his current ownership position in Blackstone—the table is completely blank. The poor man: we thought he was loaded. I guess that 60th birthday bash at the Park Avenue Armory really wiped him out.

Second, outside of the two co-founders, whose immigrant parents graced them with the unremarkable names Steve and Pete, it appears that you have to have a seriously weird name to be a senior partner at Blackstone. Hamilton E. "Tony" James? J. Tomilson "Tom" Hill? The next thing you know we'll hear that The Artist Formerly Known as Prince ("Form?") is joing the firm as Chief Technology Officer. Maybe it's not too late for me to join. I can fly fish, too. T. Epicurean "Pick" Dealmaker?

Finally, we have learned that Blackstone is selling limited partnership units in its management company, as this author (and many others) recently speculated. For those of you readers unfamiliar with MLP offerings, in simplest terms it is a security which allows you to send all your money to Blackstone in exchange for the right to have their senior management bugger you senseless. And for you to like it, too. This new entity's governance structure and practices should make the Robert Nardelli-era Home Depot look like a beacon of shareholder rights.

I knew there were a lot of desperate masochists in New York City, but apparently I underestimated their numbers and financial wherewithal. Four billion clams (before the underwriters' overallotment option) buys a lot of soap to pick up in the shower.

It just goes to prove the truth of that old saying, "Be careful what you wish for." It also proves the old saw from the poker table: if you can't tell who the mark is, it's you.

"It's a Snark!" was the sound that first came to their ears,
And seemed almost too good to be true.
Then followed a torrent of laughter and cheers:
The the ominous words "It's a Boo—"

Then, silence. Some fancied they heard in the air
A weary and wandering sigh
That sounded like "—jum!" but the others declare
It was only a breeze that went by.

They hunted till darkness came on, but they found
Not a button, or feather, or mark,
By which they could tell that they stood on the ground
Where the Baker had met with the Snark.

In the midst of the word he was trying to say
In the midst of his laughter and glee,
He had softly and suddenly vanished away—
For the Snark was a Boojum, you see.¹

In light of the importance of this issue to all concerned, Dear Readers, I have decided to break with my usual policy and issue an investment opinion on the Blackstone IPO:

Whatever you do, do not—

¹ Lewis Carroll, "The Hunting of the Snark: An Agony in Eight Fits," Chatto & Windus Ltd., 1981, p. 46.

© 2007 The Epicurean Dealmaker. All rights reserved.

Would You Buy Stock from this Man?

I am sure I have not been alone in noodling in my spare time over whether The Blackstone Group will indeed come to market with an IPO and, if so, what said IPO would look like. I await the rumored prospectus with bated breath.

While the media and punditocracy have been busy doing the same, a superficial reading of their output indicates that most of said experts have not devoted much time to thinking carefully about what indeed might happen. (A cynic might ask why I am surprised. I have no good answer.) A dominant strain in most of this commentary seems to assume that Blackstone will somehow collapse the limited partnership fund structures it has carefully constructed over many years into the financial equivalent of a 1960s conglomerate (think ITT) and subsequently offer Jane and Michael Doe suitably engraved stock certificates therein. How these authorities think Blackstone will be able to convince its LPs to consent to such a wholesale (and probably financially-, operationally-, and tax-inefficient) restructuring is beyond me and, I suspect, them as well.

Other pundits (or sometimes the same ones) wave their hands airily and talk about the IPO becoming a source of "permanent capital" for Blackstone's PE operations. Again, press these insta-experts on exactly how this might happen, and suddenly an urgent phone call lights up their other line. Yes, KKR did raise $5.8 billion on the Euronext exchange last May to create a publicly traded "Super LP," which is designed to invest in regular KKR-sponsored private equity funds, coinvest in portfolio companies alongside KKR, and generally invest in all sorts of opportunities identified by—you guessed it—KKR. Sort of like a mini-CalPERS with a Henry Kravis fixation. But said vehicle was carefully constructed to avoid the '40 Act (don't ask) and ERISA regulations (please don't ask), so the only retail investors who can buy the damn thing reside outside of the United States. Onshore, only rich dudes and selected institutions make the grade. Oops.

"Well," some say—these are the ones who actually read the Financial Times more than once a quarter in the Heathrow Airport arrivals lounge—"look at 3i." Yes, let's. Nice company. Very clean. Uses its permanent equity capital to invest in buyouts, venture capital, etc. and hives off a healthy dividend every year to boot. Problem is, its shareholders participate across 3i's entire portfolio. Either you figure out a way to collapse the entire Blackstone portfolio into one neat entity (see paragraph two, above), or you resign yourself to the fact that you are raising permanent equity for a brand new, separate fund, with all the hoo-hah that entails.

From my poorly educated, outside-the-tent perspective, the only IPO alternative that makes any sense is offering shares in Blackstone qua Blackstone, excluding its portfolio investments. Investors would have an equity claim against the fee revenues Blackstone earns as General Partner by investing its LPs' money (the famous "2 and 20"), plus other fee activities like its advisory and restructuring business. Shareholders would profit alongside Blackstone's partners from their skills in raising money, investing it wisely, and offering fee-based advice. Sort of like Goldman Sachs minus the capital-intensive trading operations or, more nearly, Greenhill & Co.. The major difference is that Blackstone's business has a far larger exposure to the fees generated from lumpy, intermittent private equity activities than from its other (presumably smoother) transaction advisory business. Whether that makes its results more or less volatile than, say, a Greenhill going forward will depend in large part on your views of the cash flow diversification inherent in Blackstone's huge PE portfolio versus the sustainability of the current activity level in the M&A market.

Alignment with Blackstone's partners and management should be pretty good in this structure, since the economics to outside investors will be driven by the same factors which compensate Blackstone's professionals today. The only potential problem with this scenario is the use of proceeds from the IPO. As described and practiced, Blackstone's role as fund GP requires very little capital: they get all the money for their electric bills, Park Avenue office space, and deal transaction expenses directly from their fund LPs. Plus, pure advisory business has always required very little money to run. (Co-founders Pete Peterson and Steve Schwarzman famously floated the Blackstone shingle with a measly $400,000.)

Therefore, if IPO investors fork over, say, $4 or 5 billion for their shares, the only obvious place to wire the money is into the personal bank accounts of Schwarzman, Peterson, and the other equity-holding Blackstone partners. Then you run the risk of seeing what happened when Goldman Sachs partners were finally able to cash in their IPO shares: a massive brain drain of the most senior and experienced talent to the shores of the Costa del Sol and the Côte d'Azur.

Never mind, though: people seem to have gotten over the reverse-graying of Goldman Sachs, and I am sure they will do the same with Blackstone. It is time to turn to the investment thesis.


Before we do that, though, if you really want to know what drives the private equity market, who is good and why, and what an expert practitioner thinks about current trends in megafunds and private equity overall, visit Going Private. If you have 10 more minutes to waste with me, read on.

The private equity business is pretty simple. Hard, yes, but simple. In my view, there are four ways PE firms can create value in their portfolio companies:

1. Buy cheap. In other words, buy cheap relative to the company's potential value. This does not necessarily mean you buy at a low multiple or even that you bid the lowest clearing price possible. It means you see more potential value in the business than you are being made to pay for it.

2. Finance well. Not just cheap debt. The right kind of debt, with the right kind of covenants, and enough flexibility to accomplish the strategic plan you developed in your value thesis.

3. Improve the business. Cut costs, yes. Or not. Invest; acquire; divest; restructure; whatever. Do what it takes to create the value you saw in (1), above. This takes time and effort. It is hard, and often not very pretty. You may change your mind, and reverse direction, more than once. This is where even the best publicly-owned corporations have a difficult time matching the speed, decisiveness, and willingness to inflict and endure pain that a good financial sponsor owner does. This is where the rubber meets the road.

4. Sell well. Time the market. Look for tailwinds. Mail big checks to your LPs.

Of course this is a simplistic view (I am an investment banker, after all), but it is correct in outline. The interesting thing, to me, is that very little of this model is dependent on favorable conditions in the equity or debt markets. Good financial sponsors have been making mouth watering returns in good markets and bad, up cycles and down, with double-digit interest rates and single for a long time. It's a good model, and an important part of our capitalist system. Unlike the public equity markets—which for all their faults are pretty damn efficient funding mechanisms for a broad range of companies in a broad range of situations (and are many multiples of the size of the PE market, to boot)—private equity is the ideal capital provider for businesses, public and private, that need to be transformed. Call it the OR, intensive care unit, and physical therapy ward of financial capitalism.

Blackstone may be drifting from this model, due in large part to its size. Equity Private seems to think so, at least by implication. She would know; I do not. I will say, however, that I have seen up close and personal the real effects of diseconomy of scale in financial services. It's not pretty. And it's not just Citigroup.

That being said, Dear Reader, I only give stock tips on micro-cap gold mining stocks and emerging "cleantech" companies. Whether or not to invest in The Blackstone Group IPO I leave up to you.

If you are interested, however, in anticipation of the eventual issue prospectus I would like to point you to a couple sources which might help you calibrate your return expectations from investing in Blackstone or any other PE IPO. Interestingly enough, they are both from CalPERS, an entity with quite a bit of experience in PE investing and a refreshingly clear website for a governmental agency:

· "Understanding Private Equity Performance," with a nifty little graph on the "J-Curve Effect" of PE investing, shown above. (By the way, J-curves happen in all sort of industries. Are they "J"-ier in private equity?)

· A table describing the returns CalPERS has earned from alternative investments (including PE) on its $35 billion portfolio

Until we meet again, keep your eye on the prize, your mind in the game, and your hand on your wallet.

© 2007 The Epicurean Dealmaker. All rights reserved.

Naughty, Naughty

DealBreaker is atwitter today about a 13-D letter filed recently by activist hedge fund Chapman Capital in its ongoing battle with Embarcadero Technologies, which Chapman wants to sell itself. In it, Chapman recounts a heated exchange with the company CFO in which the latter responded to certain aspersions cast by the former with a familiar idiomatic expression for an anatomically impossible feat (letter quoted via DealBreaker.com):

Furthermore, in response to certain comments made by Mr. Shahbazian during a conversation later that day, Mr. Chapman conveyed to Mr. Shahbazian Chapman Capital’s concern that, according to background checks directed by Chapman Capital, Mr. Shahbazian had been viewed negatively by various shareholders of Niku Corporation, ANDA Networks, Inc. and Walker Interactive, all of which in the past had employed Mr. Shahbazian in the capacity of Chief Financial Officer. Mr. Shahbazian reacted temperamentally to Mr. Chapman with the eloquent response, “Fuck you!” Mr. Chapman then forcefully informed Mr. Shahbazian that it was inappropriate and inadvisable for the Chief Financial Officer of a public company to utter such blasphemy to the advisor of a 9.3% ownership stakeholder in the Issuer.

DealBreaker gleefully notes that, to the best of its knowledge, this is the first time the "f-bomb" has been intentionally used in a filing with the SEC.

Reading the excerpt from Mr. Chapman's letter, we were shocked too, but not by the same phrase that caught DealBreaker's attention. What made us cringe was Mr. Chapman's use of the word "blasphemy" to describe Mr. Shahbazian's outburst. We turned, as is often our wont, to Merriam Webster to verify our gut reaction:

blas·phe·my
\[pronunciation stuff]\ noun pl -mies (13c)
1 a : the act of insulting or showing contempt or lack of reverence for God b : the act of claiming the attributes of deity
2 : irreverence toward something considered sacred or inviolable

Exactly who or what is Mr. Chapman implying requires reverence here? Is God the otherwise unnamed 9.3% stakeholder in Embarcadero? (Now there's a Limited Partner!) Or—heaven forfend—is Mr. Chapman suggesting that he himself is the victim of Mr. Shahbazian's blasphemy?

I am personally unfamiliar with Mr. Chapman's purportedly prodigious output of 13-D letters, which DealBreaker describes as "witty" and "literary," but I certainly hope that this one at least has been penned either (a) in great haste or (b) with tongue planted firmly in cheek. Otherwise, I think we need to notify the Booby Hatch men that they have another inmate for the Delusions of Grandeur Ward at Bellevue.

That Mr. Chapman might have a God complex should not necessarily surprise us. What with the explosion in the hedge fund industry to well over $1 trillion in assets under management and the reverse migration of hundreds of mediocre Wall Street traders to the leafy confines of Hedge Fund Central (Greenwich, CT), earning "2-and-20" is now considered among the hedgie set as prima facie evidence of your own Godhead. Should the oft-mentioned Liquidity Bubble ever burst, I am certain that Mr. Chapman would enjoy plenty of convivial company in the loony bin.

But perhaps I am being too hard on Mr. Chapman, and his malaprop was unintentional. In that case, I would diplomatically refer him to one of the earliest posts on this blog, "Mistakes." After all, I am sure a talented man like him does not want to be confused with one of those horrid investment bankers who does not know how to write good English.

© 2007 The Epicurean Dealmaker. All rights reserved.