The key reason for private equity's success

The massive profits that some private equity firms make on their investments evoke admiration and envy. The mainstream reason (which has been true for a large portion of private equity funds) is due to the firms' aggressive use of debt, concentration on cash flow and margins, freedom from public company regulations, and hefty incentives for operating managers.

But I believe the key reason for private equity's success is the forced strategy of buying to sell.

Why do I say forced? Mainly because it is my experience that  public companies, which, in pursuit of synergies, usually buy to keep. This attitude or frame of reference brings very different pressures to bear on management.

The chief advantage of buying to sell is simple but often overlooked. Private equity's sweet spot is acquisitions that have been undermanaged or undervalued, where there's a onetime opportunity to increase a business's value. Once that gain has been realized, private equity firms sell for a maximum return. A corporate acquirer, in contrast, will dilute its return by hanging on to the business after the growth in value tapers off. Public companies that compete in this space can offer investors better returns than private equity firms do. (After all, a public company wouldn't deduct the 30% that funds take out of gross profits.) Kinross is doing this by getting into diamonds, not just gold. Their more inexperienced investors attracted by the gold price hike, get nervous and want a concentrated stock. More experienced and professional investors appreciate the subtle nuance of the management team.

Corporations have two options: (1) to copy private equity's model, as investment companies Wendel and Eurazeo have done with dramatic success, or (2) to take a flexible approach, holding businesses for as long as they can add value as owners. The latter would give companies an advantage over funds, which must liquidate within a preset time--potentially leaving money on the table. Both options present public companies with challenges, including capital gains taxes and a dearth of investment management skills. But the greatest barrier may be public companies' aversion to exiting a healthy business and their inability to see it the way private equity firms do - as the sale and cashing in of a successful transformation, not a strategic error.

Jacoline Loewen, author of Money Magnet, Attract investors to your business

How Private Equity is using Social Media

Details of Simmons Bedding Co.’s bankruptcy reorganization plan have been translated into Chinese and posted on a Web site in Guanzhou to encourage Chinese bids, the Wall Street Journal reports. The move is unlikely to disrupt the company’s plans to be sold to Ares Management LLC and Ontario Teachers’ pension plan, but it does show growing interest by Chinese bidders in U.S. assets, especially at discounted prices, the WSJ writes.

Do you want to make money or do you want to tick all the boxes correctly?

"We are rowing against a tide where people are more interested in how you are ticking a box, instead of how you are running a business. In private equity we have a very simple job: make money for our shareholders. It is a purity I quite like. Lack of clarity is the source of the trouble; not knowing what your job is." The head of the British Venture Capital Association spoke out about why entrepreneurs and private equity, not government, will be the partnership to save the British economy. (Read more)

The Canadian Venture Capital Association also talks about the power of private equity versus other forms of lending or public market capital. The theme you will see repeated at CVCA conferences and their work with private equity funds,  is the superior performance of aligned interests of privately held capital versus the public markets. The private equity investment is a much more involved and engaged form of ownership that the dispersed model found on the stock market. There a company's shares are typically held by a wide range of institutions, leading to the phenomenon of the "ownerless corporation", where investors fail to hold a powerful management to account.

At Isis, which targets mid-market businesses that are seeking between £2m and £30m of equity, Kolade is looking to sectors such as healthcare and online retail for growth, along with traditional shops.

"If I were to buy into mainstream retail now, the leasehold deals I could do would be extraordinary," he says.

Jacoline Loewen, http://twitter.com/jacolineloewen

Succession Planing sounds easy - it ain't

Careful succession planning has a key part to play in a firm’s survival and long-term business sustainability, particularly given the current economic climate, PricewaterhouseCoopers (PwC) has said.

Speaking about his experience in running, and subsequently selling, one of Ireland's largest family businesses, the Gunne Group’s Pat Gunne said: “In my experience, when running the Gunne Group, long-term business success will be determined by building and maintaining business relationships, having a real focus on cash and a clear vision for building the brand around the optimum strategy.

“In addition, having the right structures in place including strong non-executives are critical. Another key issue for success in any family business is fast-tracking succession planning. Planning for the transfer of wealth in a tax efficient manner, that it is well communicated and has the buy-in from all family members is critical,” he added.

“There are a number of important planning steps for effective succession planning. Firstly, it is hugely important that a tax-efficient will is put in place in order to avoid a tax trap. There are also a number of corporate exemptions that can be availed of in order to release wealth efficiently which should be investigated,”

“Family partnerships should also be considered as a mechanism for efficient participation in the future growth of wealth,” he added.

The six key steps for efficient succession are:

• Have a clear process to manage potential conflict
• Agree a clear ‘family constitution’
• Manage the tax
• Have clear reward policy for both working and non-working family members
• Have a clear and efficient sharing of wealth framework
• Communicate clearly .

Is offshoring good or bad for Canada and why?

If offshoring going to wind down our economy and hollow out our skills? I asked Paul Hogendoorn, owner of OES manufacturing and here are his comments:
"It is a necessity, but it must be done wisely. I have seen a number of companies offshore much of their manufacturing requirements, but end up greatly weakening their product development capabilities. When you no longer buy many components through distribution, the technical support routinely delivered by those companies dries up. The engineering department loses valuable resources. New technologies come along and the company no longer has the ability in-house to pursue and develop them. No one can, or wants to design or build the prototypes, or suggest the best new components or methods, or assist in anyway. (There's nothing in it for them."
So, offshoring usually leads to lower production costs in the short term, but done wrong, it also leads to reduced competitiveness (and even viability) in the long term.
A successful formula used by some companies is to offshore production when it becomes mature production, and keep leading edge production here until it becomes mature (and you are working on the next).That way, your engineering and product developments stay healthy and adequately supported by the leading manufacturers and distributors.

So we can stop panicking...

Firms run by private equity companies have been more productive in the recession

Looks as if the private equity model of growing businesses pays off with its extra alignment of interests. Factual article on the British PE scene:

Firms run by private equity companies have been more productive in the recession. The claims by the British Private Equity and Venture Capital Association (BVCA) were based on results from a portfolio of 47 major companies including Alliance Boots, New Look, Travelodge and CenterParcs. Based on results for 2008 and the year to March 2009, the firms' average productivity reached 7.7%, "significantly in excess" of the average 1% UK rate during the same period. The association's second annual report, which comes under new transparency rules for the buyout sector, said average annual profit growth was 11%, although employment levels fell after acquisitions were taken into account.

BVCA chief executive Simon Walker said the figures were "promising" given the bleak conditions. But he added: "While the profit and productivity growth figures are testament to private equity's focus on portfolio management through the recession, the economic outlook remains uncertain.

"Private equity-owned companies are not immune from the continuing recessionary pressures."

Read more.

Perplexed by the stock market rally off the March bottom?

The stores this year have far fewer Christmas wreathes and decorations and since I am not a shopper, for me to notice that means there is a big cut back in retailing to this holiday season. Is everyone tightening the belt a few notches or is the recession finally over? Have the retailers estimated potential sales below potential? I suppose it depends on whether you are a bull or a bear. Here is the email I received from Lynn Lewis, Sr Wealth Advisor, ScotiaMcLeod, and I think it gives a very practical view from John Gudritz and Jason Tank from Front Street Investment Management.

Here's a Market Review worth reviewing:
It is fair to say that we are perplexed by the huge stock market rally off the March bottom. The bulls believe the market is just “climbing the wall of worry” as it always does. The “walls” we see are more than just worries. These walls are long-term structural problems in the economy that will not be easy to climb over and should hinder economic growth for years to come. We think that makes stocks very risky assets at current prices.
We respect the fact that bull markets normally do climb a wall of worry coming out of a recession or a sudden and severe financial crisis. The stock market rises on the relief that the actual economic data turned out to be better than what investors were worried about.
Today’s bullish investors argue that this is what has happened this year. The market had crashed to the March lows based on fears that our economy (and the global economy for that matter) was heading into a financial abyss. By avoiding the abyss through the use of massive amounts of government spending and guarantees as well as some accounting tricks by the banks, the stock market has recovered about half of its decline from its peak in 2007.
We get it. The economy is better off than it was a year ago. We would expect to see some improvement with the banking industry back up and running and those stimulus programs encouraging people to spend. And with the Federal Reserve keeping savings rates near zero, they are doing their part to entice people to do something else with their money than put it in a bank.
But how much better is the economy? How sustainable is this growth? Is it enough to justify a 65% rally from the market bottom? Are these worries of ours as unimportant as the market makes them look today? Have we really missed the start of a new secular bull market? We still don’t think so.
The bulls believe that while the recession was a bad one, it was just a recession. Therefore, using history as a guide, an economic recovery is right around the corner. Businesses will invest, consumers will shop and corporate profits will grow. It is just that simple.
Having friends and family members who have hit their own personal walls of financial difficulties from this Great Recession we would like to believe that scenario. However, the so-called recovery we have seen so far is not suggesting that will be the case. Let’s look at the data.
Job growth (and higher wages) is one of the biggest hurdles that we will have to overcome to get this economy on a higher and more sustainable growth path. Since the stock market started to rally in March the United States has lost over three million jobs and the unemployment rate has climbed to 10%. We would expect to see the unemployment rate actually rise in the months to come as more people re-enter the labor market.
While the number of job losses has substantially declined from the extremely high numbers a year ago (a favorite “less bad” statistic for the bulls), we see little hope for large gains in the job market anytime soon. In the month of November there were almost 48,000 fewer people hired than in October, which was the worst in over two years, according to the Challenger, Grey & Christmas Employment Survey.
The bulls believe that companies were too severe in the number of people they fired this past year. They will have to rehire many of them as production is increased to replenish the inventories of goods that have been depleted. That may be the case but there is another wall to overcome before that new job is created.

There are currently 9 million people working part-time who want full-time jobs. Also, the workweek is at a low 33.2 hours. Therefore, companies will first increase the workweek and then put part-time workers back to full-time before they hire new workers.
The bulls will also point out that existing and new home sales have been strong over the last few months. Once again we have our government to thank for that good news because of the tax credit for first-time homebuyers. The question is, did that government program create new sales or just take from what would have been future sales. We shall see in the next few months, especially with the FHA looking to tighten their lending standards.
Unlike the bulls, we think that falling home prices are still a major obstacle for future growth. We believe the studies that show that there is a large “shadow inventory” of homes that banks have foreclosed on but have not put on the market to sell. And to make matters worse, over the next couple of years there will be another wave of foreclosures as Option ARM mortgages that were so popular on 2005 through 2007 begin to reset at a higher payment levels and mortgage balances that are much higher than the appraised values of the homes.
Lastly, the bulls point to the better than expected corporate earnings as a reason for this rally. While earnings were better than expected, revenues were disappointing. In fact, revenues were down by a substantial amount. In order to achieve the earnings expectations next year we are going to have to see revenue growth of close to 10%. Good luck with that.
Like it or not this will not be a typical economic recovery because we are coming out of a different type of recession. Normal recessions are caused by rising inflation and interest rates and excess inventories. Once the inflationary pressures recede, the Fed cuts interest rates and production increases to meet rising demand and the economy is back on track and growing again. The worries are easily resolved.
The Great Recession was caused from the bursting of the real estate bubble that was the result of a decade of easy credit. Our economy expanded on the ability of almost anyone with a pulse to be able to get credit, whether from multiple credit cards or home equity loans. Those days are over.
We are in what we think will be years of credit contraction, and therefore, deflationary pressures on assets, especially real estate. The credit lifelines have been pulled from many people and severely reduced for others. That has limited their ability to quickly recover from the financial strains they are currently experiencing. Many more people are going to hit their personal wall of financial stress or ruin before this economy is on more solid footing, in our opinion. The timing of that will depend to a large degree on the government lifelines that continue to be extended.
Speaking of our government, the largest wall that we as a nation will have to confront with in the years to come is the debt we are accumulating at over a TRILLION dollars a year. Even using the Obama administration’s estimate of a 4% annual economic growth rate (which we think is too optimistic) we will still be looking at $10 TRILLION of additional debt in ten years. State and local governments have some sizable walls (budget deficits) of their own to overcome over the next two years.
We think these walls are real obstructions to our economy’s growth over the next few years. The exact timing of their effects is not clear. However, they will be a drag on our economy as we make our way over them. We don’t believe that current stock prices reflect this risk, which is why we remain in a protective mode.
Maybe it will turn out that we are too pessimistic about this recovery. Maybe we can borrow, tax, and spend our way into prosperity. Maybe our walls are just worries that we will easily be able to surmount. We should know the answer to that soon.

Lynn Lewis, CIMA, CIM, CMA, FCSI
Sr Wealth Advisor
ScotiaMcLeod

It's jobs, not cranes

A private equity fund manager just got back from Chicago and told me he was shocked that he could not see any cranes building new buildings. I told my private equity buddy that I had heard that the signs people use to try and find patterns has changed from cranes to jobs, and a press release from Reuters reiterated this point:

Crucially, consumers in Canada and around the globe now view job creation as

the most concrete symbol of economic revival, Wright says. That stands in

contrast to the early 1990s, when the presence of construction cranes was a

key sign of economic growth.

The RBC Canadian Consumer Outlook index also found that, while 56% of

Canadians view the current state of the national economy as good, that is down

from 59% in September and 62% in May. But 48% are extremely optimistic the

economy will improve over the next year.

The November survey results will be set as the benchmark of 100 against

which future results will be compared.

-By Monica Gutschi, Dow Jones Newswires; 416-306-2017;

monica.gutschi@dowjones.com

Jacoline Loewen, author of Money Magnet and Managing Director of Loewen & Partners, Private Equity, Toronto.

Can Green be profitable? Ask Al Gore, our first Green billionaire

Does being Green pay off?

Ask Al Gore - he's a billionaire from Green.

Al has figured out to make a profit from global warming and urging new behaviors on the rest of us. Environmentalists think that it’s a Disney movie and that we should use earth’s resources carefully because it is a good thing and tend not to think about how to use money as a motivator. For some of the environmental people, the words green and profits should not be said in one sentence. I wonder what they think of Al Gore's financial success.

For business though, Green is showing that it can be good business. Bullfrog Power released their list of the top 10 Green enterprises and Wal-Mart is top. They have discovered that Green means cost savings too. They are pushing inventory storage as far back to the supplier as they can. Instead of having a thousand delivery trucks come to a store half empty, they have 100 trucks. The real estate inside those trucks now becomes very valuable as now every inch of the pallet holding goods must be used. New boxes that lock into each other and are reusable and reusable pallets.

I was glad to see the City of Toronto is on the list as they are buying Gardens in the Air to put plants on roofs using the tax payers’ dollars to support Green products and develop a market to support their business. They have the biggest pockets and by being a first customer, can support a young industry grow and then bring down the costs.

Nortel Board thinks we are still in the dotcom boom times

With layoffs and pension losses, the Nortel Board should be managing the optics of bonus payments to top executives. This is not the dot com boom. We are in a new era where we are haemorrhaging jobs to countries where smart, educated people work hard for far less.

Nortel should have got the bail out not GM because it is new technology while GM is old technology.

Are these Nortel executives so talented? Well, yes, turnaround people are a rare breed so there is probably (hopefully) some truth there. I do wonder if the Nortel Board members have picked up the latest in compensation package trends. Roger Martin, University of Toronto, is saying bonuses should be tied to performance measures like customer satisfaction measures, not to increasing the share price.

How you pay people makes them mercenaries or patriots. Nortel executive is looking rather mercenary.