Do you know where you are in your industry cycle?

Visiting a large manufacturer located in Waterloo, the town looks shabby. My client has a large facility though, kept spotless and with a full car park early in the day. Looked good. I was impressed by his plans to sell his business in a few years.

"This is will be the culmination of my life's work," he told me.

Two years ago, he had gone out for private equity with a top bank taking them to 12 private equity firms in Canada and 12 in the USA. Since he was in cyclical business of machine parts, I said it probably was not a success as the valuations given by PE would not fit his estimates.
"You are correct," he said and went on to ask me about this business cycle issue.
It is very important to know your industry and the cycles it follows. Mining and oil has big cycles while the food industry may have lower ups and downs. (A flatter cycle means fewer overnight millionaires in that industry.)
During this owner's capital raise process, no one had mentioned to this owner that his business happened to follow very steep dips and slopes. Th is team of bankers took him to private equity when he was at the absolute peak of the cycle.
No wonder he coud not get the valuation he deserves.
Even more shocking, if he follows his current plan which is to sell in three years, he will be back smack dab at the peak again.
For this owner, it is time to strike now while the industry is in the trough. We are seeing him again this week. I hope we can help him retire really rich, rather than with regrets.

Bull is not Bullish - Gloom to Continue

July is shaping up to be a tough month for public markets. If you had sold in May and come back in September, 2010, you would be fine but my account statements are not looking happy. Meanwhile, I got to spend some time with David Rubenstein of Carlyle and private equity is able to be the nose of the dog when it comes to investing. His company has been busy this July as it bought NBTY for $3.8bn, property in London in the billions and also in China too. The Financial Times reports:

Taking NBTY private is reminiscent of the buy-out bubble that burst in 2007, when big listed companies were regularly taken over by private equity.However, buy-out activity remains at a fraction of pre-credit crisis levels, even after a rally in recent months. The NBTY deal is different from most recent buy-outs, many of which have involved private equity selling companies to each other.

Carlyle is now doing mega deals in China and it is those size of deals that were done originally by the early private equity firms in America with which gave them their lead. It put cash in the bank for later and gave enormous market profile. All of a sudden, the deals will now flood to Carlyle before any other PE player as they have put serious cash into China.
For those of you still all in the public market, here is a quick recap that arrived in my email today from KJ Harrison and a great market analyst with the right name - Ms. Sarah Bull:

The catalyst for the current correction continues to be the fear of a relapse of the 2008 global economic recession. This is really being fuelled by the:

• US debt and deflationary issues, 
• European problems and 
• Prospect of much slower growth in China. 

Here's the detailed analysis:

• China’s growth rate has slowed – not good given its “engine” status for global growth.

• European sovereign and bank capital issues continue to remain unresolved issues.Uncertainty as to the Euro sustainability is a large issue for global markets.

• U.S. employment growth appears to have peaked – in fact last month the U.S. lost 125,000 jobs, and the average work week fell. Average hourly earnings fell, and widely defined measures of unemployment actually rose. In short, the anemic recovery in employment seems stalled, suggesting the private sector is incapable of taking the “hand off” from government stimulus.

• The G‐20 in Toronto came out strongly in favour of fiscal restraint – unfortunately major economies are not strong enough to withstand near term restraints, and as such investors are now very worried about policy error. If we are at the end of Keynesian policy initiatives, what happens if we double dip?

We believe that this pessimism will continue and that we will have higher than normal volatility in the markets over the next few months. Given this view, our disciplined approach is more important than ever and we are allocating our client’s capital to securities with good balance sheets and a significant margin of safety.

 by

Sarah Bull

Partner

KJ Harrison Partners Inc.

Why is Productivity Private Equity's Obsession?

What if you heard there was a way for an investor to achieve improved results; secured jobs; created more jobs; made the Canadian office the Head Office which means more high level careers for our CFOs and CEOs. Sounds pretty good, doesn’t it? Yet, when I was visiting private equity in Boston, they were skeptical about Canadian companies ability to improve their productivity.

The Globe & Mail is running a fantastic series on productivity and Canadian attitudes. I appreciated that openness to the growing resource of private equity, not only the Bank money. Partnering with investment experts helps owners grow their businesses -- although this mantra of growth, I have discovered, is not what many owners want. Anyway, here is the article.

What could do all this you might ask? Well, the answer lies with something that most Canadians know little about—improving “productivity.” And while improving productivity can help us achieve such benefits, there are no guarantees that all these benefits will be realized. It will depend on the decisions that are made if we are successful in improving productivity. So, at the outset, let’s be clear that improved productivity brings opportunity for economic benefits—not a guarantee. 

But What is Productivity?

Productivity is essentially concerned with how we combine our various resources—labour, tools, equipment, etc.—to produce goods and services. That is, it relates to the decisions we make, and the actions we take, to try to make the best use we can of all the various resources we have available.

I heard Frank McKenna speak about making Canada a high tech expert in oil and mining products and services. This makes great sense if industries cluster and the state encourages this market - Paul Bremmer touches on this in his book, The End of the Free Market. Here is one of the comments to this article that adds to that theme.

Rather than playing to our strengths - i.e. the basic geographic and institutional make up of the country (firms, governments, land, capital, labour), most economic policy wonks and practically every government talks about the "knowledge economy", "innovation", and "productivity" in complete isolation from what it is that Canadians *actually do*. If we want those things (and in some ways we have innovative financial services for the mining industry, a technically advance energy sector, etc) then policy and thinking needs to explicitly connect them to the reality of the country. For example we are the world's *experts* in energy use and production. Per capita we use (and waste), distribute and produce the most, it's a cold country. Let's get "productive" in energy, it's a big input cost across the board. Focusing on the "strength of our banking system" and the sexy high-techiness of Blackberries and bio-tech without linking that to productivity improvements in forestry, water and energy use, mining, oil, etc. etc. proves that there is no real national effort to improve economic productivity. If it happens it's an accident of statistics and of policy.

6 Bear Traps sabotaging funding efforts for mature companies

Having seen many family companies who think they can get money because the investors will fall in love as hard as they have, I thought I would write a quick list of 6 Bear Traps of raising private equity. I asked a few fund managers for their opinions which are quoted in the book, Money Magnet. I also checked out some blogs where these sorts of lists are popular. Here are the top Bear traps sabotaging most funding efforts, in decreasing priority sequence:

1. Lack of a growth story. That story has to begin with the painful problem shared by a large collection of viable customers, with your competitive solution and why your company needs to grow. It has to be a big enough difference to get people to switch. Clay Christenson, Harvard Business School, wrote an entire book about how to get people to move from using the stairs to a new technology called the escalator. Many mature companies have not thought about how to grow their business, preferring to stay in the same, safe markets. Additionally, you need to be able to communicate the essence of that story and value to investors in a couple of sentences – your elevator pitch.
2. Lack of simple goals. Often, the number one question that owners fail to address is: “How much money do you need, and what valuation do you place on your company?” Then you have to have evidence to support your request. I’ve asked this question many times of presenters in angel meetings, and often get a blank look. What are the three things you would do with the money and in what time frame? Keep it to three. How much is your company worth and over five years forward, how much will it grow? Remember, the investor's other options are the stock market and putting the same amount of capital on gold - can you beat that growth?
3. Failure to prepare for due diligence. Any serious investor will perform a thorough archeological dig on your business and your background. Make sure there are no surprises, so you should explain any possible issues first, in the best possible light, before being asked. Get a professional financial advisor to ge you and your company ready and that should include 100% of due diligence already done and ready for the investors to merely review.
4. Lack of understanding of the fund. The book Money Magnet helps you get inside the head of the person with the capital. The key here is to create a win-win situation for your investors. Discussion of risks and rewards in an open fashion, without sleight-of-hand or shortcuts, will convince investors that they can count on you, and will avoid shareholder lawsuits later. 
5. Reliance on inappropriate business professionals. Using well-respected professionals to find you capital and introduce you to the right people as well as stick handle your way through to the check signing is smart. If you can attract well-known advisors, attorneys, and accountants, it will give potential investors comfort that you have been able to get an implied endorsement of your concept, as well as your integrity.
6. Being unprepared for the next steps. After a good elevator pitch or initial presentation, investors will ask for your formal business plan and financial projections. Don’t derail their enthusiasm or risk your professional image by not having these materials immediately available. The same thing goes for incorporating your company, having key hires lined up, and facilities arranged as required.

American businesses are uncertain about Obama's Plans for Business

I commented that I was shocked by my trip to Boston and the lawyers' and private equity's anger with government, particularly as this city would be voters for the current government. (I get tired of the obsession with Obama - it's his team too.) Even the Harvard Business Review online is bringing up "leadership lessons" directed right at Obama--which surprises me. Niall Ferguson, my favourite money expert, was on CNN talking about how American businesses are hoarding cash, not spending. And why would you hire people if you do not know the consequences of cost or maybe new rules around reducing work force and so forth. As I said before, it's a business owners's summit needed, not a job summit.
Anyway, it is clear that there is terrible uncertainty being created by Washington--where they are more lawyers and, apparently, zero business leaders or MBAs. Lack of business appreciation does create a narrower world view and when the goose is unsettled, the goose is not going to lay the golden eggs to pay for all those big union jobs. Washington needs to get to terms with this and fast.
Perhaps CNN was on in Joanna Slater's home too and she writes in The Globe & Mail:
For a clue to Corporate America’s state of mind, look no further than the piles of money stashed under its mattress. Facing an uncertain economic environment, U.S. firms have socked away cash at a rapid clip, amassing a rainy-day fund the likes of which hasn’t been seen in over 40 years. At the end of March, non-financial firms had accumulated a record $1.84-trillion (U.S.) in cash and other liquid assets on their balance sheets, according to the latest figures from the U.S. Federal Reserve Board. As a percentage of total company assets, which include factories and other investments, cash is at its highest level since the early 1960s.

When and where companies decide to use their stockpile will be a key factor in the strength of the recovery. If companies feel confident enough to invest in new equipment or make acquisitions, it will spur economic activity and hiring. If they remain anxious, such decisions will be delayed, dampening overall growth.

Such hoarding can’t go on forever. Companies that keep piles of cash sitting in the bank earning razor-thin interest rates will eventually face the ire of investors, who will demand that the money be put to better use or returned to shareholders. Two options: paying higher dividends or buying back shares.

Here are some of the more interesting comments:

 Companies use to use lines of credit or short term loans for regular operating expenses, so they didn’t need to keep such high levels of cash, but now a great majority of US banks are effectively bankrupt and lines of credit and short-term loans are all but impossible to obtain, even for the largest and most successful companies. This is why companies now must keep a high level of cash just to be able to meet financing needs for daily operations. There is no “EXCESS” hoarding of cash as this article suggests, that is just silly. 

Canadian banks see a huge market for lines of credits to American businesses and this is why our 4 big banks have huge expansion plans for the US. The American banks are dead, they are broke, so Canadian banks will move in to fill a need there. This article is off base. Yes, corporate cash is up. Corporate long term debt is slightly below record highs. This another smoke and mirror article by someone that doesn't do their homework. Corporate America is swimming debt. They have a little more cash in one pocket and a huge liability in the other. Go ahead and cheer for a day or two. It's a mess of debt out there. The party is going to end in tears.

Can we leave it to start ups to rebuild the economy?

Even Linkedin has White House staff posting questions on the public forums asking for advice on how to create jobs. If you could give the government one recommendation to create jobs, what would it be?
If that interests you, I recommend reading this month's Inc magazine; their superb cover story is

 a plan to revitalize the American economy by creating lots of new start-ups. Some of the proposals, such as a offering visas to foreign-born founders, are already generating controversy. There is a the question whether more start-ups would be good for America. In a Bloomberg Businessweek cover story, former Intel CEO Andy Grove attempts to challenge this widely accepted idea. "The underlying problem," Grove writes. "[Is] our own misplaced faith in the power of startups to create U.S. jobs."

Exactly, Andy, start ups can not work in isolated patches. You need the big companies to be the cruise ship and the start ups can be all the harbour services to that cruise ship. By letting these big cruise ships leave the harbour for China, we explicitly miss-out on the next new industry ("but what of the industries we haven't created yet?") when the knowledge and expertise that accumulates in the ecosystem of manufacturers and suppliers is largely offshore. 
Think batteries, solar power, etc. What seems like a sound farming-out-of-commodity-work this year turns into a wholesale ceding of the next step in an industry's development five years down the road. 
I believe Groves is absolutely right that we need to re-think our assumptions about what the link is between what is in the interest of an individual company and what is in the interest of our nation medium-term. 
It is not always natural for many in the business world to have an honest discussion of what kind of society we should aim for - and accept that societies do not build themselves but are build by leaders who have a vision greater than their own economic freedom. It is a discussion we should have. 
Nortel was one of those major cruise ships and should have been given the GM package of bail out money too. Problem was that no one at Nortel believed that they were in such bad shape and no one did what GM did, get together a large group of businesses and go to Ottawa to lobby their case. 
I feel heartened that finally these stories are on front page covers of magazines and that great business leaders are bringing their points to the debate.

Private Equity sees the value in Health Care

The tale of rival Indian and Malaysian bidders for a Singapore-based health-care chain might be described as "same hospital bed, different dreams."

A full-on bidding war for Parkway Holdings Ltd., a successful Singaporean provider of swanky, high-end hospital care, broke out last week when India's Fortis Healthcare Ltd. announced an offer for the shares it doesn't already own in Parkway that values the company at 4.32 billion Singaporean dollars (US$3.10 billion). Fortis's bid of S$3.80 a share tops a partial takeover offer of S$3.78 a share from a unit of Malaysia's sovereign-wealth fund aimed at securing majority control without having to buy the whole asset.

The two offers share one thing in common: a belief that rapidly growing demand for quality health services around Asia represents a unique business opportunity. But the offers from each of Parkway's two biggest shareholders envision different players—one government-owned, another a private-sector industry leader—grabbing the consolidator's position.

Malaysia's interest in Parkway is clear. It holds 24.1% of Parkway outright through Khazanah Nasional Bhd., the state-owned investment fund, and owns 60% of a Malaysian Parkway affiliate. Parkway also generates 26% of its revenue in Malaysia, which is expected to be a key driver of its future growth, according to a Citi Investment Research report.

Moreover, Parkway offers tiny Singapore's bigger, less developed neighbor a chance to leapfrog into a leading position in high-end health care, an industry the government has singled out for strategic growth. Malaysia already has used government funds in that effort: state-owned oil company Petroliam National Bhd., or Petronas, owns a luxury, "futuristically designed" (as the website puts it) 300-bed hospital in the country's capital, Kuala Lumpur, built two years ago in part to promote medical tourism.

For Fortis, Parkway offers a chance to expand from its base in India across the region. One of India's largest hospital groups, Fortis is run by billionaire brothers of the Singh family that founded drug maker Ranbaxy Laboratories Ltd. In an email, Fortis Chairman Malvinder Mohan Singh said a combination between Fortis and Parkway would create a "pan-Asian health-care platform" that stretches from the Gulf to Southeast Asia, with both China and India representing big opportunities.

Read more...

Bono Values Private Equity

Elevation Partners, the private-equity firm whose founders include Bono and Roger McNamee, added to its stake in Facebook with a $120 million investment, according to a person familiar with the matter. Elevation bought the shares from equity owners in private transactions and has invested a total of $210 million in the company. The social-networking site, with about 500 million users, is valued at $19.9 billion, according to SharesPost Inc.

Read more: http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2010/07/03/BU9B1E8EGF.DTL#ixzz0slHUtFg9

"An Unfair Advantage"? Combining Banking with Private Equity Investing

"Does the combination of banking and private equity investing endow banks with superior information that allows them to identify good prospects and garner superior returns?" asks Lily Fang, Victoria Ivashina, and Josh Lerner from HBR. "Or does the combination bestow banks with an unfair ability to expand their balance sheets, capturing benefits within the bank at the expense of the overall market and ultimately the taxpayers?"
When I first went to meet with all of Canada's Private Equity players, I quickly learned that Canada's banks had tried doing private equity, but have exited this industry. The main reason is that the Bank culture is very different from Private Equity. Banking is about managing risk, while private equity culture requires embracing higher risk than most could stomach.
It reminds me of General Stanley McChrystal's situation who was reported in Rolling Stone to have made insubordinate comments about the USA government. Many of these comments, such as "Bite Me", I have heard a million times from very senior men during my career in finance. 
Many have condemned the General for being light with his criticisms of the top leadership of the USA in front of a reporter. Yet, they would probably mostly agree that McChrystal is very smart and good at his work -cutting edge, in fact. Those criticizing McChrystal would probably even agree that his innovations have reinvented the US military. That is quite an accomplishment for a man who has now been fired for criticizing his boss in the media.
If you did a quick survey, I predict that those who think McChrystal should be fired for his insubordinate (and foolish) remarks are usually working for big companies. They can not fathom making such comments to any media, even a music magazine. I suspect that McChrystal probably thought Rolling Stone would be empathetic to his coolness and repaint the military as a hip place to be, after the Bush years of ridicule. 
Business owners and private equity would be more likely to say McChrystal should have been reined in, but certainly not have lost his job. Private equity and entrepreneurs look past these terse, sarcastic jokes and appreciate if the job is being done very well. Private equity would first ask and look for the answer "yes" to every question:

• Is this warrior of top value to building the military of the future?
• Is this person an innovator? 
• Is he bringing more to the bottom line even as he grates? 
• Does this person challenge authority, but is there value in what he is saying? 
• Could we bring him in and coach him more on how to keep the team working together, and encourage a little less of the Clint Eastwood shots from the corner of the room? 

OK then. You have a good person here, but with a badly misguided PR problem. 
General McChrystal is operating in a very different world than most corporate people. His world requires entrepreneurial thinking and attitude to challenge sacred cows. I can guarantee that corporate behaviour is not going to save lives and it is why the US military has been spinning its wheels because they stifle their true warriors. 
McChrystal's brashness  is his value. His riskier behaviour is change agent behaviour. When the leadership takes out their innovators, a bad message goes out to the rest of the military strategists. Think, but do not speak your mind. It is why innovation does not happen in big corporates. the rest of the people will not stand for it. They stamp it out viciously. 
General McChrystal demonstrates private equity behaviour. His boss, General David Petraeus, is steady at the wheel type of fellow, who tows the line, illustrates more bank relevant culture. And that - in a military story - is why banks should not do private equity.

Read more: 

  Read more at Harvard's excellent article on this: 

INSEAD's Lily Fang and Harvard Business School professors Victoria Ivashina and Josh Lerner examined nearly 8,000 unique private equity transactions between 1978 and 2009, looking in depth at the nature of the private equity investors, the structure of the investments, and the performance of the firms. Collectively, findings suggest that there are risks in combining banking and private equity investing. The results are consistent with many of the worries about these transactions articulated by policymakers. Key concepts include:

• The cyclicality of bank-affiliated transactions, the time-varying pattern of the financing benefit enjoyed by affiliated deals, and the generally worse outcomes of these deals done at market peaks raise questions about the desirability of combining banking with private equity investing.
• These investments seem to exacerbate the amplitude of waves in the private equity market, leading to more transactions at precisely the times when the private and social returns are likely to be the lowest.
• Investments involving both affiliated and nonaffiliated firms appear particularly vulnerable to downturns.
• Some information-related synergies, however, are captured internally by the banks. But banks' involvement poses significant issues as well.
• The share of banks in the private equity market is substantial. Between 1983 and 2009, over one-quarter of all private equity investments involved bank-affiliated private equity groups.

Read more at the National Post 

Canada has a productivity problem

Canada's disturbing productivity performance is getting highlighted out by one of Canada's leading economists, Sherry Cooper. According to Cooper,

" Our banks were the only ones, worldwide, that never took a single dollar of government money." 

Yet our productivity is shamefully low, a fact I learned while doing my MBA outside of Canada, many years ago. Sherry says, "Our rate of return is not as high as in other countries, and the gap has widened to the highest level in history."
Sherry pointed out another fact that disgusted my MBA professor teaching unionism - America had a very low union rate. As Peter Drucker pointed out frequently, Marxism and Unionism was built on the back of the unhappy, poor, overworked Proletarian worker. Well, in the USA, with a high school education, you could earn a huge salary in manufacturing and mining. That's when the unions and Marxism lost its force because well paid workers would rather go home and watch the World Cup soccer with a cold one than fight what exactly.
Canada does have a higher unionization rate, which made my professor happier. I was startled when a visiting productivity expert told my MBA class that the laziest workers he had seen were in Canada and worked for a union.
There are three elements of productivity growth according to the Bank of Montreal report:

1. investment in machinery and equipment, 
2. human capital development and 
3. openness to trade and investment.

All three points are debated constantly by business owners, government and interest groups but I thought that the great success story, Open Text's Tom Jenkins summed up the issue for the politicians. Waterloo region has lost thousands of jobs, yet Tom says there are over 2,000 jobs unfilled in the tech industry.

"We're a tale of two cities, in some ways. Parts have the highest unemployment rates in the country, and yet in other parts, we can't find enough people to fill the jobs."

Here is where Sherry Cooper does lay out the ugly truth to Canadians and I have to agree with this unpopular view: In the future, Canadians will have to look to new markets. One of the things that make us lazy is that we live next to the largest market in the world, but its not a growth area. We are limited by our ambition and drive."
I agree with the lid on ambition. It has something that has taken me a long time to understand but I can see the reasoning. Canada has a high percentage of family owned businesses which are quite distinct from professional corporations. The thinking of a family business owner goes along the lines of, "I have a nice lifestyle. In a family business, I can work with my kids. How great is that? Why change?" Well, unfortunately, change is usually forced upon us and I have seen too many businesses decide too late that now would be the time to take on a private equity partner.
Besides, it would be good for your son or daughter to be exposed to the best in the world and have the family business protected. Sherry Cooper would probably agree.