No more cash for trash

"No more cash for trash," says Tom Trimble, CIBC Wood Gundy. This catchy theme tracking through private equity investing is explored below by CIBC Wood Gundy's investment expert, Tom Trimble:

It is hard to believe that it has been just over a year since the collapse of Lehman’s and the ensuing market maelstrom. At one point it appeared that the whole financial system was at risk, but the concerted effort of governments around the globe staved off disaster. While conditions have improved markedly, the sheer volume of conflicting information and opinion on what the future holds is staggering.

What we do know is that both the credit markets and the equity markets have roared back from a near death experience. Over the past month we have been conducting a number of annual reviews with clients that have their birthdays in the fall. Part of the meeting has been a discussion of the performance of the portfolios from a year-to-date, one year, and two year perspective. This coincides with the beginning of the meltdown in the U.S. and includes the worst days of 2008 and 2009. It has been encouraging that over this time period the “total” return has been only modestly negative, much better than most expected.

So what now? We would like to discuss several themes that are shaping our current thinking.

Bullish On Equity

As most of you are aware, at the height of the crisis we chose to move into corporate and high yield bonds as they offered the best risk-adjusted return at the time. If the number of bond issues that have come to the market since then is any indication, then credit markets have experienced a rapid thaw from the frozen conditions of March. The difference between Government of Canada bond yields and low grade bond yields has narrowed to almost pre-Lehman levels. At the same time the yield on cash assets have shrunk to almost zero.

While nobody wanted bonds in March, we now find that there is tremendous demand for any type of income product regardless of quality and yield. We are no longer buying much fixed income due to low interest rates and are thus more interested in equity that offers attractive yields and potential for capital appreciation. We feel that equity offers us the best risk adjusted return opportunity, especially the high quality companies that have lagged the market over the past six months. That being said we are very careful about what equity we wish to own. See “cash for trash” below.

In our last commentary we mentioned that we had created four CPMS branch portfolios. We have been meeting every Tuesday as a group to review the portfolio and to make any changes we deem necessary. Since we started on April 1^st we are happy to report that the CPMS portfolios have been excellent performers. Over the next few months we will be integrating the companies highlighted in these portfolios into our accounts. Stay tuned.

No More “Cash For Trash”

We have talked about this issue before, but it is worth repeating. In fact, CPMS has analyzed the characteristics of the best performing stocks over the past six months and it was clear the only positive attributes for these companies have been a low price to book ratio and high earnings expectations in the future. Once the governments stepped in and guaranteed the financial system, these companies were tossed a lifeline and their stocks moved up. This “hope trade” helped move these stocks through several technical barriers and many speculators/investors piled in for the ride. This ride has continued, especially with the commodity based stocks.

We feel that with the third quarter results being posted now, there will be a shift away from these higher risk stocks to the less risky, more consistent companies with steady growth in profits, and good balance sheets. It is our opinion that, in times like this, these are the companies that deserve a premium valuation. There may be a few extra innings on the “cash for trash” trade, but we are beginning to position our portfolios into the companies that offer steady profits, solid balance sheets and may not have moved with the market.

Currency, Commodities And Gold, Joined At The Hip

We are bullish on materials, energy, and agriculture over the long-term based on the age old supply/demand principle. Unfortunately, the U.S. governments’ ballooning deficit adds another dimension to this investment thesis. Since commodities are priced in $US, the movement in the dollar affects the price of commodities, but this does not necessarily improve energy, material, or agricultural companies bottom lines.

For example, if the $US declines by 10% and oil prices go up 8%, the net affect to a Canadian oil producer’s net income is actually negative as they have to convert their income into $CDN and most of their costs are in $CDN. Unfortunately most investors focus only on the price of oil and bid up oil shares as the price of oil goes higher without factoring in the effect of the currency. We don’t like investing in commodities that are inflated by short-term movement of the $US and would prefer to buy them when it is clear that demand is increasing faster than supply.

While we have seen some “green shoots” in the economy, we need to see sustainable demand in the developing world for the rally in commodities to continue based on supply and demand. At the moment, 40% of the China’s GDP is government stimulus spending. This kind of stimulus is not sustainable forever so we would like to see more growth coming from the consumer. If we see a correction in the $US and thus commodities we would add to our positions.

The World, It Be A Changing

Two years ago, all the talk was about the decoupling of the developed economies from developing economies. During the financial crisis this theory was put to the test and failed as all markets declined together. Now that we are in the recovery phase it is becoming abundantly clear that 2008 and 2009 were bumps in the road for these economies of China, India, Brazil, and Latin America.

Their balance sheets and banking systems are in solid shape. They have tremendous potential for consumer growth, they are great savers, and they did not see the asset bubbles from too much leverage that the OECD nations experienced.

If we look at the U.S. we see exploding public sector debt, a huge inventory of homes in foreclosure or about to be foreclosed, decreased consumption and increases savings by consumers, which would indicate a slow rate of recovery.

It is our opinion that we will gradually see a shift from the U.S. being a consuming nation to one that grows through exports. Meanwhile China, India, Brazil, Latin America, and Asia will generate less of their GDP growth through exports and more through domestic consumption. Growth in these economies will place demands on the supply of materials, energy, technology, agriculture, infrastructure and specialized services/industries.

Canada is well positioned to benefit from this economic shift through our commodities, however, our manufacturing sector will suffer with the continued decline of the $US. Our banks have done well recently, but will likely trade sideways for a while until there is visible proof that Canada’s economy is recovering with some strength.

CIBC Wood Gundy

Lisa Applegath Tom Trimble

Investment Advisor Investment Advisor

Contact: Fossati, Susy mailto:Susy.Fossati@cibc.com

Do these ideas get implemented?

To keep up to date, entrepreneurs do appreciate great idea people. I was sent this top 50 list of the best ideas people by an ideas man himself, Flavian Delima. To qualify, your ideas must get implemented and show results in companies. The top thinker on this prestigious list is CK Prahalad who used to co-author with Gary Hamel. Together, they introduced the idea of Core Competency to businesses which is one of the most enduring strategic concepts of the past 50 years.

I met both Hamel and Prahalad at a strategy conference in Chicago back in 1993 and was captivated. Hamel was by far the more showy of the two, and he can be credited with popularizing their ideas. Prahalad was more difficult to understand as he spoke in complex terms but obviously the deeper thinker of the pair.

They stopped working together and – like The Beatles – I have found their later work not to have had the same depth of theory combined with fiery rhetoric to get your ideas jumping from the text into your business. Maybe they will stage a reunion?

Jacoline Loewen, author and partner in private equity firm.

The interview with Prahalad is terrific and well worth a listen.

Remain calm when rejected for finance

Remain calm when rejected by people with finance. Listen to their comments and ask for more feedback. You can rework it and then come back or go to a new source of capital and try yoru plan again.

Canadian Business has a useful podcast on attaining financing for small and medium businesses. Read more.

Your business will benefit from you goofing off

If you want your business to grow, you need to work all the time, right? Not according to one the most interesting entrepreneurs who started and ultimately sold Flickr. Read more.

Caterina Fake, who, with her husband Stewart Butterfield, founded Flickr, knows a thing or two about bliztkreig work schedules. But she points out that late nights are seldom very useful in the grand scheme of things. Hard work? Overrated:

When we were building Flickr, we worked very hard. We worked all waking hours, we didn't stop. My Hunch cofounder Chris Dixon and I were talking about how hard we worked on our first startups, his being Site Advisor, acquired by McAfee--14-18 hours a day. We agreed that a lot of what we then considered "working hard" was actually "freaking out". Freaking out included panicking, working on things just to be working on something, not knowing what we were doing, fearing failure, worrying about things we needn't have worried about, thinking about fund raising rather than product building, building too many features, getting distracted by competitors, being at the office since just being there seemed productive even if it wasn't--and other time-consuming activities. This time around we have eliminated a lot of freaking out time. We seem to be working less hard this time, even making it home in time for dinner.

Much more important than working hard is knowing how to find the right thing to work on. Paying attention to what is going on in the world. Seeing patterns. Seeing things as they are rather than how you want them to be. Being able to read what people want. Putting yourself in the right place where information is flowing freely and interesting new juxtapositions can be seen. But you can save yourself a lot of time by working on the right thing. Working hard, even, if that's what you like to do.

Why you shouldn't miss the Profit Small Business Show October 15th

Get entrepreneurial lessons from those who have crossed the chasm and made it. Profit magazine supports and encourages SMEs here in Canada and is putting on a terrific event.

http://events.unisfair.com/index.jsp?eid=465&seid=28

Profit has given Canadian companies a powerful forum to be showcased and attract opportunities.

PROFIT: Your Guide to Business Success, is Canada's preeminent publication dedicated to the management issues and opportunities facing small and mid-sized businesses. For more than 25 years, Canadian entrepreneurs across a vast array of economic sectors have remained loyal to PROFIT because it's a timely and reliable source of actionable information that helps them increase their revenues, boost their profitability and get the recognition they deserve for generating positive economic and social change.
Visit PROFIT online at www.PROFITmagazine.ca.

Starting and growing your own business and needing inspiration? Here is Mary Aitken, Verity, talking about how she did it with Robert Gold on BusinessCast:

http://www.mevio.com/episode/188239/125+-+Starting+And+Growing+Your+Business+with+Gold+n+Brown/?psRef=twte

Electrovaya’s journey from a technology development firm to TSX

The Indus Entrepreneurs (TiE), Toronto

Cordially invites you to

Entrepreneur Forum

Presenting

Speaker: Dr. Sankar Das Gupta, Chairman & Chief Executive Officer, Electrovaya Inc.

Case Study: Electrovaya’s journey from a technology development firm to a public company on the TSX as well as its successful funding strategies from various internal and Governmental resources to retain management control

Date: Wednesday, 14^th October 2009

Venue: RBC Conference Centre - Auditorium ‘C’, 315 Front Street West, Toronto

Agenda: 6:00pm Reception
6:45 p.m. to 8:00 p.m. Presentation followed by Q&A

Dr. Sankar Das Gupta is the CEO of Electrovaya, a TSX listed company and an Adjunct Professor at Toronto University. He received his undergraduate degree from Presidency College, Calcutta University and his Doctorate from Imperial College, London. He has about 40 US issued patents and many other publications. Electrovaya (TSX:EFL) has been developing lithium Ion Polymer batteries for Energy Storage and Electric Clean Transportation with very many Global OEMs in North America, Europe and elsewhere. Recently, Maya Electric, a subsidiary company, is demonstrating an electric car fleet in Baltimore with ExxonMobil. Sankar is a member of various associations and is a CM of TIE-Toronto.

Registration (Mandatory & Online Only): https://www.123signup.com/register?id=jsykm (Members: FREE ; Non-Members: CAD25)

Suresh Madan, Priya Patil

President, TiE Toronto Vice- President & Director – Events, TiE Toronto

smadan@tietoronto.org ppatil@tietoronto.org

The Indus Entrepreneurs – Toronto Association

150, Bloor Street West, Suite 14

Toronto, ON - M5S 2X9 Canada

Ph: 1-416-451-7113, 1-416-964-6253

Email: admin@tietoronto.org

Private equity changing its business model

Some private equity funds are always ahead of the private equity pack. KKR is one to watch as they have been at it longer than most. With new money for private equity rapidly becoming rare, KKR is one of the first private equity funds to redo their business model. Here’s more

KKR continues in its efforts to diversify its business and find new ways to access capital. Over the last two years, KKR has started investing in global infrastructure, beefed up its distressed debt arm and is investing in companies in new ways, including partnering in joint ventures. Most recently, it made a $400 million debt investment in Eastman Kodak. It is also building a capital markets capability, enabling it to access investors directly, cutting out investment bank intermediaries. And it is exploring new deal structures, including allowing investors to put money into deals directly rather than via traditional funds.

KPE's share price has surged from its low of $1.93 earlier this year as markets have recovered, more than quadrupling to $9.43. That gives it a market cap of $1.9 billion, which suggests KKR as a whole is worth $6.3 billion. That, according to Rabo Securities, would be just 6.5 times 2009 estimated earnings. If you buy into KKR's diversification efforts, that could make the shares attractive: Rabo thinks a justifiable blended multiple that takes account of the mix of fees and earnings the new KKR can generate would be 9.6 times, valuing the group at $9.3 billion.

Media needs a good strategist to blow up their assumptions

Magazines and Newspapers are struggling to re-build their business models, starting with the whole relationship between advertiser and editorial content. I read MARK EVANS' terrific essay on the topic and have made a quick comment on the strategy below:

Mark Evens says - Over the past little while, the Toronto Star has been running a series of in-house ads about how newspapers play an important role in delivering the news. Today, for example, there’s a full-page ad that says: “You shouldn’t have to search for clarity or direction”. The ads are creative and they do make you think about how newspapers play a vibrant role in the news ecosystem. But they are dancing around the key issue: the economic model in which newspapers give away all of their online content doesn’t work.

It is becoming obvious newspapers must start charging for their online content. I’m not talking about Great Wall-like pay walls in which every story is buried unless you pay but a variety of user-friendly subscriptions that provide value to readers while providing revenue to newspapers.

I think that maybe markets under the age of 20 could be pulled over to paying online for newspaper content, particularly if it was .01c per day.

Baby Boomers are just never going to pay for newspaper content online personally for a whole host of psychological and social reasons which have been discussed for the past 15 years – ad nauseam. Accept that brutal fact. Once the newspaper publisher accepts that, how else can they do the business model?

First, look at the life blood of the paper – ad revenues. We all know there is a Chinese wall between advertisers and editors. There is your first paradigm shift required – to sell content into aggregators like TD Bank. For current editors, that idea is too much of a shift. Imagine though, if you looked at target market for content. Let’s use Margaret Wente who would be of interest to women Baby Boomers, a great target market.

Second, who are top richest Canadian companies – the big banks. Could you sell Margeret Wente to TD Bank’s Wealth section, who are trying to add value to the day of a Boomer woman?

American Express gets early tickets to AGO and ROM special events. Why couldn’t TD Bank have early editions of The National Post only available to its TD clients? As TD clients log into TD, they would get the online National Post too for free. That would build client loyalty for TD and aggregate a readership for the newspaper, building a new habit of going online to check the bank balance and read the paper.

Private Equity seeking smaller deal size

Past valuations of companies partnering with private equity may have been too high and have not given the financial returns expected. Here’s my favourite private equity investor commenting on the current state of the private equity markets. David talks about how the big private equity players are shying away from the mega deals of the past and preferring smaller deals, such as struggling banks. Here's Bloomberg's interview:

Carlyle Group Inc. co-founder David Rubenstein said he expects the private-equity industry to come back and be “stronger than it was just a few years ago” as the recession ends.

Carlyle, the world’s second-largest private-equity firm, bought some companies at prices and debt levels that in hindsight were too high, he said today in a Bloomberg Television interview in Washington.

“We had some companies that didn’t perform as well as we would have liked,” Rubenstein, 60, said. “Generally I think we’re coming back. We’re now investing again. Our companies are in good shape.”

Private-equity managers are seeking to resuscitate a leveraged buyout business crippled by the global credit crisis that began more than two years ago. Carlyle and larger rival Blackstone Group LP are eschewing public-to-private buyouts of more than $10 billion that characterized the 2006 and 2007 peak in favor of smaller deals for targets such as struggling banks.