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.

Integrity is the safest way to make money, it’s terribly important

When I worked for the fastest growing bank in Africa, the CEO would often go on about how much he hated derivatives that were just beginning to emerge into the market place. He said if he could not understand it, he did not want it in his bank - it was making money like a casino not through good, rigourous banking. Michael Graham picks up this theme:

Berkshire is especially pumped about their $26 billion cash and stock purchase of the 78% of the Burlington, Northern Santa Fe Corporation (BNSF) they didn’t own. An extensively rebuilt and wisely regulated American railroad system is ushering in a whole new (green) era of national and international importance for the railroads. BNSF was described as their all-in wager on the economic future of America. It’s Berkshire’s biggest purchase ever.

Attendees and questioners from all over the U.S. also bore witness to the wealth their investments in Berkshire Hathaway has brought them. One elderly gentleman we met from Wichita Falls, Texas had come all the way to Omaha just to say thank you.

Munger’s comment that “Integrity is the safest way to make money, it’s terribly important” drew loud applause. So did his thoughts that there’s nothing wrong in “celebrating wealth when it’s fairly won and wisely used”.

There was laughter of a different kind when much of the blame for today’s turmoil was laid at the doorstep of Washington where “those who take the high road are seldom bothered by heavy traffic”.

Trust! Buffett has been criticized for his view that Goldman did nothing illegal in helping craft a between-professionals subprime mortgage deal which the seller wanted to decline, whereas the European institutional buyers of “Abacus” calculatingly took the opposite view. Munger agreed with Buffett, though musing about the ethics of such transactions. In his view derivatives play a useful role in genuine commodity and trade transactions, but when they are nothing but synthetic, casino-like bets (often also dreamed-up by academics) they should be “got rid of from the face of the earth” (loud applause).

 Trust, the plain-vanilla (“Dairy Queen”) way, couldn’t have come through more loudly or clearly. It’s a cornerstone of investing and of the Berkshire approach.

How much longer – the question of succession comes up with an increasing frequency at these annual gatherings? We were reassured that a short list of successors has been chosen, that the board knows who they are, and that the Berkshire and Buffett-Munger culture will live on.

At the same time the Qwest Center has been booked for 2011 and 2012!

By then there could also well be clearer answers to Buffet and Munger’s biggest worry; namely, how much longer Berkshire can keep building wealth for its shareholders at a rate superior to the growth in its benchmark S&P 500 index, as it has done for 38 of the past 45 years. We were told how a compound annual gain in its per share book value of 20.3% is going to be next to impossible to sustain. What should be done when Berkshire can no longer beat the S&P because of its sheer size? The question was posed rhetorically. A dividend perhaps? Knowing them, you can bet that whatever is done will be different?

There can be no question that these one-of-a-kind annual meetings and Berkshire itself will be different when its two great champions are gone. In the meanwhile, is Berkshire Hathaway a jumble of diverse parts, or an undervalued work of art like no other? I’m in the latter camp, also believing it deserving of a place in most, if not all, investment portfolios.

Private equity-backed M&A deals remain far short of the boom times

More private equity deals in Q2

Business owners will get more phone calls to partner with private equity fund managers but these good times will come to an end as money flows more to growing markets like India and China. In the meantime, Reuters tells us Buyout funds are making a comeback, scouring deals from Australia to America after nearly two years of virtual shutdown, but private equity-backed M&A volumes remain far short of the boom times.

Bankers say that while a return to the mega-deals of 2006/07 is still some time away, there is now a steady flow of transactions, with private equity activity picking up in the second quarter.As of June 22, private equity-backed mergers and acquisitions in the second quarter were up 125 percent from a year earlier to $40 billion, and were up by a third from the first quarter, Thomson Reuters data showed. For the year, such deal totaled $70 billion, more than double a year earlier. The general stock market recovery early this year encouraged PE funds to push through listing plans, while a freeing up of debt markets opened up markets for secondary sales to other buyout funds. But with the European debt crisis denting the stock rally, there are concerns about whether PE activity can keep up the recent momentum.

"M&A markets are fragile. There was a slight loss of momentum in the second quarter. Coming off year-end into Q1, momentum was good," said Jeffrey Kaplan, global head of mergers and acquisitions at Bank of America Merrill Lynch.

"There was strong strategic activity and active PE bidding, much of which slowed down. EMEA has seen the biggest slowdown," he added, referring to Europe, the Middle East and Africa.The $70 billion of PE-backed deals this year through June 22 compares with the record $542 billion in the first half of 2007.Availability of easy credit is the key for a pickup in PE buying, and bankers say the U.S. market has seen the most dramatic improvement in financing, driven by large financial institutions.Europe has lagged in its ability to leverage because it is more of a bank-funded market. Overall, choppy equity markets and the rising cost of debt funding will make private equity dealmaking more of a challenge, though bankers say the market for mid-sized deals should open up.

"It will be a while before we get back to mega-deals," said Mike Netterfield, head of financial investor coverage for Asia at RBS.

"We're seeing some larger deals, but it'll be a while before we see the days of the TXU, HCA kind of deals," he said, referring to big U.S. private equity deals involving the likes of TXU, now Energy Future Holdings, and hospital operator HCA Inc.

"The liquidity isn't quite there just yet for mega-deals."

How Private Capital Helps Entrepreneurs and Family Businesses Grow

Private capital can assist owner managed or family businesses realize their liquidity or growth capital needs through flexible structuring. The deal structure is customized to the timing needs of the business owner. At the onset of the investment from the PE fund, the company is valued at fair market price. The business owner is able to cash in on this fair value to diversify the family’s financial holdings or for estate planning purposes. The “second bite of the apple” occurs upon exit of the PE fund when the total value is received exceeds the full sale now.

Private capital provides a tool to solve common family company issues such as succession planning, while also putting the company on a growth path. 

The long term elephant in the room

I listened to Michael Lee-Chin describe learning about Warren Buffett's wealth strategies he learnt back in 1979. I always like to hear about the annual Berkshire meetings which are legendary but this year's one has a different tone altogether. Michael Graham gives us the inside scoop:

My sixteenth pilgrimage to Berkshire Hathaway’s annual Woodstock of Capitalism (refer later) was to bring a reminder of Warren Buffett expressive likening of financial crises to the exposure of those swimmers without bathing suits when the tide goes out.
This ebb tide, it’s not the banks or corporations of 2008 – 09, but sovereign governments that are bringing a type of risk traders and investors haven’t had to worry about since the Asian financial crisis – sovereign default.
It might well also be that the growth of government that began with the Keynesian experiment after World War II is reaching the limits of acceptability. And all the more in Western democracies after the lifesaving, pedal-to-the-metal government stimulus and deficit spending of recent years. (Thank you Tony Plummer and your astute Helmsman Economics commentaries.) Regardless, there must now come unavoidable and extremely unpalatable preventatives – the shrinking of bloated or disproportionately-large bureaucracies, deep cuts to government spending and stringent deficit reduction.
In the EU, it’s no longer Portugal, Iceland and Ireland, but a growing number of others where fiscal discipline and rehabilitation are urgently required. In the UK, a tough-talking new cabinet has led off with a 5% pay cut of its own salaries, along with example-setting limits on ministerial limousines and first-class air travel, and the promise of draconian spending cuts to come. The same in Spain and Portugal which are both urgently addressing unsustainable deficits with big budget cuts. In France, all government spending has been frozen except for pensions and interest payments. And on and on!
Yea for deficit reduction as what could be a recuperative austerity wave begins to roll clean across Europe.At the world level, the IMF is urging governments to cut public debt in order to prevent higher interest rates and slowing economic growth. To these ends it is also advocating stepped-up value-added taxes in countries that already have them, and their imposition in countries that do not. Its message to a debt and deficit-laden U.S. couldn’t be more pointed.

Prime Minister Stephen Harper has also weighed in with hard-choice, deficit-reduction urgings ahead of the G8 and G20 summits he's host at Deerhurst and in Toronto.
Wouldn’t it be great if the Western world were to at last be getting the message about the risks of spending and borrowing one’s way to disaster!
Of course, words are one thing, implementation and perseverance another. There should be no doubt about the angry resistance to come, or the political (and re-election) temptations of monetizing deficits and repaying debts in still-cheaper (i.e., further-devalued) currencies. They’re continuing fork-of-the-road risks investors cannot afford to ignore.
Also to be kept in mind is how the fork of expediency could lead to the next wave of inflation (even hyperinflation) which might be subdued for now but, considering today’s strangling national and international indebtedness, has to remain the longer-term elephant in the room.
The other fork in the road leads to austerity – spending cutbacks, higher taxes and new frugality. It can only be tough, but is surely the healthier road to take even if it means reduced future investment returns. (In Charlie Munger’s view, refer later, there is no better way of being happy than getting your expectations down.)
The disciplined fork will not halt the shift in global power to Asia led by emerging powerhouses like China and India. Nor will it soften the aftershocks of the EU debt and deficit crisis on global trade, capital flows and economic growth.
However, in what cannot be a zero sum game, if China, India, Asia and the BRIC world continue to do well, we should do well too.Crisis, discipline and opportunity were words featuring prominently at an overflow Berkshire Hathaway annual meeting that was to leave 38,000 attendees, including the Grahams, much encouraged about the worldwide future for investing.
I always come away from these meetings the better for the wisdom, humour and taciturn wit of the ageless Warren Buffett, rising 80, and Charlie Munger, 86.
This time, I may not have learned that much new, but it was refreshing all the same to be reminded of time-proven homilies like investing not requiring brilliance as much as it does discipline and the avoidance of stupid mistakes. (A related example touched upon is fuel from corn which was described as “stunningly stupid”.) And also that investing requires continuing learning because the world keeps changing, and it will be hard to fail (in investing) if “each night you go to bed a little wiser than when you woke up”.
I am also always reminded at these meetings how Warren and Charlie love declining share prices because “we can then buy more”, whereas it “pains” them to buy more when share prices are going up.