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.

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.

These are times that try men’s souls

Business owners are wondering if we are heading for flat growth which means values of businesses may not be preserved from the same old, same old. With BP and Europe, we have had a busy first half of the year. Something to keep in mind is that there always seems to be something bad happening in the world. I have been reading forecast books written in the the early 1990s - one by Peter Drucker - and they all miss the Internet and the incredible increase in global connectivity. It has unleashed wealth for millions of people.
I was reminded of the gloom only forecasters by Michael Graham and liked his comments on Thomas Paine. Here is what he has to say about our troubled times:

No one would have thought, and I still can’t, of the mighty European Union with its (equivalent) $16 trillion economy being threatened by the over-indulgences and debt excesses of a handful of its smallest members whose combined GDPs total well less than $1 trillion. However, as with the banking crisis of 2008 – 09, excesses like these can be contagious. Hence, the need to beware of modern-day Greeks bearing debt and even after Greece’s rescue from the brink of collapse to question whether an emergency Euro 750 billion safety net for the remaining PIIGS (Portugal, Iceland, Ireland, Spain) is enough.

Yes, “Acropolis Now” could be presenting the 27–nation European Union and its 16–member Euro with a debt crisis threatening their very existence. The respected German Chancellor Angela Merkel, is one who believes it could be that serious. But, by the same token, could countries like Greece be canaries in the coal mine providing timely wake-up calls of much worse potential disasters needing to be urgently headed off?

 In another tumultuous era, Thomas Paine, the renowned American writer, began his 1776 pamphlet “The Crisis” with the words “These are times that try men’s souls”. Little did he foresee the incredible progress a stricken America’s was to go on to make in becoming the most magnificent wealth-building economy the world has ever known. And concomitantly to unleash human potential no other society may ever rival.

“Weiji”, the Chinese word for crisis has two meanings – danger or opportunity. No doubt which has dominated in China’s spectacular leap to modern-day world ascendancy? Yet not too many years ago, in 1997, an Asian financial crisis that included China posed destabilizing threats similar to today’s Europe. Instead, what followed was an astonishing recovery. And, if China and Asia, why not also the opportunity for constructive change out of crisis in our debt and deficit-riddled world?

By Michael Graham

Michael Graham

Michael Graham Investment Services Inc. Tel: 416 360-7538 Fax: 416 360-5566 Web: grahamis.ca

Advantages and Disadvantages of U.S. Private Capital

I try to warn business owners that U.S. PE funds have a huge range of personalities. Some are unpleasant, such as vulture funds. The onus for due diligence lies with the business owner and it’s very important to do due diligence on the PE funds. “You are in a marriage where you cannot get divorced,” I like to say to business owners. The success of the relationship is determined by the personality and chemistry of the fund. Different styles of investing can lead to a deterioration of the relationship which can throw off the dynamics of the partnership and attaining growth may become hard pressed.

U.S. firms can provide American-specific expertise, in terms of market knowledge, networks, banking relationships and exit alternatives.

PE funds can also provide value through effective board members, helping make complex decisions and providing expertise on M&A. Upon exit, the PE fund can help pull valuation up by effectively positioning the company to sell to a bigger universe of funds.

The litmus test is the composition of the firm’s professional staff and track record with other management teams. I encourage CEOs to contact the CEOs of previous and current investments of the potential fund investor. Communicating CEO to CEO, there will be “no surprise in the end zone”. As a business owner, you will gain a better understanding of how the fund works -- if they are crowding on day-to-day operations or if there’s a previous onerous relationship.

This is the ultimate litmus test for business owners, contacting the entire list of CEOs that a fund has worked with. Business owners need to know how the fund they’ve partnered with will react when the going gets tough – this is when the fund shows their metal!

Boston Private Equity Fund Managers are Heartier than Canadians

I recently visited Boston to meet with the Private Equity Funds interested in Canadian investments. It was interesting to see how many were Harvard graduates, Harvard with distinction. I also noticed that Americans cultivate a hearty, can-do welcome. It does feel louder and more aggressive than many Canadians. I liked it but could see how America is where the strong do go to excel, while the shyer ones who do not self promote may be left in the dust.
America is a pushy place and I liked it. I was reminded of the huge cultural gap in style between Americans and probably the Brits and us Canadians. What do you think of this advice?
From Entrepreneur
(Read the full article.)

Everyone likes to do business with a winner. No matter what stage of your career, you need to look like you've made it. That means wearing a suit that will impress. As a universal rule, make it your business to be the best-dressed in the room. If you lack the fashion sense, a premier store will be more than happy to assign a knowledgeable salesperson to assist you.

And if you're thinking of the budget thing again, forget it. Put it this way; a smashing, well-tailored suit will last you for years. Allocate the upfront cost over dozens or possibly hundreds of business meetings and the investment becomes a mere pittance. Remember that your goal is not to save money; it's to make the sale--leave the penny pinching to others.

Bring your ego with you in full bloom. It's not enough to look successful; you need to act it as well. This demonstrates that you are also one of the smartest people in the room.

Again, take a page from Trump. Sure, he can be garish and way over the top, but no way is he going to check his ego at the door. Neither should you. So find a way to bring up your most significant achievements, tell an intriguing story and talk up your travels, discoveries and epiphanies.

The timid and the small thinkers will talk sports and weather. They will pale in comparison to the bold winners who regale their prospects and customers with compelling ideas and stories.

I'll never forget the afternoon I spent with legendary Washington attorney and presidential advisor Clark Clifford. He didn't just "meet" with me; he held court in a walnut-paneled office, wore a suit fit for a monarch and fascinated me with vividly colored stories that thrilled as much as educated and entertained. He established himself as one of the most important people in a town filled with big egos and left the impression that when it came to lawyers in the nation's capital, there could be only one choice.

This is the challenge and the opportunity before you--to make certain that of all the salespeople your customers and prospects come in contact with, you are the one indelibly imprinted on their brains. You don't sell. You thrill.

---

Mark Stevens is the CEO of MSCO, a results-driven management and marketing firm, and the bestselling author of Your Marketing Sucks and God Is a Salesman. He is a popular media commentator on a host of business matters including marketing, branding, management and sales. He is also the author of the popular marketing blog, Unconventional Thinking.

Do companies actually want to grow?

I have discovered in my work with business owners and private equity, that many owners do not want to grow their businesses. I found this wonderful twenty minute conversation between P. Bruce Hunter and Robert Gold invaluable. 
Robert is an accountant for many years to owners. He is himself an entrepreneur and business founder. Bruce drives a TEC group where he is to fire up Canadian business owners on the key issues. Bruce knows the right questions to ask - you know the ones, you do not want to think about them, never mind discuss them with someone like Bruce who is familiar with issues. I suggested to Bruce and Robert that they make this a weekly podcast conversation because they have a great chemistry. Here's Bruce about his podcast:

My recent interview with Robert Gold and Andrew Brown can be heard at BusinessCast.ca, the world's pre-eminent podcast for Entrepreneurs. I understand from Robert that it is the number one podcast on the Financial Post podcast page as of today. The subject of how to drive

BusinessCast - The Podcast for Entrepreneurs businesscast.ca

The iTunes-featured BusinessCast is the best business podcast for entrepreneurs developed to help small and medium-sized businesses.

Identifying Best Fit with Your Firm

U.S. PE funds can provide a compelling financial offer while also bringing relevant industry experience. As business owners, an investor that is able to gain a firm grasp of your business concept quickly is advantageous. Otherwise, the investor can be a costly drain on your time.

In selecting a best-fit investor, your needs as a business owner must be aligned with the investor you select. There are a wide variety of PE funds, tailored to a variety of business owner’s needs. Will the PE fund add identifiable value?

A lot of PE funds simply supply the capital injection and remain a passive investor for the term of the investment. Others are much more focused in providing a team effort with management to kick-start the growth plan.  If applicable, a PE fund can also assist with U.S. expansion.

I encourage business owners to ask for the track record of PE funds. Canadian companies should opt-out or avoid being the test case for a fund’s first Canadian investment. “What is the fund’s track record in Canada?” Call up the list of CEOs the PE fund has worked with in the past. They can shed light on the relationship and experience.

Evaluate the fund’s total strategy and investing style for compatibility. There is a huge diversity in the U.S. realm of PE funds. Funds typically vary in size of investment, industry focus, preferred stage of investment company, ownership of investment, and board participation to name a few. PE funds invest in late stage growth where products already exist and there is a revenue stream. Large investments can be up to $100 million USD in equity or as small as $10 to 15 million USD. With their equity stake, some funds may prefer a control or minority ownership position.

Typically PE funds reside on the board of the investee company as either active or passive board members. Active is good, but not undermining management, which often can be a slippery slope. The degree of diversity of investment professionals is also important as business owners should be looking for board members who provide expertise in a wide range of business areas. Maturity of the fund is also imperative as the stage of the fund’s life will dictate the timeline of investment. 

Chinese Stock market down 22%

We had a very busy week in Ontario. There was a 5.0 earthquake, with the epicenter 61 km north of Ottawa. The earthquake could be felt from Montreal to Toronto. A tornado touched down in Midland and now we are enduring the G20 Summit Lockdown in Toronto. I saw Goodluck, the Nigerian leader, get into his limo and spoke to Kola, one of the Nigerian guards. They have been enjoying the warm weather and are impressed with how clean and quiet Toronto seems. The streets are empty and it seems like a scene from Zombies in the City.

While this was happening around us, the markets were also enduring a very rough week pulling the returns for the month and the year back into negative territory. Year-to-date the S&P TSX Composite is down -.65%, the S&P 500 is down -3.77% and the Dow Jones is down -2.92%. What you may not know is that the Chinese stock market is down -22% year-to-date and other international indices are also in negative territory. The markets are currently in a trading range and we have gone back to touch the 50-day and 200-day moving averages. With more and more economic indicators coming in below expectations even the most ardent commodity bull has to step back and assess at least the near-and intermediate-term landscape. 

Private equity is awash with cash - for now. In two years time, the tides will have receded though. For business owners, entrepreneurs and CEOs, now is the time to look seriously at private equity partners. There is no market mood to affect your valuation of your business and you get experts putting their thinking caps on to build your business. Right now, we all need all the help we can get.

Jacoline Loewen, expert in private equity and family business and author of Money Magnet: Attracting Investors to Your Business which is now a text book at Ivey Business School.

If you’re following Steve Jobs’ advice, you must know the risks to growing

A business owner was happily engrossed by his business and making a great deal of money. Inspired by a speech by Apple founder, Steve Jobs, however, his dream became to grow the company more. This CEO knew that he had the drive but worried about putting so much of his personal money at stake. He could not afford to take the risk, but nor could he go to the public markets at that stage. To help his company evolve, the CEO sold 75% of the company’s shares to private equity partners. They helped build up the staff, create systems, and identify acquisitions. Ironically, his 25% share ownership ended up giving him more financial return than if he had kept 100% to himself. How incredibly satisfying when the difficult course turns out also to be the best! Of course, if you’re following Steve Jobs’ advice you must know the risks to growing. One additional point—Jobs may have lost his spot at Apple for a decade but he says the company made it through that period due to the private equity financial partners in place.

Risk is relative. A medical device company wanted to launch a new product. As the owner knew it would cost $5M to bring to market, he weighed the risks. “Right now, I’m profitable. If all goes well, the product will grow my $10M company to $30M, with a cash flow of $1M. If it does not go well, I’m in the hole for $5M and it will take me five years to break even and get back to where I am now.”

Pass!

But private equity partners will be lured to the possibility of growth. They catch a glimpse of the big fish in the dark water and appreciate the gleam of its scales; they will pick up the harpoon and take on the struggle, bleeding from holding the line, facing unbelievable adversity to bring home the fish others can only admire from the shoreline. That medical device company’s CEO settled on admitting to the conservative nature of his personal and financial goals. “I built this business in my garage and now it has to fly without just me. Let’s get in partners and share the risk.” He got enough cash off the table to cover his retirement and compensate for all the hungry years, but he was still able to stay around to enjoy the new growth with the partners who brought valuable new skills—vision, contacts, and patient capital through the storm.

How to Take Advantage of American Capital Flooding into Canada

In terms of American private capital investors, the U.S. based industry is broadly comparable around the world. The typical private equity structure is 2/20, which means that the fund is structured as a 10 year partnership. The committed capital is provided by an institutional investor such as the Harvard Endowment. The fund managers draw down a 2% fee (used to keep the lights on) and are expected to obtain a 20+% gain over the threshold. In light of the Great Recession, the fee structure has been under much debate.

U.S. funds are able to leverage their U.S. industry experience to help Canadian companies expand their business footprint and help launch them into a market close to home before tackling the worldwide stage. Through an American fund’s U.S. pedigree, a fund can leverage their experience in the American markets to pick out the consumer market nuances and help Canadian businesses expand south of the border.

Many Canadians currently reside in the U.S. as professionals in the private equity industry. With Canadians on the inside of the U.S. based PE funds, there is a natural orientation to help out fellow Canadians and their companies by bringing capital to Canada. However, business owners beware; funds in Boston or Chicago are probably more likely to invest than funds in Houston and cultural fit is a factor that cannot be overlooked. 

What Do Canadian Entrepreneurs Have to Offer?

When the flow of credit to companies dried during the credit crisis, large companies cut expenditures in their Research & Development budgets and hoarded cash. Now that the general economic outlook has eased and companies are starved for innovation, business owners and management are now looking at ways of obtaining growth.

Canada possesses a legacy of strong returns and successful deals. Also, boasting the largest announced leverage buyout of our time.

As Canadians, we live in what is often called the “Great White North”.  Our neighbours to the South and the rest of the world have a common perception that there is less competition in Canada. This is a commonly accepted truth for private equity funds as the U.S. has a greater number of funds with larger capital base. However, there is currently no known analytics verifying the perceived lower level of competition.

Currently, Canadians can also boast about the strength of the Canadian economy. No banking system is fundamentally as sound as ours. Our education system and clusters of innovation across the country provide us with a talented and high calibre workforce. Our legal framework is also well developed to facilitate the growth in private equity. And with the continual “Brain Drain” to the U.S., we have Canadians working on both sides of the border.

As an added bonus, Canadian investments are not counted in “foreign” concentration limits for PE funds. Typically, in a PE fund’s investment mandate, the Limited Partner (“LP”) list restrictions in the types, size, risk level, etc. of investments. Such restriction may include the amount that a fund can commit to one investment opportunity (not >25% of entire fund capital) or foreign investments (not >25% of capital committed overseas). The advantage for Canadian companies is that North America is not treated as “foreign”.