Friday, March 23, 2007

The Fed's Language & Pundits, Analysts and Investors

This week's Fed meeting had a noted and unexpected effect on the US equity markets. Due only to a change in language, not a rate change, the equity markets rose 1.71% on Wednesday.

The logic here is interesting. Essentially, the Fed has indicated that, although it does not currently feel the economy requires a rate cut to help avoid a recession, it is now leaning more toward a rate cut as its next move, than a rate hike.

Since equity market investors react to lower rates rationally, by bidding up prices, the market rose. This is fairly direct, simple economics, with a lot of historical evidence to back it up.

That day, CNBC aired some discussions of the Fed language and rate inaction among various pundits whom they frequently feature. One of those people is Doug Kass, a prominent, bearish hedge fund manager and senior partner at SeaBreeze partners. Kass argued that the rate cut bias now means the economic is in trouble, so equities should begin to experience price declines.

I wrote this post last June, discussing economists, analysts and pundits as they criticize Ben Bernanke and the Fed. It seems very relevant again now. There's only one Ben Bernanke, and one Board of Fed Governors. Doug Kass is not on that board.

Kass' comments provide a view to a strange sort of economic analysis and commentary that seems to be quite common these days. Secondary meanings and tortured behavioral implications gain credibility over the simpler, more direct analyses of various business and economic information.

In this case, the direct analysis is that the Fed is not overly worried about a recession. It simply indicated that it is prepared to move to reduce the probabilities of such an economic development. Rick Santelli, CNBC's excellent Chicago correspondent for interest rate products, noted, correctly, that the Fed will act when it needs to. Otherwise, its words are just that.

On the other side is Kass, and another, lesser CNBC light, economics correspondent Steve Leisman. They both contend that the secondary implication of the Fed's language is that there will be a recession, and the Fed will cut rates, and equity market indices will fall soon. Notice that this interpretation requires the assumption that the Fed cuts rate, but fails to prevent a recession. Two rather significant assumptions, indeed. From second-rate, non-Fed sources.

To many investors, all these opinions may be confusing, and seem equally probable. However, the net effect of investors' behaviors this week demonstrate that they are able to understand the primary implications of the Fed's language and inaction, and believe those.

For now, this is gratifying. With so many more B-team pundits and analysts than A-team counterparts, it's amazing the primary message can sometimes make it through all the noise at all.

Thursday, March 22, 2007

Continuing Changes in Consumer Media Consumption Behaviors

Today's Wall Street Journal carried two rather complementary articles.

One of the three page-one columns featured an in-depth look at the decline in music CD sales. The mainstay physical delivery vehicle of the music industry has suffered a decline of between 15% and 20% over the past three years.

In referring to the article this morning on CNBC, on-air co-anchor Joe Kernen repeated NBC-Universal's executive, Bob Wright's, comment, to paraphrase, 'losing analog dollars for digital nickels.'

The rise of Apple's iTunes, as well as illegal file sharing services, beginning with Napster, have finally sapped music sales to the point of actually shrinking physical unit and dollar sales.

The moral of this story, of course, is that, when better alternatives arrive, consumers will migrate to completely new delivery models, if the benefits are compelling. And in music, they are.

The second story also features Apple. Walt Mossberg reviewed, very favorably, the new AppleTV device. Without repeating his review, let me just note that he found it very easy and effective to use.

Mossberg commented on Apple's current software as crippling the streaming of video from your PC to your TV, via AppleTV, except for content already stored on your PC, i.e., legitimately bought and stored as resident files. However, he also intimated that it's just a matter of time, and legality, before Apple pushes software upgrades down the 'net to provide for a wider selection of streaming video.

Think, for example, playing streaming video, bought directly from a content producer's site, through your PC, right onto your TV, via AppleTV.

Now, my consulting friend S believes this is going to be a long, hard slog. That it will be many years before a sufficiently large segment of Americans, or other global citizens, forsake their cable subscriptions and broadcast TV, to access video content in this manner.

Take another look at the first part of this post. I've posted on this topic so often, I probably can't find all the cites myself. If you search the blog for keywords like 'appletv,' 'itv,' 'cable,' etc., you will doubtless find many of them. It has taken just three years for the iTunes model to shove physical music delivery downhill so fast, that all the major retail music chains are gone, the current electronics stores are shrinking retail space devoted to music, and the labels themselves are getting worried about survivability.

Now consider how much more immediate and important video is to many consumers. I just watched my younger daughter spend hours this evening watching Disney channel television program reruns on a wireless laptop connection in this hotel in the middle of the Northeast woods.

I don't think it's going to be long at all before a variety of video content producers collaborate with Apple to allow their directly-purchased content to stream down the path I mentioned earlier, hopping from the PC to the TV.

If physical CDs could be toppled in so short a time, how much less time will it take for video to do likewise to broadcast video and cable networks, once the requisite hardware and software are available?

Wednesday, March 21, 2007

The Blackstone IPO : Part 3 of 3- Private Equity Going Forward

In my prior two posts, here, and here, I discussed how the expected Blackstone IPO raised issues of motivation and valuation for private equity firms, as well as how the IPO affects the rationale for the existence of private equity firms in the first place.

In this post, I'd like to consider how Blackstone and its still-private competitors may now operate.

Regarding Blackstone, what will now become of its unrelated parts? In a world where the firm frequently was seen as a sort of intensive care ward of the corporate world, hidden from view, how does its imminent new role as a public company affect this portfolio? Can Blackstone still confidently bid on turnaround candidates, or "misunderstood" companies, and patiently hold them among other, unrelated companies and active financial service divisions, such as asset management and M&A advisory? If its former cloak of privacy gave it the wherewithal to do so, is that now no longer possible?

Doesn't Blackstone become just another public corporation bidding on assets of other companies?

If so, does this leave other private equity shops with less competition? But with all the existing private shops, and the liquidity among them, could they perhaps put an end to Blackstone's successful bidding for new assets? Doesn't the still-private nature of the sector's remaining titans, such as KKR and TPG, mean that they can reliably and consistently outbid the public Blackstone for assets, just like Blackstone did in the past?

If a handful of other large, private equity shops, such as, e.g., KKR, TPG, and/or SilverLake Partners, all decided to exit the private equity sector, would that mark the end of the era of such firms and activities? Could it be that they all will aim to cash in their "magic dust" premiums, apparently ascribed to the larger, more successful private equity firms? After all, what is so different, or special, about Blackstone's portfolio of assets and operating units, that makes it unique among private equity firms to contemplate throwing in the towel on their business model?

Could we be seeing a situation in which greed for monetizing current value ironically removes a fear of many investors, regulators, and legislators, i.e., that there will be too few quality public companies in which to directly invest?

Simply put, when one of the best-managed firms in a sector plans to leave that sector, it makes you wonder: a) why others won't do so, too, and; b) whether any decent firms will remain in the sector?

The more I consider these questions, the more I'm coming to the conclusion that Schwarzman and his management team see a confluence of important trends. Premiums for private equity buyouts, due to heightened awareness on the part of boards of targets, are rising, while the expected multiples on the exit end are unchanged, shrinking the expected returns to the sector. Too much liquidity is adding to this return pressure. Thus, excess capacity should be drained from the sector.

Seeing all of this, I think Blackstone's managers see the opportunity to cash in first on their perceived value, while most sellers and investors are unable to yet appreciate that, having done so, the Blackstone they will now own can't create the value of the firm that just went public.

This being the case, we should see a few larger shops follow Blackstone into the public markets, while the remaining private equity firms continue to ply their trade in a somewhat more profitable, if smaller, sector.

Like so many other economic challenges, this one seems destined to be worked out in the free capital markets of its own accord, long before any legislation can affect the sector, its constituents, or the eager investors waiting to pay up to own a share of the newly-public, former private equity giants.

Tuesday, March 20, 2007

The Blackstone IPO : Part 2 of 3- The New Private Equity Philosophy

This morning, I read through the Wall Street Journal's Monday article concerning the potential Blackstone IPO. Most of the piece seemed to dwell on how many other parties will be upset with Blackstone or Schwarzman over the IPO. There were comments about how investors would react to the large payouts to management and partners. Plus a lot of ink about existing public investment banks getting upset at the rather more brazen competition from the newly-public private equity giant.

However, all that notwithstanding, I am interested in the second of my two topics on this IPO- the new meaning of private equity's philosophy, in light of Blackstone's IPO.

Everyone reading this blog is likely to be very conversant with the world of private equity, and Blackstone, as well as have read several stories by now in various business publications, if not seen endless stories about it on CNBC and CNN. So I won't restate what it is that Blackstone and its ilk do to create the value that they do.

What mystifies me, to be blunt, is how the Blackstone management team will "create" value when their central raison d'etre is gone. When they have to file quarterly reports, be valued as a conglomeration of wildly different businesses, and become hostage to public investors, and their expectations, how will they maintain their 'patient money' credibility and capability?

What, precisely, will the new Blackstone offer managements to buy them, since they can't be 'taking them private' anymore? And what does Blackstone hope to do for a prospective acquisition, since it is now just another public bidder. Does it believe it possesses a superior turnaround staff? Because if the turnaround is in the hands of existing management, then what does Blackstone add to the firm's efforts?

After so many years of ostensibly creating value in a sheltered, patient manner, the firm is throwing all that away in one go. How, then, will it continue to create comparable value going forward? With its complicated mix of financial service and operating parts, how will it be properly seen and understood for value maximization? Won't Blackstone have to slowly, but surely, unravel itself, in order to "unlock" the values of each constituent element, just like the firms from which it has made its money by buying those parts?

If it cannot, or does not, continue to create value through all of these efforts, then is not the investing public buying the prior value creation model, but holding the current/future model? Is this not a classic case of paying for prior accomplishments, while the very environment which allowed those achievements, those returns, is eradicated?

Given that other private equity firms will continue to exist, perhaps Blackstone will have a diminishing share of that activity. Perhaps this is Schwarzman's way of assuring that he and his partners are not the last ones holding the bag of overly-competitive private equity competitors, while the value of the model decreases with time.

If the Blackstone IPO is, in reality, the first significant removal of capacity from the private equity sector, then Schwarzman will probably win again, by attaining a high value for his business, before the true state of the sector becomes generally known.

Monday, March 19, 2007

The Blackstone IPO : Part 1 of 3

The Blackstone IPO that was announced last week has certainly created a wealth of topics on which to comment. There are probably at least three posts in this announcement.

First, there are the questions of motivation and valuation. Second, that of philosophy of the private equity management style. Third, the ramifications of this IPO for the future of buyouts and the now-about-to-be-public private equity firms.

For starters, Steve Schwarzman's decision to reverse course on Blackstone's organizational form is clearly linked to the firm's apparent ability to cash in on its imputed value. The numbers being tossed about value Schwarzman's stake in the neighborhood of at least $800MM.

The weekend Wall Street Journal piece rather caustically contrasted Schwarzman's extolling of the benefits of private equity with the world into which he is about to plunge Blackstone.

The truth is, though, that such amazement is appropriate. I'm not against greed or opportunism. But I don't like inconsistency. Especially not in personal principles.

To me, Schwarzman's entire raison d'etre is now suspect. The party line on why private equity is good for managers, companies, the economy, etc., is now a sham. The 'magic dust' that firms like Blackstone sprinkle on otherwise-normal firms is about to become suspect.

The greed Schwarzman has now displayed will pass, I think, without criticism from the business community, because that community understands power and taking advantage of it when you have the opportunity.

However, that done, what is Blackstone? Isn't it, in aggregate, as messy and undirected as, say, that other financial mess, Citigroup? Or Chase? Only worse

It has trading, asset management, M&A advisory- all the cream financial service businesses- plus a slew of operating companies.

Whatever mythical valuation all of this has when private should, one can be forgiven for supposing, that valuation should shrink as soon as the lot is merely part of a publicly-held, routinely-reporting entity.

It would seem to be the business equivalent of the physics debate about the nature of light- wave, or photon? Blackstone cannot be both preferentially-valued private takeover, rehab and financial services shop, and a public entity as well.

To preserve access in this very small world, it's even possible that media personnel and analysts alike will give Schwarzman and Blackstone a pass for a few months, to a year, before the private equity 'magic dust' begins to evaporate.

I think it's highly likely that Schwarzman sees the rising tide of combative public boards, and takeover prices rising, returns falling, and the eventual compression of his overall business returns.

What better time to move, and cash in, than before the other side becomes fully aware of this sea change?

On one hand, Schwarzman is striking opportunistically and 'fairly,' but, in the same moment, he is transmuting that which he is selling, for a higher value, into something generally conceded to be worth much less and, usually, nightmarish to operate for consistently superior returns.