Friday, June 15, 2007

GE To Become A Public/Private Equity Shop

In an attempt to justify GE's existence as a conglomerate, its CEO, Jeff Immelt, announced today that, henceforth, he would transform GE into a public/private equity enterprise.

"If Steve Schwarzman (Blackstone CEO) can go public with its portfolio of operating businesses, then I can take GE into the private equity game," Immelt was quoted as saying.

Tiring of getting "no respect," and feeling like "the Rodney Dangerfield of CEOs," Immelt has decided to spin off his entire business portfolio, while buying ailing units of other firms.

"We're going to show the world, and our investors, that GE's vaunted management system is the best in the world. We can take a corporate sow's ear and make it into the proverbial business silk purse, then spin it back to the public, just like Blackstone, KKR, and TPG," Immelt declared.

Regarded for decades as one of the two most influential incubators of US corporate management talent, along with Proctor & Gamble, GE has been known for training generations of financially-oriented managers who have gone on to lead other American corporations. Not, mind you, always to consistently superior total returns. But lead, nonetheless, complete with comfortable compensation packages.

As such, Immelt intends to convert GE into a sort of managerial competence "pure play." According to pundits and analysts, Immelt intends to put every manager in GE's new acquisitions through its storied Crotonville 're-education' center, in order to remake them as fully-trained, GE-style managers.

Immelt, tired of the heckling of numerous analysts and bloggers, declared,

"We're going to prove to investors, analysts, bloggers, and the public, that GE managers can manage anything well. If private equity shops can buy on the cheap and fix businesses, so can we. And to prove it, I'm starting with a clean slate of operating businesses."

To be sure, it's a novel approach. But, then, nothing else Immelt has done has delivered consistently superior returns for his shareholders. They would have been far better off selling their GE stock upon Immelt's elevation to CEO, and simply buying and holding the S&P500.

In a related story, GE's board was reportedly raising Immelt's compensation for 2008 to approximately $800MM. A spokesperson for the board noted that Blackstone's Schwarzman had received some $700MM from his company's IPO, and, thus, the CEO of a public 'private equity' shop, as GE's Immelt has reclassified his company, ought to be worth the same, if not a little more.

CNBC said it would not be interviewing Immelt on this latest compensation-related development. Not, at least, until NBC/Universal has been spun off to shareholders.

(The preceding piece is intended as humor. None of the quotes are factual. However, given Immelt's insistence on running a conglomerate, it may well be that the only way he can avoid penalizing GE shareholders with a discount to net asset values is to transform GE into the only type of successful conglomerates on the American business scene today- private equity firms.)

Thursday, June 14, 2007

Blackstone's IPO Underwriting Strategy: Silence The Street

"Bribe" is an ugly word. So I'm not going to use it again in this post.

I read yesterday that Blackstone has employed 17 Wall Street investment banking houses in its IPO process. Even, according to the Wall Street Journal article by ',' Goldman Sachs. The latter was originally snubbed for having worked on another private equity shop's IPO.

Additionally, it is alleged that Chase was allowed in, despite its having backed a competing bidder for Equity Office Properties, a recent Blackstone purchase.

To quote the Journal article,

"But perhaps Blackstone has another motive. By bringing everyone on board, it may keep criticism of its trumpeted $33 billion-plus valuation at a minimum. This is particularly important for, say, Goldman, whose own stock trades at a whopping price-to-earnings discount to Blackstone's implied valuation.

Yet, behind closed doors, it's widely believed that those who publicly criticize Blackstone's value won't be invited to sell its IPO. Looks like Wall Street opted to keep its collective mouth shut."

You think?

This is unquestionably the motive for Blackstone's hoovering up any party whose credible scepticism about its IPO valuation might cause investors to balk. The effect is to mute all sell-side criticism. Then you have the unstated silence of anybody else with a trading desk, who hopes to broker any of Blackstone's order volume in this lifetime.

You can search my blog for posts on Blackstone's IPO. For starters, however, read this one, from April.

In this post, I wrote,

"What I find amazing, however, is that investors are lining up to buy shares of an entity in which they can't even measure risk levels. Essentially, they are buying income 'participation shares,' much like I advocated last year in this post regarding corporate governance and takeovers. But, rather than retaining interest in a previously-public firm, they are buying the equivalent of a blind pool.

In a very real sense, Schwarzman has created the best of both worlds- retaining total control and privacy of operations, while establishing a value for the firm, and cashing out while doing it.

Honestly, I have even more respect for him now than I did before. Not that I would be on the other end of an equity transaction from him. And, correspondingly, I have less respect for the investors who buy the Blackstone IPO shares."

I can only reiterate my earlier sentiments. As I said to my partner over lunch yesterday,

"Who would be foolish enough to be on the other side of an equity deal from Goldman or Blackstone?"

I own Goldman in my equity portfolio now. But I only bought it in January, not as an IPO. As such, it is market-valued now, not seller-valued.

With all the hoopla on Capitol Hill this week regarding new taxes for carried interest income in private equity deals, and Schwarzman's $700+MM payday, and $7B interest in Blackstone, the real danger is overlooked.

I contend it is this pervasive, collaborative silence on Wall Street, as it collectively abets Blackstone in valuing its IPO.

Alas, no amount of legislation will ever remedy this. No, for this, we have to trust people to use their common sense. To think.

And that brings me to an old story about the former Governor and Senator from my home state of Illinois, Adlai Stevenson.

When running in one of his campaigns for President against Eisenhower, it is said that Stevenson was approached by a woman who gushed,

"Governor, you have the vote of every thinking American."

Stevenson, perhaps apocryphally, is said to have replied,

"Oh, Madam, I'll need many more votes that that to win the election."

Caveat Emptor, indeed!

Wednesday, June 13, 2007

Private Equity Meets The MBA

Yesterday's Wall Street Journal carried a piece about private equity and MBA schools in its Career Journal section.

Where to begin? Perhaps with the question,

"Have these already questionable educational programs absolutely no shame?"

As I have written recently, here, and less recently, here, here, and here, the once-vaunted MBA is already, in my opinion, a shadow of its former self. Between more mediocre talent pools, teaching ranks stretched more thinly as more schools offer the degree, and a shift in focus to 'soft skills,' it's become a mere trade school certificate.

However, today's Journal article shocked even me. The gist of the piece is that MBA schools are angling to get more of their new grads into the lucrative private equity firms. They are trying to set up co-taught courses, using retired private equity partners. Trying to make contacts for mainlining their grads into the firms.

At this point, let's have a brief reality check. Private equity firms are, by and large, composed of very experienced, once-senior executives in publicly-held companies, who realized they could do better managing and fixing some businesses without the glare of shareholders and required SEC filings. They hire, for the most part, similarly-seasoned managers to actually work on and improve the businesses they buy. Then they spin them back out for the profit.

Where, in the model, besides ordering take-out for delivery late at night, or perhaps scheduling car services for the late-night workers on the various acquisitions, is there room for newly-minted, inexperienced young MBAs?

Didn't we all learn from the consulting sector that, ultimately, customers wise up to being read rehashed B-school platitudes from fresh-faced young things with MBAs? Last I looked, McKinsey, Booz Allen, and most of their ilk had much reduced circumstances and reputations, as their customers began to catch on.

So, now, the MBA mills are training their sights on private equity firms?

This is either about to be comical, or tragic. Comical, because PE firms are the real McCoys of smart, no-nonsense capitalists. Tragic, if some of those firms actually buy this line, and begin hiring novices to ply their ultra-profitable trade.

Not to mention, again, as in this post, that so much of what private equity does is simply better, faster implementation of the classic lessons of old-style, non-soft skill MBA and BS in BA programs. It's not so much the insights, as it is the experience of knowing just what to do, when, in which situations.

At some point, there actually are jobs that require experience, not simply a newly-minted degree from the right school.

It should be interesting to see if this story has legs, and we learn, in a year or so, that there is, indeed, an influx of newly-graduated MBAs into the sector. And what effect they are having on their employers.

On that note, one last word of warning. Back in the day, when I was a young MBA myself, a little outfit called Atari ruled the newly-digitizing world. I don't recall the exact number, but one year, something like 25% of the Harvard Business School's graduates went to work there. The next year, 1984, Atari, then a unit of Warner Brothers, and a victim of overheated expansion and loss of control over the company's strategic direction, was, in large part, sold to Jack Trarmiel. Upon this ignominious event, one wag commented that it should be a signal to the market that anytime a company begins hiring that large a portion of HBS's graduating class, it's time to dump the company's shares.

Last year, 11% of the HBS class went to work in private equity companies.

Tuesday, June 12, 2007

The Market, She Be Confused

Roughly a year ago, in one of the earlier pieces on this blog, , "The Market, She Be Angry...," I commented on how analysts so often, mistakenly, anthropomorphize capital markets.

In part, I wrote,

"Despite the signs of investors waffling on the economy's health, Brian Wesbury commented that average mortgage interest rates are still a full point lower than they were during the last expansion. And the Fed is moving to ensure low, long-term inflation. Thus, there's no reason to expect the economy to suddenly sieze up and slide into a recession."

And that paragraph roughly fits today's market, too. This time, the S&P500 Index is down recently due to investor worries about inflation.

In the past week and a half, inflation worries have trimmed roughly 3 percentage points from the Index's year-to-date return, driving down to about 5.3%.

But, wait. Weren't investors worried only two months ago about global economic growth and weak earnings? Wasn't the last earnings announcement season a big surprise, accounting for the Index's more than 8 percentage points of gain in April and May?

So, in the space of something like 60 days, we apparently have investors moving from worries about too little growth, to worries about too much growth, too little liquidity, and rising inflation.

Which is it? Or is it even either one? Is it simply the usual case of many inept pundits and analysts misleading equally-naive investors?

That would be my bet. More heat than light, again. In fact, in each of the past three years, pundits have called a near-recession for later in the year, only to see investors push the index up by November, as low-inflation growth was confirmed by the fourth quarter.

What is disconcerting is how much of this misinterpretation of economic signals is repetitive, and, yet, goes unreported as such. The much heralded recessions have not materialized. Now, the much heralded inverted yield curve is normal, rather than inverted.

So, where's the celebration, now that the non-inverted yield curve should be signaling no recession? Instead, the pundits frown, note the possibility of a Fed rate hike, or less global liquidity with higher rates, and, thus, slowing growth.....and a recession.

I think we're seeing more confusion on the part of most market watchers, pundits, analysts, talking heads, etc. And even retired Fed Chairmen, albeit one who has a spotty record on forecasting equity prices.

When I see this amount of baseless, rapid change of thinking in the equity investor base, I pay it little heed for long term equity market trends.

Monday, June 11, 2007

The New York Times Gives Jeff Immelt A Pass

New York Times writer Joe Nocera penned a long, fawning piece about Jeff Immelt, GE's CEO, in the paper's Saturday edition. My partner had mentioned it to me on Sunday morning, and sent me the article, knowing of my prior posts on GE and Immelt (search on either term, and/or click on the two labels on the side of the main page).

I wrote most recently on this topic here, and here. For the record, let me state my unequivocal belief that Immelt has failed in his richly-compensated role as GE's CEO for nearly six years. I believe that Immelt should go, as the company is spun into its constituent parts as standalone businesses. The firm no longer has an economic reason for being.

That said, let me quote some of the more outrageous passages from Mr. Nocera's Times piece,

“When you put your foot on the gas in this company,” Jeffrey R. Immelt said a few weeks ago, with just the slightest trace of a satisfied smile, “the car goes forward.”

Oh, and one other thing: the entire time he’s been chief executive, the stock hasn’t budged. (It closed yesterday at $37.32.) In April, Jeffrey T. Sprague, the Citigroup analyst, called for “a partial breakup” of G.E., arguing that the company’s “size and complexity is working against investor interest in the stock.” During Mr. Welch’s 20 years at the helm, G.E.’s stock had a staggering 7,000 percent total return, including dividends. If the company’s share price doesn’t start to rise soon, Wall Street is going to be agitating for more than a breakup.

Mr. Immelt seems pretty much at ease about that, too.

Mr. Immelt also felt that G.E. needed to do a better job at what is called “organic growth,” that is, growth that is not a result of acquisitions. So he had G.E. study companies that excelled at internal growth, like Apple and Toyota, quantified the qualities that those companies had in common, and began teaching them at General Electric. Now, Mr. Immelt has told Wall Street that he wants the company’s organic growth rate to be 8 percent a year, twice what it used to be.

Most C.E.O.s whose stock hasn’t moved in five years would be in a world of trouble, of course. And Mr. Immelt is not going to get his 20-year run if he can’t get the stock to move. But he’s still got plenty of time to show that his repositioning is working; Wall Street may be antsy, but no investor is crazy enough to call for his ouster. And he’s adamant that the solution is to wait for the market to catch up with the company’s changing nature, rather than to execute a partial breakup just to please the Street.

“Investors go through cycles where they don’t like conglomerates,” Mr. Immelt said. “But if you want to be a lasting company, you have to know how to be a multibusiness structure. If Google is going to be a 100-year-old company someday, it is going to have to learn to do more than search.”

Let me make a few points, by way of rebuttal.

First, my proprietary research has concluded that, in order to have a significantly above-average probability of earning consistently superior total returns, companies need to post real rates of revenue growth in excess of Immelt's goal of 8% per annum. Less than the rate I discovered, and the company will not be considered a consistently high-revenue growth firm. Earnings growth, by the way, is statistically unrelated to consistently superior total return performance.

So much for Jeff's foot on the accelerator helping shareholders enjoy consistently superior returns by holding GE stock.

Second, as I wrote in one of the linked posts recently,

"Few today realize how Jones, of whom I have heard it said, "once a beanie (accountant), always a beanie,' stripped much of the strategic vision from GE that Borch had instilled through his business unit investments. Jones retooled the company to be a cash machine because, well, he was an accountant. He liked cash.

Welch, upon taking the helm from Jones, faced an unprecedented period of high inflation and a wide array of non-strategic businesses at GE. He rapidly cut and pruned the company's businesses, earning the now-forgotten moniker "neutron Jack."

What's ironic is how everyone seems to have forgotten GE's heritage of being subjected to wrenching change with each new CEO of the prior forty years, except for Immelt. He's the only one not to have actually made a big change in the firm, and it has stalled."

Thus, Immelt has actually broken the pattern of GE leadership through the ages by essentially changing virtually nothing. The firm has adapted to past eras, that is true. And this era is one of the continued de-conglomeration of American business. His sarcastic shots about Google to the contrary, Immelt's firm is too diversified to provide consistently superior returns to shareholders, because it's taxing them to feed an overgrown bureaucracy presided over by....none other than Chairman Jeff the First.

What Immelt fails to understand, in suggesting Google can't continue growing in its natural niches, is that every business undergoes a Schumpeterian life- and death- cycle. My guess is, Immelt is going to preside over GE's death.

Third, regarding Immelt's observation about investors "going through cycled where they don't like conglomerates" is a bit disingenuous. As I wrote in one of the linked posts above,

"Simply put, corporate diversification for cash flow smoothing has been a discredited management approach for creating consistently superior total returns for some time. My own proprietary research, which drives my equity portfolio selection of consistently superior large-cap companies, confirms this. Back some thirty or forty years ago, when trading equities was expensive and information and innovation were in shorter supply, it may have made sense for investors to hold shares of conglomerates. And, in the day, they existed- Gulf&Western, ITT, and Litton, to name just a few. But they are gone now. ITT still exists, but in nothing like the shape it had under Harold Geneen."

The era of growing, permanent corporate conglomerates is over, thanks to very efficient, large and deeply liquid capital markets. Markets so liquid that private equity firms can borrow to buy ailing business units of conglomerates, fix them, and spin them back out to the public. The only apparently consistently profitable "conglomerates" these days appear to be the large, multi-operating-unit private equity shops. But they don't seem to want to hold their businesses- just increase their value and flip them back to the public.

I question Nocera's trust that Immelt has 20 years to eventually re-ignite GE's total return performance. In Welch's day, the large private equity pools now common did not exist, and investors were far more patient.

Typically, it's been my experience that corporations, and their CEOs, cite 'soft' values and concepts when they simply can't earn consistently superior total returns for their shareholders. Even today, as Yahoo's Terry Semel came under assault for that company's abysmal performance under his tenure, Yahoo's corporate spokesperson recited a long list of non-quantitative 'accomplishments' under Semel's reign, carefully avoiding the clear record of financial failure.

Immelt is no different, nor are his supporters, such as Mr. Nocera.