Posted tagged ‘conflicts’

GOES: Government Owned Equity Stake. What could GOES wrong?

October 4, 2008

Here’s the biggest question I have about all these 79.9% stakes the government is taking in various companies: what happens to these stakes?

1. What will the government do in terms of exercising control? How heavy handed will the government be in forcing the businesses out of risky business lines?

2. How will these G.O.E.S.’s be disposed of? Who determines the price? When do the people sell? How do they get their money back? Is there a targeted return? Does the government even have to sell?

3. How will the conflicts of managing private businesses be managed? For example, if the government starts playing favorites when it comes to making discretionary regulatory decisions, potentially in the name of protecting it’s investment, then it’s a huge potential problem for the players in the same space that are healthy.

4. Speaking of which, what duty does the government have to protect it’s investment?

5. How do we avoid people getting rich off of the taxpayers’ money? What kind of compensation controls will the government seek to impose?

6. If these companies exist can they still employ lobbyists (Fannie and Freddie don’t, but I saw nothing about AIG being banned from lobbying)? Why should they be allowed to continue lobbying? (Why these companies shouldn’t be allowed to continue lobbying is left as a simple exercise for the reader.)

Seems like Hank Paulson has just gone out and taken over a bunch of companies. Didn’t anyone ask what his plan was? Well, except of course buying the rest of them too…

Advertisements

The Discord in Similarity

May 14, 2008

here’s an interesting Alphaville post that ran recently that pointed to an article in the FT. From FT’s Alphaville:

Recently installed chief executives at Merrill Lynch and Citigroup are raiding the ranks of their former employers, Goldman Sachs and Morgan Stanley, as they seek to transform the culture and management of banks shaken by the credit crisis.

The article actually has a bit of a glaring error, Vikram didn’t raid Morgan Stanley for the people they mention (John Havens, Don Callahan, and Brian Leach), but rather they came with Old Lane (except for Callahan, who came over from Credit Suisse). Other than this, there are some differences that should be highlighted.

1. At Citi, the team was brought in and given jobs for which they were ill suited. These people had all run businesses, but none had been focused on or solely in the alternative asset management business. That’s why the Old Lane acquisition has been such a disaster in the context of adding to the alternative asset management platform. One need look no further than the man that was heavily involved in the deal:

But the point, [Lewis] Kaden told Fortune this past March, was not for Citi to secure a hedge fund business but rather to capture the talent of Pandit and his team. That was like acquiring Morgan Stanley’s trading establishment, Kaden said, without paying billions to do it.

So, now what do we find? Pandit running the whole of Citi, including a massive and mediocre consumer bank, a large investment bank, an alternative asset management business, and a huge brokerage firm. John Havens, who only ever ran equities at Morgan Stanley, now also has an investment bank, fixed income division, corporate banking, and alternative asset management business under him. I’m sure it’s all the same… Also, the Citi executives have made it a point to bring in Morgan Stanley people at every possible juncture, mainly through acquiring middling (or completely new and not yet open for business) firms staffed by ex-coworkers (although never promoting these acquired people to positions with more responsibility, making it look like they are merely being made rich with Citi money). I’ve documented a fair amount of them in this post. At Merrill, however, Thain is filling positions with people that held those same positions elsewhere. Thomas Montag is running a sales and trading operation after … wait for it … running a sales and trading operation. Noel Donohoe spent eleven years running risk management at Goldman and will now be … well … running risk management at Merrill. Much more symmetry.

2. At Merrill, John Thain is flattening the organizational structure. This is a point the FT piece makes. Mr. Montag, for example, will report to Mr. Thain–This takes a major business unit and un-layers it. It shortens lines of communications and allows one of the C.E.O.’s trusted deputies direct more authority than if a middle ma were involved. At Citi, Vikram Pandit is creating a more complex structure. Now there are regional reporting lines and product reporting lines, resulting in many senior executives with two bosses. When you have the potential for a very opportunistic but very time sensitive investment, and you have two bosses, how many people do you need to get on the phone to make a decision? How many people are pulled in? How conducive is all of this extra work to getting decisions made and promoting a centralization of authority to make and enforce those decisions? As a matter of fact, it’s acknowledged that regional decisions have to travel to the central authority. From the horse’s mouth:

“It’s going to take some time because we have to be diligent,” Pandit said to a questioner in Turkey who asked when decisions can be made without New York’s stamp of approval. Translation: Don’t hold your breath.

At least they know it’s a problem.

3. Merrill’s talent and past leaders were harvested long before John Thain arrived. John Thain even brought back a popular Merrill figure, Jeffrey Kronthal, to help rebuild after Stan O’Neil churned many senior positions. Citi, on the other hand, had all but the most senior executives intact and has taken almost no one from their internal bench and promoted them during Mr. Pandit’s reign. Michael Klein was moved into a new role after threatening to resign (surprising that the C.E.O. would bend to the will of a subordinate who is known for being hard to deal with, but I’m not making the decision). When Tom Maheras and Randy Barker left, Maheras’ old job was filled (and then later demoted) and no one else was named (instead, they reorganized fixed income and equities entirely). The consumer bank, however? The top people are still there (with Ms. Dial augmenting the lineup). Indeed the only people that seems to have changed in senior management are the ones that were between Vikram and the C.E.O. spot (and his subordinates following him up the chain).

4. John Thain was hand picked for the top spot at Merrill and part of the job is being able to hire your direct reports and other key personnel. Indeed it was well documented in the financial press that there were many suitors for the C.E.O. spot at “Mother Merrill” and Thain was selected out of a field of candidates. Vikram, on the other hand, as I stated just above, fell into a power vacuum. It was even reported that most qualified contenders decided they didn’t want to be considered for the job. Clearly this is much less of a mandate to fill the ranks as one sees. There are the egos of the people that were passed over to consider as well as various internal problems that arise from such a sudden shift in power.

It seems pretty clear that once one looks deeper than the surface, there are some subtle but pervasive differences in how the two executives are choosing to fill the ranks at their new firms. These differences will make a massive difference in things like morale, talent retention, and tearing down internal silos. I guess we’ll have to see how all this plays out…

Debt? Equity? Let’s Not be Nitpicky … Invested Capital!

April 14, 2008

Here’s an interesting trend: lots of investment banks and buyout firms buying debt from their own and others’ acquisitions (and, obviously, the most recent headline, something that sounds familiar). With recent developments it seems like some roadblocks have been removed to actually getting banks to sell these loans. However, one has to wonder what kinds of issues this will raise down the road… If, for example, Chrysler, TXU, or First data run into problems, how will things be different with the financial sponsor (P.E. firms) in the debt? (Although, for P.E. firms and investment banks that invest through funds that raise third party money, it’s obviously a requirement to have information barriers in place to prevent conflicts and all kinds of other illegal and improper behavior.)

Well, how about some current events to help answer the question? As one could read here Apollo’s portfolio company, Linens ‘n Things, is expected to file for protection under Chapter 11 of the United States Bankruptcy Code.  From the New York Post (as much as it pains me use this publication as a source…):

Apollo Management, which took the retailer private in 2005 for $1.3 billion, is weighing the idea of a potential “prepackaged” bankruptcy, sources said.

In such a plan, Apollo and creditors would settle on a restructuring plan before a Chapter 11 filing is made.

The speculation comes as the cash-strapped chain faces a clampdown on its $700 million revolving line of credit from GE Capital, sources said. While GE hasn’t cut off the flow altogether, sources said payments to vendors that supply sheets, towels, curtains and kitchenware have become more selective.

That, in turn, has prompted several of the largest suppliers to stop shipping merchandise during the past few weeks, sources said.

About half of the largest 25 vendors have halted deliveries because of late or insufficient payments, according to one source familiar with the matter.

(emphasis mine)

Now, this an interesting situation. Imagine “and creditors” reads “and Apollo’s debt fund” (or some other P.E. fund’s debt fund) or “and the institutions that depend on Apollo for fee revenue” (investment banks) … I wonder how things would be different. Anyone who works in finance, at some point, has seen a customer or other client of the firm go high up the food chain to make a “relationship call.” Certainly there are examples of very public outcomes that are both positive and negative for many “relationships.” But, honestly, isn’t a “top of the house” decision, when supportable, going to be in the favor of the house, versus the part of the house that has the upper hand in negotiating? The part about, “when supportable” is key, obviously. Why would Leon Black’s creditors accept his plan? As a matter of fact, if the company is going to default, then why would he even come out with a plan? Most likely because his plan doesn’t wipe out the equity holders. And why accept said plan? Because it’s probably unclear what the company is worth if it defaults (to the creditors). And, to be honest, can’t one almost always find a reason to go with a decision supported by numbers and projections instead of a protracted legal battle?

It’s instructive, also, to look at the entire process. P.E. firms were purchasing companies and financing those purchases with cheap debt that banks committed to providing. Some of these transactions, however, took over a year to close, like Harrah’s, for example. Now, with the credit crisis having gotten into full swing, the P.E. firms are relying on these below market debt commitments to generate their returns. Having seen this process from the inside, this isn’t really the intention. Have we seen any lowered purchase prices? Not really. Have we seen M.A.E. clauses engaged? Certainly a few, but mainly focused on business conditions and operating results (at least as reported and stated publicly), not related to financing. So what does this mean when a company is bought using debt, funded at 100 cents on the dollar, that is trading at 80 cents on the dollar? Twenty percent of th debt value is a wealth transfer from the financing institutions’ shareholders. Now, in ties of market turmoil, this kind of thing happens, but it’s certainly odd that some P.E. funds can wind up owning the entire capital structure (in different pockets or capital pools, most likely) of a company at a cost basis less than the purchase price. If a firm owns 100% of a company and paid greater than ten percent less than the buyout price that just sounds amiss soehow…

Now, also, think about this: If banks couldn’t even negotiate materially more favorable economics on these deals, and even refused to litigate or pursue valid avenues of breaking financing commitments, then how are they going to react when they own the debt o these same deals and these P.E. firms call them asking for amended terms? I wonder….