Why Private Equity Works

When it does.

Some Private Equity firms make purely finance deals where the main value is in the financing, but the frequency of these deals are on the decline.  So what are they counting on, and how do they make it happen?

Before we answer that question, let’s look at a related play that is still operative; breaking up the parts.  Many companies are so large that their public valuation is less than the sum of its parts.  Despite the delicious innuendo of the movie “Wall Street” often buying these companies and splitting them up is a good play in the long run.  If you have ever worked in a subsidiary allowed to languish hidden, unchallenged and unloved within a large corporate umbrella, and you have any aspiration at career development or in pursuing excellence in general, then you know that this is true.

Specialized and top industry knowledge in the sectors in which they operate.   Most Senior management in equity firms are high profile managers with intimate knowledge of the sector, able to bring their decades of experience to the table but also the benefit of an extensive list of industry insiders and vendor and customer contacts.

Especially with all that talent, operational improvement is a good possibility.  If you’re running your company 4-5% over industry cost structures, you can bet the private equity owners are going to be looking to shave that off.

At its best, more active and aware boards of directors.  Too often public company boards border on dysfunctional.  Many members not do not understand the industry in which they are serving, they really don’t have much business experience either.  Private equity firms can bring a very active board to senior management, with measurable, active targets and ongoing project reviews.  In that regard, they act not as some older brother looking over your shoulder; they are an added resource and an ear to discuss strategies, as well as keep senior management focused. 

Imagine a well informed Executive coming into your Senior management’s offices and one at a time, asking what the benchmarks of their jobs are, and the hard, measurable bottom line responsibilities they manage.  It’s quite energizing to the top say, 25 Senior Executives of the firm to realize they must justify the value of their existence, especially when the explicit implication that there be a synergism with the rest of the company.

This type of situation is really all too rare, and at least one of the reasons Enron situations can exist.  Think for a moment of Kenneth Lay’s defense; basically claiming he had no knowledge of the activity that brought the company down and therefore was ‘innocent.’  As CEO, he was implying he didn’t know what his right hand was doing, and also that his Board didn’t care either.  There is a huge fiduciary gap here which is almost ludicrous to ponder, not withstanding that one of the reasons we pay upper management millions of dollars a year is first and foremost to “take care.”  Claiming unawareness is like showing up at bank robbery with your friend and claiming in court that you didn’t realize that’s why you were there.  In my mind, Senior Management must be held accountable just because they were there.  It’s their job.  We’ll have more to say regarding fiduciary duty in other articles.

Incidentally, our example also brings up another aside worthy of a future article; the terrible record of the government deregulating industries.  A look at them, including energy, telecommunications, and the airlines is really a look at under-performing companies, still shackled by culture and regulation decades later, generally holding the entire sector back from stepping into the current century.  More on that later also.

At its best, a high performing Executive not only appreciates this kind of active, measurable accountability, she demands it.  How else can one gauge their and most importantly the firm’s success?  Private Equity brings a much better chance that the Board knows how to put such a process in place, and that the people they send to help have real specialized knowledge and value to the positions they are over seeing.

Music: The Free Market Moves

The music industry has been in trouble for decades.  There’s a lot of reasons.  But here’s an interesting advancement:

It seems that Sun has built ‘one of the best music similarity algorithms’ that’s based on the actual sound, with machine learning that analyzes features such as frequency and beats per minute to map out the rhythm structure, and determine the genre and which instruments are playing, Lamere said. Sun has taken advantage of prior research into speech recognition technology to tease out the features that correspond with the timbre of music and can be measured with computers, he said.”

A music store like Apple iTunes contains more than 5 million songs today. And there are plenty of similar music stores online. With people posting online their own creations or excerpts of the concerts they attend, it’s possible that a million new songs appear every day in a near future on the web. So how will you find new music you like? Right now, two approaches are prevalent: Amazon and other sites use collaborative filtering while Pandora and others use content matching. Both approaches are time-consuming, using both humans and computers. Now, according to Network World, Sun Microsystems is about to release an open source music recommendation technology far superior to current systems and totally automated. Read more…

A new music recommendation system from Sun | Emerging Technology Trends | ZDNet.com

http://blogs.zdnet.com/emergingtech/?p=737

Read the whole thing.

Ayn Rand

It has been fifty years since Ayn Rand first penned her opus.  Views vary widely on the importance of her work.  Unfortunately many folks actually believe she was saying that it was good to be greedy, as opposed to acting with unapologetic self-interest.

Robert Tracinski wrote an enlightening article on this special anniversary (read the whole thing):

The most important event of the past two centuries, with which artists and intellectuals ought to have come to grips, is the rise of capitalism and the Industrial Revolution–a social revolution that has radically transformed human life for the better. Free markets and industrialization have produced a previously unimagined wealth, which is enjoyed not only by captains of industry but by the common man, who is able to afford luxuries–large homes, automobiles, air travel, everything down to his caffe latte at the corner book store–on a scale that could not even have been conceived in earlier centuries. Capitalism has also afforded the individual a degree of personal independence and unlimited opportunity that has fully liberated men from the stultifying tyranny of previous aristocratic and feudal systems

The Historic Significance of Atlas Shrugged  Oct 2007

Atlas Shrugged illustrated in romanticized novel form the gifts that capitalism gives us.  She wrote it in a time when the world was neck deep in the allure of socialism, a grand experiment that western Europe has never given up, even as they grow poorer by the decade, and their governments inch towards bankruptcy.  But Tracinski draws associations not usually made:

A few decades later, a German intellectual named Karl Marx gave one of the most influential accounts of the new capitalist system–and he got everything wrong. An Industrial Revolution driven by scientific and technological advances springing from the minds of a few extraordinary individuals, he would describe as the anonymous, collective product of brute physical labor; an economic system of liberty, he would describe as a system of oppression; a system built on the right to property he would describe as a system based of expropriation–and then he would propose actual oppression and expropriation as the solution.

Of course Tracinski is correct.  As it turns out, Marx was a fascinating theorist, but fundamentally, tragically wrong.  The world is not a fight between the glorious worker and ‘evil’ capital.  If one is attracted to dichotomies, it is much more likely a fight between workers / entrepreneurs and government control.

I often draw the analogy of personal computing with mainframes.  For years mainframe manufacturers (sorry IBM, you’re the evil government in this story) viewed the PC as an expensive and irrelevant fad, not really useful for anything beyond an expensive terminal emulator.

Their management thinking was simple: mainframes are more efficient, cheaper per megahertz, easier to program and maintain, eminently more manageable and secure, and already had huge libraries of software (especially business) to run.  In our analogy, this is the central planning or socialist model.  The egalitarian central planning model implied by socialism is seductively more fair, efficient, safe, secure and moral than the capitalist model.

Except for one huge thing: the almost unfathomable power of millions of entrepreneurs, in our analogy allowed inside the computer itself to innovate, experiment, program and otherwise improve and proliferate.  They forgot the power of the solitary capitalist entrepreneur, in our model the programmer, whether he wants to make cash profits from his work or not.  The resultant explosion of innovation in computing power has literally rocked the world to its foundation.  And, like socialism, one of the most virulent backlashes has been by those who feel Microsoft, like any government, has attempted to control it.

In our computer analogy, every time we give government or any large organization more power over how our PC’s are built, or the Internet is governed or policed or managed, we give up some computing freedoms and our ability to innovate.  IBM’s mistake was huge.  All of Intel and Microsoft could have been theirs; they outsourced and sub-contracted their IBM chips and operating system to these companies because they didn’t think it was worth their time.

Mainframe computing, although retaining a place in our society, just as governments do, has been forever altered.  Before the capitalism of PC’s, no one could have envisioned how IT departments were stifling innovation and treasure (measured by money and happiness) and productivity.  They have been forced to open up and become more user friendly (Corporate IT departments still tend to force companies to run half as fast they could).  And this is the same indelible mistake socialists make; the power of entrepreneurs to innovate and create value.  Socialism stifles that creativity, just as surely as feudalism.

The analogy is a good one, and that is why Ayn Rand is absolutely right, and Marx is absolutely wrong.  Tracinski makes one more great point:

Throughout most of mankind’s history, moralists have warned that individuals driven by “greed” and left free to pursue their self-interest would plunge society into a destructive war of all against all, a system of brutality, plunder, and exploitation–precisely the qualities Marx projected onto the new capitalist system. Instead, capitalism produced a system of freedom, independence, prosperity, and super-abundant creative energy–while the societies most thoroughly dedicated to the sacrifice of the individual to the collective, the 20th century’s Communist regimes, were guilty of the greatest crimes ever recorded…

This has been the pattern of the artists and intellectuals in dealing with the most significant phenomenon of our age. While the world was transformed around them, they refused to grasp the real meaning of these events, choosing to ignore or denigrate the forces that were rapidly improving human life.

And so it continues to this day.  Where are the intellectuals espousing the greatness that is capitalism (innovative entrepreneurs)?  As the socialists grow more emboldened here in America, I see more articles questioning the merit of free trade, encouraging protectionist proclivities, and increasing numbers of articles urgently arguing the need of more government control.

It shall be the ruin of us.  More folks should be shouting from the rooftops celebrating the unfettered human spirit.

 

Technorati Tags: objectivism , Rand , socialism

How the Government Mandates Inflation

or, “How the Government legislates Environmentally stupid laws and makes you poorer at the same time”:

The EnergyStar fridge costs $1329 and uses $41 of electricity per year while the conventional one costs $1029 and uses $48 per year. It would take about 43 years of energy savings to make up for the difference in cost between these two refrigerators. Many consumers might not think that’s such a good deal.”

This green lobby is out of control.  Why micro-manage production?  If, in Congress’ omnipotent view, all Americans should pay more for power, why don’t they just increase the price of energy?  The market will find the right payback for that, and Congress will have more money to fritter away, I mean, to explore more energy alternatives.

These laws are senseless, regressive and administratively horrendous for life and living.

Remember What They Did to Galileo?

Newsweek equates global warming skeptics with Holocaust deniers and accuses reputable scientists of being paid to create confusion in the face of consensus.  Read the review by Investors’ Business Daily.  It’s worth reading, unlike the Newsweek article.

UPDATE:

Aug. 20-27, 2007 issue – We in the news business often enlist in moral crusades. Global warming is among the latest. Unfortunately, self-righteous indignation can undermine good journalism. Last week’s NEWSWEEK cover story on global warming is a sobering reminder. It’s an object lesson of how viewing the world as “good guys vs. bad guys” can lead to a vast oversimplification of a messy story.

[Samuelson: A Different View of Global Warming - Newsweek Robert Samuelson - MSNBC.com]

Clearly an attempt to apologize:

Against these real-world pressures, NEWSWEEK’s “denial machine” is a peripheral and highly contrived story. NEWSWEEK implied, for example, that ExxonMobil used a think tank to pay academics to criticize global-warming science. Actually, this accusation was long ago discredited, and NEWSWEEK shouldn’t have lent it respectability. (The company says it knew nothing of the global-warming grant, which involved issues of climate modeling. And its 2006 contribution to the think tank, the American Enterprise Institute, was small: $240,000 out of a $28 million budget.) [Samuelson: A Different View of Global Warming - Newsweek Robert Samuelson - MSNBC.com]

As honest a review from the Left Wing journalism as I’ve seen.  But still in ultimate denial.

 

Technorati tags: Global Warming

The Battle in Iraq

It’s not a war; it’s a battle.

Similarly, we are fighting in Iraq a battle, one of many we have or will fight in the War on Terror. Play in your mind with the difference that concept battle makes in evaluating the struggle there over treating it as a war. To claim it is a war localizes it, raises questions of why we are there, and suggests we should get out and leave it to the Iraqi’s to settle. But, if we consider it a battle, then….

Is Democratic Competence Possible?

Jeffrey Friedman is a senior fellow of the Institute for the Advancement of the Social Sciences, Boston University.

If you’re interested in debating forms of government, he wrote an interesting article on the connundrum of elected structures:

ABSTRACT : “The Nature of Belief Systems” sets forth a Hobson’s choice between rule by the politically ignorant masses and rule by the ideologically constrained—which is to say, the doctrinaire—elites. On the one hand, lacking comprehensive cognitive structures, such as ideological “belief systems,” with which to understand politics, most people learn distressingly little about it. On the other hand, a spiral of conviction seems to make it difficult for the highly informed few to see any aspects of politics but those that confirm the cognitive structures that organize their political perceptions.This is a troubling situation for any consequentialist democratic political theory, according to which what is crucial is the electorate’s (and subsidiary decision makers’) ability to make informed policy judgments, not their possession of willful but uninformed political “attitudes.” Any political theorist who does not take democracy to be an end in itself (regardless of its consequences) should be concerned about Converse’s findings.

In a review titled, “Is Voter Ignorance killing Democracy?” Salon makes further comments on the ideas Friedman has illustrated.  They’re off the mark, as usual.

Nevertheless, it’s an age old issue; by necessity, we need to have governments, or in the case of companies, we need managers, but we wish the ‘managers’ wouldn’t be so dumb.  But especially in issues of government, it is the nature of the discussions both by the politicians and the media, that are inappropriate, not the inteligence of the voters.  The public has never been wiser.

To illustrate, I do not need to understand computer systems to sit on the Board of Directors of a company.  Neither do I need to have a vast understanding of law, or financial instruments, or the latest in human resource theory.  But I do want to be afforded a good honest, and open debate of goals and direction, and be reasonably assured of where it is you and your party are meaning to go if we grant you public office.  For my purpose, and leaning towards a decidely libertarian, free market approach, I would humbly suggest you compare yourselves to the Constitution, and take a more active interest as politicians to amend it (rather than reading weird interpretations into it that are clearly not there) so that we can all have clearer understandings of where we’re going and better live the product of goal and strategy papers in our lives.

So I don’t think we need smarter voters.  I think we need smarter politicians with vision.  And smarter journalists.  Both have continued to sink to new lows over the last 200 years, and have immeasurably fouled the discussion in the process.  As a result we voters are frustrated beyond measure, and dearly wish to throw the whole lot of them out.

The CIA Follies

The CIA is fundamentally broken by almost any measure:

Picture a large and very important federal agency. It happens to conduct highly specialized work that requires close and attentive management. One of its basic assignments, for example, is to collect intelligence. Toward that end, it relies on twelve major stations from which it gathers data. The information thus assembled has to be reliable, meaning that those who collect it, and those who organize the collection process, must be both trustworthy and highly trained. And once the intelligence is gathered, it has to be analyzed. This process, too, requires a high degree of organization, and the men and women who engage in it must be top experts in their field. Their final product, hugely influential, and released to the outside world only at specified intervals, is by necessity wrapped in secrecy. Indeed, unauthorized disclosure is punishable by law.

The organization he’s talking about?  The Federal Reserve.  Read the whole thing.  Imagine an almost limitless technological budget, but in many ways less informative than the Internet.  Imagine a bureaucracy so byzantine no one knows what’s happening.  Imagine a culture where state top secret information is now commonly leaked to the press.  Imagine a spy agency with less than 30% of their agents in the field.  Imagine that the CIA says it will take at least 10 years to put it house in order to counter the ‘terrorist’ threat.

Related reading: When Mohammed Atta landed in the US, CIA’s Tenet was celebrating gay pride

Congress long ago sowed the seeds of the CIA’s destruction as an institution; not having clear goals is its foundational issue.  But this is a common mistake made by governments and its journalistic reporters; talking and legislating how things are done rather than debating and reviewing the Objectives (What you want) in the first place.  Businesses that take this approach live a short life, and people that live their personal lives in this way remain vaguely unhappy and unfulfilled.  Congress’s role should be to give them goals and the tools to let them win, along with only general lines they are not able to cross.  Micro-managing beyond these boundaries is inappropriate and inefficient.  Perhaps most importantly, they are almost singularly unqualified and ill suited as politicians (public servants with an established elective agenda, and huge incentives to sensationalize and publicize) to do so.

Once last thought: since bureaucracy in any institution, whether government or large business, or charity, inevitably slows its endeavors down, thwarts innovation, and rewards the status quo in its Associates, why would further bureaucracy as suggested by the 9/11 commission and implemented by Bush and Congress, have any chance of ‘fixing’ anything?

Free Trade is Good. Protectionism is bad.

The Club for Growth sponsored 1,028 economists from all 50 states to pressure congress not to enact protectionist policies against China.  Democrats have been rattling their sabers for months now with any number of suicidal thoughts on trade.  Not only is the trade helpful to both countries, but China buys billions of dollars of low interest treasuries with their American dollars, keeping rates low.  Who in their right mind would want to stop either of those things?   Here’s the 2007 petition (PDF) as it ran in the Wall Street Journal this morning.  It is deliberately reminiscent of the 1930 petition (PDF) also signed by 1,028 economists as it ran in the New York Times, in hopes of dissuading the government from signing the Smoot-Hawley Tariff Act.  The 1930’s petition was not successful and the resulting tariffs drove the nation into depression. 

PETITION

 Concerning Protectionist Policies Against China

We, the undersigned, have serious concerns about the recent protectionist sentiments coming from Congress, especially with regards to China. By the end of this year, China will most likely be the United States’ second largest trading partner. Over the past six years, total trade between the two countries has soared, growing from $116 billion in 2000 to almost $343 billion in 2006. That’s an average growth rate of almost 20% a year. This marvelous growth has led to more affordable goods, higher productivity, strong job growth, and a higher standard of living for both countries. These economic benefits were made possible in large part because both China and the United States embraced freer trade. As economists, we understand the vital and beneficial role that free trade plays in the world economy. Conversely, we believe that barriers to free trade destroy wealth and benefit no one in the long run. Because of these fundamental economic principles, we sign this letter to advise Congress against imposing retaliatory trade measures against China. There is no foundation in economics that supports punitive tariffs. China currently supplies American consumers with inexpensive goods and low-interest rate loans. Retaliatory tariffs on China are tantamount to taxing ourselves as a punishment. Worse, such a move will likely encourage China to impose its own tariffs, increasing the possibility of a futile and harmful trade war. American consumers and businesses would pay the price for this senseless war through higher prices, worse jobs, and reduced economic growth. We urge Congress to discard any plans for increased protectionism, and instead urge lawmakers to work towards fostering stronger global economic ties through free trade.

I love it.  Congress would be beyond silly to go ahead now.  And I wonder what the reaction will be in The New York Times, after this incredibly silly article of a few days ago.  This story will be fun to watch.  Reason backed up by statistics and logic vs. alternate reality claptrap always provides great theater.  It’s like watching Hitchens debate Michael Moore.

Stay tuned.

Tags: Free trade, Economics, China, Politics, Sanctions

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Pettiness In and Out of Government

For many us who must successfully get things accomplished in this world, following are the kinds of stories that makes it so difficult to remain positive and hopeful about our government these days.

Because it matters not a whit what you thought of the country entering the war in Iraq.  It matters not a whit what you think of Bush, or your own chances of becoming President.  If you are an elected official, it matters not a whit whether your vocal minority back home wants our military to turn tail and run.  The fact of the matter is that we are in a war, right now and right here.  And people from all over the world, especially Iraqis and Americans, are dying.  And we must figure out a way to end that war and resolve the conflict without millions of people dying.  We are truly and well in it now.  And if you can not make rational judgments about that, and can not even bare to hear the real facts on the ground to better make up your mind on future strategy and tactics, then you should absent yourself from all discussion.  Because you are a whining child, and your thoughts only frustrate and obfuscate the situation, and generally distract the rest of the folks who must work towards the solution.

This reported from Kansas City:

Washington — Kansas Rep. Nancy Boyda is defending her decision to step out of a hearing room last week while a retired Army general testified about U.S. progress in Iraq…

Boyda, a freshman Democrat from Topeka, said she left the House Armed Services Committee hearing on Friday for about 10 minutes during the testimony of retired Gen. Jack Keane…

“There was only so much that you could take until we in fact had to leave the room for a while,” Boyda said after she returned, according to a transcript of the hearing. “So I think I am back and maybe can articulate some things — after so much of the frustration of having to listen to what we listened to.”

Keane had testified that since the troop surge began, U.S. forces “are on the offensive and we have the momentum.” He also said that security has improved in every neighborhood and district in and around Baghdad, and that “cafés, pool halls, coffee houses that I visited are full of people.”

When Boyda returned to the hearing, she ridiculed Keane’s description of Iraq “as in some way or another that it’s a place that I might take the family for a vacation–things are going so well–those kinds of comments will in fact show up in the media and further divide this country instead of saying, ‘Here’s the reality of the problem.’ ”

By the way, if you are actually interested in exactly what Keane said, here’s an interview with him at NRO.  He seems fairly realistic and is both positive and negative.  In fact, two scholars from The Brookings Institute are also surprised with the change in Iraq, and say so in The New York Times.

The Wall Street Journal has more, commenting on the fact that a major party in Washington is actually invested in us losing the war.  They cite this story in the Washington Post in which House Majority Whip James Clyburn (D-S.C.) said Monday:

“that a strongly positive report on progress on Iraq by Army Gen. David Petraeus likely would split Democrats in the House and impede his party’s efforts to press for a timetable to end the war…

Many Democrats have anticipated that, at best, Petraeus and U.S. ambassador to Iraq Ryan Crocker would present a mixed analysis of the success of the current troop surge strategy, given continued violence in Baghdad. But of late there have been signs that the commander of U.S. forces might be preparing something more generally positive. Clyburn said that would be “a real big problem for us.”

The Claremont Institute recounts even more instances of politicians “exulting in misfortune.”  Hugh Hewitt has gone so far as to commemorate ‘The Nancy Boyda Award’ for everyone who denies good news about Iraq or twists it to their negative end.  I like this portion of his article best, when recounting his interview with Andrew Sullivan:

“ODDLY ENOUGH, ANDREW SULLIVAN provides the perfect coda to our debut of the Nancy Boyda Award. Earlier today, Andrew was slightly miffled that I suggested that “the left and other anti-war figures like Andrew Sullivan have a lot invested in this war failing and failing miserably.” Andrew took delight when someone took my logic and inverted it, writing, “The right and other pro-war figures like Dean Barnett have a lot invested in this war succeeding and succeeding well.” Andrew commented with a portentous and approving “Hmmmmm.”

Probably unwittingly, Andrew has confirmed my theory that this war’s opponents have forgotten something basic and elemental: Every American, regardless of his party affiliation or political philosophy, has “a lot invested in this war succeeding and succeeding well.” Andrew Sullivan used to know that. Best to ask him why he’s forgotten it.”

Well said Hugh.  But it goes far beyond all of this now.  To see a war through the prism of partisan politics is to be party to a perspective of the most aggregious and petty.  To walk out on briefings of your government that are meant to aid you in making some of the most important decisions of a lifetime, much less a generation, is to back childishly away from your duty and responsibility as a representative of the United States and its people.  And you should be ashamed, and are not emotionally fit to lead our country.