What drives private equity
Dan Denning is on a roll down under, with still more reflections on the phenomenon of private equity. Here he demolishes a Fed Head who's evidently confused this sort of money manipulation with actual productivity and prosperity:
By the way, there is official support for the idea that Americans are "superior allocators of capital." It reminded me of a speech I read by Richard Fisher, the President of the Dallas Fed.
The shorter excerpt is below. This superior class of managers he refers to must be the private equity guys, right?
For example, just yesterday we read that the world's largest casino operator, Harrah's (HET) is entertaining a bid by private equity outfits Apollo and Texas Pacific that values the company at $16.7 billion (HET has a current market cap of $14.7 billioin.) Here's my question for you: what does Harrah's have in common with every other major private equity takeover target of the last year? It's not debt (although a company in distress is often an attractive target in that its assets trade at a discount). It's cash.
You see, private equity transactions usually involve a lot of leverage (debt). The organizers of the transactions look for a company that throws off regular cash…cash that be used to service the accumulated debt. That's the one single most important attribute a company must have to be attractive to private equity.
There are others. But if you only started with that one and say, companies that sold a low price to sales multiple, you'd have in front of you a list not that different from what private equity mangers who make ten millions of dollars a year look at when making decisions.
Anyway, the idea that these private equity guys are superior allocators of capital is a huge load of bull****. Some of them are smart. But they aren't smart because they know how to spot a great business better than you or I. They are smart because they've learned how to buy a dollar's worth of earnings with fifteen cents of someone else's money—-and they get paid millions to do it!
I know a 26-year old guy in Sydney, smart, sociable, straight teeth, full hairline, looks good in a suit, who makes $250k for Macquarie bank…as an analyst. Analyze what? Balance sheets? I guess. He says he can't figure out he got paid so much to do what he does…but he isn't complaining.
Nice work if you can get it. Anyway, here is what Fisher says:
The agent of reorganization is not the government or the central bank but the talent of our business managers, something that economists rarely talk about. The managers of our businesses are the key to our continued adaptation and growth.
They are our greatest comparative advantage. I like to say that the managers in our business community serve as the nerve endings in Adam Smith's invisible hand, stretching capitalism's fingers into every corner of the world to extract value at the lowest cost—in order to enhance productivity.
I am not talking just about CEOs who get paid big bucks. I am talking about the millions of middle managers who operate supply chains, control inventories and fine-tune operations.
Every day, these managers get up and go to work to exploit those competitors who come to market with cheaper products by buying those products and using them as inputs for providing better deals to their customers.
They are the masters of the best manifestation of "creative destruction."
They are the folks who exert the gravitational pull for the recycling of those monies we pay out to secure cheaper inputs. Their ability to wring value out of all sources, everywhere, is what makes the United States the preferred risk-adjusted destination for surplus investment monies.
They are the people who enable us to finance our external deficits, and inevitably redress them.
They are the key to our transforming what some perceive as a weakness into a fundamental strength.
You know what, I do think all this is very bullish, in the strict mathematical sense. There's going to be a buying boom, via leverage. The indices are going to soar. Buy call options.
"Creative destruction?" I haven't seen this obscene a corruption of Schumpeter's famous expression since the neocon Michael Ledeen appropriated it to justify his insatiable lust for world-improving wars.