Fighting for a piece of the pie...

Blackstone's upcoming IPO has received a lot of media attention last and this week. Part of the reason is executive compensation package, totaling a multi-billion dollar figure (More on the distribution of Blackstone IPO proceeds: http://online.wsj.com/article/SB118156915112631131.html).

This whooping sum is characteristic for the private equity sector, which is the place to be nowadays - lots and lots of money can be made " by amassing investments from pension funds, endowments and wealthy individuals -- then buying up companies, turning them around and reselling them" (The WSJ on the private equity firms, http://online.wsj.com/article/SB118156915112631131.html). The attitude of business schools supports the notion of the private equity sector's popularity. The best business schools in the country create classes and specializations focusing on private equity, try to attract people with industry experience, as well as guest speakers and professors from the sector (See: http://online.wsj.com/article/SB118160869757131959.html).

It is all an understandable process; however, others might want a piece of the same pie. The hedge funds and private equity firms which are publicly traded and are limited liability partnerships have enjoyed lower tax rates than entities formed as corporations. However, the government tries to get more from their profits: "Wall Street's new masters of the universe, hedge funds and private-equity partnerships, are suddenly finding the universe a less-hospitable place.The latest pressure arose this week when the Senate Finance Committee decided to introduce a bill to tax financial-services partnerships that are publicly traded, as giant Blackstone Group soon will be, at the same higher rate paid by corporations." (From: http://online.wsj.com/article/SB118195651141637425-search.html?KEYWORDS=private+equity+taxation&COLLECTION=wsjie/6month More on the issue at: http://online.wsj.com/article/SB118185483791435821-search.html?KEYWORDS=private+equity+taxing&COLLECTION=wsjie/6month). The Wall Street Journal also notes, that lawmakers in Britain have similar intentions as the American ones: "Private Equity's Tax Breaks GetHard Look on Both Sides of Pond " (Read the whole article at: http://online.wsj.com/article/SB118212440211838480-search.html?KEYWORDS=private+equity+taxing&COLLECTION=wsjie/6month). The attitude is clear - private equity firms enjoy a real boom of their sector, as well as the advantages given by being publicly traded, without what is felt as fair rate of taxation imposed on them. Regardless whether it is the case, or the buyout firms just do not have enough lobbying power (See: http://online.wsj.com/article/SB118212767498638611-search.html?KEYWORDS=private+equity+taxing&COLLECTION=wsjie/6month), it is clear that in the end it is just about a greater cut of the big and growing private equity pie.

High risk loans - financial salvation, or another slump approaching?

Not all business entities enjoy a successful start up period, as many new business projects fail. Apart from that a lot of the established companies run into trouble, for a number of reasons including erosion of customer base, bad investments, a down turn in a given industry and many more.

The bankruptcy legislation in the USA is quite lenient in comparison with other developed countries. This is the main reason for a large number of post-bankruptcy emergences in America. The airline sector can serve as a great example - companies disappear and returns, the latest examples being Delta and Northwest (See: http://online.wsj.com/article/SB117792554117386751-search.html?KEYWORDS=bankruptcy+emergence&COLLECTION=wsjie/6month . Still, the whole process associated with seeking Chapter 11 protection is painful for the management, employees, creditors and stockholders. To put it clear or even blatantly - every one tries to avoid if possible. What can financially troubled firms do then?

There's a lot out there...

"In a world awash in investable funds, even many of the most troubled companies are finding lenders willing to offer them big money. This rescue financing, as it's sometimes called, can give companies time to clean up their balance sheets and avoid a trip to bankruptcy court. U.S. filings for bankruptcy reorganization -- a painful experience for employees, creditors and shareholders alike -- are at a 10-year low. Also at historic lows are U.S. corporations' debt defaults." (From: http://online.wsj.com/article/SB118161526044432160.html).

Seems like the perfect deal - troubled companies get the time and means to turnaround their business, and lenders, mostly investment banks and hedge funds, get a nice risk premium on the loans amounting to a couple percent over the LIBOR rate. The whole process is so easy because "There's a lot of money out there" (From: http://online.wsj.com/article/SB118161526044432160.html). As mentioned above - corporate bankruptcies are at decade low. Everything seems perfect, does it not?

Shaky grounds

"When rescue lending fails, the extra debt can make a bust just more spectacular" (See: http://online.wsj.com/article/SB118161526044432160.html). The head of restructuring and recapitalization at the investment bank Jeffries & Co puts it this way in a quote for the Wall Street Journal: "To quote Alan Greenspan, there's some irrational exuberance on the part of investors." (From: http://online.wsj.com/article/SB118161526044432160.html).

Seems like the investors did not learn much on the rise and fall of junk bonds in the 1980', or the recent sub-prime mortgage sector failure (An interesting view on that: http://online.wsj.com/article/SB118212541231038534-search.html?KEYWORDS=bankruptcy+emergence&COLLECTION=wsjie/6month). A rational investor has to remember to asses the risk of an investment and measure the benefits on the risk adjusted basis. Private equity firms, as well as investment banks or hedge funds may have a lot of capital, which does not mean they should just throw it away! Hopefully, rescue financing will stay a useful investment/financing tool and not a symbol of the next big slump.

Notice

My blog has not been updated in the last couple of weeks. There is a number of reasons for that, mainly the fact of being overseas for most of this time. However, this should change now.