Using Fuzzy Math to Calculate What is Fair

Didn’t fuzzy math go the way of the crooked “E”? Back when the smartest boys in the room were booking unbelievable profits, Enron relied on what is referred to as “fair value” accounting. Spring is here and it seems that Blackstone thinks that practice is back in vogue. A recent piece from the WSJ highlights how Blackstone plans to adopt this accounting practice once it becomes a public company. Fair value accounting would give Blackstone full discretion in deciding what its investments are worth and consequently, what performance and management fee revenue it can book in interim periods. The problem with this practice is that most of those investments are very illiquid and coming up with some fair market value can quickly become an exercise in subjective self-affirmation. “Good job Mortimer! Good job Randolph!”

How many of us couldn’t have used a “fair grade” system in college. Imagine it, our professors would have trusted us, and let us give ourselves a mid-term grade based on how we thought we’d do on the final exam at the end of the semester. So much for being merit-based. This is the same concept, except with dollar signs and IRR figures instead of a GPA. According to the WSJ, even accounting experts express doubt that Blackstone’s intentions are sound. All of this should remind us of the KISS principal. Earning an honest buck shouldn’t be so complicated. Or is that being too naïve? Is it the machinations that allows one to make a buck in today’s world? What would we call this, “Smarts Arbitrage” or “Hired Gun Arbitrage”? I guess the rest of us should have studied harder for those mid-terms . . . or stumbled upon fuzzy math sooner.

Private Equity Feasting at an "All You Can Eat" Debt Buffet

News came in yesterday that private equity has so far raised more than $35 billion this year for buyout deals. That will make for a nice down-payment for a lot of big deals, which would lead to a lot of new debt. While many speculate on how legislators on the Hill will address the question of how to tax private equity profits, others are looking at where these firms get the money to make their deals. Specifically, what are the ramifications of buyouts that depend on high levels of debt?

Standard & Poors warns that the debt levels of European private-equity deals means there is a one in five chance that companies taken private using debt financing will go into default and CNBC’s David Farber recently reminded readers about the 1989 deal that nearly bankrupted its creditors. So why are financial institutions lining up to finance these deals with leveraged loans that require few, if any, covenants? (Remember, Blackstone's record-breaking $39 billion purchase of Equity Office Properties, for example, included $16 billion in debt.) Some suggest that the handsome fees investment banks earn for their advising services might be one answer. The fees to advisors in the Equity deal totaled $75 million, and Bloomberg calculates that banks stand to collect over $2 billion in fees for deals announced in the last few months alone. As Goldman Sachs CEO Lloyd Blankfein is reported to have said recently, if a company wants to be an advisor on these deals, "one of the consequences of that is we will have to do more financing in addition to the advice we give."

With the deals getting ever larger, feasting on cheap debt, we are left wondering who is going to have to pay the tab if private equity’s plans to create value in their portfolios don’t pan out. The availability of easy credit and the lowering of underwriting standards led to the current collapse in the subprime mortgage market, are we to see the same with private equity?

APOLLO...are you cleared for takeoff?

It appears that Blackstone’s proposed IPO and the investment practices of its private equity brethren are now deserving of their own section in the New York Times. Today's edition includes a full Special Section on the DealBook, with a cover story looking at all the cash that is fueling leveraged buyouts. This acknowledgement by the NYTimes that private equity is on the mind of the modern-day average Joe is likely not lost on Blackstone's Stephen Schwarzman or the other "Masters of the Universe" whose business ties are mapped out by A.R. Sorkin's team.

Today's news that Apollo Management, another leading private equity firm based in New York, is exploring going public, only validates concerns that these investment firms are seeking to get out while they still have chips on the table. Private equity firms, like other cohorts in the financial markets, tend to graze in herds and move from grassy knoll to grassy knoll. Fortress kicked off the IPO train and others now feel compelled to get on the tracks. One posible motivator for Apollo Management is worry that investors looking to participate in a private equity IPO will quickly have their appetites satiated by the Blackstone IPO and not want to take another bite of the same apple. If that is the case, we should not be surprised to see other mega-cap private equity firms come out from behind the shed and make their intentions clear. Seems a bit like the political tarmac that continues bringing new presidential candidates to the American voter, or in this case the American investor.

The Taxman Cometh...But Only for Some?

Today Bloomberg reports that the partnership structure Blackstone is proposing in its IPO could give it a tax advantage over such rivals as Goldman Sachs and Morgan Stanley. This is just the latest of the tax-related questions that have come up around the public offering. Last week on NPR's Marketplace, Alan Sloan noted the complications common shareholders might have accounting for Blackstone shares on their own tax forms; a challenge Blackstone itself noted in its filing, stating "Our counsel has not rendered an opinion on the state or local tax consequences of an investment in our common units," and informing potential shareholders that they "should anticipate the need to file annually a request for an extension of the due date of their income tax return" because the firm anticipated delays in furnishing tax information in time. (For more analysis of the tax implications of Blackstone's proposed partnership structure, see Victor Fleischer's blog at http://www.theconglomerate.org/2007/03/blackstone_ipo.html)

Of course, this debate pales next to that over the overall tax structures that private equity firms operate under, specifically questions about whether the money firms make on the "carry"--or their share of the profits of the fund, typically 20%--should be taxed as capital gains or income tax. Private equity firms stand to lose a lot of money if Congress decides to clarify the law and treat their carry as income (taxable at 35%) rather than as capital gains (taxable at 15%). Avoiding such a hike could be one of the reasons that Blackstone wants to make a public offering now. Stay tuned for responses from politicians, potential shareholders and everyday taxpaying Americans.

Blackstone Recoups More Than $3.7 Billion on Equity Office Buy-Out This Week

Press releases have been flying fast and furious about purchases of pieces of Blackstone’s recently acquired Equity Office portfolio. According to news stories, sales of buildings in Austin, Portland, OR, , Stamford, CT, and Denver (http://www.cpnonline.com/cpn/article_display.jsp?vnu_content_id=1003563671), total 68 properties and more than $3.7 billion moved off of Blackstone’s ledger. The Equity buyout, finalized less than two months ago, totaled $39 billion, indicating that if the papers have it right, Blackstone made back nearly 10% of the total deal this week.


“Thomas Properties venture to buy $1.15 billion of Austin Real Estate”
http://www.bizjournals.com/losangeles/stories/2007/03/26/daily31.html

“Shorenstein closes $1 billion Oregon property deal”
http://portland.bizjournals.com/portland/stories/2007/03/26/daily21.html

“RFR agrees to buy EOP’s Stamford Portfolio from Blackstone for $850M”
http://www.costar.com/News/Article.aspx?id=B24B9844B76F724FD8D990F311209187

“$770M Takes EOP’s Former Denver Holdings from Blackstone”
http://www.cpnonline.com/cpn/article_display.jsp?vnu_content_id=1003563671

“Blackstone’s Bid for Equity Office Prevails”
http://www.nytimes.com/2007/02/08/business/08real.html?ex=1328590800&en=f82eb4b2ec2106e5&ei=5088&partner=rssnyt&emc=rss

Goldman Sachs Can Do Anything Blackstone Can Do Bigger

Just when Blackstone thought they held the record for the largest buyout fund ever, at an estimated $18.1 billion, Goldman Sachs announced an even bigger fund...read what FINAlternatives had to say about the new fund here http://www.finalternatives.com/node/1393


Goldman Plans Buyout Fund Bigger Than Blackstone’s
March 28, 2007 Private Equity -->
Just a week after being snubbed in The Blackstone Group’s initial public offering, Goldman Sachs announced that the private equity firm’s new $18.1 billion buyout fund—revealed in its IPO prospectus—will not, in fact, be the largest ever. Goldman plans to take that honor itself.
Lloyd Blankfein, CEO of the Wall Street giant, told shareholders at the company’s annual meeting that Goldman will raise upwards of $20 billion for its next corporate buyout fund. “It might be a little more, it might be a little less,” he said.

Searching for the right metaphor for the Blackstone IPO

The news coverage of the Blackstone IPO over the last several days has raised more questions than it’s answered. Newsweek magazine asks who benefits under the structure proposed in the SEC filings. Without typical information like guidance earnings, Newsweek asks, how are investors to know they are sharing in the prosperity? Meanwhile, Time asks if the offer isn’t like “selling full-price tickets to a ball game in the ninth inning,” and the International Herald Tribune speculates that the IPO is largely about easing the retirement of founders Schwarzman and Peterson.

AFX International Focus also noted the proposals for limited shareholder rights, saying that Blackstone was “extending an interesting proposal to retail investors: a piece of the action, just not a seat at the table,” while the Financial Times warned that investors are “strictly along for a the ride” with Blackstone’s management.

In the New York Times, Andrew Sorkin highlights Blackstone’s own “baby steps” toward changing the industry’s image by including a provision for a charitable foundation in their IPO and solicits his readers to help suggest a new moniker for public relations troubled “Private Equity.”