Wii Points Index

I recently got a Wii. How I am going to find time to play it is irrelevant, I just wanted one.

Those who have one, or may have been following its progress, would probably know that Nintendo has a Wii Points system to allow players to purchase retro games from its online channels. The games are priced by Wii Points, with the more popular/more recent games obviously charging higher prices.

That, and my great admiration for The Economist's Big Mac Index, gave me a thought: how much do these Wii Points cost in different countries? Clearly every Wii Point is exactly the same, and should theoretically be worth exactly the same. In practice, regional restrictions mean there are no arbitrage opportunities. In any case, I started with what I could find off the net, as follows:

Cost of 2000 Wii Points
Country	Local Currency	Store	Price (in local currency)	Implied FX Rate to USD
US	USD	Toys R Us	21.9900	1.0000
UK	GBP	Woolworths	13.9900	1.5718
AUS	AUD	EB	35.0000	0.6283
CAN	CAD	Sears Canada	24.9900	0.8800
JAP	JPY	Indicative	2,000.0000	0.0110
Country	Local Currency	Current FX Rate (USD equiv) www.xe.com	Implied Price based on Current FX Rate	Over/(under) pricing relative to current FX rate
US	USD	1.0000	21.9900	N/A
UK	GBP	2.0609	10.6701	31.11%
AUS	AUD	0.8770	25.0741	39.59%
CAN	CAD	0.9895	22.2233	12.45%
JAP	JPY	0.0092	2,390.2174	(16.33%)

So the lesson isn't so much about international economics and arbitrage; it's simply that UK and AUS gamers are clearly being ripped off by local retailers, who aren't passing on the benefits of a weaker USD. Time to campaign, geeks. Japanese players, as usual, are treated to an entirely different echelon of gaming goodness. I would move there just to be hooked into Nintendo nirvana.

Highly doubt this will replace the Big Mac Index; for one, it does not account for the "basket of goods". Still, makes you realise why game console makers continue to maintain region coding even though there are clear benefits to gamers to remove them (i.e. being able to import hot games from overseas, rather than relying on the pitiful supply from local distributors).

Bring Green Pencil To Voting Booth!

Can't decide the lesser of several evils in this election?

Vote Laberalocrats First - with a green pencil! The ultimate fence-sitting vote, and it's QUINTUPLE VALUE voting!! (Take that, cheap Greenies with your double value voting.)

How To Lose $3 Billion in 21 Days

Well, banker karma got to me. After the last post which arose from superchronopossession, three deals dropped on my desk at the same time, and closing pretty much one after the other (which was last Friday). Hence the extended absence of tales of Rockett Fuel office shenanigans.

Since the last post, Messrs E Stanley O'Neal and Charles O Prince III (no, the OTHER Charles) will, sadly, be leaving the great ships Merrill Lynch and Citi. In a loving tribute, both were handsomely rewarded as a result of the deft management. If you think it is easy to lose tens of billions of dollars, think about this: you have 24 hours to spend $5 million, and not a cent less, and you can't keep a cent or keep anything you buy with it or make any money out of it. Yes... not so easy to think of how to make $5 million disappear into thin air. It takes a special kind of leader to do the almost-impossible.

But my oh my, aren't we all blessed in our lifetimes to see two high-profile leaders achieve exactly this. That is why, ladies and gentlemen, they will be walking away with roughly $200 million, give or take a lazy few tens of millions. It takes talent, it takes bravado, and unrivalled knack for timing the market (i.e. jumping into high-risk debt and structured products at the exact time they were turning unsustainable). You and your silly quant models could not have timed it any better. Unless you are Bear Stearns.

Why I now dislike redneck unemployed lying useless lazy criminal borrowers even more than I did before (subprime crisis impact - it's PERSONAL)
Keeping it brief due to propensity to cry when thinking about it:
- not happy* with bonus
- not happy* with pay rise
- pay rise actually lower than that offered by competing bank earlier in the year, when I was as green as Link's costume
- making me think... can one actually do a valuation on loyalty, and therefore, did I overvalue it?

* NOTE: gross understatement of the night.
** The irony of my situation, in light of the above take on Wall St maths, is not lost on me. Please do not rub it in by pointing it out.

Why bankers + free time = stupidity

Often, simply saying "I'm an investment banker" is enough to make women (esp at Establishment) swoon... if that's your thing. This list is for the more discerning banker, one who is trying to find a woman who is switched on and "gets it". And there's no better way to test her "getting-it-ness" than to pile on the jargon and see. So here we present the latest Frankenstein lovechild of banker brain power and permanently adolescent humour: banker pick-up lines.

1) Let's correlate.
2) That's not a Capital Market Line in my pocket.
3) No, it's not a Laplace distribution either.
4) I'm a big fan of two-asset models.
5) Only the price-earnings ratio matters, baby... your price, and my earnings.
6) You're already a positive NPV investment. (I've lowered my expected rate of return.)
7) I'd like to be on your efficient frontier.
8) I'll be the alpha, you be the beta.
9) I'm long-only.
10) I'd like to Ctrl + "+" then C if you'll let me.
11) I'm into M&M. No, I'm not talking about the chocolates either.
12) May I toggle your PIKs?
13) You can subordinate me tonight.
14) I'm experienced in long, drawn-out mergers.
15) Baby, you are the market portfolio.


P.S. I like this. "Take a quick look around you right now. If you are surrounded by attractive models, fast cars, and high-quality cocaine, you have a good pickup line. Either that or you are an investment banker, in which case you also probably have syphilis."

P.P.S. I don't have syphilis. Honestly.

What's he saying?

After Citi's $5.9B third quarter writedown, what is the very regal Citi CEO Charles O. Prince III saying here?


(a) "But luckily for me, it was your 5.9 billion dollars."
(b) "And I'll see YOU in the penthouse *wink*"
(c) "If I go down, you're coming with me."
(d) "You stay classy, Planet Earth."
(e) "Quick pull my finger, I can't hold it anymore!"

EXXXcel

You know you have a serious problem when this turns you on. I have already scheduled my appointment with a shrink.

I am where I should be.

R.I.P. Rockett Stepdad. I know you'd be stoked about where I am and what I do. Thanks for believing in me. I am where I should be. My only regret is, you only got to see it in your mind's eye.

Labour Day Holiday (oxymoron alert)

Last week was a little quieter than I expected. Or rather, my expectation did not normalise for the fact that last week was the annual Private Equity Schoolies Week, hence nothing gets done, unless you include golf and mistresses (phwoar indeed). It's like the grown-up version of all those school excursions to fun places... a site/activity is chosen, and it is somehow made to look weakly related to the curriculum to justify miles of beaches (Geography), Men's Gallery (Phys Ed), and rollercoasters (Maths, what else).

With the market being so hot right now (yawn), the office environment becomes a tinderbox, ready to explode at any moment. For example, on Friday night we nearly had to settle a heated argument about where we should go for Friday night drinks... with a coin toss. Luckily my leadership skills saved the day, and everyone managed to have an equally bad time all round.

Yesterday being a Labour Day holiday in this fair city, I decided to take advantage of the great weather and leave the office, Jimmy Cayne-style, for a game of golf. Unfortunately I had some trouble procuring my golf clubs (they are 'in transit', so to speak), and so I was reduced to borrowing the clubs for hire. Any hardcore belief that golf is a non-discriminatory sport was quickly assuaged by the fact that I, as a tall southpaw, was given the worst set of clubs I have seen in my life. I couldn't hold the clubs without nearly sitting down. The putter was short, skinny, crooked, and went both ways... who wants a stick like that? Needless to say, the craftsman was frustrated by his tools. I would have scored better kicking the ball along.

In general news unrelated to my golfing prowess:

UBS and Citi write off enough money for the past three months to give US $1 to every person alive (give or take a few dollars).

RAMS sells name to get cash to delay its death. I wish I could sell my name to pay off my debts too.

Signs of life or just a dead-cat bounce...

OK been a while since the last post, I figure it's time to show some minor sign of life. Maybe a link dump to warm up with...

For the young ones, who thought bank runs were a relic of the "old world" like the gold standard, Lotus 1-2-3 and EMH, Northern Rock must have been a fascinating read. And if the rumours of low-ball bids end up true, then I will flip out if Northern Rock executives reject the bids because they are "opportunistic" (as seems to be the excuse given by many management teams who are unlikely to be given equity in the acquired entity). Aren't all bids opportunistic?

An interesting take on magic, and its implications for IP law.

Investment bank third quarter reporting season is upon us, with Lehman Brothers and Morgan Stanley starting things off, and Goldman Sachs and Bear Stearns following on Thursday ET (Friday AEST). These firms have been in the middle of the current crisis, so their third quarter results will be very interesting if only as a barometer of the impact of the crisis on its most visible players. By the way, the Bear Stearns and Goldmans results announcements are open to the public; you can dial in for a live conference call (10am ET and 11am ET respectively), or download from their sites afterwards.

Since the last post, our US and UK sources have been reporting doom and gloom... credit markets are closed... devalued portfolios... massive (~US$400B-odd) overhang of loans that no one wants to buy... bankers trying to jump out of reinforced windows and instead bouncing back to the office floor... it's terrible.

Here though, we are seeing some twitching (though I wouldn't say "normality", given how flexible the term is). Semblances of deals are trickling in at a slower yet steady rate. Normally this would make me quite happy because deals = fees = nice fat bonus. The problem, however, is two-fold:
1) there still appears to be some insistence on pricing debt at pre-August levels; and
2) no one wants to commit!

The first issue is pretty easy to solve - you can wait it out until they come crawling back (as happened to a few major local deals already... though the "restructure" of the packages is more froth and optics than an actual restructure).

With the second issue, perhaps remind them of the fact that they are sitting on billion-dollar cash boxes if they don't do any deals - and a lazy balance sheet for a PE firm is (though tastily ironic to me) a sure way to lose your BSD status in the market. This is more of a medium-term approach though... sort of like tapping someone's leg with your boot for hours, and then when they eventually try to get up, they fall into a heap because you've pulped their muscle... but I digress.

Anyway, the situation is a double-edged sword: one the one hand, the crisis has weeded out a lot of terrible deals (though certainly not all...). On the other hand, even those sitting on very good, leverageable (note: must check if this is a bastardisation of the English language) businesses are hesitant to do deals - deals that any banker worth his salt will do without even blinking.

And it is wrecking my already Lara Flynn Boyle-esque social life. I had to turn down several invites because I "am juggling a number of deals"... and so far none of them have gravitated back to my hands yet. So I'm sitting there waiting for signs of life, when I could instead have been out and about, blessing this city's somewhat tolerable establishments with my presence. And I know, I JUST know, that they will all suddenly go live next week - just before the long weekend.

Lost magic

I previously posted here about the real diversification benefits of investing in wine and artwork (either directly or via the funds that do).

Anyway I was trawling through old not-so-urgent news and found this. A downturn in the art market? So if the values of residential properties, commercial properties, high-risk asset-backed debt, high-yield LBO debt, investment-grade corporate debt, stocks across the corporate spectrum, and "alternative assets" like artwork and wines seem to move in sync of each other... where are the diversification benefits when it matters the most?

Of course, none of this is really surprising for those who first heard about diversification in undergrad and thought it wasn't all it was cracked up to be (and hence subsequently struggled for brownie points from Investment Management lecturers). I remember in one class, the lecturer began explaining diversification thus:

Lecturer: "Don't put all your eggs in the one basket, that way if you drop one basket, you still have eggs in the other baskets."

Student: "What if all your baskets are in the same cart and it crashes?"

Lecturer (himself not that far out out undergrad): "... then you have a big problem."

ABSOLUTE NONSENSE: There is no truth to the rumours that I sparked the selloff in the art world with my blog entry, which was one month before the Bloomberg report in the above link. Of course, truth is only a small percentage of what moves the markets...

Urdhva Dhanurasana for dummies (and other news bites)

It has been a while since the last blog, and the start of the market downturn, and I was tempted to give an update on how awesome it is to watch it unfolding, with my entire watchlist bathed in a sea of blood, and me doing my best re-enactment of Warren Buffett's infamous "oversexed guy", having too much to buy and nowhere near enough money to buy them all with.

But lo and behold I pick up the Sunday paper (for the first time in what must be years), and front page is this article, which I decided is funnier to write about. Justin Hemmes, self-proclaimed god of the totally substandard Sydney nightlife and owner of the no. 1 meat market, The Establishment (or "The Stab" as locals quite appropriately call it...), is throwing a hissy fit that the powers-that-be are not performing the Urdhva Dhanurasana so that his $150M new [meat market] hip strip can get its alcohol licence.

Mr Hemmes is "distressed" that he has taken "100% risk" by developing without certainty of being licenced, somehow thinking that just because he sunk his [i.e. the banks'] money into the development that he is therefore entitled to "the dream" of separating sleazy drunks and their cash. Mr Hemmes' stakeholder relations strategy is interesting, and will likely make for at least a hilarious case study at a local second-tier MBA program. He first pleads with the police not to "stamp out the dream" and then tells them exactly what they should be doing instead of policing the regular alcohol-related problems on George St: "government bodies such as the police should be bending over backwards to help innovative and creative developments." Instant classic.

Anyway, after I wiped up the milk that came out of my nose from laughing after reading that quote, I managed to find a few other, more worthy, articles:

Ms Gail Kelly wins the Westpac chief teller job. Well done (and that wasn't a sarcasm-laced congratulatory remark, either). This means the mighty red-and-white will be headless (much like their football team, really).

Exclusive from Rockett Fuel: Westpac takes over St George Bank. It must be crossing Ms Kelly's mind every ten seconds. They don't even have to change corporate colours! You know I'm right.

Talk about picking the top of the market to sell: check out when RAMS Home Loans (ASX: RHG) listed at $2.50 a couple of weeks ago and how it's gone since. There will be a few PE firms who are ecstatic about NOT buying an asset. The question is, did management see their fate in the tea leaves before they listed, and knowing how hard it would be to refinance their $6B warehousing loans in the ailing credit markets in a few months, decided to sell up?

UPDATE: in another "exclusive interview", NSW Police Commissioner Ken Moroney denies all reports that the NSW Police's lagging performance in their core [in]competency is leading them to diversify into property development, as may have been implied by Mr Hemmes' comments. The Commissioner states that Sydney's egotistas have a competitive advantage in this area and believe the industry (and the Police business model) is better served by maintaining status quo.

For next blog: how much money I lost by being cash-strapped during a stock market correction.

SECOND UPDATE!! Congratulations to everyone who passed their CFA exams (especially Level 2). I will see the rest of you next year hehe.

Dive! Dive! DIVE!!

So how about that market huh?

The ASX 200 starts last week at 6,422.3 and at today's close is sitting at 5,941.2 (-7.5%). Today alone it was down 3.3%. Key factors (in the Aussie market at least) look to be continued uncertainty in the US market due to the subprime debt fallout, and increased risk of another rate rise from the RBA next week.

The subprime debt crisis is the slowest-moving crisis I've seen in my (admittedly short) life. I compare this to watching "House of Wax". Paris Hilton is in the movie. Ergo, she will die. It's just a matter of time. But it doesn't happen fast enough so that you can get over it and get on with the rest of the (crappy) movie. I feel the same way about this subprime thing. I think it will (and in some ways, already does) have a contagion effect. I know it will be bad. Others think it will be bad - the point of contention is the degree of severity. But it just won't happen fast enough so everyone can have a good cry over it and move on to buying up the decent scraps left in the crash.

Notwithstanding some potentially profitable trades now made available to me, the whole situation poses an interesting chicken-and-egg financial conundrum. So whose fault was it - the low-income high-risk borrowers who, in pursuit of happiness or the Great Aussie Dream or some other noble variant, thought it's worth mortgaging everything they own (and then some), lying on their forms, and buying overpriced houses, cars and goods? Or is it the fault of the banks who, seeing an opportunity for profits, went out and met the demands of these high-risk borrowers? Is it those baby boomers who, as they approached their twilight years, demanded ever-higher returns from their investments? Or is it the institutional investors who promised they could deliver it by investing in "safe" packages of loans to risky borrowers?

I'll continue to ponder those thoughts while I await approval for my margin loans. Surely, surely, this approval is a done deal - my job in leveraged finance means I'm a low-risk borrower. Right?

Finance jargon of the day

Pier Financing: a bridge loan (short-term acquisition loan) with no defined "takeout" (repayment method).

Commonly used in: financing the acquisition of crappe` assets.

Commonly associated with and/or mistaken for: pier jumping - an action whereby the investment banker, who lent out the pier financing at rock-bottom rates and now finds himself/herself unable to syndicate it, decides the honourable thing to do is go for a long walk on a short pier and never come back.

When we're not busy...

#1
CS: "Hey Rockett, I can't find the executed documents in Debtdomain."
Me: "Why would they be there?"
CS: "Didn't you say it was on Debtdomain?"
Me: "Mate we're using Intralinks for this deal, why would I say that?"
CS: "Hmmm OK that makes sense now."

#2
BV: "What's the deal with your hair?"

#3
Source unknown: "Credit can wait, Days Of Our Lives is on."

#4
CS (talking about deal teams): "ST, you and I are 0-for-10. Rockett and I are 1-for-1. This is the dream team right here."

#5
BD: "Rockett how much debt do you think we can stuff into this?"
Me: "Depends - is their EBITDA $30M or $120M?"
(Nervous laughter at the thought of another nightmare deal.)

#6
Multiple sources and in various permutations: "So when are we doing the due diligence and management meeting for Perisher Blue? I hear the snow's good this season."

UPDATE: Added a new blog link to my list, Aleph Blog. Check it out.

Plonk and doodle investing

Recent students of finance will know that theoretically, a "market portfolio" consists of all possible assets that one could invest in, traded in a liquid market. There was a time when this was only very partially true, and even then, the wider range of asset classes to make up a "market portfolio" were only available to the rich.

However, with improvements in technology, better financial engineering, and the sheer weight of money begging to be invested, investment funds specialising in "alternative assets" like fine wine and arts (apart from your run-of-the-mill long-short funds and CDO's/CLO's) have sprung up to meet the demand.

In theory the wider range of asset classes improves the ability of an investor or fund manager to diversify investment risks, as each asset class responds differently to economic and business cycles, and the returns of some asset classes may move in a different direction to certain other asset classes. My question (and perhaps it's because I haven't delved into this long enough) is that a fund that invests in "prestige assets" like fine wine and artwork will be investing in assets that (a) derive their value from conspicuous consumption of the rich, and (b) are traded in very illiquid markets (if at all), and hence pricing signals and valuations are difficult to come by.

I imagine that demand for luxury goods don't change all that much in the stratosphere that the super-rich mingle in, so I guess demand for Bordeaux wines and Picasso paintings are fairly inelastic. Of course, I am also assuming that the noveau riche have marginal impact on the market for luxury goods; and that the funds investing in wines and artwork are not relying on a healthy market supported by freshly-minted millionaires to realise their profits. Because if they are, and the economic cycle turns, then the market liquidity could easily dry up, making it difficult to buy and sell assets at the "right price" and seriously endangering their ability to create significant supernormal returns uncorrelated to "traditional" assets like bonds and shares.

Simply put, if the economy tanks, we will have less rich people, which means less demand for luxury goods, driving their value down along with the rest of the general investment market. Not exactly the definition of diversification. Happy for someone to explain this to me in more detail...

The open secret

Now I may not be entirely aware of the situation, as the private equity industry tends to be, well, private (at least for a little while until just before announcements, when someone who owes somebody a favour leaks just enough to offer a profit opportunity and call it even stevens). But I have a question, which I believe is a valid question, and I think you will agree once I explain.

What I don't understand is this: why hasn't anyone bought out Limited Brands (NYSE: LTD)? Now for non-American readers, you might be thinking "what the heck is Limited Brands?" and to which I will reply with two words... "Victoria's Secret".

Yes dear reader (if you exist), Limited Brands is the proud owner of Victoria's Secret. Purveyor of the most seductive undies ever imagined. Brought to the limelight some of the most beautiful women in world history (and almost single-handedly justified the Spanish colonisation of South America. Almost.) Made it acceptable for men to be found in the ladies' section - not to be judged and jeered, but to be respected as thoughtful and confident men purchasing very expensive intimates as a sign of their affections for their female beloveds. Created the one unifying dream for the common appreciation of man and woman alike... that of the woman (preferably of Alessandra Ambrosio-like proportions) prancing around in their lacies with angel wings attached to their backs.

OK seriously, why hasn't this happened? Let's compare it to a typical private equity checklist:

- growing sales: CHECK... but hampered by underperforming departments.
- high and consistent profit margins: CHECK. EBIT margins of 10-11% in retail in the past five years?! And how about Victoria's Secret... 19-20%!!
- recent setbacks/mismanagement resulting in worse financial performance: CHECK... gross profit margins have reduced from 38% in 1Q06 to 34.7% in 1Q07, which flows on to a virtual halving of NPBT margins.
- low gearing: CHECK. 1Q07 debt/equity = $1.664B/$3.010B = 0.55 (anything below 1.00 is healthy/undergeared)... and debt/LTM EBITDA* = $1.664B/$1.435B = 1.16x (anything under 2.00x is regarded as undergeared.)
(*LTM EBITDA = last 12 months' EBITDA, calculated by adding the last three quarters of FY06 to 1Q07... EBITDA = operating income and add back depreciation & amortisation.)
- competitive advantage: CHECK, CHECK, CHECK. Adriana Lima. Alessandra Ambrosio. Gisele Bundchen. Karolina Kurkova. Our very own Miranda Kerr. Best-known underwear brand in the world. Five times the number of stores as your next-best competitor. I mean seriously, if you don't think those constitute "competitive advantage", you shouldn't be playing with other people's money. In fact, you should hand it over to me.
- room for operational improvement: CHECK. See point 3 above.
- thorough due diligence: CHECK. What, you don't think the legions of accountants, tax practitioners, lawyers and management consultants wouldn't be falling all over each other to examine this business, check every nook and cranny, hold multiple site visits, conduct product testing to the nth degree, and discuss "key person" contracts? I swear to you, they would do it FOR FREE.
- easy syndication in debt capital markets: CHECK. By the same token, you think the bankers will say no for the once-in-a-lifetime opportunity to have Victoria's Secret catalogues lying around on their desks, plastered all over their cubicle walls, and strewn all over the male bathroom, AND be able to say "it's for a deal I'm working on" with a straight face? It will be the most oversubscribed debt issue of the year.
- a liquid market to sell off the business to in five years' time: CHECK. You mean we get a SECOND SHOT at due diligence on this company? Hot-diggity!! (The real dilemma is whether you would want to sell it in five years.)

So what am I missing here?
Have women stopped buying sexy lingerie? (No.)
Have men stopped appreciating women who wear sexy lingerie? (Hell no.)
Have they started making a "Victoria's Secret Stash" in plus size? (Oh dear Lord please no.)
Is there a strong supermodel-led campaign against VS with a catchcry of "wearing nothing is better than wearing VS"? (ummm... I can see the pros and cons of both arguments...)

Anyway, I think I've made my point. Kravis, Roberts, Schwarzman... I know you want to.

Just add wings.

UPDATE: Read this report. This was obvious three years ago! You have to respect any report (no matter how unpolished) that somehow manages to use the technical term "going commando".

Cuff me

I'm so ticked off at myself right now. I was packing for Melbourne tonight and I dropped one of my favourite cufflinks on a hard surface, cracking one of the stones. Very ticked off. I want a new pair. Must be red.

EDIT: I'm not being a princess. Any male who works in finance knows that style is in the detail. Any half-arsed street bum can wear a nice suit, shirt and tie (and often do, judging from the beggars in Martin Place). How do you stand out in a stream of suits during rush hour, or at a management presentation with other bankers, or a celebratory cocktail function to nab the ladies?

Subtlety. There's something different about you, but no one can put their finger on it... one by one they chat you up to get a closer look, and little by little the subtleties are revealed... sharply pressed suit... dark purple pinstripe (not blue like everyone else)... European slim cut shirt with fine detailing, and a bold but complementary tie for contrast... impeccably shiny high-grade leather shoes...

And then you reach out your hand to shake theirs, and from your sleeve, out comes the ace... a glimpse of your cufflinks, perfectly suited to your attire, your personality, and the occasion. Uniquely you.

If I am this good with fashion, imagine what I can do for your money.

Maybe I am a sore loser with a bad case of Mondayitis

One of the most difficult things in my line of work is losing a large, high-profile deal (or more in one day, if you are really unlucky) at the finish line. Those who like competition live for those moments, and get a euphoric rush from photo finishes. But it is devastatingly depressing when you come in second.

Today was one of those days. We lost two large high-profile deals today (any wonder why Monday is the most depressing day of the week?) and the mood was predictably down. One of them we sort of expected to lose anyway - it was far too large for our balance sheet, the international banks had the upper hand (the clients clearly said so), and the PE firms we were supporting weren't even sure they would like to stay in the hunt. Eventually they decided it was not profitable enough for them, backing out over the weekend, leaving all leveraged finance houses bidding for the lead arranger rights deflated.

To me, that is a perfectly acceptable - it is the nature of the business. The first imperative is to make the investment worth it, not how the banks feel about all the hours they put in. After all, the PE firms also worked hard (moreso than the banks), it is their equity and reputation, so they call the shots. They communicated their intentions clearly and openly, and conducted themselves well during the deal.

The second loss, however, was not. It has been a six-month long slog, having gone through numerous permutations, and at each turn the two competing banks were pitted mercilessly against each other. Competition I can handle. Wait, let me clarify - FAIR competition, I can handle. In an attempt to short-circuit the long-running saga and get to a decision (whether in our favour or not), we at one stage asked what the other firm was offering and we will match it if we could. We were told that it was not going to happen - but apparently, from what we can gather from reliable sources (and what we can logically gather from market developments), it did.

I get it - business is a competition, and had we been in the shoes of the other firm, we too would take advantage of the leg up. I also do not have a problem with the client shopping around - I would act the same way in their shoes. What I would NOT do, however, is tell one firm "hey, I won't give you a leg up by showing you the other firm's offer, it would be unfair to them and totally anti-Confucian in nature"... then turning around and DOING EXACTLY WHAT I SAID I WOULD NOT DO. I also would not go and keep the firm in limbo, when I had already made my choice. I would also not wait until the deal is practically public knowledge before giving notice of the decision.

This is the ugly side of dealmaking. Perhaps I am still a little naive, thinking that business can still be done within gentlemanly (or gentlewomanly) conduct. But seriously, what is wrong with acting with a bit of decorum? Who exactly loses out by doing business as if your word IS your bond? Isn't this fundamental to how our markets work?

LBO to the head

Standard & Poors recently did a study in Australia (which unfortunately is not publicly available on their site) that discusses what is driving the risk profile of a particular segment of debt capital markets here. In summary, the study believes that the risk profile is being driven by:

- benign economic conditions (low interest rates, high and growing earnings, low default rates); and
- unprecedented bargaining power in the borrowers' hands, as banks aggressively fight for market share,
which feeds into:
- inflated asset values (if you can borrow more, you can bid a higher price); and
- mispriced debt (i.e. interest charged is too low compared to the risks being borne by the banks),
thus substantially increasing the risk profile for the banks and debt investors.

The question for you is, is it talking about residential loans, or leveraged buyout (LBO) debt?

My title would have given it away: it is indeed discussing LBO debt. But what I wanted to highlight was that it could have equally applied to residential mortgages. The reason I wanted to draw the parallels is that, as of right now, the residential mortgage market in the US is in turmoil (the current poster boy for this being the Bear Stearns hedge funds that spectacularly collapsed in recent weeks).

While it appears that Australia has been able to escape such spectacular failure in our residential mortgage market, it is not a stretch of the imagination to see that it could happen to our corporate debt market. And I am unsure if we can pull a similar Houdini act again.

The LBO market in Australia is relatively young, though it is developing rapidly and adopting many features of the US and European LBO debt structures (e.g. heavy reliance on pro-forma forecasts, equity cures, generous covenant headroom, and not long from now, covenant-lite structures). Often, of course, this is because the client demands these terms, and a bank who wants to participate has no choice in the matter. The terms are great for the client because of the flexibility it offers them, thus they can concentrate on their core competency: improving businesses (or overpaying for assets, if you are cynically inclined).

But in finance, risks are transferred, not eliminated; because of the debt structures, banks are increasingly taking on risks that would have made them vomit not even two years ago. It is the classic "frog in slow-boiling water" (though whether frogs are really that stupid, I don't know yet). Debt levels in deals have been slowly but steadily increasing (while returns earned from them decline), and as they continue to compete aggressively, debt appetites are also slowly (if reluctantly) increasing. It does not help that there is a gross mismatch between the long-term sustainability objectives of a bank (i.e. minimise loss of capital) and the short-term performance objectives of its bankers (i.e. do the biggest deals, charge the highest fees, gain the best dealmaking reputation). Given the tight market, I highly doubt any banker who writes deals now will be around to see those deals flounder or flourish - by then, they would have either moved on to another bank or taken residence in the Caymans. The only impact these bankers see is the provisions charge against the profits they generate - and with default rates at current lows, these provisions are not onerous enough to prevent mispricing of risk.

Should there be a severe shock to the system, the self-fulfilling nature of our financial markets means things could rapidly get ugly for participants (which was what the S&P study was driving at). Of course, it is these same financial markets, demanding ever-higher returns while desiring little risk (or ignoring it altogether), that drove banks to this kind of risk-taking behaviour. So in a way, there is a poetic justice to it all, a vivid reminder that high risks do not mean high returns... such is the painful but necessary reality of our markets.

When we're not busy...

#1...

CS: "There's an error in the model!" (followed by laughter from ST and CS).
Me: "I thought it was all hardcoded?"
CS: "Yeah... there's a formula in it!"

#2...

ST: "Woo-hoo!"
Me: "Must be good news?"
ST: "My model's working! Wait, what's it doing? Why is it doing that? Dammit!"

#3... (after another late night marathon session with credit executives that goes nowhere)

SM: "That's it, I'm going for a pizza and editing my resume."

#4...

*SMASH*
(Sound of another Blackberry dying an honorable death at the hands of an angry director.)

#5... (after a mandatory fire drill)

HM: "Wow I'm tired after walking down 19 friggin' flights of stairs."
CM: "You fat bastard."

UPDATE: back-to-back-to-back-to-back-to-back 4.30am finishes are not fun, even more so when the "hard deadline" you were working towards gets moved because your client couldn't get their equity piece in place BEFORE they asked for debt (as most right-minded managers would do). Many Blackberries died last week due to this, please take a moment of silence to commemorate them before we upgrade.

How to kill a deal

Email conversation this week between myself and a client's analyst on a deal. We had told them through the night and into the morning that the $500M+ debt they were looking for was, well, a tad high for a business they had done zero due diligence on, and which they gave us a 2-day deadline for. We said low 300's via securitising the debtors was as good as they can get with what they had given us. They asked us to sharpen our pencils again (who uses pencils these days???). Let's pick up from this point...

Me: "Hi [deal analyst], just checking if we can have a chat to you about the deal this afternoon - if not, let me know what time we can call you."
Analyst: "Is it a discussion about a number with a 5 in front of it?"
Me: "It starts and ends at 5." [Imaginary response I wanted to send back, but out of respect for his boss and mine, I didn't.]

I realise it's a negotiation and everyone's trying to get an upper hand, and maybe I am a bit of a nice guy, but getting lip like that from an analyst (whose fault it was that no due diligence had been done in three weeks) is uncalled for, doesn't improve his negotiating position, and lastly doesn't even answer the question. Did he mean he's not interested in talking if we don't give up 500 big ones? Who are you, Linda Evangelista?

Sometimes it pays to know what your real bargaining position is before you lord it over someone. His boss eventually called up and said they'll take the $300M.

Rockett Trails:
Like the recent (well, for Australia anyway) episode of "Heroes", we go forward in time to see the aftermath of the Blackstone Group's IPO. Hiro Nakamura isn't happy.

In shocking and unexpected news, good times encourage more risk-taking, as evidenced here.

Good primers for CDO's and CLO's, which are helping drive the appetite for riskier debt.

BRW Rich 200

So I finally got around to buying my annual copy of the BRW Rich 200. I think it's terribly unfair that the cutoff has (AGAIN!) been raised, this year to $180M net worth. It was disappointing. I was THIS CLOSE to getting into the list which is within earshot of the list that is on the way to the BRW Sort Of On The Way To Being Somewhat Middle Class 200, which as you know is not far from the Rich 200.

Anyway I got a copy and sent an email out to my colleagues, see if any of them wanted to mentally crucify themselves by reading about the filthy rich. Especially when some on the list are probably less qualified than my Masters-level, CFA-suffering, Excel-accredited peers. Or, that we are more likely to be begging them for deals than they are to beg us to watch their TV network with stupid shows like this one. (Just on this note - wonder what Mr MacKenzie, as the new king of the idiot box, thinks about a show like this... somehow I don't think his Excel model shows a high IRR on it.)

Based on Mr SC's reply to my email invitation, he's already started to feel the pain before seeing the first page:

Me: "Copy of Rich 200 on my desk. Boozy lunch tomorrow will be the perfect opportunity to discuss the increasing gap between the have's and the have-far-too-much's."
Mr SC: "And the have-not-nearly-enough's."

There will be much lobbying for bonuses in the next three months.

PS I've only just caught up with Going Private's latest... I know, shame on me... and as always, EP's dug up some gems...

Number 1: everyone's been really hard on on this poor girl, but when you (presumably) work long hours and have lost all your friends (so sad), what else would you do with your money? Exactly - you too would buy a $3,500 bag and help the poor Chinese 14-year old girl earn her 35 cents. Don't hate her. Just laugh and move on to...

Number 2: "It made me say, 'You know what? This firm has shown a commitment to me. Let me in turn show some commitment to the firm.'" He pauses, a twinkle in his eye. "So this is a merger, if you will - Josh and KPMG." Oh dear God. The accountants think they're special.

News items

I wanted to have a section in my blog where updated news items of relevance to this blog would appear. I tried "newsreel" but it looked kind of ugly - I just want the headlines, not search results. I tried the "shared items" from Google Reader but it doesn't update itself.

Will try and figure out a way of doing this...

CFA Level II Exam

It's the night before the CFA Level II Exam, and I am sitting at home relaxed and blogging.

I decided I won't sit this year's exams. I didn't realise when I enrolled that I would have the job I have now. Needless to say the job meant many late nights, robbing me of precious socialising/drinking time. To maintain work/life balance, I instead maintained my social life and reduced my sleeping hours. However, this turned out to be unsustainable (given my natural tendency to be a morning zombie).

So in order to do the long work hours, maintain a good social life (after all, one must celebrate deals) and still get roughly four hours' sleep per night, I decided I will instead postpone taking the exam. I know, weak. I should hang my head in shame. But I was never great at exams (mainly because of poor study habits). Hopefully having an extra 12 months means I will eventually end up with four weeks to cram rather than the two weeks of cramming I did for Level I.

To my fellow CFA Level II Candidates, all the very best for you. I will see most of you next year (after all, you can't all be in the 36% that annually passes Level II). For those who are smart enough to pass Level II in less than three turns, hats off to you, don't turn into an arrogant jerk!

Blind leading the blind

Here's a simple question: oil company has excess cash that it needs to invest, or return to shareholders. It acquires an internet company, saying it was doing it to get the best returns for its shareholders. The question is, do you believe the company did the right thing.

Basic business know-how tells you that this is a preposterous situation for a company, and any shareholder who buys this crap deserves to get their money taken from them. Internet companies have volatile returns because of their inherent risk, which is the source of the high returns as well as high losses.

But apparently that is not the correct answer, according to the Monkey Tutor they have "teaching" finance at Rockett Girlfriend's university. Apparently the oil company did the right thing because "risk = return" and because it diversifies the oil company's earnings stream.

Firstly, only ignorants who don't understand how business and markets work think that "risk = return". There is no God-given right to high returns just because you took great risks. However you do earn the rights to great losses if you are inept enough to put oil managers in charge of an internet company. Risk does not equal return - otherwise, what's so risky about it? This is a subtly important but highly misunderstood concept, and the misconception is spread because tutors (often students themselves) everywhere are careless with their teaching, or worse, don't understand the concept themselves.

As for the point on diversification, another misunderstood concept. Any basic corporate finance textbook will tell you that diversification has limited benefits, and these benefits almost always occur at portfolio level (where a portfolio manager acquires diversified shares) rather than at corporate level (where one company may acquire a company unrelated to itself). The risk of loss is magnified when you have one management team (say, from an oil company) taking over or presiding over the management of the unrelated firm (say, an internet company). So not only do you have the inherent business risk, you have added management risk - clearly antithetical to the whole point of diversification!

Theory aside, I am appalled that this tutor saw fit to confuse his students by using incorrect justifications. If he was trying to play "devil's advocate", the responsible thing to do was to clarify this, state the correct answer, and the correct responses against his "devil's advocate" response. To leave it up in the air causes two things to happen: to confuse a weaker student, and to convince the stronger student (or her Rockett Fuel boyfriend) that the tutor is an idiot.

Happy birthday to me

There is eight minutes left on my birthday, and I am at work.

Dammit.

Slater & Gordon: I don't like being third!!

[Personal opinion only, no financial advice. Heed this at your own peril.]

So on Monday, a local law firm, Slater & Gordon, listed on our humble stock exchange, the first law firm to do so in this sunburnt country. This is the quintessential law firm... fighting for the battlers, setting right what the mega-corporates (and their larger lawyers) did wrong. Who wouldn't want to invest in something so representative of the tall-poppy syndrome? Apparently quite a few wanted a piece of this Aussie-ness; one week in the market and it's trading at $1.585, 58.5% higher than the listing price (maths skills remain sharp as ever).

Ignoring the perennial argument over whether the bookrunners underpriced the stock at launch, it is rather interesting (read: puzzling) what the appeal of this stock is. It's a tiny firm, and they do LITIGATION. They sue poor, defenseless, hardworking mega-corporations for a living. How much more anti-capitalist can you get?

Well, the irony is not lost on me. No way am I investing (a totally capitalist recreational pursuit) in an anti-capitalist company. So it's not the fact that it's a tiny firm that can't crack the biggest city in Oz and produces a tiny return on equity while booking dubiously valued "Work In Progress" which may or may not turn into cash. It's the fact that it clearly and unequivocally states that their duty is firstly to the courts, then to the clients, then to the shareholders... SHAREHOLDERS!! A DISTANT THIRD!! Well, I'm not joining this silly new "I Like Being Third" Club.

The funniest thing that will come out of this though, is when the inevitable writeoff of WIP happens, the company goes insolvent (hello, Knights) and there is a shareholder class action against the company... what if your clients ARE your shareholders?! I'll bring the popcorn.

Travesty of travesties

There is something evil happening at the University of the Real Capital of Australia right now.

Rockett Girlfriend has a financial analysis assignment that she has asked me to look over. One of the things she has to do is rip apart the valuation model used in their case study by a hypothetical retarded financial analyst (how dare this hypothetical character use that hallowed title).

We got to the section on whether to use "arithmetic returns" or "geometric returns". Easy right. Apparently not. To the confusion of all finance students in the University of the Real Capital of Australia who have a modicum of maths skill, their lecturer (and probably their lecture notes as well) claimed that "the majority of finance people recommend arithmetic mean returns".

WHAT?!

Who uses arithmetic mean? Which firm do they work for? I want to know this. I will IMMEDIATELY short their stock. If they don't have stock, I will advise them to go through an IPO, and then I will IMMEDIATELY short their stock.

Can you imagine, throngs of university students graduating, thinking "arithmetic mean returns is the market standard calc for everything". They will go NUTS when they start working. "Geometric mean returns? Yeah, I've heard of that. What? You want me to value using geometric returns? Ummm yeah, of course I can. [sweat. gulp. pee.]"

As far as we care, arithmetic mean is a mathematical oddity that has no practical use. Like pi and imaginary numbers and the sideways 8 (actually, we like using the sideways 8 to demonstrate blue sky potential of our valuations, but that's another story).

Please, University of the Real Capital of Australia. DO NOT teach this crap to your students. When our stocks show returns of 25%, 60% and 128%, we only say "the three-year average return is 71%" for our simpleton investors because it's a bigger number than the REAL geometric return of 65%. (Oops just gave that one away.)

Placeholder blog

Well I'm back from my Japan trip, refreshed, ready to take on the world, blah blah blah. I don't really want to divert away from this blog's primary topic (which for the time being is "anything somewhat related to finance"), so I won't say much about it except that it was an awesome experience, made even moreso by the fact that the Japanese yen seems to be in out of FX favour at this time. Sadly, even high demand for Nintendo Wii's and Sony PS3's aren't enough to prop up the big JPY.

Anyway, I walked in to work last week, and before I even sat down, I get a call from my director:

Him: "G'day how are you this morning?"
Me: "Great, I just got in. What's up?"
Him: "How's your calendar looking for today?"
Me: "I have no idea, I haven't opened it yet, and you guys don't want to give me a Blackberry." (OK, not the last bit. But I thought it.)
Him: "OK well I want you on these two deals. The first meeting is 9am, then another at 10.30am. I'll see you on the ground floor of [address of IB] and we can grab coffee 20 minutes before."
Me: "OK. Let me just check if I've broken my record of most unread emails during my holidays, then I'll come out."

No rest for the wicked.

In other news, I was talking to a couple of friends of mine, Mr JJ and Ms CC (I didn't realise that until just then...). Ms CC is at a rival bank. She's thinking of quitting. Hours are too long, and the team is too small to handle the deal flow. Plus spreadsheets can get kind of boring. (HERETIC!!!) Mr JJ, her partner, got offered a job in an IB, which he turned down because of the hours. They're slightly ahead in the "stages of life" cycle, so I guess for them it's about finding a comfortable routine, building a foundation on which to start a family and raise a few little rascals.

I guess I'm in a slightly lucky position where I think I can afford to make the sacrifice right now. I don't have any kids (that I know of). I don't have a mortgage, and am quite willing to travel for work. But I haven't quite decided if I'd be willing to do this down the track. I haven't quite figured out where I could go if I do decide the change tracks, either. Plus, sitting around at a desk all day makes me fat, and I don't like it.

I had a chat with someone today (who was sussing out my interest in joining a rival bank's team), and after the usual chat about how grossly underpaid I am, he goes "you're in a good position anyway, in 6-12 months you'll have more experience, then I assume you would want to naturally move to a larger IB". And I nodded, but in my head I thought, do I?

Oh how exciting. Now THIS has the potential to make politics interesting, irrespective of the new lows they happen to plumb over the next four years (click here).

I'm flying out to Japan tomorrow morning, and so probably will not be able to blog for the next three weeks. Not that you care.

Recruitment Season Part 2

I always hear stories from HR about the weird and wonderful applications people send in during recruitment season. I always thought they were a bit of a stretch, until recently when I, trying to be a good corporate citizen, promoted my company's graduate program in Asia to my contacts. They obviously then sent it on to their contacts, because I then received some choice emails from random strangers. It was quite an experience - if I was in HR, I would be compiling a "Most Entertaining Applications" collection, publishing it and making some money on the side. I don't really want to embarrass anyone through specific references, so instead I have compiled an imaginary FAQ for all would-be applicants from here on:

- Do we send applications to you? No... All applications must go through the website. I cannot forward them to HR for you, because it's against my beliefs.

- Are you the hiring manager? No... I wish I was, but the company won't give me a free holiday.

- Can you be my referee? For a price.

- So what good are you to me then? It's called "currying favour" to "get an edge" through "inside information". Geez, what DO they teach in university these days?

- I graduated more than 12 months ago OR I won't graduate until after 2008 - can I apply? No, because it means you are either too old (which probably means you are as jaded as veterans like us) or too young (which means we have to teach you how to make coffee).

- Are the work hours long? As long as my... deal flow list. More deals = more hours = more bonus money. Pick your poison.

- Will I get paid well? That depends on your definition of "well".

- Are the people nice? That depends on your definition of "nice".

- Do I get to work in Australia? Of course not. We are hiring graduates in Asia for the Asian outposts because it is cheaper than sending a more senior person there. If we brought you here, that cancels out the expected cost savings, doesn't it? Basic business analysis. Go back to school.

- Do I need a commerce/business degree? Yes. Although sometimes we tolerate second-rate physicists because they have mad modelling skills. And maybe the odd Arts graduate or two because they are hot.

- Do I need to be good at maths? No. That's what second-rate physicists are for.

- Do I need to be good at English? No. We have an in-house random word generator that we use for drafting approval papers and loan agreements. We hire expensive top-tier lawyers to spell-check for us (and sometimes tell us where the random word generator went wrong).

- What do I need to know then? How to play golf; how to laugh at stupid racist/sexist jokes made by really really rich people; how many ping-pong balls will fit into a Boeing jumbo jet; how I like my coffee (strong, one sugar).

Recruitment Season Part 1

It is that time of the year when final year students of all shapes, sizes and IQ levels try to parlay their expensive degrees into somewhat meaningful careers - thereby absolving them of the guilt and regret they might otherwise feel for having spent most of their university lives passed out.

Most hopefuls I come in contact with are considering accounting, finance (I hate it when people lump those two together - they are clearly different and only an ignoramus would think otherwise), law or consulting. Clearly the poster boys for "meaningful careers". I guess this is because these careers don't really require an understanding of string theory (of which we have none), but plenty of fleece theory instead (of which we are abundant in). It's also the fastest way to repay the student loans from your parents/the government. A Nobel Prize takes, what, at least 25 years of hard slogging, and you only get $1 million (which you'll probably have to share)? In commerce or law, you can easily get that in 20*.

Sometimes we get randoms from the Arts faculty who have somehow come to the conclusion that studying Turkmenistani philosophy makes them perfect investment bankers. Maybe so, but until they can prove they know how to securitise and hedge it, they will have to settle on being management consultants (which they invariably do).

In commerce and law faculties throughout the sunburnt country, students listen with eagerness as waves of investment banks, law firms and consulting firms ply their wares. Nothing much changed from back in my days. Common themes become obvious early on:

- every bank, law firm and consulting firm is Number One at something... #1 junk bond syndications team... #1 M&A advisory house ("OF COURSE you should take them over!")... #1 in "most number of recycled knowledge peddled out to clients for fat fees"... #1 in "most number of conflicts of interest"...

- every student will try to impress, even the lowliest analyst or legal clerk, trying to curry favour to "give them an edge" during the interview process. Analysts and clerks, despite their enormous workload, usually like attending careers fairs because they get to lord it over students. It's the only ego boost they will get at that stage in their careers.

- there will be at least one director/partner (invariably male) representing at the careers fair who will hit on a much younger hottie (invariably female). And they will get away with it. This will earn great hate and respect from all male students, motivating them to emulate said director's/partner's success (for better or worse).

- students will all try to ask questions which to them sound unique and intelligent... not realising that question has already been asked (probably originally by me all those years ago), is no longer unique, and makes you sound like a twat who doesn't deserve to even work as a doorman for any of these prestigious firms.

- firms will usually fall into two categories: those that boast about their "work-life balance", and those that scoff at it. The former will bait those Generation Y'ers who believe work is an optional activity, just like lunchtime soccer, yoga, and committed relationships. The latter will bait those who think they are "elite" and have no use for such nonsense as exercise, family, or the ability to make decisions without using nested IF functions, and hence don't need balance. Either way, the end result is eager beavers of today ---> rocket fuel for tomorrow.

Anyway, I was asked to participate in this year's carnival to represent my employer and paint it in glowing terms. As much as the afternoon off would have been nice, I declined for two reasons:

- another firm is still using their three-year-old brochures... and I'm in it. How you could justify using the same brochure when over half the people in it have left is a mystery to me. This has to be in breach of TPA or something.

- they stuffed up my original application... twice. I am still bitter over this.

As a compromise, I voluntarily promoted our graduate program via email to contacts, especially for the Asian offices. Actually this is rather interesting on its own, and deserves its own post later. For now, I must find some other distraction from this stupid game of chicken that we are playing with the client.

* Under certain unrealistic Modigliani-Miller-type assumptions.

There is a bit of downtime at the moment. We are putting the finishing touches to the board paper seeking approval for the deal we are working on. I hear there will be at least four, possibly six, board members sitting to listen and approve/decline the deal. This is not good. Normally there is only two or three. More board members means more brains thinking of ways to trip you up. This current downtime has the eerie feel of the eye of a storm.

Downtime has benefits beyond thinking of the multitude of ways your carefully crafted deal might fall over. For instance, I've been able to read more news, such as this (click here). This is shameful. If I were the president, this would never happen on my watch.

UPDATE

Had some tech difficulties at work, so couldn't publish the above post. Anyway, since the above was written, we had held the board meeting to discuss the deal. Seven board members participated in person or by phone. After fielding the expected questions, and managing to satisfactorily answer a left-field question (how do you prepare for a question on legal risks that arose from the board member being privy to confidential information on a similar business he happened to be an adviser to?), we received approval for our deal. Now we just need the client to accept the terms, and we are good to go... very relieved to have this deal go through.

Look who's come crawling back...

I am floundering here. Too much to learn. Too many variables. Model is ugly and does not flow properly, requiring me to fix them at every scenario change. Hence, not enough time allocated for frivolous (but entirely cathartic) blogging. Until tonight anyway.

Yes, I haven't posted for over two months of this fledgling blog. I will make a very bad father. A great uncle, maybe, the favourite uncle that buys lots of nice expensive presents and doesn't mind wearing the crappy pirate costume for impromptu comedy. But based on my ability to devote time to a newborn blog, and extrapolating that 20 years into the future, and adjusting for terminal value, the NPV of my fatherly instincts are almost zero. I contend it's not negative in an effort to convince myself it is worth improving, and also for the unproven correlation between blogging frequency and fatherhood.

Anyway, I have been working fairly average IB hours since starting in my new role. Actually we just finished writing up a deal, which has given me enough breathing time to be writing this entry up and then playing indoor soccer later tonight. OK "playing" might be an overstatement; my job is to dynamically occupy enough space so as to minimise the other team's score. I can't even call it goalkeeping... I think it's more akin to space-hogging.

New plan is to try and write short entries while waiting for a model to fall on my lap (the financial kind, unfortunately), or sipping my hot chocolate while updating myself on the news, and write the longer ponderings at home in front of the TV (note to self: multitasking is bad for you).

Let's see if we can keep up the new plan.

Rockett Trails

I found some interesting links, which will be a nice break from my usual tirade...


The Harvard Business School has an interview with Josh Lerner regarding the private equity boom. Click here for the podcast. Seems like an ominous term to use; in word association exercises, I associate "boom" with "bust" 100% of the time (although it doesn't apply as well vice versa).

The McKinsey Quarterly website has a few articles I found interesting. Find them here and here. (Requires registration to see full articles.)

DealBook had a short article on how the SEC (the Securities and Exchange Commission in the US) plans to curb the hedge fund industry, by making it more difficult to qualify as a "wealthy investor", by moving the minimum net worth from $1M to $2.5M. Only investors (which includes companies, partnerships and trusts) with a minimum $2.5M net worth can invest in hedge funds. My guess is that this will have very little effect. Even people who are nowhere near that level of wealth are already exposed to hedge funds... through their superannuation/pension funds.

Another DealBook article gives hope to that hardworking lot, the investment bankers, of finding true love in between spreadsheets and tender documents.

Finally, this is one of the best videos of 2006, so I'm putting it here. Watch this first... then watch this and this.

The big financial topic for 2007 (and hopefully, 2008) will be private equity. Or so says a number of top CEO's interviewed in a recent Australian Financial Review article.

The last year gave us great trophy deals: KKR jumping into Australia and buying the Cleanaway business, and painting a great big bullseye for other firms to aim at; the thwarted attempt at buying out one half of the grocery duopoly (Coles); the buyout of the Flying Kangaroo (Qantas); and so on.

It was also the year when people, having noticed the frequency that "private equity" and "leveraged buyout" was appearing in texts and flowing from everyone's lips, started to ask: what is it; is it good; and will it last. The year 2007 will have people sitting down with popcorn to watch and find the answer.

The "what" is easy. Imagine taking out a home loan. You put in a 10% deposit (more or less), and borrow the rest. You buy a house "with potential", you renovate, add bits and pieces, in the meantime paying the loan off using rent income or other income (most likely your salary). Then you pick a time to sell, and hopefully you sell at a nice profit.

For private equity, replace "house" with "public company", replace "income" with "operating cash flow", and there you have it.

The next two questions are much harder, and will depend on your perspective on the market. If you own a dog of a company, with bad management that you can't seem to get rid off, then a PE firm willing to pay a premium on the market price to take the company off your hands is a blessing. Same thing if you manage the company, are sick of the short-termism of the market, and have grand plans to make the company a success - if only someone would give you the capital and help you realise your dreams.

If, however, you are one of a (currently small but growing) number of people who believe the market is becoming/already is overvalued, then PE firms are to the market what petrol is to fire. Paying premiums for companies that are (in your belief) already overvalued is a sure sign that it's time to short some stocks. If you believe that most companies worth buying have already done all the cost-cutting and window-dressing that can be done, then PE firms will be buying companies that have no upside. If the market tanks during the typical 5-7 year investment horizon held by PE firms, then selling out at a profit (like selling a renovated home at the bottom of the market) will be almost impossible.

And of course, how long it lasts will depend on how long it takes until a major blow-up occurs and sends everyone running for cover.

This year will be an interesting one. Personally, I've been a believer in investments based on fundamentals. On one hand, I think PE firms do that: they buy firms with good foundations but mediocre structure or management, fix it up so the companies live up to their potential, and receive the rewards. They are the ultimate renovators.

But more and more, PE firms are paying higher prices, which to me does not seem like sound investing. It will reduce their ROI unless they do one of two things: borrow more as a proportion of the purchase price ("gearing up", which increases default risk), or somehow offload their investments to someone else at an even higher price. Whether that someone else is another PE firm or the public, whoever ends up with it will be playing a similar game of "pass the bomb" that was played in the late 90's/early 2000's during to dotcom bubble. But then again, I'm sure they know more than me, and that's why they're in the game and I'm not.

On the other hand, I've got to be feverishly optimistic about the prospects of PE in Australia, because my new job lives and dies by it. If the market tanks or PE firms go out of favour, the deal flow stops, and I sit there twiddling my thumbs (or worse, I lose my job and will have to go back to my old job).

At the end of the day, I believe PE is just like any other investment strategy: the asset has to be sound, the entry price low, and the exit price high. At the moment, I am beginning to wonder how much all three will hold up.