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.