Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
8:30 AM Friday, September 16, 2005: How
do private equity funds, also called buyout funds, perform? The answer -- not
brilliantly for their investors, but brilliantly for themselves. One of the
largest organizers of these funds is the Blackstone Group, formed in 1985 by
Pete Peterson and Steve Schwarzman. Here are their results gleaned from a 100%
accurate source I don't want to tell you about.
The most important
thing to note about these returns is that they are before the fees paid
to Blackstone for managing the funds. I don't know what the fees on these funds
were. But the fees on the new fund -- BCP V -- they're raising at present are,
in their words:
and expenses charged by the Fund are in addition to fees, expenses and carried
interest charge by BCP V, which will generally include an annual management
fee (1.5% of capital commitment up to $6.5 billion and 1% thereafter; the blended
management fee on an $11 billion fund would be 1.3% and 20% carried interest
after an 8% preferred rate of return."
means, according to my top-of-the-head calculations that a return of 14.8%
(see below) would be reduced to 11.38% after all fees. But that number
of 14.8%, which uses Blackstone's average, is way high. Here's my chart:
General Corporate Private Equity Funds have performed
Rate of Return*
My own calculation. This is before fees paid to Blackstone.
** Calculated over 7 years, which is my guess.
*** Calculated over 5 years.
**** Calculated over 3 years
Blackstone itself calculates14.8% "estimated adjusted net internal
rate of return (IRR) for realized and unrealized investments on this bundle
of funds. By contrast, shares of Warren Buffett's Berkshire Hathaway rose at
a compound annual rate of 29.2% from 1970 to 1995.
+ BCP stands for Blackstone Capital Partners
+ Results until 12/31/04
Blackstone says its results are great, compared to others of its ilk. But I
don't believe that it -- and many other big private equity funds -- actually
report their numbers publicly. They're comparing themselves against a few who
do and some guesses by various organizations. This chart is "iffy."
* Blackstone's name
for this chart
Communications Partners I
** Year it was formed
*** Sources: Venture Economics, National Venture Capital Association, Thompson
Financial Securities Data, 2004
The business of
running large private equity funds is enormously profitable. Let's form a $6.5
billion fund. Let's run it for five years. We will earn a management fee of
$97.5 million a year. If, at the end of five years the fund earns, let's
say, 14%, we will earn a "carry" fee of $78 million. Thus,
over the entire five years, we (i.e. Blackstone) will have earned $565.5
million. And remember we have other funds we're running, also.
I'm not knocking these numbers. Nice work, if you can get it. Here are the
reasons Blackstone says you should give it money for BCP V (which is now open):
Advantages in Large Transactions
|+ Fewer competing
||+ Often better
IPO for today's capital markets
|+ More efficient
to attract superior management talent
||+ More strategic
|+ More negotiated
deals (fewer auctions)
||+ More "fat"
|+ More corporate
able to weather downturns
|+ Lower relative
frequently gets the "first call" and "last look"
we amateurs aren't stupid: Delta and Northwest
have filed for bankruptcy protection. When a company files for bankruptcy, the
first to lose everything are typically the shareholders. Yet -- despite the
obvious, namely these companies were doomed -- a whole bunch of professional
investors have been buying their shares. From today's Wall Street Journal:
Who would be
foolish enough to buy up the shares and debt of struggling Delta Air Lines
and Northwest Airlines? Some of the smartest investors on Wall Street, that's
In recent months,
hedge funds including Ziff Brothers Investments LLC and Kingdon Capital Management
LLC, as well as money managers like Charles Schwab Corp.'s U.S. Trust Corp.,
Wellington Management Co. and Deutsche Bank AG all piled into shares of the
airlines, according to regulatory filings. And in recent days, a rush of hedge
funds bought up Northwest's debt, betting that the airline would avert a bankruptcy
Bad call. Northwest
and Delta both made voluntary Chapter 11 filings Wednesday. Delta's shares,
which hit $4 in June, yesterday were at 75 cents, up 5.6%, in 4 p.m. composite
trading on the New York Stock Exchange. Northwest tumbled 53% yesterday to
88 cents in 4 p.m. composite trading on the Nasdaq Stock Market, after trading
above $6 in June.
Ziff reported Aug. 10 that it had built a new position of almost 5.3 million
Northwest shares, or about 6% of the airline's outstanding shares. For its
part, Wellington established a new position in Delta during the second quarter
of this year, buying up 5.3 million shares, though the Boston-based firm reduced
its position in Northwest to 2.4 million shares from about 5.1 million in
the first quarter, according to regulatory filings.
Others got out
in the nick of time, though not without having losses. On July 28, large hedge
fund SAC Capital Advisors LLC said it had added 2.8 million shares to an existing
2.1 million-share position in Northwest, while on July 14 SAC reported that
it added 5.8 million shares to a 3.7 million stock position in Delta, according
to FactSet Research Systems Inc. People close to the firm say SAC exited these
big positions a few weeks ago, selling Northwest stock when it was still around
$3 a share, avoiding some of the pain. But SAC still lost money on the trades.
provide a snapshot of holdings on a certain date, of course, and the investors
may have adjusted their positions, or offset them with other trades. Still,
all the buying is surprising because it came in the face of persistent worries
about the impact on airlines of hefty fuel and labor costs, onerous pension
obligations, strained union relations, brutal competition and a history of
well-regarded hedge funds getting burned by betting on airlines.
of Ziff, Kingdon, Deutsche and Wellington declined to comment.
So what were
these guys thinking? Some of these investors say they were hopeful that Northwest
could forge a closer relationship with it unions, helping to send shares close
to $10. Others viewed the investments as inexpensive ways to bet that oil
prices would fall. Had jet-fuel prices dropped, instead of soaring after Hurricane
Katrina, the airlines would have been much healthier, and the stocks likely
would have climbed. Indeed, shares of other airlines, such as AMR Corp. and
Continental Airlines rose over the summer as business travel picked up.
The days leading
up to Northwest's bankruptcy have seen particularly strong buying of the airline's
debt, traders say. One reason they had hope: Northwest never arranged debtor-in-possession
financing from creditors, usually a precursor to a bankruptcy filing, suggesting
to the investors that the airline wasn't about to file. Northwest has said
that it decided against a DIP because it believes it has sufficient cash and
most of its assets already are pledged.
investors are trying to establish large positions to gain a seat at the table
when the airlines' fates are negotiated. Still others are hoping that the
airlines could end up merging with rivals or think Congress will step in to
provide pension relief.
in the debt was heated, as some traditional money-management firms and mutual
funds sold bonds, while some investors covered short positions, or bets against
the price of the bonds, by buying back the debt. In recent weeks, others traded
"recovery swaps." These new instruments are an obligation to buy
the cheapest bond within 30 days of a default, an attractive investment for
those convinced that the value of the debt will rise during the bankruptcy
most heavily traded bonds, those maturing in 2008, traded at about 24 cents
on the dollar yesterday, down from 26 cents late Wednesday and from about
34 cents last week. Though the equity of the airlines likely will be wiped
out, there likely is some value to the bonds at these levels, some say, because
the bonds will be converted into equity in the airlines when they emerge from
guess the value of jet fuel in 18 months when the airlines emerge, but there
is some value to the bonds at these levels," said David Feinman, managing
director at Havens Advisors LLC, a New York hedge fund. He says he hasn't
yet purchased debt of the airlines, though he has wagered against the shares
of the carriers. "But you better have a strong stomach and a lot of patience
to get involved at this point."
That hedge funds
continue to place big bets on airlines is somewhat surprising given the poor
track record many of the best in the business have in divining the future
of this notoriously challenging business. Legendary investors Michael Steinhardt
and Julian Robertson both suffered big losses from stakes in US Airways Group.
Warren Buffett made money investing in US Air but not before writing off 75%
of its value and calling it a "mistake." Carl Icahn had a difficult
ride after gaining control of Trans World Airlines in 1986. In all, more than
100 airlines have filed for bankruptcy in the past 25 years.
exits at Microsoft: As a stock, it's all over for Microsoft (MSFT).
The stock is going nowhere fast. (I've written this before.) The company has
become excruciatingly slow and ponderous, with new products delayed and delayed.
This weekend's Business Week's cover story reports:
For most of
its three decades, Microsoft has faced intense criticism. But in the past
it came from the outside world. Now much of the sharpest criticism comes from
within. Dozens of current and former employees are criticizing in BusinessWeek
interviews, court testimony, and personal blogs the way the company
operates internally. More than 100 former Microsofties now work for Google,
and dozens of others have scattered elsewhere. Microsoft certainly is chock-full
of smart employees who want to do better. Still, many of them say that jumping
through bureaucratic hoops and struggling to link products together is preventing
them from being the best they can be. Theres a plea for action to Gates
and Ballmer to do more slash the bureaucracy, tend to morale, and make
it easier to innovate. But is anyone listening?
Four surgeons are discussing who has the best patients to operate
The first surgeon
says, "I like to see accountants on my operating table because when you
open them up, everything inside is numbered."
The second responds,
"Yeah, but you should try electricians! Everything inside them is color
The third surgeon
says, "No, I really think librarians are the best; everything inside them
is in alphabetical order."
But the fourth
surgeon shut them all up when he observed: "You're all wrong. Politicians
are the easiest to operate on. There's no guts, no heart, no balls, no brains
and no spine, and the head and the ass are interchangeable."
A woman from Los Angeles, who was a tree hugger and an anti-hunter,
purchased a piece of timberland. There was a large tree on one of the highest
points in the tract. She wanted a good view of the natural splendor of her land
so she started to climb the big tree. As she neared the top she encountered
a spotted owl that attacked her.
In her haste to
escape, the woman slid down the tree to the ground and got many splinters in
her crotch. In considerable pain, she hurried to the nearest doctor. She told
him she was an environmentalist and an anti-hunter and how she came to get all
the splinters. The doctor listened to her story with great patience and then
told her to go into the examining room and he would see if he could help her.
She sat and waited three hours before the doctor reappeared. The angry woman
demanded, "What took you so long?"
He smiled and
then told her, "Well, I had to get permits from the Environmental Protection
Agency, the Forest Service and the Bureau of Land Management before I could
remove old-growth timber from a recreational area. I'm sorry, but they turned
+ Manhattan Pharmaceuticals: Click
+ NovaDel Biosciences appeals. Click
+ Hana Biosciences appeals. Click
+ All turned on by biotech. Click
+ Steve Jobs Commencement Address. The text is available:
Click here. The full audio is available. Click
+ The March of the Penguins, an exquisite movie. Click
+ When to sell your stocks. Click
This column is about my personal search for the perfect
investment. I don't give investment advice. For that you have to be registered
with regulatory authorities, which I am not. I am a reporter and an investor.
I make my daily column -- Monday through Friday -- freely available for three
reasons: Writing is good for sorting things out in my brain. Second, the column
is research for a book I'm writing called "In Search of the Perfect
Investment." Third, I encourage my readers to send me their ideas,
concerns and experiences. That way we can all learn together. My email address
is . You can't
click on my email address. You have to re-type it . This protects me from software
scanning the Internet for email addresses to spam. I have no role in choosing
the Google ads. Thus I cannot endorse any, though some look mighty interesting.
If you click on a link, Google may send me money. That money will help pay Claire's
law school tuition. Read more about Google AdSense, click
here and here.