Harry Newton's In Search of The Perfect Investment
9:00 AM EST, Thursday, September 11, 2008: Lest
we forget. It was seven years ago this morning.
continued: In the old days, private equity funds and leveraged buyout
funds -- which are often the same -- routinely gave their investors 40% IRR
a year. These days are not those days. As part of my brilliant diversification,
I have money invested in a couple of these funds. My funds are run by brilliant
managers, whom I thoroughly due-diligenced (new verb). All the managers had
done brilliantly -- until I invested. I'm not entirely the King of the Declining
Industries, also called every fund manager's worst enemy. But -- let's put it
this way -- past performance is no guarantee of future performance.
mail brought a "Letter to Investors as of August 29, 2008"
from one of the funds. This fund has been around several years. The investments
it holds are theoretically now worth a miserable 4.6% more than what
we paid. Muni bonds have done much better. What happened? The Letter to Investors
I deliberately bolded
those words because I thought them particularly important. What is bringing down
companies today are inflexible capital structures -- some things to watch out
for. I don't know what word "optionality" means, but I can guess.
year has passed since the initial dislocation in the credit and capital markets
sparked a global repricing of risk. The financial crisis that has ensued has
continued to weigh on the health of financial institutions worldwide and has
led to a severe reduction in the availability of credit. At the same time,
further weakness in the housing market and inflationary pressures (particularly
higher oil and food prices) have negatively impacted consumer spending. As
a result, the U.S. And Europe have experienced an economic slowdown that is
likely to continue well into the second half of the year.
it relates to private equity, periods of market uncertainty are almost always
accompanied by a slowdown in private equity activity. Indeed, extremely tight
credit conditions have made financing new investments increasingly difficult.
However, despite market conditions, we continue to see some activity, particularly
in the small and middle-markets and in sectors such as energy and healthcare.
the magnitude and duration of the economic downturn, the pace of recovery,
and subsequent economic activity are difficult to predict. ... Clearly with
a softer economy and weaker stock market performance, valuations of certain
portfolio companies have come under some pressure. ...
believe what ultimately matters is how well the portfolio companies perform
operationally over the long-term and what valuation we realize upon exit for
these investments. To that end, we feel comfortable that the portfolio's diversification
and, in many instances, significantly flexible capital structures -- many
of which include long-tenored debt, substantial undrawn lines of credit, loose
or no maintenance covenants and/or payment-in-kind toggle notes -- help
provide the time and optionality for the portfolio to mature and navigate
the currently weak economic environment.
loans are blossoming: With capital tight, funds and companies are
turning to their shareholders for loans. Be wary. Remember you and I are not
banks. These loans (and their conditions) are often presented on a "take
or leave it" basis, often with balloon payouts many years hence. These
days I prefer regular dividend checks and investments I can sell from one day
to the next. Cash remains kings. I wish it paid a little more.
gamble. I've been pushing WaMu because my talented friend, Alan Fishman,
is WaMu's new CEO. That hasn't stopped the market from beating up on the stock.
It's down substantially since I recommended it. Personally, I saw it falling
after my recommendation and didn't buy. The New York Times had a piece on WaMu
Mutual Stock Falls on Investor Fears
As Wall Street scoured the financial industry Wednesday for the next weakest
link after Lehman Brothers, it set its sights on a familiar target: Washington
Mutual, the nations largest savings and loan.
Shares in the
troubled lender, one of those hardest hit by the nations housing crisis,
plunged 30 percent, falling below $3 for the first time since 1991. Investors
grew increasingly nervous that, like Lehman, Washington Mutual is running
out of time and options to save itself.
As losses from
subprime mortgages and credit cards mount, investors are increasingly concerned
that the troubled bank will be unable to raise fresh capital or find another
institution to take it over. A new accounting rule that would force potential
buyers to write down assets of target companies to current market value may
also dissuade a would-be acquirer.
And with the
Treasury Departments bailout of Fannie Mae and Freddie Mac fresh in
mind, even a decision over the weekend to replace the lenders chairman
of 18 years, Kerry K. Killinger, with Alan H. Fishman on Monday failed to
dispel concerns that the worst is yet to come.
only go on for so long, said Christopher Whalen, a managing partner
at Institutional Risk Analytics. If this goes on until the end of the
year, the bank is either going to have to be sold or recapitalized by the
government. Those are the only choices.
Mutual, executives were perplexed by what they saw as paranoia driving down
the stock, according to people briefed on the situation.
to hire Mr. Fishman, a veteran banker, had been seen as a way to clean up
the mess left by Mr. Killinger after a series of deals that built Washington
Mutual into a large but poorly managed lender. The bank had also reached an
agreement with the government that effectively put it on probation. But Washington
Mutual announced that its plans would not require it to raise capital or improve
Even so, investors
remain nervous about its financial health and believe the job may be too big
for Mr. Fishman. Washington Mutual is in a precarious position because it
has roughly $180 billion of mortgage-related loans, which could result in
$9 billion to $14 billion in losses this year, said Jaime Peters, a Morningstar
analyst. Losses in its big subprime credit card portfolio have ballooned.
rates continue to rise, WaMu could see charge-offs of 4 or 5 percent by the
end of the year, Mr. Whalen said. Their entire capital could be
It has been
15 years since any bank larger than $10 billion in assets collapsed. The largest
bank failure on record occurred in 1984 when Continental Illinois National
Bank and Trust in Chicago ran into trouble, presaging the savings and loan
crisis. Should Washington Mutual, with assets of $310 billion, find itself
in a similar predicament, the Federal Deposit Insurance Corporation would
take a crushing blow to its insurance fund.
In early March,
JPMorgan Chase sent a letter to Washington Mutual, urging it to consider a
deal quickly because the environment was becoming worse. Washington Mutual
balked, preferring to remain independent. A month later, Mr. Killinger turned
to TPG and several other private equity investors after it became clear that
the bank needed capital. The deal allowed Mr. Killinger to keep his job, but
many analysts said the bank would need another infusion.
the picture has only become more bleak. In the second quarter, Washington
Mutual posted its biggest loss ever, which sent shares plummeting. Its stock
price fell to just over $3 in mid-July, roughly 65 percent less than the $8.75-a-share
price that TPG paid in its transaction.
also had its credit outlook cut by Standard & Poors, the ratings
agency, this week because of its position in the housing market. The cost
to insure the companys debt rose to a record high Wednesday, another
sign that investors are increasingly nervous about the companys ability
to pay back its loans. Washington Mutual has $44 billion of debt that falls
due this year and $43 billion due between 2009 and 2014, Ms. Peters said.
Mutual needs to raise capital quickly, it will very likely find itself between
a rock and a hard place, because credit markets have all but closed their
doors to troubled banks.
TPG, the big
private equity firm, agreed to pump in $7 billion in June and might be a logical
choice to invest more. But with Washington Mutuals stock trading at
less than $3 a share, that investment has not turned out well so far. TPG
has a track record of being patient. Still, it is unclear whether it would
choose to double down on its bet or cut its losses.
plan would be for Washington Mutual to pursue a suitor. But there are few
banks healthy enough, or willing, to strike such a big deal. JPMorgan Chase
has long had its eye on Washington Mutual for its big retail branch network,
which would give it a foothold on the California coast and add to its heft
in the New York and Chicago markets. A JPMorgan spokesman declined to comment.
Even so, a change
in the accounting rules, effective in December, make that extremely difficult.
In the past, an acquiring bank would be able to record the value of the assets
of the institution it bought as a portion of the value that it paid for them.
Under the new rules, a bank must immediately mark them to where they could
be sold, causing any acquirer to absorb a big hit to its capital. That would
most likely force the buyer to raise fresh capital.
that you do that normally is by making it up through earnings, but here you
dont have that luxury, said Robert Willens, an independent accounting
As a result,
some in the industry have started to wonder whether the government might have
to step in. One option, similar to the approach taken with Fannie Mae and
Freddie Mac, might be for the government to agree to buy shares issued by
Washington Mutual. Some analysts said that would provide the capital to allow
the bank to get through the current problems.
be for the government to provide assistance with a sale, similar to the Federal
Reserve Bank of New Yorks approach in the JPMorgan-Bear Stearns merger.
Such a move would help reduce the blow to the acquiring banks capital
caused by a sale, and allow it to start benefiting from such a deal.
can get through this initial capital defect, you are going to be buying guaranteed
earnings for as long as the eye can see, Mr. Willens said.
I have faith in
Fishman. I know he wouldn't have taken the job if he thought he couldn't fix
it. I wouldn't bet the house on WaMu, but as gambles go, it's interesting. .
Australian humor at its best. In case you missed yesterday. This
little video clip tells the story of the oil tanker whose front fell off. Click
here. It's hysterical. Use Internet Explorer.
court help: Has anyone played on Nova-Pro Bounce and / or synthetic
grass with sand infill? What's your feelings about which surface you prefer
and why? Background: Four of us own an indoor tennis club in a metal building
with three courts, one of which is Har-Tru. It's been difficult. We're looking
to resurface the Har-Tru with a surface that's easier to maintain. Any thoughts?
As the old man lay dying, his wife of many
years was sitting close by his bed. He opened his eyes and saw her. "There
you are, Agnes," he said, "at my bedside again."
his wife said.
back," the old man said, "I remember all the times you were at my
side. You were there when I got my draft notice and had to go off to fight in
the war. You were with me when our first house burned to the ground. When I
had that accident that destroyed our car, you were there. And you were at my
side when my business went bankrupt and we lost every cent."
his wife said.
The old man sighed.
"I tell you, Agnes," he said, "you've been a real jinx."
"Start worrying. Details to follow."
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
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