Private equity's first casualties

After the mauling the BVCA got at the select committee evidence session this week, it's no surprise to see that head of the organisation has been drop-kicked. Officially he has stood down, but there are few doubts that he was given a major shove, rather than jumping himself. As the Torygraph opines, this is a bad time for the trade body to lose its leader.

Notably the CBI is now sniffing around the buyout firms. Undoubtedly the CBI could do a much better job of lobbying on behalf of the industry (it would be pretty hard to do a worse job). But I wonder if it is really a sensible move on the part of the CBI. The unions have successfully created a popular image of private equity as super-rich robber barons, does the CBI really want to be associating itself with that?

Casualty number two is the tax treatment of carried interest. Any hopes on the part of PE professionals that this would be left untouched must surely be dashed now that Sir Ronald Cohen has argued the case reform. Cohen is the (politically) acceptable face of the industry, and a friend of the Government. If he is talking this language the writing is surely on the wall. See the FT report.

Private equity takes a pounding

Has the wind finally shifted in the debate about buyout activity? It certainly looks like it. Yesterday a range of groups (including the TUC) were giving evidence to the Treasury select committee about private equity. From the press reports it sounds like the BVCA got a real shoeing.

Reports in the Grauniad, Indie, Times and Torygraph all tell the same story. Reading the runes, I wouldn't want to bet against changes to the way that carried interest is taxed. The industry might bleat that their stars will move elsewhere, but I suspect that the patience of regulators around the globe at the PE industry's "and we're talking our ball with us" attitude is wearing thin.


Plug Alert!

Thanks to Naomi for providing me with the direct link to the GMB's stuff on insolvent pension funds at PE-backed companies. Here it is -

http://www.gmb.org.uk/Shared_asp_files/GFSR.asp?NodeID=95553

Wrong thinking on directors' pay

I came across this piece in the Telegraph whilst I was on holiday. I can't think of a bit of commentary recently that I have disagreed with so much (apart from the Indie editor's response to Blair's speech on the media today!).

Here's the first bit I don't like -

The shock is that Richard Lapthorne, chairman, and his management team, have doubled the value of the company over the past 12 months, adding £2bn to the value of the pension funds which own it.

He is ascribing increase in share prices to management competence. The more I learn about the stockmarket, the less I am willing to believe that share prices are anything more than a consensus of ignorance. I am wary of attributing movements in the price to anything more than trading activity, so I do not believe you can stand up the claim that the C&W management have created money for pension funds. the shares have gone up - that is all.


Second gripe -

If someone had called me this time last year (never mind in the dark days before that), and said C&W could consistently be in the top three of the world's telecoms businesses I would have hung up assuming they had got their lines crossed.

Another insight I have gleaned from my geeky interest in behavioural economics is our poor ability at interpreting stastistics. A good example of this is reaction to failures. If a football team gets walloped 5-0 in one game, and the manager makes changes to the team and next time they win 1-0 he might be hailed as a turnaround expert. But in reality it could just be the randomness of the data. After a heavy defeat (or an extreme event if you prefer) the probability is that the next result will be less 'extreme'. It is likely to be so regardless of what activity is undertaken.

However because of our desire to see causality when it is isn't there, will likely attribute a modest victory following a major defeat to tactical nous (unless we are talking about Steve McClaren). There is no reason why this should not apply to businesses. Unless you believe that C&W was a basket-case, it was likely to turn the corner after a dodgy period, that's just the randomness of reality.


Gripe 3 -

The shock is that management, notably John Pluthero who runs C&W's UK business, have already got so close to reaching all their targets that a £20m cap on how much he can receive, has been removed. It's easy with hindsight to say that those targets must have been too soft when agreed last year. Well actually no, they weren't soft, and no one said they were.

Wow, so the company looks liek hitting targets that it set itself. And how can we say whether the targets were "soft" or not except with hindsight? I'm also presuming that his "no-one" here is a reference to analysts, who are not celebrated for their ability to predict the future. Directors themselves will tell you that they manage down analysts' expectations in order to ensure they can hit targets.


Gripe 4 -

What's shocking is that more companies don't align management and shareholders' interests more closely and that shareholder groups, such as the Association of British Insurers, don't insist on it.

Eh? Quite clearly the big shareholders have spent a lot of time trying to do precisely this over the past few years. Has he slept through that? Either that or the "point" is that shareholders aren't suggesting packages like the C&W one often enough, In other words we aren't paying our directors enough money.


Gripe 5 -

At least C&W's biggest shareholder, Standard Life, has come out in support of the plan. More should follow.

I will resist questioning Standard Life's motives on this one, as corp gov people I have met there have always struck me as very straight. However the support of one institution proves nothing.

And finally - where in all of this is any recognition that the success of C&W recently is the result of the efforts of anyone below board level?

Investment charlatans

Interesting bit on the back of FTFM today -

Get real on investment charlatans
By Jonathan Davis

Published: June 11 2007 12:12 | Last updated: June 11 2007 12:12

Can the business of investment really be dominated by charlatans? In a provocative new book, entitled Black Swan, Nassim Nicholas Taleb says, in as many words, that the answer is Yes.

The arguments he advances in support of this claim are, it may pain some readers of these pages to hear, remarkably convincing. In fact many of his arguments are beyond rebuttal.

Forget for a moment, however, the pejorative connotations that the word “charlatan” has in common speech.

Mr Taleb, who made a name for himself with an earlier book, Fooled by Randomness, in which he castigated human beings’ capacity to see meaningful patterns in random data or events, is no stranger to self-regard.

You have only to read a few pages of his latest book to discover the pleasure he takes in the rage that his ideas are prone to incite in others, notably self-important Nobel Prize winners in economics.

Yet such ad hominem weaknesses should not detract from the force of his arguments. If you define a charlatan as someone who promises (and is paid for) results that he or she knows cannot in reality be delivered, the allegation need not reflect poorly on the integrity of the professional involved. It is perfectly possible to go about your business with the best of intentions and the loftiest of motives, while continuing to be a pedlar of false promises, simply because your job is undoable.

Economic forecasters, for example, are in this position much of the time. They make forecasts not because they know, but because they are asked. So what, if they are likely to be providing an illusory comfort blanket to investors and businessmen? Fulfilling a demand for bogus precision about an unknowable future is a service of sorts, even if the results rarely stand up to intensive scrutiny – which, interestingly, they rarely are given.

The reason that Mr Taleb’s new book should be required reading for all would-be investment professionals is not because of his scorn for self-righteous seers of all types, entertaining though his many asides can be. (“Being an executive does not require very developed frontal lobes, but rather a combination of charisma, a capacity to sustain boredom and the ability to shallowly perform on harrowing schedules. Add to this task the duty of attending opera performances!”)

The real reason for saying Black Swan is a powerful antidote to most received wisdom on investment is that its subject is a fundamental issue that confronts anyone involved in financial decision-making, namely how to confront the limitations of knowledge and the human mind in processing and acting on unreliable information in conditions of complex and persistent uncertainty.

Mr Taleb’s biggest bugbear is the academic community, with its attempts to impose models on financial markets that are built on entirely false and unrealistic premises, such as that returns in the financial world are normally distributed. Even though this is patently not the case, models built on probability theory, what Mr Taleb calls “the ludic fallacy”, the idea that markets follow the same rules as a game of dice, are still the basis of most finance theory that is taught in business schools.

The black swan of his title is an unexpected “fat tail” event of the kind that emerged to confound Long Term Capital Management and Amaranth, among others. In the latter case, he notes drily, only days before its demise the fund had written to its investors urging them to take comfort from the fact that the firm now had 12 “risk managers” in place. (In the same spirit he quotes a letter from the captain of the Titanic, boasting that he never expected to be involved in a dangerous incident at sea.)

Mr Taleb’s point is that the most important events in the financial world, the ones with the greatest consequences, are almost always “fat tail” events that are not and often cannot be predicted.

If 9/11 had been foreseen, it would surely have been prevented. These trend-breaking occurrences are the ones for which investors must be prepared, even if they cannot hope to predict them.

In Pasteur’s words, “luck favours the prepared”. Those who think that regressions and correlations based on past data are a guide to the future, however perfect the fit, are guilty of wishful thinking. Being able to live with rare events that nevertheless have seismic consequences is uncomfortable, but it is the mark of the true risk manager in finance.

Yet by a strange irony, notes Mr Taleb, those who think of themselves as conservative financiers are often the most blind to risk, such as the senior bankers who saw the entire cumulative earnings of the banking system to that point wiped out in the international debt crisis of the early 1980s.

The literature of scientific discovery and behavioural finance, on which Mr Taleb draws freely, helps to explain why in practice human beings prefer to impose comforting retrospective order on events that in reality are more random and non-sequential than the mind likes to pretend.

It is hard to think of any subject that is more relevant to fund managers and stockbrokers, who work in a business where reality and marketing perceptions are often widely divergent.

The fundamental pitch that both trades make for some kind of forecasting ability is demonstrably false, certainly at an aggregate level and often in individual cases as well.

It is small wonder if cognitive dissonance is commonplace among those who make their living by pretending that they have some superior insight into the future, while daily confronting the reality that in practice their understanding of risk is partial at best.

Private equity round-up

Plenty of news on the PE front while I have been away on holiday. I even managed to catch up on some Telegraph coverage whilst on the beach. Here are a few snippets...


GMB report on private equity and pensions

Interesting report looking at the correlation between private equity ownership of companies and insolvent pensiobn schemes.


Government looks at tax treatment of PE earnings

Apparently they are going to review the taxation of carried interest. I'm surprised this has happened, but it's a good news. Seem to have been given weight by this bloke from the industry.


FSA update
A follow-up on the previous FSA report.

Wal-Mart is "too PC"

Well, it is Friday. Just a glimpse of shareholder democracy US-style, this American outfit has been targeting Wal-Mart for "turning to the Left" (chuckle). Their main bloke spoke at the company's AGM today -

NLPC to Criticize Faltering Wal-Mart Share Price at Company’s Annual Meeting; Ethics Group Says Attempt at Political Correctness is Distraction for Management

Date: May 31, 2007
Contact: Peter Flaherty 703-864-7902 or John Carlisle 703-798-0655
Website: www.nlpc.org

Falls Church, VA- The National Legal and Policy Center (NLPC) today released excerpts of remarks NLPC President Peter Flaherty plans to deliver at the Wal-Mart (WMT) annual meeting taking place on Friday, June 1 at the Bud Walton Arena in Fayetteville, Arkansas. NLPC is the sponsor of a shareholder proposal asking for the company to disclose its charitable giving to controversial causes.

From Flaherty’s statement:

In the year 2000, Wal-Mart stock was at $60. Today it is $47. In 2000, Target stock was at $34. Today it is at $60.

Instead of focusing on the share price, Wal-Mart management is too busy trying to appease critics funded by corrupt unions.

Go outside and look at the price of gas. It is over $3 per gallon. Thank environmental extremists who have prevented refineries from being built. They openly say that gas should be much more expensive, say $5 or $6 a gallon. Yet our CEO has embraced environmental alarmism. If Wal-Mart customers spend all their money on gas, how will they have any left to spend inside the store?

Our CEO invited Al Gore to Bentonville to talk about global warming. If Al Gore gets his way on carbon emissions, there is no way our economy can grow. How is this good for Wal-Mart?

Jesse Jackson slanders this company. The company’s response? Put Jesse Jackson’s crony on the board of directors. Did that shut up Jackson? No, not at all.

People shop at Wal-Mart because of low prices, not because the company is politically correct.

In December, NLPC released a special report titled Wal-Mart Embraces Controversial Causes: Bid to Appease Liberal Interest Groups Will Likely Fail, Hurt Business. The 11,000-word report is authored by John Carlisle and may be downloaded in pdf format at http://www.nlpc.org/pdfs/Wal-MartSpecial%20Report.pdf

NLPC promotes ethics in public life, and sponsors the Corporate Integrity Project.

Boots trustee attacks board

Interesting report on the Thomson investment managemet news site. This site is (currently) free to register so worth checking out.

Alliance Boots board takes flak from pension scheme chairman over KKR deal

LONDON (Thomson IM) - The board of Alliance Boots PLC came under attack today from the chairman of the health and beauty group's pension scheme, John Watson, for recommending an 11 bln stg offer from US private equity firm Kohlberg Kravis Roberts (KKR) and executive deputy chairman Stefano Pessina without ensuring the scheme's future planning and funding.

At the Court Meeting and Extraordinary General Meeting, convened to rubber stamp the 1,139 pence agreed offer, Alliance Boots' chairman Sir Nigel Rudd also drew flak from small shareholders opposed to the deal.

Their opposition was, however, in vain as the deal was overwhelmingly backed by investors.

Acceptance of the offer means Alliance Boots shares will de-list on June 28 -- the group becoming the first FTSE 100 company to fall into private equity hands -- less than a year after it was created through the merger of Boots Group PLC and Alliance UniChem PLC.

Watson, chairman of the Boots Pension Scheme since 1998, said he was 'disappointed' the board had backed KKR/Pessina's offer before agreement had been reached on how to fund the scheme's current deficit of 305 mln stg.

'I take no pleasure in coming to this meeting and asking a question,' he said, reiterating the trustees view that a new private owner taking on 8.2 bln stg of debt has 'serious implications' for the position of the scheme.

He said that, although meetings with KKR/Pessina were proceeding, no satisfactory agreement has yet been made.

'What will you (the board) do to influence ... to give the scheme the support it deserves,' he asked Rudd.

The chairman responded by saying he had been assured by KKR/Pessina that the Boots scheme will continue to be one of the best funded in the sector.

'You have my assurance that over the next two or three weeks I will be pressing for a resolution,' he said.

A spokesman for KKR/Pessina confirmed that talks with the trustees are continuing. 'We'd like to think that both parties are working to a constructive conclusion,' he said.

He declined to comment further. However, industry sources suggested the gap between what the trustees want and what KKR/Pessina are prepared to give is not huge -- tens of millions of pounds rather than hundreds of millions of pounds.

UPDATE - There is a piece about this in today's FT too -

The Kohlberg Kravis Roberts-led takeover of Alliance Boots looks poised to become a key test of the Pensions Regulator’s powers to protect company schemes after the buy-out was backed by shareholders but without any agreement on filling the fund’s deficit.

At a thinly-attended shareholder meeting on Thursday, John Watson, chairman of the board of trustees of the Alliance Boots pension scheme, said it and the consortium had not yet reached agreement on additional funding.

Mr Watson said the trustees “have made it clear that the borrowings in excess of £8bn being taken on to finance this acquisition have serious implications for the scheme”.

He said: “We have still not reached a satisfactory agreement, which inevitably gives trustees serious worries about the future.”

One pensions lawyer said the dispute was “shaping up to be the showdown at the OK Corral”.

Pensions lawyers believe that KKR, which has not yet received “clearance” for its transaction from the pensions watchdog, will challenge the latter’s ability to insist trustees negotiate up-front payments from employers to fund deficits.

The rules only apply to transactions that are structured to avoid paying pension liabilities.

The regulator recently issued guidance urging trustees to seek clearance – a procedure that absolves them of personal liability in the event the employer later becomes insolvent – when corporate transactions pile on heavy new debts.

However, lawyers said the regulator’s ability to do so, while enshrined in the general spirit of the Pensions Act of 2004, was not specifically written into it.