Andre J. Peschong

Why are private equity investors sniffing around the Lehman Bros. deal?  The unlikely match is because private equity funds currently have all the money.  Year over year for the last three years private equity has had record breaking capital raises.  This is not just a domestic phenomenon, but a global one.  Private equity has become a main stay investment vehicle in the global marketplace.  Helped out by extremely large Sovereign wealth funds raising astronomical amounts of capital, private equity is flush with capital. 

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The US economy is retracting, jobless claims are increasing, consumer confidence is dwindling, the housing market is cratering, oil prices are skyrocketing and the credit markets are tightening.  Almost makes you want to stay in bed and pull the covers over your head.  If you take in all this news and data about what is happening in the US and around the world it is enough to make any sane person curl into the fetal position.  People are trying to get some form of normalcy back in their lives and at every turn a new twist seems to leap out.  Wait, there’s more! Airlines are going out of business with no forewarning, oil is marching to new highs almost every day and the dollar continuously hits new lows.  As I write these down in one paragraph I can see why these events are shaking people to their core.  All of this happy news now coincides with more uncertainty,  an election year which will prove to be an all out battle between McCain and Obama.  If there is one thing the markets dislike it is uncertainty.  I suppose that goes for Joe Q. Public as well. Have I depressed you enough yet?

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When it comes to deals, I have always wondered when you take a step back and look at the whole picture if things seem more in focus or just more chaotic.  Sometimes you can be so close to a deal or an industry that you lose your macro perspective and cannot always find the answer even when it’s right in front of you.  The great players in history have been extremely focused and are detail oriented but they also had the unique ability to stand back and see the big picture. 

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I have always asked myself what makes a deal successful, not a company but a deal, or maybe better put, a transaction. Private equity and VC’s alike are merely doing transactions with a longer term horizon than investment bankers, brokers or even angel investors. At the end of the day a deal is a deal because if it wasn’t then there would be no need for “exits.” What is so important about exits? There is an old market saying that goes, “any idiot can buy a stock, its knowing when to sell it that makes him successful.” But I digress. Back to the three pillars theory (which has only been a working theory since the time I wrote it down two minutes ago.) Basically, there are really three parts to any transaction. These are security, structure and exit. I’m amazed at how often we see deals that don’t have these pillars in place. Without them, it is sure to be a failure, so pay attention! Let’s look at these parts separately while keeping the pontification and soapboxing down to a minimum. Before anyone, be it professional or not, looks at a deal the first thing they do is gauge the risk and see how it can be mitigated.
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I just attended the LAVA(Los Angeles Venture Association) conference which was held at a very unique, old school hotel that was completely refurbished called the Millennium Biltmore Hotel. It is interesting because over the years LAVA has had its moments when the who’s who of finance showed and deals were getting done and other times when it seemed like an elephant graveyard. Well, I can tell you that this was one of the go-go times of deal making. The conference was extremely well attended and by a very diverse group of people, not just the usual “service providers.” Venture funds were well represented and so where institutional groups such as hedge funds, private equity and the APO (Alternative Public Offering) groups. This is where I felt the real winds of change…

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While oil continues its meteoric rise into uncharted price territory, the real story is how this is playing out with consumers. Plagued by an anemic economy and the lowest consumer confidence index in the last 16 years, the people at the pump are being hit especially hard. When gas reached $3 last summer most consumers looked at it more as a fluke than a trend and did not adjust there driving habits accordingly. With gas pressing past $4 per gallon and with the realization that $3 gas was actually cheap; consumers are finally starting to change their spending habits.

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When the internet bubble popped back in March of 2000 there was a lot of lost footing and confusion, including a bunch of shell shocked venture capitalists, private equity guys and, of course, investment bankers who were walking around dazed, asking one key question, hoping to rescue their future… “What is the next big thing?”

When I talk about “big,” I mean really big, in the context of changing the landscape of the capital community and, in turn, changing the mind set of people changing the way they live.  To explain a little better, let’s look at the “last big thing,” the internet.  The internet certainly provided the type of changing landscape that I’m referring to.   As a powerful and robust catalyst, providing the masses cheaper, faster and better experiences, the information highway changed the way we do business, buy consumer goods, communicate and more.  On a fundamental level the internet changed the way we operate on a daily basis.  It is this type of paradigm shift that I am referring to when I speak of a “big thing.”  

Getting back to the next big thing, we needed a catalyst that was backed up by an event or events.  .  In my opinion, Al Gore was that catalyst.  Through his film, An Inconvenient Truth, he brought attention to the masses on the global warming issue.  Coupled with the  rapid global economic acceleration fueled by China and India’s torrid rate of growth, we see the next big thing taking shape: alternative energy sources.   The massive and rapid growth of China and India has strained consumption of basic resources such as copper, steel, cement and oil which means substantially higher costs for these resources.  We are particularly feeling the pinch of oil prices here in the US (we have jumped from approximately $20 per barrel to over $100 per barrel in just three years,) which is the final and strongest catalyst for seeking alternative fuels.  Al Gore started the beating of the drum and it was validated by rising commodity prices and has been brought to a fever pitch by oils meteoric rise.  The world has suddenly realized that natural resources are finite and we should figure out a way to save the planet. 

Alternative energy, whether it be solar, ethanol, biomass fuels, bio diesel, wind power generation, hydro-electric plants, or electric cars, will fundamentally change the investment landscape and subsequently trickle down into lifestyle shifts. Take a minute to think about all of the industries that are now in business to support these endeavors, there is a massive market opportunity.  The world (or at least the United States) has woken up and has jumped on the “green” wagon.  To get proof of this fact, simply follow the money.  A substantial shift is occurring within venture capital, private equity and to some extent, hedge funds.  Capital is being deployed in this green/alternative energy initiative at a very rapid pace.

Some outside pundits say that this space is getting over heated and everyone is trying to throw money at any company associated with the green space, but from what I see, that is not the case.  The alternative energy space is extremely large and can include many different types of technologies and companies, and is attracting some very serious attention from major capital players.  Trust me, I haven’t traded in my SUV or put solar panels on my house yet, but I think there is really something to this trend and believe we will see another major paradigm shift in the next few years. I will continue to follow this space closely and will have follow up articles and interviews with key people and companies. 

Woke up bright and early on Friday morning for this interview on NY’s Mike Norman Show.  We discussed my take on the Bear Stearns bailout.  Listen to my two part interview here:

http://www.dealflowdiaries.com/mp3s/audioplayer.htm

Select “BizRadio 04-11-08″ and “BizRadio 04-11-08pt2″

It seems that everyone I talk to on Main Street is all concerned and angst ridden towards the government’s bailout of Bear Stearns.  They are angry because they believe the government is supporting big business and even worse, they are supporting Wall Street big business.  It is interesting to hear an everyman’s perspective on something that is so extremely complex and has ramifications that the brightest in the financial community cannot really fathom yet.  This is a very polarizing issue and one that probably has been brought to the surface because of the weak and uncertain economy coupled with election year upheaval. 

What people fail to understand is that the government cannot let Bear Stearns fail!  Why?  It would literally be a massive domino effect that has the potential to lay waste to the fabric of our capital/free market system.  Elizabeth MacDonald at Fox Business explains it well in her article: The Brinkmanship at Bear Stearns.  To put that last statement into perspective the US government issues bonds which have the highest rating possible. What are these bonds backed with?  The answer is nothing but the full faith of the United States government.  What happens if the people lose faith in government, which means the world loses faith that means the bonds tumble, the US credit rating sinks, and we see the dreaded domino effect.

In the case of Bear Stearns, they were utilizing yield enhancements, which is a fancy phrase for using leverage, and a lot of it, with the CDO products (Collateralized Debt Obligations). This is not an unusual practice, as most hedge funds implement yield enhancements. However, the sheer amount of CDO’s that Bear Stearns was holding as not only a principal but also as a clearing firm and a prime broker for other hedge funds was staggering.  Additionally,  the amount of leverage used was enormous. 

As a result,  basic supply and demand issues really came to play in the governments’ decision for a “bailout”.    If the government had not guaranteed the Bear Stearns debt for JP Morgan’s buyout offer then the deal never would have taken place. Bear Stearns would have gone into liquidation, which would have literally dumped the assets of the company onto the street where buyers were extremely scarce to begin with.  This devastating domino effect would have led to a complete meltdown in the mortgage securities market which would have dumped a massive amount of foreclosures onto an already saturated real estate market thus compounding the pain to individuals and so on and so on… you get the idea.  Sometimes discretion is the better part of valor.  If in fact there was no quick and decisive decision by the Fed to guarantee the debt the hardworking people on the street would have suffered the most.  There  would potentially have been a run on banks, companies folding because of no liquidity, housing prices plummeting to all time lows and unemployment rates exceeding 10- 15%. 

What the Bear Stearns “rescue” has really done is allowed the government to come into these massive investment companies with more rules and regulations similar to the Glass-Steagall Act in the banking sector.  This will create more bureaucracy but in the long run should minimize another potential domino effect.  History has given us some lessons…we should learn from them. 

I was recently interviewed on BizRadio’s Brent Clanton Show on the current real estate market as well as Angel Investing.  Listen to my interview here:

http://www.dealflowdiaries.com/mp3s/audioplayer.htm        

Select “BizRadio 03-28-08″