Wednesday, March 31, 2010

Martin Luther King wrote "The ultimate measure of a man is not where he stands in moments of comfort and convenience, but where he stands at times of challenge and controversy."

Certainly the last eighteen months merit the label "times of challenge and controversy." Measuring the men, women and our institutions by that standard produces an interesting roster of the tall and the short. Certainly one of the more visibly tall has been Federal Judge Jed Rakoff. He rejected the SEC/BofA proposed settlement as a "contrivance" that punished only the shareholders, the victims of the purported under-disclosure. He ruled the settlement "does not comport with the most elementary notions of justice and morality". Juxtaposed against Judge Rakoff's clear compass is the reincarnation in Washington, DC of Tammany Hall. Recent disclosure of "hands in the kitty" as trades for votes offer Darwinian evidence of why mankind is endowed with the ability to blush. A local girl's soccer league in CT was forced, due to aggressive parents, to switch to "silent sidelines" where no one is allowed to cheer. Perhaps Congress could consider a version of "silent sidelines" outside their corridors.

Less in the eye of the media, where abrogation of contracts seems to be a new federal sport, is the "measure" of individuals in the commercial arena. We have seen multiple situations where large customers have unilaterally modified long term agreements effectively telling small suppliers "Take it or sue me." The tendency to hide behind a lawyer instead of living up to one's obligation is increasing. Rather than reasonably settle differences the party with the more tenuous moral position tends to instead have their attorney dredge up arcane legal arguments and assert them as a smoke screen to obfuscate their actual behavior. Sadly, the system does not penalize lawyers for knowingly wasting time and money. We have seen this strategy in all aspects of our business as the economy has weakened.

The markets seem to have acquired a short term amnesia. In the past few months staple financing for as much as 6X EBITDA has returned. PE buyers are again offering to purchase companies with no financing contingences and with management option plans tied only to time and not to performance. Multiples for solid, but very unspectacular companies have risen to the 8-9X EBITDA range, perhaps testimony to PE capital with a short half-life. Lyondell Bassell, that just emerged from bankruptcy, recently completed a covenant "lite" financing! Equally stunning is the proposed strategy by some state pension funds to leverage their assets by as much as 20% in an attempt to boost returns. Certainly leverage can provide a boost in a rising market, but as 2008 illustrated, it tends to diminish returns per Neil Bohr's model of the atom. Since both the S&P 500 and the PE allocation of most state pension portfolios have healthy amounts of leverage it is an interesting measure of prudence to increase it. An additional harbinger of the future of our pension schemes was just reached as Social Security payouts, for the first time, exceeded deposits.

Perhaps the most quixotic PE conduct has been that of the founder of Terra Firma, Guy Hands. Leaving your family and friends in England for a different country, solely for the purpose of reducing your tax bill, is a mystifying priority. To maintain his status he cannot visit England for three years. Meanwhile his London based firm is guided by the Invisible Hands. Each day we see people working in our town who have left their families in Latin America so they can earn money to feed them. I doubt they would sympathize with Mr. Hands. Separately, Terra Firma has sued Citigroup for "tricking" them into buying EMI for $6.7 billion. Apparently, to keep this trick well hidden Citigroup loaned EMI $4.3 billion to complete the transaction. It is fascinating that the bid price levels are so easily modified by tricking and not by the fundamentals of the target company.

I’m Rob Morris and I approved this blog.

Martin Luther King wrote "The ultimate measure of a man is not where he stands in moments of comfort and convenience, but where he stands at times of challenge and controversy."