Saturday, March 30, 2013

A Saga Worthy of an Investment Bank: Steve Alford Bolts the University of NM

A Saga Worthy of an Investment Bank: Steve Alford Bolts the University of NM

As you watch student athletes run up and down the court in the Elite Eight round of the NCAA Men’s Basketball Championship, the business side of this “amateur” sport has produced another ugly chapter.  Athletic programs are subject to all kinds of picayune rules, and the NCAA drums athletes out of college for relatively small violations.  Meanwhile, coaches operate by ethical standards that are worthy of Wall Street.  While University budgets are being slashed, basketball coaches are reeling in millions of dollars.

Despite losing to Harvard in the first round of the NCAA Tournament, Steve Alford has led the University of New Mexico to a series of conference championships and tournament appearances.  Earlier this week, the University rewarded the coach with a ten-year contract extension. In reaching this extraordinary agreement with the University, Mr. Alford said:

“There is no other place I would rather coach than at UNM, representing the best fans in the country.  I appreciate all of the efforts of my staff and student-athletes over the last six years in building a championship program.”

The agreement was to go into effect on April 1st.  However, while the ink was drying on his new agreement, Mr. Alford was off in Los Angeles talking to athletic officials at UCLA.  This morning, Mr. Alford signed a 7-year, $18.2 million contract with UCLA.  Mr. Alford didn’t have the decency to call New Mexico’s Athletic Director, Paul Krebs.  Rather, he sent him a text message informing Mr. Krebs of the deal.  In leaving New Mexico, the coach said:

“I love the University of New Mexico, I love Albuquerque and New Mexico.  This is truly a leap of faith decision. I think it becomes easier when it’s UCLA. You’re talking about the premier basketball program in the country. This kind of opportunity doesn’t come around every day.”

Several hours later, he then told the UCLA community:

“I have been so fortunate and blessed in my life, and an opportunity to lead the one of the greatest programs in college basketball history is once-in-a-lifetime."

The contract with the University of New Mexico was laced with bonuses and incentives that increased Mr. Alford’s total compensation well above the old package which paid him well over $1 million per year.   While UCLA did not release any details, it looks like Mr. Alford got himself a nice little raise.  There’s a bit more to this transaction.  Mr. Alford said that his son, Bryce Alford, who had signed a national letter of intent to play for his father at UNM, would instead go to UCLA.

Clearly, Mr. Alford’s words, both written and spoken, don’t mean very much.  One minute he’s pledging undying loyalty to New Mexico, and days later he’s expressing unending devotion for UCLA.  While Mr. Alford is a proven winner, I wouldn’t my son to his set of values.  Even the coaches who turned down UCLA and stayed at their current jobs put pressure on their athletic director to sweeten their contracts.  Big-time college coaches preach selflessness and integrity to their student-athletes. Their actions teach student-athletes selfishness.

If Mr. Alford wants to maximize his economic prospects, he should test his skills in the NBA and not exploit student athletes.  I should turn off the television, but I still have a chance of winning my bracket.

A Week In the Life of SAC

A Week In the Life of SAC

Earlier this week, Stephen A. Cohen purchased Picasso’s “Le Rêve” from casino owner Steven A. Wynn for $155 million. A day later we learned that Mr. Cohen had acquired a new place in East Hampton for $60 million.  Mr. Cohen already owns a place on the same street, but it doesn’t have an ocean view; hence the upgrade.  Then on Thursday, SAC and the SEC went into court to obtain approval of a $616 settlement over insider trading charges.  Early Friday morning, Michael Steinberg, one of SAC’s senior portfolio managers, was arrested by the FBI and charged with trading on inside information.  All in all, this is what passes for a typical week at SAC.

Off-Site (2008)

However, SAC hit a small speed bump when Judge Victor Marrero did not approve SAC’s settlement with the SEC.  The judge could not get past the fact that SAC was neither admitting nor denying that it had done anything wrong.  Martin Klotz, the attorney representing SAC, explained his client’s willingness to settle:

“We’re willing to pay $600 million because we have a business to run and don’t want this hanging over our heads with litigation that could last for years.”

Mr. Klotz’s statement encapsulates the moral corruption that is at the heart of SAC’s and Mr. Cohen’s world.  Everything Mr. Cohen does is simply a matter of money, whether it’s collecting fine art, acquiring houses, or settling legal matters.  Everything has a price.  As a result, settling insider-trading charges is just a cost of doing business.  Sadly, investors may be willing to go along with Mr. Cohen’s philosophy.  So long as SAC doesn’t admit that it did anything wrong, a good number of investors seem willing to leave their capital under SAC’s care.

The SEC routinely settles cases with the financial services industry in which the accused party “neither admits nor denies” the charge.  I’ve written repeatedly about this practice (see, “Mad Libs: The Financial Settlement [January 16, 2013]”, “Bank of America: It Failed Long Ago [January 9, 2013]”, and “Ferociousness Contained: Banks Settle Money Laundering Charges [December 12, 2012]”).  The SEC also inserts a “keep your nose clean, or else” provision, which is meant to warn that the settlement will be overturned if there are future transgressions.   Serial settlers have agreed to include this language time and again.  Understandably, it’s easy to agree to put the “keep your nose clean, or else” in a settlement agreement because the SEC never enforces it.

If you can charge high enough fees so that your financial or money management business is very profitable and powerful, then running afoul of the law is just another business expense.  As a result, SAC has learned that they operate in a privileged space in our society where you can break any number of rules as long as you always obey one rule.  The one rule you have to obey obliges a financial institution to write out a big check and allow the regulator to publish a stern press release.  If that rule is followed, then the financial institution is relatively free to commit insider trading, ignore money-laundering rules, manipulate LIBOR, or otherwise fleece their clients and the public.

Judge Marerro is the latest Federal District Court judge to cast doubt on the practice of respondents paying sizable penalties without acknowledging their improper conduct.  Since the SEC isn’t likely to change its mind and risk having to litigate, the judge or some other court will eventually bless SAC’s settlement with the government.

In the end, it will be another routine week for Mr. Cohen.  He added to his art collection, acquired another 10,000 square-feet of house, saw yet another of his employees arrested, and tried to settle a $616 million legal matter with the SEC.

Friday, March 29, 2013

But For Our Wealth, We’d Have Been Cypriots

But For Our Wealth, We’d Have Been Cypriots

Take yourself back to 2008.  One bank after another was on the verge of failure.  Stock prices were spiraling downward.  Now let’s change the story a little bit.  What if we didn’t have the financial means to forge our own bailout? Instead of holding emergency meetings in New York and Washington, suppose our financial leaders had been forced to fly to Berlin or Beijing to ask for massive loans.  What would your days have been like?  Rather than going about your business, you would have spent the day in line at your local bank branch trying to withdraw money.  Unfortunately, the ATM would have only dispensed $100, and the bank building would have been locked.  If you’d been running a business, you wouldn’t have been able to process payroll or finance your inventory. Meanwhile, foreign investors would have scrambled to sell US Treasuries and otherwise liquidate their American holdings. 

Angel Investing (2001)

This is the reality in Cyprus.  You’re probably thinking that we’re a lot smarter and more sophisticated than tiny Cyprus.  You may also believe that our financial crisis shares little with events unfolding in the eastern Mediterranean.  I think our experience is strikingly similar, except that we’re incredibly rich, and therefore, extremely fortunate.

As our financial crisis unfolded, the Chairman of the Federal Reserve Ben Bernanke, Chairman of the Federal Reserve of New York Timothy Geithner, and Secretary of the Treasury Henry Paulson were able to deal with one another without leaving the country.  Among other measures, they increased the amount of deposit insurance, removed toxic assets from bank balance sheets, injected massive amounts of low cost capital into the banks, and loaned the banks virtually unlimited amounts of money at no interest.  Cyprus, on the other hand, had to ask Brussels for a loan, and Brussels asked Cyprus to inflict severe pain on its economy and bank depositors in exchange for the lifeline.

Our financial sins were not so different from Cyprus, or for that matter, Italy, Ireland, or Spain.  We borrowed massive amounts of foreign capital in order to inflate our current rate of consumption and made incredibly massive and imprudent loans.  In our case, it was the housing sector, but every one of these cases involves large and unwise uses of credit.   Of course, we suffered through a long recession, and for those who lost their homes and jobs, a full-blown depression.  However, for the vast majority of Americans, the experience was nothing like the nightmare unfolding in Cyprus.

If our financial leaders had been forced to travel abroad to seek a bailout of the US financial system, you would have lived in a world where your ATM withdrawals were limited to about $400 per day and capped at $5,000 per month.  Your bank, if it were still in business, would have accepted your checks for deposit, but refused to cash your checks.  Your bank balance would have been debited by a healthy sum above the FDIC insurance limit, and many of your mutual fund holdings wouldn’t have just lost value; they would have been wiped out.  This is the situation facing Cypriots.

I suppose we could feel superior because we didn’t have a bunch of “dirty money” sloshing through our financial system from Russian Oligarchs.  Yet, I’m not so sure our foreign money is squeaky clean.  We have billions and billions of dollars coursing through our economy that began its journey as drug proceeds, or capital seeking a safe haven from the uncertainty of one or more emerging markets.  We know that our banks, Citigroup being the latest example, turned a blind eye to our money laundering laws.

The real difference is that even after two expensive wars and a big debt crisis, we’re still an incredibly rich nation.  For now, we’ve got enough wealth to get away with doing foolish things.  Nonetheless, our system is fraying on many levels and isn’t strong enough to withstand repeated abuses.  We might pause during this season of Easter and Passover to contemplate the plight and prospects of Cypriots, and think about how we might employ our good fortune to nobler purposes.  

Thursday, March 28, 2013

Multiple Bids for Dell, but Not a Bidding War

Multiple Bids for Dell, but Not a Bidding War

According to The Wall Street Journal[1] and The Financial Times[2], Dell is about to experience a bidding war as Blackstone and Carl Icahn compete with Michael Dell to acquire the company.  I may wind up getting this situation completely wrong, but I’m not expecting a bidding war.  While this additional interest is likely to force Mr. Dell to increase his price from $13.65 to a higher figure, Dell is highly unlikely to turn into a frenzied series of offers and counteroffers. 
Questions (2002)
In my view, there are three major constraints to anyone paying much above $15 per share.  First, Dell’s core businesses haven’t been growing much in the past several quarters.  Thus, anyone acquiring the company cannot rely on organic growth to finance a substantially higher bid.  We’re dealing with a challenged company in an industry that has seen dozens of companies lose their competitive position and fail to regain their footing.  Before Mr. Dell made his initial bid, fear ruled and the company’s stock traded below $9 per share.  Now there’s an element of greed as investors suggest that Dell is worth substantially more than Mr. Dell’s proposal.

Second, the banks will have a lot to say about how much any one of the potential buyers will be able to offer for Dell’s stock.  The major banks have had a close look at Mr. Dell’s and Silver Lake’s original proposal as well as Blackstone’s recent offer, which appears to be worth a bit more than $14.00 per share. Any bidding war is going to be constrained by the banks’ unwillingness to lend more to finance any deal.  It’s not surprising that the Blackstone’s proposal leaves a portion of Dell in public hands.  Blackstone’s only way to achieve a higher price and placate Southeastern Asset Management, Dell’s largest shareholder, was to create a stub.

Third, none of the interested parties are strategic buyers.  If one of Dell’s competitors were to have entered the fray, then perhaps they could have justified a substantially higher price based on potential synergies and cost savings from combining the companies.  However, in this instance, we’re looking at three financial buyers.  The strategic acquirers decided to pass on Dell.

According to press reports, Mr. Icahn’s proposal offers $15 per share for 58% of the company.  In the end,  I don’t expect Dell’s board to opt for Mr. Icahn’s proposal because it doesn’t address Dell’s strategic issues.  I’d expect Mr. Icahn to remain a factor in trying to push up the price.   He’ll be a potential source of litigation if he feels slighted by the acquisition process.

There are undoubtedly numerous possible permutations to the Dell saga.  I’m betting that Mr. Dell, Silver Lake, and Blackstone, as well as its partners, Francisco Partners and Insight Venture Management, will eventually join forces.  Even at Mr. Dell’s original price, this is a large deal ($24 billion).    I bet all the private equity sponsors will be glad to spread the risk across more parties.  After a great deal of posturing, this will become a typical manager-led club deal.

Unfortunately, the acquisition process will take time, which isn’t great for a company facing significant strategic challenges.  Dell’s special committee must first explore and flesh out the Blackstone and Icahn proposals.  Then Mr. Dell has to be given an opportunity to match or exceed their proposals.  In due course, Mr. Dell and Blackstone will get together and the company will be taken private. 

By the time all of this is resolved, it’s going to be summer in Round Rock, Texas, and Mr. Dell won’t just be sweating because of the heat.  Turning around Dell isn’t going to come easy.  Being a private company isn’t the magic elixir.

Wednesday, March 27, 2013

Warren Buffet Should Thank Us: His Deal Versus Ours at Goldman Sachs

Warren Buffet Should Thank Us: His Deal Versus Ours at Goldman Sachs

In October 2008 when the financial system was on the verge of collapse, the US Government and Berkshire Hathaway stepped forward to invest in Goldman Sachs.  Back in those dark days, it was already apparent that Warren Buffet had a much better deal than the tax payers because the US Treasury had given Goldman incredibly generous terms under the TARP program.  On Tuesday, we were reminded of Berkshire Hathaway’s sweet deal, as Goldman agreed to convert 43.5 million warrants into common stock.  Even if you’re not financially savvy, you’ll see just how poorly taxpayers were compensated for the risk they took in injecting capital into Goldman.  Meanwhile Mr. Buffet’s company made much more money on a smaller investment and will wind up with a 2% position in Goldman Sachs thanks to you.
Old Car Plants (2005)

Both the US Treasury and Berkshire Hathaway invested in preferred stock.  The US Treasury invested $10 billion with a 5% dividend.  Berkshire invested $5 billion with a 10% dividend.  Warren Buffet had the comfort of knowing that the US Government was prepared to support Goldman and the entire financial system with cheap capital.

Mr. Buffet’s deal gets even better.  The US Treasury’s preferred could be redeemed by Goldman without paying any premium.  Berkshire Hathaway’s preferred required Goldman to pay a premium if it was redeemed within five years.  When Goldman paid us back in June 2009, they wired the Treasury $10 billion.  When they repaid Mr. Buffet’s company in April 2011, they returned $5 billion, plus a $500 million premium.

Both transactions included warrants to buy Goldman’s stock, but Berkshire’s deal was sweeter.  The US Treasury received 12.2 million warrants to buy stock at $122.90 per share, or 6.1 million warrants, if Goldman issued enough common stock within a specified period of time. Berkshire Hathaway received 43.5 million warrants to purchase Goldman stock at $115 per share. At the time of these deals, Goldman’s stock was trading at about $90 per share. 

The US Treasury had 10-years to find out if its Goldman warrants would be worth exercising and Berkshire only had five year.  This advantage clearly belonged to the US Treasury.  However, Berkshire many more warrants (4 to 8 times as many) at a more attractive price.

What happened?  Almost from the outset, Goldman wanted to rid itself of the Treasury’s preferred.  Goldman, like other banks, didn’t like the compensation restrictions or the “stigma” of government ownership.  After less than eight months, Goldman had paid off the government’s $10 billion preferred, and a month later paid another $1.1 billion to buy back the warrants.  Treasury trumpeted its 23% return, but sophisticated investors knew that government’s cash multiple was a paltry 1.14 times (total proceeds of $11.4 billion on a $10 billion investment).  We were poorly compensated for the risk Treasury Secretary Henry Paulson took on our behalf.
Meanwhile, Berkshire was allowed to keep receiving their 10% preferred for two and one-half years, and then as I mentioned received an extra $500 million when it was redeemed.  If Berkshire were to have converted their warrants into stock, and sold them at today’s price of $146 per share, they would have received a total return on their investment of 20% or a 1.63 times multiple ($8.1 billion in proceeds and dividends on their $5 billion investment).  Had the United States received the same treatment as Warren Buffet, our $10 billion investment would have netted us $16.3 billion, instead of the $11.4 billion we actually received. 

Treasurer Paulson, former Chairman of Goldman Sachs, gave his former firm an enormous financial windfall.  This wasn’t a case of naïve public bureaucrats cutting a bad deal with the private sector.  Wall Street executives, including Goldman Sachs alumni in key positions, surrounded Mr. Paulson, and structured TARP to be hugely advantageous to the banks.  As for Mr. Buffet, he owes the US taxpayers a large debt of gratitude for making his large stake in Goldman Sachs possible.