Inside Investment |
| See Inside Investment: Endgame for private equity Euromoney May 2007 |
In March 1781 on his way to rendezvous with his newly landed French allies at Newport, Rhode Island, George Washington wrote in a letter: "We ought not to look back unless it is to derive useful lessons from past errors, and for the purpose of profiting from dear-bought experience." Within a year the War of Independence was won. That quotation and Yogi Berra’s far better known "it’s déjà vu all over again" came to mind when commodities trader Glencore floated on the London Stock Exchange last month. Investors paid little heed to either the first president of the US or the legendary baseball coach. Shares worth $11 billion were sold at 530p, valuing the business at an eye-watering $62 billion.
Crowd madness
The similarities between the listing of Glencore and previous investment manias accompanied by blockbuster IPOs are too glaring to ignore, not least because one such manifestation of the madness of crowds was so recent. In 2007 there was a sudden rush to market by alternative investment firms. Hedge fund manager Fortress Investment Group led the way in March. The shares rose 70% soon after listing, valuing the company at 40 times historical earnings.
Peers were quick to take note. Next out of the traps was private equity firm Blackstone Group. Its listing was every bit as spectacular as Glencore’s recent market bow. Blackstone raised $7.8 billion, selling 20% of its equity in the third-biggest IPO seen in the US. As is the case with Glencore, instant billionaires were created. Pete Peterson, co-founder of Blackstone with Stephen Schwarzman, walked away with a handy $1.8 billion (on top of cash compensation of $213 million the prior year). His remaining equity was valued at $1.8 billion.
Investors have done rather less well. Blackstone trades at around 40% below its listing price. It has underperformed the S&P500 index by 30%. But shareholders in Blackstone are better off than those that bought Fortress. Its shares have slumped by 80%, underperforming the index by a painful 75%.
There are clear parallels between the Blackstone and Glencore IPOs that, in spite of dear-bought experience, investors seem content to ignore. First and foremost, the insiders in these businesses know more about their dynamics and prospects than anyone on the outside looking in. They are the smartest guys in the room, traders with an instinctive feel for when to buy and sell.
Patently absurd
As this column noted in 2007, the primary skill of private equity’s bosses is "making money for themselves". The piece concluded: "The notion that they will leave some [money] on the table for public shareholders is more than just quaint – it is patently absurd." On the day of Glencore’s market debut, the Financial Times quoted, "people familiar with the IPO" as saying that the offer price was an attempt to: "leave something on the table". The observation left me with a wry smile.
Private equity was clearly a bubble in 2007. Abundant liquidity and cheap credit was fuelling mega deals at stupid prices. In February that year, Kohlberg, Kravis, Roberts and Texas Pacific Group bought TXU, one of the largest power companies in the US, for $45 billion. It was the biggest private equity deal ever. The average multiple for these transactions was close to six times ebitda, also a record.
Speech bubbles
Commodities might or might not be a bubble. Space does not allow a careful examination of the arguments for or against, let alone an economic exegesis on why China means that this time it really is different, super-cycles or Kondratiev Waves. Suffice to say that when such arguments are routinely trotted out to support the seemingly inexorable rise in commodity prices, it is probably time to pause. It is bubbly talk. The Reuters CRB index is up more than 80% from its post-Lehman lows. Individual commodities, such as silver, have already shown that parabolic price rises never persist.
| There are clear parallels between the Blackstone and Glencore IPOs that in spite of dear-bought experience investors seem content to ignore |
There are, of course, also differences between Glencore and Blackstone. Leaving aside the rank hypocrisy, Blackstone had no reason to access public markets. Fund management businesses do not need a lot of capital. Glencore does. But a firm that generated $3.8 billion in profits from $145 billion of sales in 2010 is hardly cash strapped; unless it wants to acquire mineral resources on a scale unseen since Cecil Rhodes.
There is one final echo from the summer of 2007. Glencore’s prospectus runs to a prodigious 1,639 pages. This reflects the complexity of its businesses and the myriad of risks it is exposed to. In the wake of the structured finance debacle, complex was a dirty word. That useful lesson has also seemingly been forgotten. Why did Glencore float? It is only conjecture but perhaps the principals had another Berra-ism keeping them awake at night: "The future ain’t what it used to be."
Andrew Capon has worked as an analyst, strategist and financial journalist for more than 20 years, winning multiple awards for commentary on markets, investment and asset management. He welcomes comments from readers, including literate cephalopods, and can be reached at amcapon@btinternet.com