Randomly Noted

As an asset class, private equity is a losing proposition.

That bald assertion comes not from an outside critic, but from an insider, Erik R. Hirsch, the chief investment officerof Hamilton Lane, a private equity asset management firm with more than $100 billion managed and advised.

Private equity, from the point of view of investors, or limited partners, is expensive, it is illiquid and often doesn’t beat returns from equity markets.

So what’s the punchline from Hirsch, who was interviewed today at the Dow Jones Private Equity Analyst Conference in New York by Laura Kreutzer of Dow Jones? (Dow Jones employees write for this blog.)

While the industry taken as a whole might not be a great deal for institutional investors (Hirsch said he wouldn’t want to own an index of the private equity asset class), Hirsch talked of a “brass ring,” s certain club of private equity managers who consistently outperform public markets. If investors find them, long-term rewards will allow them to put up with high fees, the significant length of investment and lack of liquidity.

In the same interview, Hirsch bemoaned the fact there’s no agreed-upon benchmark for the private equity sector. It allows for a variety of measures and more managers than warranted to refer to themselves as top performers.

As for the health of the sector, Hirsch said that as a class, private equity is adding capital. That fact means this is not an industry in trouble, not an industry in “a death spiral.”

A good old-fashioned, flip-around-the LBO via IPO could be coming our way soon. And it will be another test of how resilient the markets are today.

LRI Holdings plans to sel up to $200 million of shares in an initial offering underwritten by Credit Suisse. The exact number of shares or price talk range have not been set. LRI is the parent of Logan’s Roadhouse, a chain of restaurants that have grown impressively over the past decade – it today has 211 restaurants. It’s a steakhouse and, as the company says in its preliminary prospectus, was inspired by the roadside-style restaurants that populated Route 66 in the 1930s and 1940s.

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So much dirty laundry has come out during the past year’s financial mayhem it’s a wonder I still have the capacity to be shocked. This piece of news shocks me: “Calpers, the nation’s largest public pension fund, is launching a ‘special review’ of fees paid by some of its money managers to an investment advisory firm run by a former Calpers board member,” the WSJ reports online.  It turns out some $50 million in fees were paid over five years to Arvco Financial Ventures LLC, headed by former Calpers board member Al Villalobos. Some poor-performing investments made by Calpers were recommended by Arvco. You might wonder why I’m so stunned by this news. Since Bear Stearns and Lehman, we’ve had all manner of appalling revelations thrown in our faces, underscoring that our national well-being was in the clutches of the unfit or immoral. It still amazes me that establishment pillars such as Calpers, which manages the wealth of  thousands (maybe millions) of California public employees, would be run by a coterie of mutual back-scratchers. Of course, we recently learned that New York’s state fund exhibited similar traits; but California, too? Say it isn’t so! The other day some colleagues were teasing me – saying my criticism of so many titans of finance suggests I’m turning into a “socialist.” Nah, I’m fairly sure people behave badly in just about any economic or political system. In fact, it’s a sign of my visceral faith in free markets’ logic and inherent parameters that I’m still capable of being surprised and dismayed when they go awry. All that’s happening to me – and, I believe, many of you – is that we’re yet again being reminded of the frailty of human nature and the importance of defending oneself, one’s loved ones, and one’s nest eggs against the likelihood that the guardians of wealth are out to increase their own wealth, not ours. Consider this story by the NYT’s Julie Cresswell, which appeared last week. Despite a few thinly reported passages, it’s very well done – and, yes, it reminds one that private equity titans will first and foremost extract massive dividends from acquired companies – and secondarily worry about the health and well-being of the enterprise and its employees. Have a look: human frailty is on full display.

It’s not the kind of jaw-dropping returns we saw in the go-go years of private equity. And we don’t want to see those kinds of obscene returns anytime soon because of the statement that makes about greed overlooking risk. But there is a minor lesson in the initial public offering of RailAmerica, that was priced hours ago and will begin trading on the New York Stock Exchange on Tuesday – there still is an opportunity for private equity to make money.

Fortress Investments took the short line/regional rail operator private in  a $1.1 billion leveraged buyout in February of 2007.  Fortress and its investors paid the equivalent of $10.83 per share of equity in connection with the buyout. The stock was priced to the public late Monday at $15 per share (22 million shares sold, half by Fortress and half by the company). So Fortress and its investors made $4.17 per share. Not a huge amount by about an 11% return per year. Which is not too shabby considering what has happened to the equity markets over the past two years.

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You could be cynical and just suggest that Blackstone Group is talking its book. But it does have the look and feel of something much bigger than that. The Financial Times reported today that the huge private equity firm has told investors in its funds that it is looking to sell chunks via stock offerings of up to eight companies in its portfolio (for full story, click here.) The move is notable for a handful of reasons. You could sugest that Blackstone perhaps is making a call that the market move higher since the March lows is likely to continue going in that direction (not making a statement about when). The FT notes that Blackstone was one of the first private equty firms to get cautious on the financial markets and this move might herald Blackstone becoming one of the first private equity firms to be making such a bold call. It’s also worth noting that buyout activity has begun to pickup and Blackstone may be thinking it needs to raise more cash to play in that game.

Once upon a time when people talked about Kohlberg Kravis Roberts, you thought of takeovers – some hostile and some friendly. The business has certainly changed and even more so by the credit crisis over the past year. Today, KKR essentially played the role of lender, if not of last resort, pretty close to it.

KKR agreed to loan Kodak up to $400 milli0n and along with the between 10% and 10.5% annual interest KKR receives for 8 years, it gets warrants to purchase up to nearly 20% of Kodak. This deal shows how difficult times have become for Kodak. Not only is it paying a higher interest rate on the loan, but it looks like it is a pay-in-kind loan – meaning Kodak doesn’t pay KKR cash interest but instead, new securities. So, the principal it owes when these bonds come due will balloon. Payment on these bonds become tomorrow’s headache, not today’s.

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Dorothy & Scarecrow Are Off To See The Wizard

If only the folks at Metro-Goldwyn-Mayer studios had a wizard to visit, who, at the click-of-the-heels three times, could make all of their financial dreams come true. And their nightmares go away.

Instead, the studio known for James Bond movies and the above “Wizard of Oz,” is bringing on board a restructuring expert to help it rework a mound of debt it took on from a $5 billion leveraged buyout in 2004.

The Wall Street Journal’s Peter Lattman reports that a bunch of equity investors in the original LBO have been essentially wiped out. Providence Equity Partners has marked the investment at about 10 cents on the dollar. When the deal was originally announced, Providence said it was committing $525 million. That would be worth but $52.5 million today.

Other big investors, according to the press release in September 2004: Texas Pacific Group ($350 million), Sony Corp. ($300 million), Comcast ($300 million) and DLJ Merchant Banking ($125 million).

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The housing crisis hasn’t been good to companies that build them or make products that go into them. Like Armstrong World, which produces flooring, ceiling materials and cabinets. In the most recent 2Q, Armstrong said sales were off 20% versus last year and net income was down 50%. And the outlook for the rest of the year remains equally grim.

So why did private equity firm TPG Capital just spend $180 million to buy a big chunk of Armstrong and structure it in such a way that Armstrong doesn’t receive a nickel?

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This one doesn’t seem to take an advanced degree in finance to get the right answer: You need to borrow some money. You have two options. One is to pay 4.17%. The other is to pay 10% and with it you give away part of the franchise.

You take the 4.17%, right? Well, that’s not what Office Depot did. The office products superstore operator said today it raised $350 million through a convertible preferred stock offering that carries a hefty 10% dividend and potentially dilutes current shareholders by 20%.

On April 28, when Office Depot filed a quarterly report with the Securities and Exchange Commission, it said it had available to it $630 million under a short-term revolving line of credit that, over the course of the quarter, it paid on average 4.17%. So, if the banks were willing to extend that credit, why would you pay 10% (which is paid out after taxes) rather than the 4.17% (which is paid out pre-taxes and actually lowers the tax bill?

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Baltimore Inner-Harbor

General Growth Properties, the big real estate investment trust that filed for bankruptcy today, expanded through acquisitions and a few years back bought The Rouse Co., which developed places like South Street Seaport in NYC and the inner-harbor area of Baltimore. A crushing debt-load and inability to refinance did General Growth in. Desperate companies have to do desperate things to stay alive. And that opens the door for opportunists like hedge fund manager William Ackman, who runs Pershing Square Capital Management. Ackman owns outright about 7.5% in General Growth stock and has swapss with banks that gives him another 18.1% in economic benefit. Ackman today offered $375 million in Debtor-In-Possession (DIP) financing to General Growth at remarkable terms.

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