Here’s an observation about the private equity aspect of the proposed Qantas deal. It is easy to spend someone else’s cash when it really isn’t cash. How hard is it to be a pirate equiteer, or at least figure out what they’re doing?
There are two ways of looking at the explosion of pirate equity deals. One way is that you’re witnessing a global “equity rush,” in which well-funded groups of high-net worth borrowers are buying “strategic assets” or large, cash-flowing, multi-national businesses. It’s a stretch, but you could say there are only so many global, cash-generating brands on publicly listed exchanges. Is the stock market telling us that these brands are worth paying top dollar for?
It is worth listening to the language of the market because it invariably tells you something. But what is it telling us today? If the stock market leads the economy, then are these private equity deals telling us another great age of globalization is in the offing, and that no price is too dear for brands with global reach or balance sheet growth? That’s one way of thinking about it.
But the stock market can also tell us that investors—drunk on borrowed money—are going completely bonkers. If that is the case, the private equity boom—especially the rush to buy Australian assets—reminds us of the Japanese boom in 1998. The Japanese went on an asset buying kick, eyeing American real estate icons like Rockefeller Center to ad to their huge local portfolios.
When the stock and real estate markets in Japan went bust, the cash dried up and the debt stayed. Real estate values fell for 15 years. We pop over to Bloomberg and find that seventeen years after its high, Japan’s Nikkei is stands at just under 16,000, less than half its record level of 39,000 in 1989.
Do we have a point? Yes. And here it is: Watch out for an epic bust.
Last we checked, the emergence of pirate equity is not one of the signs of the apocalypse in the book of Revelation. But when so much money chases so few assets, virtually indiscriminately, you get what you’re getting: broad-based, irrational inflation in all kinds of financial assets.
Of course we’re assuming that the private equity guys are being less than rational. “I’m stunned that private equity would be interested in an airline, says Atul Lele in today’s Age. “At $5.20 it looks to be expensive to us on fundamentals.” As we said, when you’re spending other people’s money (OPM), price is no object, or objection. Besides, airlines roughly fit the profile of what private equity firms look for, enough cash flow to service enormous debt.
Here’s what we wrote to our colleagues internally about a month ago, “If you wanted to get a little more technical, you could run a stock screen easy enough. What are you looking for? Well, in the case of GM and Delphi you had companies selling at less than one times sales and with lots of cash, or high cash-flow per share. For a moment, you have to suspend all the usual fears about debt, litigation, and whether the business will be a going concern in a month. For now, just run a screen on those two metrics.”
“I did that and I came up with an interesting list. I won’t bore you with the details but I’ll share a few names: UAL Corporation (NASDAQ: UALA), Avis (NYSE: CAR), Visteon Corp. (NYSE: VC), Loral Space & Communications (NASDAQ: LORL), and the headquarters of our UK business , Sea Containers Ltd. (OTC: SCRA)… Now there are good reasons why each stock is beaten up and selling at a discount. Lots of reasons to hate them, in other words. And lots of ‘ifs’ before the stock could be considered ‘fixed up’ (like an incorrigible dog or a good boob job). But that’s the point isn’t it?”
We didn’t recommend a buy on any of those stocks, and are certainly not doing so now. Our point was that you can track or even anticipate what pirate equity is doing if you look for businesses that produce regular cash flow and stocks that are selling at low multiples of sales. From there it is not hard to do a little leg work and find distressed assets that could be quickly turned-around (gutted/re-arranged/rationalized) and resold in a short time at a higher price.
Or you could forget the fundamentals and begin buying companies like mad with other people’s money. That seems like what some pirate equity firms are doing. But don’t expect it to stop any time soon. In fact, we considered launching a tracking service for investors about what publicly listed companies might be pirate equity takeover targets. We are still considering the idea. And in the meantime, we are enjoying the spectacle, the way you might enjoy watching a blueberry pie eating contest. Sooner or later someone is going to throw up. It will be messy, but quite colourful.