Felix Salmon

There’s one thing that art dealers and venture capitalists have in common: a severe allergy to “down rounds”. A dealer will never sell an artist’s new paintings for less than the cost of the paintings in the last show, and a VC-backed company will never raise funds at a lower valuation than in the last round of funding.

Until now:

We analyzed the terms of venture financings for 89 companies headquartered in the Silicon Valley that reported raising money in the second quarter of 2009.

Down rounds exceeded up rounds 46% to 32%, with 22% flat. This was slightly better than 1Q09 when down rounds outpaced up rounds 46% to 25%, with 29% flat. The past two quarters are the only quarters since 4Q03 in which down rounds have exceeded up rounds.

The Fenwick & West Venture Capital Barometer™ showed an average price decrease of 6% for companies receiving venture capital in 2Q09 compared to such companies’ prior financing round.

I don’t know how you’d even begin to do this kind of analysis for primary art-market prices, but it would be fascinating. Have art dealers finally capitulated and started cutting their list prices from boom-era levels? Or are they just offering much larger discounts these days?
(Via Stone)

Proof that you don’t need elaborate CDS conspiracy theories to find lenders trying to drive borrowers into default:

Some of the largest lenders to the private equity groups that led the $23.8bn buy-out of Clear Channel Communications intend to turn down a proposed debt exchange, hoping to drive the radio and outdoor advertising company towards default.

The company, taken private in a leveraged deal that came to symbolise the excesses of the buy-out boom, has proposed a swap of some parent company debt for debt in Clear Channel Outdoor Holdings…

However, some of its largest senior creditors say they would rather wait, in the hope the company will violate its lending agreements, enabling them to force a default and to take control of its equity at a steep discount.

This might have been part of the game plan all along, for the junior lenders. In a highly-leveraged deal such as this one, the chances of default are quite high — and the junior lenders, being junior, are generally well aware of the downside risk. But at the same time they’re also well aware of possible upside: if the company violates its covenants and the junior lenders take control of the company, they can actually end up making more money than if Clear Channel simply made all of its debt payments in full and on time. As ever, the closer you are to equity in the capital structure, the more like equity your investments behave.

Fights within the confines and around the edges of bankruptcy can be extremely brutal and dangerous, even when there’s no CDS complication, and both risks and potential returns are very high in these situations. Expect much more of this kind of thing over the next five years or so, as leveraged loans mature with little if any chance of being rolled over easily.

A lot of fortunes will be made and lost within the private-equity and hedge-fund industries, but thankfully the systemic consequences are likely to be minimal. After all, in nearly all of these cases the underlying companies are still very profitable, assuming they can get their debt load down to a reasonable level. So we’re not going to see all that much in the way of damaging liquidations. And in fact if the companies do emerge from these fights with lower debt loads, that will help them borrow and invest more going forwards, which should help, rather than hurt, the economy.

Mark Patterson, of MatlinPatterson, is having his lawyers run around all manner of blogs trying to get them to remove a story originally printed — and possibly to be printed again — in the Daily Telegraph. At this point, all the unhelpful publicity that’s resulting is making it seem as though he would have been better off just ignoring the original article. But while he’s in the news, let’s not forget that he’s not only being accused of calling the TARP a “sham” and a gift to speculators. He’s also the chap who seems to be doing end-runs around bank-ownership rules which seem to be designed to violate the spirit if not the letter of regulations barring private-equity shops from owning banks. Since he’s in the public eye, perhaps now is a good time to start investigating that side of things more closely?

Here’s a snippet from that Michael Lewis review of The Snowball:

Buffett’s second great decision was to maximize, at great financial cost to himself, the interest that the public might take in his business affairs. In 1986, Congress passed a tax reform that changed how Berkshire Hathaway’s capital gains were taxed. Previously, those gains had been taxed only once, when a shareholder sold his shares. Now, so long as Berkshire remained a public corporation, Buffett would need also to pay tax on any gains from the sale of stocks inside his portfolio. There was an obvious solution, and it was seized upon by public fund managers everywhere in Buffett’s position: shutter the corporation and become a private equity fund. At the time Berkshire had $1.2 billion of unrealized capital gains. Buffett might have doled these out, and then restarted as a partnership free of corporate double tax. Instead, at a cost to himself that Schroeder puts at $185 million, he kept Berkshire intact.

A man who cares so deeply about money reveals himself most wholly in his decisions to part with it. Buffett had exchanged cash for an audience.

Would Buffett really have gained from going private? I doubt it, somehow: having sought-after equity with which to pay for acquisitions was extremely valuable to Berkshire Hathaway. What’s more, Buffett prides himself on (to a first approximation) never selling anything; he doesn’t even pay a dividend. As a private-equity fund manager, he would have to give his investors back their money at some point, and that would mean selling assets he loved.

What’s more, there’s something fundamentally unegalitarian about private equity funds: they’re for millionaires only, while a large part of Buffett’s dream was always to take ordinary middle-class Americans and make them millionaires. (On paper, at least, since they never got any dividends from their stock, and he encouraged them regularly never to sell their BRK stock.)

So I’m not sure that it really makes a lot of sense to say that Buffett took a decision which personally cost him $185 million. It doesn’t make sense with hindsight, since Buffett went on to make untold billions more and become even wealthier than he would have become had he gone private. And it doesn’t make sense in terms of opportunity cost either, since while going private might have saved Buffett $185 million in taxes, it would also have cost him a number of golden opportunities down the road. Indeed, Lewis himself explains that Buffett is a master at monetizing his reputation:

By 1986, Buffett’s every move was being watched, and usually cheered. His fame became not only a pleasure but an asset. His capital became unlike anyone else’s, because it came with his name attached to it. Warren Buffett saw deals that no one else saw, and had access that no one else had. If the stock market was a roulette table, he had his hand on the wheel.

Later — much later — a handful of private-equity groups (TPG, KKR) started to get some small measure of the kind of access that Buffett had enjoyed for years. Even then, however, that access was entirely a function of their ability to borrow money, and it disappeared the minute that the market in leveraged loans dried up.

Finally, as Lewis says, “as rich as Buffett became, he never stopped measuring himself by how much money he had”. When Berkshire Hathaway was trading at a significant multiple of book value — as it nearly always was — Buffett could judge how much money he had just by taking the number of shares he owned in Berkshire Hathaway and multiplying them by the share price.

If Berkshire went private, however, Buffett could do that no longer: he would have to measure his own wealth on book value alone. Which, while surely a large number, wouldn’t be quite as large as the market value of his stake in Berkshire Hathaway. And that might well make the difference between him being the richest man in the world and, well, not being the richest man in the world.

Given that choice, it’s quite easy to see how he chose the former course of action.

The NYT sent Eric Lipton all the way to Cainsville, in the middle of absolutely nowhere, to visit what used to be called the First National Bank of Cainesville and is now called Flowers Bank, after its brand-new owner, Chris Flowers. Lipton has filed a great story of attempted regulatory arbitrage, where Flowers is personally buying this bank just so that he can get its national banking charter — his private equity shop being considered by the Fed to be not boring enough to own a bank.

The Fed is right, as Lipton shows — he even quotes Flowers talking about how “lowlife grave dancers like me will make a fortune” from the bank crisis and bailout. Which is not really the attitude that one wants bank owners to have: they should be boring and conservative, not greedy Masters of the Universe who happily drop $53 million on buying an Upper East Side townhouse.

Incidentally, the NYT’s picture caption is very wrong: it says that the value of the Cainsville bank is “about a third” of the value of Flowers’s townhouse. Not even close. As of the end of last year, the bank had $16.699 million in assets and $12.492 million in liabilities, for a book value of $4.2 million. Even if Flowers paid 2x book (unlikely, but possible, given that what he really wanted was the banking license rather than the bank) he will only have shelled out about $8 million for the bank, or about 15% of what he paid for his townhouse. More likely he paid less than a tenth of what he spent on his home.

If Lipton wants to follow up on the subject of regulatory arbitrage among private-equity shops which own banks, he might want to take a look at MatlinPatterson, a distressed debt fund right here in New York which has been going through all manner of contortions to avoid breaching rules preventing it from owning more than 24.9% of banks such as Flagstar Bancorp in Michigan. When it wanted to buy Flagstar, it couldn’t do so directly. So it asked its limited partners to send more money to a new entity it set up for the purpose, and as soon as it got that money, it refunded an identical amount back to those partners in a deal which looked very fishy to John Hempton back in April. (One of the limited partners was Nicola Horlick’s Bramdean Alternatives.)

I think it’s about time that we move from a rules-based system where private-equity types spend vast amounts of time and effort trying to get around rules preventing them from buying banks, and move to a principles-based approach where anybody attempting something as blatant as this (“it’s not my private-equity shop buying this bank, it’s me personally, so that’s fine”) gets slapped down sharpish. And that goes for MatlinPatterson, too.