Wednesday, February 2nd, 2011
stagecraft here

The specifics of a recent posting on three prominent valuation debates in the marketthe research puzzle | It began:  “What’s it worth?” were old news a few days after the piece appeared.  Each company (Groupon, Facebook, and Apple) had developments that changed the debate about its value.  (Since I write about the “how” rather than the “what,” the themes of the piece still apply, in case you haven’t read it.)

Reflecting on those changing situations, I was reminded that the staging of a transaction affects notions of price and value.  It’s true for the floating of a new issue, the provision of guidance regarding a company’s prospects, the selling of an investment product, and other thespian activities performed for the audience of investors charged with discerning some reasonable estimate of value.

The master stage managers may be the private equity funds.  It’s not that long ago that they were viewed as engines of growth for the economy, valuation support for the stock market, and much-needed sources of performance for the institutional investors who poured money into them.  Each of those beliefs was built over time, carefully crafted and marketed and, as always, spun from a historical record into an assumption of the future.

Let’s look at one deal, Freescale Semiconductor.  When the business stumbled in early 2007, shortly after the LBO, Bud Watts of Carlyle Group was quoted as saying, “We have a structure that can take the 100-year storm.”  Despite weakening fundamentals, the credit dance was still going feverishly enough that the Freescale bonds were then quoted above the deal price, even though they were “covenant-lite,” lacking in protections for the investor that are standard in less-frothy times.

It was a well-told tale, the illusion made easier by investors who had replaced any modicum of disbelief that they possessed with gullibility.  However, by that time cracks had begun to emerge in Freescale’s business and in the private equity model itself, even as bigger and bigger deals were announced each weekend.

In fact, Freescale sold almost six billion dollars of debt that July, after the weak results.  By March of 2009, one dicier tranche was trading below ten cents on the dollar and a senior piece below twenty.  They are above par now, so I guess you could say that the company survived the 100-year storm, but just barely.  One wonders what would happen to it if we had even a modest economic squall.

Do I think the bondholders were sold a bill of goods?  Yes, and they may be repeating that purchase today.

But the real sleight of hand by the private equity funds was reserved for the investors in their funds.  Surely those investors should have suspected that the magicians could not just keep pulling rabbits out of the hat ad infinitum.  Higher valuations being paid and money cascading into the business should have caused them to turn away from the spiel, but they did not.  They went for the pitch.

Ever since, the value of Freescale on the books has been determined by the private equity fund through which they invested.  Interestingly, that value varies dramatically depending on which of the four participating firms you invested with, according to the New York Times.New York Times | The article was by Julie Creswell; a Times subscription may be required to read it online. The firms put in seven billion dollars total, “now said to be worth $3.15 billion.  Or $2.45 billion.  Or $1.75 billion.”  Depending on which one you ask, of course.

The article indicates that (not just in this case, but pervasively) private equity funds have too much leeway in determining valuations, and that their decisions “influence how pension funds and others allocate their money.”  No surprise that, according to Josh Lerner of Harvard, “There’s a lot of smoothing out in these numbers and even stagecraft here.”

As luck would have it, when I finished this posting, I saw a report that Freescale has hired several investment banks in preparation for an IPO.

Let the next act begin — would you like to attend?