TARP for Dummies

Quick post:
Very funny TARP for dummies from PEhub http://tinyurl.com/cj7rmv

IBM buying Sun - good or bad for business?

There is an interesting article in the WSJ about the potential acquisition of Sun Microsystems by IBM. There are a few issues that the WSJ did not address that are direct affects of this transaction to the venture capital and IT oriented private equity markets.

1) One less acquirer -

There is only a handful of large tech oriented companies in the world that are active acquirers of tech businesses and pure innovation. Sun Microsystems is one of them. They did more than 20 transactions in the 1990s and more than 20 in this decade. Sun has not been such an active acquirer of Israeli tech (like IBM), but they acquired Aduva and they have a nice sized R&D center in Herzeliya. The VC / PE model is based on M&A exits to provide financial returns. More than 80% of exits are M&A. The M&A market will shrink after this acquisition. This handful of companies in the world understand that in order to sustain market leadership and in order to grow shareholder value is through organic AND inorganic / strategic growth.

Parenthetically, most large Israeli companies do not realize that acquisitions are necessary for value creation. Case in point, lets quickly explore arguably the star of the Israeli tech scent - Check Point. They are the founder of firewalls. Great internal innovation. Selling software at close to 100% gross margins and 40%+ net margins consistently. Sitting on a huge bag of cash. And only making small or distressed acquisitions - not strategic acquisitions. Growth is hurting and shareholder value is relatively low, compared to other active acquirers in the security software space - companies with less cash and worse operating performance (see MFE, SYMC, etc). But value is forward thinking. Forward thinking = longer term and strategic thinking, not just tactical. Therefore, acqusitions are key for large tech companies to grow.

2) Sun has more than 30,000 employees

"Consolidation" and "efficiencies" are code words for firing and shutting down units. This has good and bad implications. Mostly good for our industry, since it forces good people to enter the work force - where many will enter in start up world. This generates the recycling model, allowing for sound investment opportunities. This is true for Israel as well, where IBM has been and will be an active acquirer of Israeli tech. They have subsequently created R&D divisions across the country - Jerusalem (iPhrase, Unicorn, etc), Haifa (historical applied research center), and Tel Aviv (XIV, Diligent, etc).

3) BPM

Lastly, a bit more closer to home, within some period of time after the acquisition, there will be one less BPM player competing in the market (disclosure: Goldrock Capital is an investor in PNMsoft). Sun acquired SeeBeyond and is now called Sun Java Composite Application Platform Suite. And IBM made BPM acquisitions with FileNet and ILOG. It will also take some integration time for IBM and Sun, and may set them back in the market a bit. We shall see!

No more need for leverage in the Private Equity business?

Is seems that for the past year, a trend has been developing in private equity. Non leveraged buyouts. deals are harder to find. credit is harder to secure. LPs are 'unsure' if they want funds to call capital. So the funds are getting creative to be able to continue to invest. The funds must pay much cheaper pricing and have a story that can convince LPs that the upside is huge. Risk, or course, is higher, since the funds have to deploy much more capital per investment, and the value of the asset must significantly increase to exit with a profit. In the old days, LBOs could make serious returns without creating too much value - since profitable businesses would be paying off the debt, paying less corporate tax and within a short period of time - paying off the debt while the fund owned the company. The funds could do 2-3x without creating any value!

Will LBOs continue to exist, or will only a handful of EBO value generators take over - leaving behind the days of financial engineering?

A few big LBOs have been seen trying to move to the EBO model - like Advent, Hellman & Friedman, and others.

Here, at Goldrock, we are pure equity players - and we strive to assist our companies to grow and create REAL shareholder value. Will see if the rest will follow...

The climate is Right for innovation

I would like to draw your attention to an interesting blog posted today by PNMsoft on innovation. I liked their realism, connected to a desire not to give up on innovation as a culture. Since I know the guys over there pretty well, you can assume that they have their feet on the ground and use innovation as a driver for furthering their business in a way to give benefit to their customers, rather than for its own sake. This helps them to keep the right balance and perspective during these uncertain times - happy reading!

Gartner's Kathy Harris is pushing the innovation agenda in her latest blog. "The climate is right for innovation and organizations that don’t change may lose their edge or even disappear. You can’t not innovate"

Kathy's innovation strategy is a bit ahead of its time.

Most companies are in the midst of the credit crunch. Their focus is on survival. Some will cut projects, some will cut staff. Long term planning usually gets chucked out the window in times like these. Innovation budgets are slashed. It takes real guts to be able to sit down calmly and think of innovation.

But when the panic dies down, and company execs realize that the new circumstances requires rethinking - they will find Kathy's strategy "spot-on". Companies will need to innovate in order to remain competitive. Most current business models are no longer sustainable.

"Innovation is the ability to see change as an opportunity - not a threat."

The current crisis (burning platform) is a great driver for innovation...

Click here to read more

Leadership as a Management Tool – or How to ask for a Cup of Tea

I have the great privilege of seeing many mangers at work (and some at play). In many cases our interaction with management is during a process by which we are checking their company out as a potential investment. This naturally means that they are in "sell" mode.

As a potential investor I have to try and find ways of getting behind this and discover what the manager is like in "real life" situations.

I have learnt that sometimes the really small things are the ones to watch for. How a CEO asks for a cup of tea from a secretary or colleague. How other employees talk to him during a tour of the office, or just as he is walking down the corridor. How management refers to one and other in meetings, and indeed what view they take of the contribution made by others in the organisation.

Why do I apply importance to these matters?

For me one of the most difficult intangibles when looking at a potential investment is the leadership skills or style of the management of the company. This typically starts at the top and is usually reflected all the way through the organisation.

In order for a small company to grow there needs to be strong leadership from the front. This leadership needs to encompass all of the employees and in many cases partners and shareholders of the company too.

Authoritarian style alone cannot achieve this, in order to the maximum from the company everyone must feel that they are making a contribution, and that this contribution is valued by the company's management. This in itself engenders out-performance by employees at every level as they strive to improve the company that they now identify with.

Managers can and must be pro-active in this area, and this style must be prevalent at all levels of the company:

• Lines of communication must be open and transparent: Employees, Management, Investors, Board, Partners etc
• No idea is a stupid idea
  
• Make sure that you interact with as many employees as possible on a regular basis
• Don't just talk about immediate goals
• Use the time to understand what employees and partners would do if they were CEO for the day
• Lead by example
• Be accessible
• Earn the respect of the company, don't demand it!
• Recognise the strengths and weaknesses of those around you

These are just a few ideas about how to lead the company that you are trying to grow, in adverse markets you need better than average performance from the entire company in order to continue to grow. It is your job as a manager to achieve this, and it can only be done if you succeed in inspiring rather than demanding.

Management who either have this or learn it will be the ones to come out of the downturn, not just in survival mode, but also stronger.

Good luck!

Is Mark-to-Market a Good or a Bad Rule?

For those of you who aren’t familiar with mark to market, the term refers to the present day value of an investment, regardless of how much was originally invested. It was put in place as a part of US GAAP in the early 1990s, and the use has increased steadily over the past decade, primarily in response to investor demand for relevant and timely financial statements that will aid in making better informed decisions (according to Wikipedia J).

A good example of mark-to-market is people’s homes. Let’s say you bought your 2 bedroom apartment in Miami Beach for $300k two years ago. Taking into account the current real estate market, if you were to mark-to-market the current value of the apartment it would probably be closer to $200k.

Companies like GE, Citigroup, Bank of America, Wells Fargo, and many other financial institutions would benefit greatly if mark to market accounting were suspended.

The largest example is probably AIG. Currently, AIG is a $1b company, give or take. The stock is teetering at around 50 cents! Compare that to Bank Hapoalim – Israel’s largest bank – which has a $2.2b market cap – with a tenth of the assets! AIG became insolvent and was subsequently bailed out by the US TARP, due to mark-to-market accounting standards. Without mark-to-market, it would have survived. But would this been a good thing, or a perpetuation of the financial facade?

But more importantly – to save the global economy - the question is would suspending mark-to-market be a good idea or a bad idea to stimulate or save the economic meltdown? Two options:

1) Bad: Suspending mark-to-market accounting could completely destroy the financial system, since banks would be able restore assets to their original value and investors would have a much tougher time understanding the true value of these companies.
2) Good: On the other hand, on paper the banks would look more attractive and the investment dollars would return to these institutions. Subsequently, lending / borrowing would be restored quickly, and perhaps the underlying values would slowly catch up to the paper value.

I am not an economist, so thoughts?

Sport and Politics

Sadly over the last few couple of weeks we have been witness to several occurences where sport has been badly overshadowed by politics or terrorism.

As a lover of sport I have always found it remarkable that it is often used to as a way of creating leverage through the influence politics has on these situations.

The three most recent incidents are:

• the visa row in Dubai, when two Israeli tennis players were denied entry because of where they came from. In this case, due to some fairly heavy international pressure and fairly obvious financial threatening, the Dubai authorities relented allowing the second of the two banned players to enter.
• The second tennis incident is the David Cup match in Malmo that was played behind closed doors,without any spectators from either side (Sweden or Israel), under the guise of security considerations. In the background to this decision there seems to have been some political influence, rather than pure security based concerns. In this case it does not seem to have worked out for the Swedes as they lost the tie.
• Finally and far more seriously was the terrorist attack in Pakistan on the Sri Lankan cricket team. This is an outrageous crime, which will create potential long term damage to cricket in general and Pakistan in particular.

We are living in very unstable times, and there is increasing tension around the globe as uncertainty on both political and economic problems blend to form a potentially toxic blend of unrest.

Perhaps it is naive to believe that we can keep sport and international politics separate, but we must hope that this remains the case. otherwise it will be a signal that there is very little left in our lives not tainted by the wider political environment.