Tuesday, July 31, 2007

Buffett Wrong Already

The mark of an original thinker may be that you never know how they’re going to answer a question you’ve never heard them get asked.

That’s how NotMakingThisUp started a recap of the private equity discussion at this year’s Berkshire-Hathaway annual meeting, which came about when a shareholder asked Warren Buffett—The Oracle of Omaha—this simple question about the private equity mania then raging across the land:

“What could cause it to bust?”

The shareholder's question seemed entirely reasonable and timely, given the fact that we had as recently as February seen the classic “cover story” top-of-the-market headline from Fortune Magazine, about the Blackstone Group and its top Alpha Male, Steve Schwarzman:

Wall Street’s Man of the Moment

In the 1980s, Wall Street Power brokers wore red suspenders, dined at Le Cirque, and made their money in junk bonds and arbitrage. A decade later they wore polo shirts and played Foosball at the venture capital firms that line Silicon Valley's Sand Hill Road, reaping billions from tech. Today Wall Street's newest titans can be found every Monday morning
gathered around a long, slightly scuffed conference table in a windowless boardroom high above Park Avenue, the home of the Blackstone Group.

Wearing white shirts and pinstriped suits that underscore their Harvard Business School credentials, Blackstone's top dealmakers have learned well the techniques pioneered by previous masters. What makes them different is that they also happen to dominate the iconic business of this decade - private equity.

The rest of the article was highly predictable, having appeared in various forms regarding various Masters of the Universe overseeing various Thousand Year Reichs including, but not limited to, Drexel Burnham, Enron and Tyco.


Indeed, anybody with more than ten minute’s experience on Wall Street, upon reading that article, should have experienced shivers of precognition that the end of the private equity mania was in sight, if not immediately overhead.

But not Warren Buffett. Here’s how we reported it:

As it turns out…Buffett doesn’t think the private equity mania is a bubble, despite, in my view, all the evidence to the contrary, what with everything from deeply cyclical semiconductor companies to fashion-dependent retailers being leveraged up with the kind of debt loads that would make Donald Trump nervous.

In fact, Buffett said the whole private equity thing “isn’t really a bubble.”

While he did bemoan the high prices the private equity wizards were willing to pay—making it harder for him to put Berkshire-Hathaway’s ample cash to work—he did not seem to think the mania was unsustainable, citing the fact that private equity investors lock in their investors for years as being a bulwark against some kind of dramatic end to the feeding frenzy.

“It takes many years for people to take their money out” of private equity funds. Thus Buffett makes the subtle distinction between a mania that might well end in disappointment for all concerned, and one likely to end in a crash.


Perhaps back then (this was early May) Buffett did not contemplate the hysterical buildup to the June 22 IPO of Blackstone Group—poster child of private equity’s self-proclaimed “golden era”—in which a private partnership whose income consists largely of one-time gains on asset sales would go public at a valuation approaching that of the highly diversified, recurring-revenue generating Lehman Brothers.

Or perhaps Buffett did not look more deeply into his argument that the bubble couldn’t “burst” simply because the buyers wouldn’t get margin calls, and ponder whether the bubble could burst because the buyers’ financiers would indeed get margin calls.

Or perhaps he was just being nice about it.

But he was wrong.

For now that the music has stopped, the investors who have committed their funds for “many years” are stuck; the banks who committed many billions of dollars for short-term bridge financing are stuck; and the poor shlubs who bought Blackstone Group on the IPO are probably wishing they’d never read Warren Buffett’s “all-clear” on private equity.

The private equity bubble has burst, and nobody knows how it will end. But one thing we can take to the bank: trust Warren Buffett to pick through the debris and find the values.

Jeff Matthews
I Am Not Making This Up

© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.


Alex Khenkin said...

I'm waiting for the words "private equity" to become the "dotcom" of 2002. BX likely will be a buy then. Want to take a guess? Mine is "under $8".
Small Investor Chronicles™

whydibuy said...

And it seems to be following closely on the heels of the CDO/housing bubble burst that none of the names I mentioned seemed to see cresting ( KEN FISHER SETH GLICKENHOUS or even DAVID DREMAN who has much of his funds invested with mortgage co's and banks and other financials). Thats why, while I read them and ponder their investments, I still decide for myself if they're aware or just clueless about a situation. Ditto for Buffett. Noteworthy to me is this common belief among them that if its widely known, than the situation is not really a bubble. It only after the bubble bursts that people see it as a bubble. I'm not so sure about that. Seems to me that with all this internet info ( blogs, personal experiences and obscure news items not normally seen nationwide ) people are calling bubbles and manias as they happen in real time. This CDO/housing stuff has been known since at least early '05. And I don't know how many times the internet mania of '99-'00 was described as just that. Even CNBC refered numerous times to the dot com bubble, the dot com mania or the internet bubble while reporting on it. So it may be a new development these days to actually see speculative fevers in real time.

NJ said...

Wait a minute here....Private equity bubble? Is Blackstone going away? Did someone order Carlyle out of DC? Are the PE firms returning funds to investors? Are investors even asking for any money back?

What's happened is that the deals are done -- for now. The public companys have been bought out, public investors have taken their cash, and the market waits for the next cycle to begin. Oops almost forgot about the outrageous fees that will be delayed. (I guess now the hedgies that get 2 and 20 will return to the newspapers' front pages.)

Warren Buffet was right. This isn't a bubble. It hasn't burst. Despite what happened with KKR last go around they came back. This
time it doesn't even look like anyone will go to jail. Which from the last few examples was part of the bubble definition.

Herb said...

I actually think you and Buffett are saying the same thing. Buffett was responding from the perspective of the PE firm itself and it's GP's (not stock investors, not their financiers, not investment bankers, not owners of potential takeover targets). Their bubble has not burst: they have their client's (LP's) money (and in the case of Blackstone, the public's money) and can now wait patiently for markets to return to more favorable conditions. Although not as pleasant an activity as investing, they have no liquidity problems of their own. Buffett defines crash as "a run on the bank". If PE firms are the "the bank" the doors are locked and depositors are out of luck.

fred said...

its the "cocktail party theory". when you hear about it at a cocktail party, its time to short.