Posts Tagged ‘Goldman Sachs’

Soros Says the U.S. is Already in a Double Dip Recession – Defining Balance Sheet Recessions

Sunday, September 25th, 2011

Soros recently asserted that Europe could be more dangerous to the global financial markets than the default of Lehman Brothers in 2008, because of the political stubbornness of European policy makers.   He has been saying this for over two years now, while government officials continue to ignore him, focusing instead on making bold statements and causing riots.  In a brilliant move, Soros returned investor capital at the end of July to avoid the eyes of the public.  I am sure he is now short sovereigns via CDS, currencies, and synthetic instruments, while he continues to donate to the poor in Eastern Europe like a modern day Robin Hood.  Since March, Italian CDS has more than doubled, and French and Belgian CDS spreads will continue to creep higher as the sovereign crisis persists.  How are Greece, Italy, Spain, and Portugal supposed to grow their way out of debt, as deficit cutting reduces European GDP growth to less than 1%?

The public doesn’t trust officials to make timely decisions to protect the EU.   The PIIGS (Ireland and Italy included) pose an insurmountable task for the region, as the combined nations have far greater GDP and net leverage than Germany, the only country that will be supporting the EFSF with a AAA rating. Italy itself has €1.2 trillion of debt, which is  more than Germany, and France may be downgraded in the next 6 months, which is evident in how much its CDS spread has widened over the past 2 months.  France also cannot print money like the United States, and certainly should have been downgraded beforehand, sharply decreasing the effectiveness of the stabilization facility in the EU. A French downgrade would not only endanger French banks, it would create counterparty risk for its U.S. partners as well.  Soros has already claimed that the U.S. is currently in a double dip recession, which I personally think to be true.

Both the majority of the EU and the United States are in a global double dip already not only because of policy mistakes, but due to unsustainable leverage, overspending, broken healthcare and education systems, and corrupt governments. Recent real estate, manufacturing, and confidence numbers, along with revisions down in the earnings of major metallurgical coal and transportation companies in developed countries support my thesis (look at tickers ANR, WLT).  Alpha Natural Resources recently cited a sharp decrease in coal demand for steel production in Asia, reflecting weakness in both its U.S. and ex-U.S. clients.  In the U.S., real estate usually contributes 15% to GDP growth, and it is showing no chance of recovering (HOV), as most sales over the past two years have been distressed sales driven by investors, not families or single buyers.  Developed economies are slowing down quickly, as elected officials argue over who is more important than the other.  The S&P 500 ex-dividends is at the same level it was in 1998, the FTSE MIB in Italy is down 30% on the year (40% from April), and the emerging market index (EEM) just broke its 2010 lows.  Many European financial institution equities are down 60%+ to date.  Markets are broken, as the CME has to raise margins every other day to bring down the prices of precious metals, which are rising in the face of fiat destruction and future inflation risk.  Poverty has reached 15% in the United States, unemployment is over 9.2%, underemployment is about 17%, and local government cuts have resulted in the layoffs of countless public employees, like the recent 3,000 teachers who were fired in Providence, Rhode Island.

There are 44 million people on food stamps in the United States, which is supposed to be the wealthiest nation, and the land of hope for many immigrants.  Over 30% of the U.S. population pays more than half their gross income on rent, since incomes (adjusting for inflation) have not increased since 2000.  With rents projected to increase 3-4% in metropolitan areas over the next year, even the educated poor may be driven out of cities or on to the streets. The land of hope? Why don’t you ask my hardworking university friends about hope, who are much more qualified than some of their U.S. peers, but cannot get jobs and improve the quality of our economy due to the difficulty of obtaining visas.  This country was built by immigrants, who are now blocked out of entering the nation. Teen unemployment also hit decade lows this past month.

According to New York-based Economic Cycle Research Institute (ECRI), which tracks some 20 large economies contributing about 80% of the world GDP and provides critical information about upturns and downturns of economic cycles to money managers, we will know within the next 60 days whether we are in a recession or not.  ECRI’s Lakshman Achuthan has been one of the most accurate forecasters for economic cycles over the past decade.   He argues that the 2008/2009 recession was different than the sharp recession of the 1980s, “This is very different than the early 1980s. The issues that ail the U.S. economy and the jobs market today are not things that result from nearby events. What we’re living through and dealing with now has been building for decades,” he says. “If you look at the data, you see that the pace of expansion has been stair-stepping down ever since the 1970s, on all counts — on production, how much can we produce, how many jobs can we create, how much money do we make, how much do we sell. These are all trending down.” In the deep recession of the 1980s, GDP growth was 5%+ coming out of it…our growth in Q111 was revised down to 0.4%, and will be less than 2% for the year. Don’t believe me? Check on your own.

“If we do have a double-dip recession, Achuthan says, the people who are already having trouble finding work and paying bills are already in a depression and that they “are going to suffer more.”  ”It poses massive problems for policymakers because a new recession automatically increases all of these expenditures out of the public sector, while at the same time dramatically decreasing all their revenue,” he says. “So there’s even less ability to help the people who are hurting the most.”

Although I am not a fan of Roubini for his sensationalist gloom and doom scenarios, he does do decent research and predicted a 60% chance of a double dip in the U.S. three weeks ago.  The United States is in a balance sheet recession, as the economist Richard Koo, a strategist at Nomura, predicted may happen back in 2009.   Most of the growth we have experienced has been the result of continued fiscal and monetary stimulus from the United States government over the past three years, as well as inventory restocking.  The biggest driver of this slow and painful recession is that more stringent underwriting standards for real estate lending and small business lending are slowing down aggregate demand and GDP growth.  Koo argues that once you have a balance sheet recession, people focus on paying down debt, making the situation much worse over time.   The government has to increase fiscal stimulus for the entire duration of the private credit contraction cycle to overcome private deleveraging.  Unfortunately war and internal conflict has made this impossible in the United States as our debt to GDP nears 100%. Since the private sector has moved away from profit maximization to debt minimization, newly generated savings and debt repayments enter the banking system but cannot leave the system due to a lack of borrowers.  The economy here will not and cannot enter self-sustaining growth until private sector balance sheets are repaired.

If the government tries to cut spending too aggressively in 2012-2013, Koo thinks that we would fall into the same trap President FDR fell into in 1937 and that Prime Minister Ryutaro Hashimoto fell into in 1997.  The deflationary gap created by a lack of credit creation and fiscal stimulus “will continue to push the economy toward a contractionary equilibrium until the private sector is too impoverished to save any money.”  The economy will collapse again, and the second collapse will be worse than the first.  It will be difficult to convince people to change their behavior in this scenario.

In a typical recession, private sector balance sheets are not hurt very badly, and most still express profit maximizing behavior.  People borrow money and spend as interest rates are lowered.  In a balance sheet recession, consumers refuse to borrow even if rates are at 0%.  This results in asset prices collapsing and banking crises.  Banks then cannot lend into the private sector, and the government becomes the borrower of last resort, at extremely low rates, because banks don’t need to hold capital against government loans.  When people use money to pay down debt, they withdraw money from their bank accounts and pay it back to the banks, so both deposits and the money supply shrink, which actually caused the Great Depression.  For example, 88% of Obama’s tax rebates have been used to pay down debt.

Let me put it in perspective:

According to Koo, “The Board of Governors of the Fed in 1976 estimated that deposits lost in Depression-era bank closures and through increased hoarding of cash outside of the banking system explained just 15% of the almost $18 billion decline in deposits during the period. Meanwhile, bank lending to the private sector plunged 47%, or by almost $20 billion, from 1929 to 1932. The conventional wisdom is that lending fell because banks panicked in response to dwindling reserves and forcibly called in loans. But that same Fed study shows that bank reserves did not actually fall during that period, when borrowings from the Fed are taken into account. In addition, a survey of almost 3,500 manufacturers, undertaken in 1932 by the National Industrial Conference Board, showed that fewer than 15% of the firms surveyed reported any difficulty in their dealings with banks.”
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If bank closures, cash hoarding and heartless bankers didn’t cause the Depression, what did? ”There’s only one possible alternative explanation for that era’s dramatic shrinkage in deposits and loans — or, at least, for the 85% of those shrinkages that can’t be attributed to the traditional villains. And that is that firms were reducing their debt voluntarily. At that time, the Fed tried to increase money supply by pumping reserves into the system, but with everyone paying down debt, the multiplier was actually negative, so it produced no results whatsoever.”
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And companies became hellbent to pay down debt because — “The price of assets purchased with borrowed funds (as most had been, during the Roaring’20s) collapsed after the stock market crash, and companies’ leverage had already gotten extremely high before the Crash. In other words, companies in the 1930s faced the same balance sheet problems as Japanese firms confronted in the 1990s. The lesson we learned from our experience in Japan is that with the government borrowing and spending money, the money multiplier will stay positive, and that’s basically how Japan kept its GDP growing throughout its Great Recession. So we have a situation where fiscal policy is actually controlling the effectiveness of monetary policy. It’s a complete reversal of what almost everyone alive today learned in school — that monetary policy is the way to go. But once everyone is minimizing debt instead of maximizing profits, all sorts of fundamental assumptions go out the window.” Just like a severe asset price crash on leverage caused crises for the U.S. in the 1930s and for Japan in the 1990s, our real estate driven recession is more than just a manufacturing slowdown or a simple policy mistake.
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In the U.S. we had over 150 bank closures last year, and have had 72 in 2011.  Banks are reticent to lend, but the real problem continues to be that there is less demand for money, and deleveraging will continue to weigh on growth for years. There are many parallels Koo describes with the Japanese crisis as well, which I will discuss in another article.
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The worst part of our current situation in the U.S. is that new bank capital adequacy standards are making it even more difficult for banks to encourage private lending.  So banks do not wish to lend, lending standards have increased dramatically, and citizens don’t want to borrow…and now with a flat yield curve, I don’t understand how financial institutions are going to dig their way out of this mess with profits either. Thank you Ben Bernanke.  Your “operation twist” policy has eroded all profit potential for financial institutions in 2012.  Let the deleveraging continue…

Cheers, Singh

“As I said there is nothing wrong with failing. Pick yourself up and try it again. You never are going to know how good you really are until you go out and face failure.”
-Henry Kravis

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Bank Stocks Beware: Bernanke & Fed Support Increasing Capital Requirements

Tuesday, June 7th, 2011

U.S. bank indices fell 2% yesterday after fears that capital requirements would increase as much as 7%.  Bank of America (NYSE: BAC), fell below $11.00, the lowest since last year.  The discussion came about after the Basel Committee on Banking revealed how levered large financial institutions still were, and tried to reconcile levels with future recession risks.  A 7% equity capital raise for most banks would be catastrophic and dilute equity by 50%+, but a 3% raise seems manageable in a functioning economy.  The problem is that the U.S. economy is on life support, and that life support is called Quantitative Easing 2.  Once this support fades on June 30th, how will U.S. banks (at their already low valuations due to real estate risk and put backs) raise new equity capital?  A replay of 2009?  You be the judge.

According to Bloomberg, “The Fed supports a proposal at the Basel Committee on Banking Supervision that calls for a maximum capital surcharge of three percentage points on the largest global banks, according to a person familiar with the discussions.

International central bankers and supervisors meeting in Basel, Switzerland, have decided that banks need to hold more capital to avoid future taxpayer-funded bailouts. Financial stock indexes fell in Europe and the U.S. yesterday as traders interpreted June 3 remarks by Fed Governor Daniel Tarullo as leaving the door open to surcharges of as much as seven percentage points.

“A seven percentage-point surcharge for the largest banks would be a disaster,” said a senior analyst at Barclays Capital Inc. in NY. “It will certainly restrict lending and curb economic growth if true.”

Basel regulators agreed last year to raise the minimum common equity requirement for banks to 4.5 percent from 2 percent, with an added buffer of 2.5 percent for a total of 7 percent of assets weighted for risk.

Basel members are also proposing that so-called global systemically important financial institutions, or global SIFIs, hold an additional capital buffer equivalent to as much as three percentage points, a stance Fed officials haven’t opposed, the person said.

Bank Indexes Fall

The Bloomberg Europe Banks and Financial Services Index fell 1.45 percent yesterday, while the Standard & Poor’s 500 Index declined 1.1 percent. The KBW Bank Index, which tracks shares of Citigroup Inc., Bank of America Corp., Wells Fargo. and 21 other companies, fell 2.1 percent.

In a June 3 speech, Tarullo presented a theoretical calculation with the global SIFI buffer as high as seven percentage points.

“The enhanced capital requirement implied by this methodology can range between about 20% to more than 100% over the Basel III requirements, depending on choices made among plausible assumptions,” he said in the text of his remarks at the Peter G. Peterson Institute for International Economics in Washington.

In a question-and-answer period with C. Fred Bergsten, the Peterson Institute’s director, Tarullo agreed that the capital requirement, with the global SIFI buffer, could be 8.5 percent to 14 percent under this scenario. A common equity requirement of 10 percent is closer to what investors are assuming.

‘Across the Board’

“I think 3 percent is where everyone expected it to come out,” Simon Gleeson a financial services lawyer at Clifford Chance LLP, said in a telephone interview. “If it is 3 percent across the board then it will be interesting to see what happens to the smallest SIFI and the largest non-SIFI” on a competitive basis, he said.

U.S. Treasury Secretary Geithner, in remarks yesterday before the International Monetary Conference in Atlanta, said there is a “strong case” for a surcharge on the largest banks. Fed Chairman Bernanke is scheduled to discuss the U.S. economic outlook at the conference today.

“In the US, we will require the largest U.S. firms to hold an additional surcharge of common equity,” Geithner said. “We believe that a simple common equity surcharge should be applied internationally.”

Distort Markets

Financial industry executives are concerned that rising capital requirements will hurt the economy, which is already struggling with an unemployment rate stuck at around 9 percent.

Higher capital charges “will have ramifications on what people pay for credit, what banks hold on balance sheets,” JPMorgan Chase & Co. chairman and chief executive officer Jamie Dimon told investors at a June 2 Sanford C. Bernstein & Co. conference in New York.

The Global Financial Markets Association, a trade group whose board includes executives from GS and Morgan Stanley, said the surcharge may apply to 15 to 26 global banks, according to a May 25 memo sent to board members by chief executive officer Tim Ryan.

Dino Kos, managing director at New York research firm Hamiltonian Associates, said the discussion about new capital requirements comes at a time when banks face stiff headwinds. Credit demand is weak, and non-interest income from fees and trading is also under pressure.

Best Result

U.S. banks reported net income of $29 billion in the first quarter, the best result since the second quarter of 2007, before subprime mortgage defaults began to spread through the global financial system, according to the Federal Deposit Insurance Corp.’s Quarterly Banking Profile.

Still, the higher profits resulted from lower loan-loss provisions, the FDIC said. Net operating revenue fell 3.2 percent from a year earlier, only the second time in 27 years of data the industry reported a year-over-year decline in quarterly net operating revenue, the FDIC said.

“You can see why banks are howling,” said Kos, former executive vice president at the New York Fed. Higher capital charges come on top of proposals to tighten liquidity rules and limit interchange fees, while the “Volcker Rule” restricts trading activities. Taken together these imply lower returns on equity, he said.

“How can you justify current compensation levels if returns on equity are much lower than in the past?” Kos said.

Deutsche Bank Discriminates Against Indian Rainmaker

Thursday, March 10th, 2011

It is March 10, 2011, and today I read that a German bank is discriminating against a top banker, a “rainmaker,” because he is Indian.  Anshu Jain is a 48 year old head of investment banking at Deutsche Bank and has generated hundreds of millions of Euros in fees for the bank since 1995.

Anshu was born in 1963 in the humble town of Jaipur, India and later studied economics at Shri Ram College of Commerce at Delhi University.  He earned a bachelor’s degree with honors in 1983 and then pursued a Masters in Finance at UMASS Amherst.  He then started as an analyst in derivatives research at Kidder Peabody (now UBS), from 1985 to 1988.  Anshu joined Merrill lynch in 1989, where he started the first hedge fund coverage group.

By 1995, Anshu joined Deutsche’s markets business and stared a unit focusing on hedge funds and institutional derivatives, later becoming the head of fixed income sales and trading and global head of derivatives and emerging markets.  In 2002, he joined the Deutsche Bank Group Executive Committee and became the head of Global markets and joint head of the Corporate & Investment Bank in 2004.  Anshu’s segment of Deutsche Bank’s business generates 80% of the Company’s revenues, and he still may be passed over for CEO.

Mr. Jain has been in the media under speculation that he could succeed Josef Ackerman, but the Company’s Board of Directors won’t have it.  Key members of the bank’s supervisory board are not in favor of an Indian born banker at the helm.  They want to see the bank under more “traditional” leadership.  The bank also wants to diversify revenues away from the profitable investment banking segment.  Is this just an excuse to pass over Mr. Jain?

The next CEO of the 141 year old bank needs a 2/3 majority vote and approval by the 20 member advisory board.  The board has 10 German labor representatives and 10 shareholder representatives.

According to Reuters, “In a written statement Deutsche Bank said selecting the CEO is a task which the “supervisory board is pursuing in an orderly and professional manner. A decision will be taken when the time is right. There is no urgency, given that Dr. Ackermann’s contract runs for another two years.”

BARCLAYS SOLUTION?

Investors, though, are sure to worry that the move could alienate the hard-charging Jain. Supervisory board chairman Clemens Boersig knows this, according to two people familiar with the supervisory board’s thinking, and is working on ways to retain Jain and his colleague, Chief Risk officer Hugo Baenziger. In the end, however, “the supervisory board believes everybody is replaceable,” a member of the supervisory board said on condition of remaining anonymous. The board feels it is too dangerous for the bank to rely on any one person. “You cannot be held to ransom,” another person, who is familiar with the supervisory board’s thinking, said.

Jain, who would not comment on the issue of succession, could well stay. He has had a hand in hiring most of the key staff at the investment bank, and his considerable stake in Deutsche in the form of shares and options gives him a vested interest in the place. But if he does walk, the bank hopes one of his proteges will step up in the same way that Jain himself emerged after his mentor Edson Mitchell died in a plane crash in December 2000. Most of Deutsche’s top 15 investment bankers have been with the firm for more than a decade, something that should instill loyalty toward the firm and not only its leader, the person close to the supervisory board said.

In private conversations between supervisory board members and Deutsche Bank executives, there has been talk of a “Barclays” solution, named after a recent arrangement at British bank Barclays where John Varley, a Briton with connections to the political establishment, took the title of chief executive, while Robert Diamond, a powerful American investment banker, held de facto power in the background. Diamond finally took the reins from Varley two months ago.

“Perhaps one could whet Jain’s appetite for a similar solution,” one of the people close to the supervisory board said. “In the end we may have to divide up the role among different sets of shoulders,” a supervisory board member said adding. “But we’re not yet at that stage.”

A decision on succession won’t be made this year, another supervisory board member, who declined to be named, said.

The German establishment has long been skeptical of investment banking, a conviction that has hardened since the subprime debacle and the ensuing financial crisis. When the German government stepped in to bail out a raft of lenders including Hypo Real Estate, IKB and Commerzbank, many Germans pointed to “casino” style investment banks as the main culprits. Deutsche Bank, Germany‘s biggest, did not require a bailout itself, but had long been a lightning rod for criticism as Europe’s largest economy moved away from old-fashioned “Rhineland Capitalism,” in which a close-knit clique of bankers, politicians and company executives fostered business and dictated change in corporate Germany, toward a more cut-throat “Wall Street” model where shareholder return is the main driver of change.

A raft of supervisory board members believe Deutsche should focus solely on providing simple financial services to corporations and the “real economy,” rather than dabbling in more complex and higher margin financial products. “Wall Street style capitalism doesn’t have many friends on the supervisory board,” a person close to the supervisory board said.

The opposing camp believes that Deutsche should be a place where gifted and risk-hungry bankers can make outsized bets to generate profits for themselves and shareholders. That view is often associated with Jain, who oversees some of the world’s most talented bankers.

Perhaps crucially, members of the board’s four person chairman’s committee, which is formally tasked with drawing up the shortlist of CEO candidates, consists of only Germans: two labor representatives, chairman Boersig, and Tilman Todenhoefer, former deputy chairman of the board of management at Robert Bosch, an engineering company that specializes in high-tech automotive technologies and is known for its skeptical view of Wall Street-style capitalism.

Although not bestowed with formal powers to appoint the next leader, chief executive Ackermann and shareholder representatives on the supervisory board will have considerable influence over who makes it on to the shortlist, a person close to the supervisory board added.

A PILLAR OF THE GERMAN ESTABLISHMENT

For decades the system that helped steer Europe’s largest economy was controlled by Deutsche Bank and insurer Allianz. Working with large German corporations in which the two financial institutions held stakes, the network of bankers and executives formed what became known as “Deutschland AG”.

The system worked, in its own way. By holding large stakes in companies like Daimler-Benz, Siemens and Thyssen, Deutsche protected German industry from foreign takeovers and provided a system of mutual support in the event of large-scale bankruptcies. Market forces were an afterthought. When German Chancellor Helmut Schmidt decided Germany’s aerospace companies needed to consolidate to stay competitive, he simply talked to then Deutsche boss Alfred Herrhausen, who promptly nudged Daimler-Benz to absorb the big aerospace and defense companies and form German aerospace company DASA.

Deutsche Bank’s seats on corporate boards meant it could win mandates for bond and stock issuances and force changes when it saw the need. In one infamous incident, in 1987, Herrhausen dismissed Daimler-Benz chief Werner Breitschwerdt and installed another executive, Edzard Reuter in his place.

But by the 1990s, as German companies pushed more aggressively into global markets, they needed more sophisticated products even to meet simple needs such as currency or oil price hedging. When Ackermann joined Deutsche in 1996 he was tasked with transforming Germany’s corporate fixer into a “global champion”.

“Joe,” as Ackermann is known by colleagues, had worked at SKA — later to become Credit Suisse — and liked to use tactics and strategy he learned as a Swiss army officer. He decided to accelerate a selloff of industrial stakes — which made up half of Deutsche Bank’s market value as late as 1998, and were proving a drag on the company’s share price — and use the proceeds to build up its core business of banking. The last significant holding — a stake in Daimler — was sold in October 2009.

GLOBAL EXPANSION WEAKENS LOCAL TIES

When Ackerman became the first non-German in the top job in 2002, his academic background and gentle demeanor masked an ambition to shake up the lender. He embarked on a radical program to boost the profitability of bread-and-butter corporate loans, even if that meant alienating established customers.

In early 2003, Ackermann, together with investment banking co-chiefs Jain and Michael Cohrs, and Baenziger, then head of credit risk, introduced the “loan exposure management group” to ensure that each loan to be approved was priced in accordance with international market standards, rather than traditional German ones, and to guarantee that the “overall customer relationship” was generating a 25 percent pre-tax return on equity. The move helped lift Deutsche’s pre-tax return on equity to 14.7 percent today from just 1.1 percent back in 2002.

Competitors like Commerzbank also quietly introduced profitability targets for corporate loans. But it was — and still is — Deutsche that attracted the most criticism for abandoning the old system. Ackermann remains unrepentant. “As a bank with global operations that conducts more than 75 percent of its business outside of its home market, we have obligations to numerous stakeholders around the world,” he told shareholders at Deutsche Bank’s annual general meeting last May. “We have to carefully weigh up these obligations. Sometimes, in Germany, this can lead to criticism by the political community. We have to be able to take it.”

One of Deutsche’s key stakeholders is internal: golden boy Jain. A keen cricket fan, he built up what has become known within Deutsche as “Anshu’s Army” from the original core of mostly American bankers who defected from Merrill Lynch in 1995. The defectors had followed Edson Mitchell, a brash American who demanded fierce loyalty from those who served under him.

Mitchell’s team was instrumental in introducing a more aggressive Anglo-Saxon style of management which sacrificed long-term job security for eye-popping pay packages. Ackermann later cemented the new culture by transferring decision-making power away from the German “Vorstand”, or management board, to a new committee known as the Group Executive Committee, dominated by London-based investment bankers.

The power of the investment banking arm became clear in 2000, when its senior officials sabotaged a signed 30 billion euro merger deal with Deutsche Bank’s main rival, Dresdner Bank, because of overlaps in investment banking. Following a strategy meeting in Florida, Deutsche told Dresdner that of the 6,500 investment bankers at its investment banking unit Dresdner Kleinwort Wasserstein, Deutsche could only take 1,000, a person familiar with the conversation said.

Another clash between the Deutsche’s management board and the supervisory board came in February 2004, when it emerged that Ackermann and senior executives had met Citigroup’s chairman Sanford “Sandy” Weill, and chief executive Charles Price a few months earlier to discuss a takeover of Deutsche Bank. When Ackermann raised the possibility of a sale, members of the German-dominated supervisory board blocked the deal, arguing that Deutsche would be reduced to a local branch office of a New York bank.

As the investment banking arm has grown more powerful, Deutsche’s center of gravity has shifted to London, where key staff including Baenziger and Jain spend most of their time, and where the company now employs more than 8,000 staff. Their London base helps Jain and Baenziger remain close to key clients. But has it also hampered their ability to build up a network of political and corporate contacts in Germany.

CASINO BANKING?

A sign of potential trouble emerged two years ago, when the supervisory board chose to dodge the issue of succession by extending Ackermann’s contract until 2013. Some inside the bank blame that in part on Ackermann, who has not successfully nurtured a clear successor.

Tensions between the supervisory board and Deutsche’s management have grown since 2008, when the global financial system went into meltdown. Deutsche was under extreme pressure to help rescue failing rivals. In mid-March 2008, while Ackermann was in New York, U.S. treasury secretary Henry “Hank” Paulson called him and tried to get Deutsche to buy Bear Stearns, a person familiar with the matter said. Later Deutsche was pushed to buy parts of Lehman. In both instances, Ackermann declined. Deutsche also turned down offers to buy parts of UBS in the second half of 2008, two senior executives familiar with the lender’s thinking said. The Swiss bank was looking for fresh leadership and mulling a sale of its investment bank, but Deutsche preferred its wealth management assets, these people familiar with the talks said. Deutsche walked away when it couldn’t get sufficient detail on balance sheet risks. Regulatory approval may also have been a hurdle, a senior Deutsche banker said.

Only months earlier the bank had been giving its traders a remarkable degree of leeway to place large directional bets, a strategy that had proved extremely successful, current and former employees of the global markets division said, also declining to be named. Proprietary traders — small teams that bet with a bank’s own money — made up to 15 percent of revenues at the sales and trading division between 2002-2007, a senior banker familiar with Deutsche’s strategy told Reuters.

At the sales and trading division, managers such as Boaz Weinstein, a former head of credit trading North America and Europe, and Greg Lippmann, global head of asset-backed securities trading and syndicate and collateralized debt obligations (CDOs), were particularly aggressive. Lippmann made a $1 billion bet against the subprime market, a gamble that started to come good in the second half of 2008 when global markets fell. Weinstein — a chess fanatic known for taking teams of traders to Vegas for poker tournaments — also had large positions running into the billions, a person familiar with his business said.

Single bets could be very large. One left the bank with 600 million euros of rates exposure, a former colleague who worked at Deutsche’s credit trading division at the time told Reuters. This sort of extreme trading led The Economist to describe Deutsche as a “giant hedge fund” run by an “Indian bond junkie” in 2004, a view some could argue was not justified by the investment bank’s relatively consistent performance over the past decade.

Things were less rosy at the proprietary and credit trading divisions during the financial crisis: they fueled Deutsche’s 4.8 billion euro loss in the fourth quarter of 2008 and prompted its management board to abandon proprietary trading the same year — months before regulators discussed a move in that direction.

Despite shedding almost a third of its risky assets between 2009 and 2010, Jain has managed to retain his top staff and win market share in key areas of investment banking. Research firm Greenwich Associates last year ranked Deutsche Bank No. 1 in U.S. bond trading. Profits from the corporate and investment bank have jumped from almost 4 billion euros in 2000, to a near record level of 6 billion euros in 2010, a testament to Jain’s ability to deliver profits in extremely challenging market conditions, analysts and rivals say.

GERMAN REQUIRED

Ackermann’s recent language indicates how difficult it has become to defend risk-taking. In countless speeches to the German business community and politicians, he has said the country “needs to decide whether it wants a globally successful investment bank or not.”

But the son of a doctor from the village of Mels in Switzerland has also tried to ease tensions between business and politics. “Especially here in Germany where those responsible in business and politics live and work further apart geographically than in other countries, we must make a greater effort to listen to one another,” he told the company’s annual general meeting in Frankfurt in May. “Verbal attacks on so-called speculators and political rhetoric about a ‘war’ between governments and markets is not conducive to such a dialogue,” he said.

Bundesbank president Axel Weber’s name has surfaced as a potential candidate though critics on the supervisory board highlight his lack of experience running a commercial bank, as well as his recent clash with Merkel as weak points for such a candidacy.

Helmut Hipper, a fund manager at Frankfurt-based Union investment, thinks Deutsche should not leave it until the last minute to reveal who will take over: “For an institution like Deutsche it is important to announce a successor. Designating a candidate will provide security and predictability.”

Also in the race with an outside chance are internal candidates such as Deutsche’s Germany chief Juergen Fitschen, retail chief Rainer Neske or Chief Financial Officer Stefan Krause.

Whoever does get the job will need to be able to mediate between Berlin and Germany’s financial players. That became clear during the credit crisis. In September 2008, Ackermann was involved in rescue talks for German lenders IKB and Hypo Real Estate. Discussions involved the then finance minister Peer Steinbrueck, regulator Jochen Sanio and representatives from the German banks.

“You need to speak German, period,” a senior German financial figure who was familiar with these talks said. Ackermann himself, asked if the next chief of Deutsche Bank needs to speak German, said, “That’s for the supervisory board to decide.” He had found speaking German “helped.”

Although Jain has been with the Frankfurt-based bank since 1995, he has never spoken a word of German in public and relies on a translation service during press conferences. Late last year when Jain made an appearance at a banking conference in Frankfurt he was asked “Sprechen Sie Deutsch?” a question designed to find out whether he had been brushing up his German. Jain dodged the answer with a smile and said, “I’m not going to go there,” before walking away.”

Check out our intensive investment banking, private equity, and sales & trading courses!  The discount code Merger34299 will work until April 2011.


KKR & Bain to IPO HCA at $30 per Share – Mega IPO, Sponsors to make 2.5x on Deal

Friday, March 4th, 2011

HCA Holdings, the large hospital operator in the world, confirmed that it had set a preliminary price range for its initial public offering of $27 to $30 a share last month.  The company was taken private in 2006 for about $30 billion, with an equity check that was only 15% of its purchase price!  Last year, HCA’s $4.3 billion dividend recapitalization itself made many parties in the deal whole on their initial investment.  The IPO is gravy, icing on the cake.  And to top it all off, this had been done with the hospital operator before: “The company had been under private-equity ownership before, completing a $5.1 billion leveraged buyout in 1989. When it went public again in 1992, it handed its backers, including units of Goldman Sachs Group Inc. and JPMorgan Chase & Co., a more-than- eightfold gain, BusinessWeek magazine reported at the time.”

According to BusinessWeek, after a tepid turnout in 2010, there has been a modest uptick in buyout-backed offerings this year, with several exceeding expectations. Among the recent I.P.O.’s are Nielsen Holdings, Kinder Morgan and Bank United. HCA is currently pitching its offering to investors.

A private equity consortium, including Kohlberg Kravis Roberts, Bain Capital and Merrill Lynch, acquired HCA in 2006, loading the company up with debt. HCA, in its filing, said it planned to use proceeds from its offering to pay off some of its debt.

What a difference 10 months have made for HCA Inc. and its private-equity owners, KKR & Co., Bain Capital LLC and Bank of America Corp.

When the hospital operator, which went private in a record leveraged buyout in 2006, filed in May to go public, U.S. initial offerings were stumbling, with deals in the first four months raising an average of 13 percent less than sought. Rather than press ahead, the owners took on more debt to pay themselves a $2 billion dividend in November, in a transaction known as a dividend recapitalization.

This month, HCA’s owners are betting that stock markets have recovered enough for investors to pick up the shares, even with the additional debt. If they’re right, they may triple their initial investment in what would be the largest private- equity backed initial public offering on record.

“This has been a classic case of buy low, sell high from the beginning,” said J. Andrew Cowherd, managing director in the health-care group of Peter J. Solomon Co., a New York-based investment bank. “Private-equity buyers have timed capital markets perfectly on this deal.”

The offering, if successful, underscores the crucial role played by the capital markets in leveraged buyouts, at times eclipsing the impact of operational changes private-equity firms make at their companies. A surge in demand for stocks and junk- bonds, fueled by asset purchases of the Federal Reserve that sent investors searching for yield, have helped KKR and Bain reap profits from HCA, even as the company remains burdened with $28.2 billion in debt and slowing revenue growth.

Record Deal

KKR, Bain, Bank of America and other owners invested about $5 billion in equity in the $33 billion takeover of HCA, which including debt was the largest leveraged buyout at the time. The backers, who took out $4.3 billion in dividends from HCA last year as the high-yield market soared, stand to get more than $1 billion from the IPO and will retain a stake in HCA valued at about $11 billion.

In acquiring Nashville, Tennessee-based HCA, KKR and Bain chose a company with steady cash flow and a business that’s protected from swings in the economy. Cash flow from operations was $3.16 billion in the year before the 2006 buyout, according to data compiled by Bloomberg. As of Dec. 31, 2010, that number was little changed at $3.09 billion.

The company had been under private-equity ownership before, completing a $5.1 billion leveraged buyout in 1989. When it went public again in 1992, it handed its backers, including units of Goldman Sachs Group Inc. and JPMorgan Chase & Co., a more-than- eightfold gain, BusinessWeek magazine reported at the time.

Income Streams

Unlike some other buyouts of the boom years that had less predictable income streams, HCA has reported revenue growth of between 5 percent and 6 percent every year it was private, except in 2010, when growth slowed to 2.1 percent. Net income has increased 17 percent since the end of 2006.

NXP Semiconductors NV, another 2006 buyout involving KKR and Bain, had combined losses of $5.8 billion between the takeover and its IPO in August. NXP, which sold just 14 percent of its shares, had to cut the offering price, leaving investors with a 21 percent paper loss as of Dec. 31. The stock has more than doubled since the IPO.

HCA, the biggest for-profit hospital chain in the U.S., attributes gains in income to cost-cutting measures and initiatives to improve services for patients. The company sold some hospitals after the buyout and made “significant investments” in expanding service lines, as well as in information technology, HCA said in a regulatory filing.

‘Aggressive Changes’

“HCA was already one of the better operators when it was taken private so it was hard to see how much cost could be driven out of the business,” Dean Diaz, senior credit officer at Moody’s Investors Service in New York, said in a telephone interview. “But they are very good at what they do and are above where we would have expected on Ebitda growth.”

Some of the improvements in earnings have come from “aggressive changes in billing and bad debt expense reserves,” Vicki Bryan, an analyst at New York-based corporate-bond research firm Gimme Credit LLC, said in a Feb. 22 report.

Provisions for doubtful accounts dropped 19 percent last year, to $2.65 billion. Capital spending, or money invested in the company, declined to about 4 percent of revenue last year from 7 percent in 2006. The company hasn’t used its cash to bring down the debt load, which is about the same as it was at the time of the takeover.

That debt will contribute to a negative shareholder equity, a measure of what stockholders will be left with if all assets were sold and debts were paid, of $8.6 billion, according to Bryan. Excluding intangible assets, new investors buying the stock would own a negative $51 per share, she said.

‘Funding the LBO’

“Today’s HCA stock buyers are still funding the 2006 LBO, which enriched many of the same equity owners for the second time, plus the massive dividends and management fees paid to those equity investors who will remain very much in control,” Bryan wrote in the report.

While it’s not unusual for companies that exit LBOs to have more debt than assets, it means they will have to use cash flow to reduce debt rather than pay out dividends, limiting returns for shareholders. HCA’s share price doubled in the 14-year period between its 1992 IPO and the 2006 buyout, not including the impact of stock splits.

Ed Fishbough, an HCA spokesman, declined to comment, as did officials for New York-based KKR, Bain in Boston, and Bank of America in Charlotte, North Carolina.

‘Slight Premium’

Even so, investors may pick up the stock after U.S. equity markets rallied to the highest levels since June 2008. So far this year, eight companies backed by private-equity or venture- capital firms have raised $5.9 billion in initial public offerings, five times the amount that such companies raised last year, according to data compiled by Bloomberg.

At the midpoint of the price range of $27 to $30, the IPO would value the company at $14.7 billion. Based on metrics such as earnings and debt, that valuation would give HCA a “slight premium” to rivals such as Community Health Systems Inc. and Tenet Healthcare Corp., according to a Feb. 22 report from CreditSights Inc.

Community Health Systems, currently the biggest publicly traded hospital operator, in December bid $3.3 billion to buy Tenet in Dallas. If the takeover is successful, the combined company with about $22.2 billion in revenue as of Dec. 31, 2010 will still be smaller than HCA.

With as much as $4.28 billion in stock being sold, the HCA offering is poised to break the record set by Kinder Morgan Inc., the buyout-backed company that last month raised $2.9 billion in an IPO.

‘Medicare Schedule’

Shareholders will also have to weigh the impact of government spending cuts and changes to hospital payment schedules prompted by the 2010 U.S. health law and rules from the Centers for Medicare and Medicaid, which administer the federal programs.

Baltimore-based CMS has been pushing to bundle payments to doctors and hospitals, giving them a set amount for a procedure that has to be split among providers. The agency also plans to penalize providers if patients acquire infections while in treatment or fare badly after stays. Too many readmissions, once regarded as more revenue, may now result in lower payment rates.

The federal health-care law will extend health insurance to 32 million more Americans and may prompt some employers to drop company-sponsored health benefits in favor of sending employees to state insurance exchanges the new law creates. While the newly insured may mean less bad debt for hospitals, fewer private sector-paid benefits may mean lower revenue for for- profits like HCA, because commercial payers and employers tend to pay the highest rates to providers.

Health-Care Impact

“Hospitals are going to have to learn how to be productive and profitable on a Medicare rate schedule,” said R. Lawrence Van Horn, who teaches at the Owen Graduate School of Management at Vanderbilt University in Nashville. Medicare and Medicaid pay less for procedures and treatment than employers and commercial insurers, which are “traditionally the most generous payers,” he said.

HCA said in its filing that it can’t predict the impact of the changes on the company.

For-profit hospitals like HCA depend more on commercial payers and less on government beneficiaries than do nonprofits, which have already seen their revenue reduced by government cutbacks, particularly in Medicaid. Chains like HCA, with their access to capital, may be able to take advantage of weakness among nonprofits to consolidate the industry further, Van Horn said.

Megan Neuburger, an analyst at Fitch Ratings in New York, said the biggest impact of the health-care reform won’t be felt until 2014, and the market recovery will play a more important role for now in determining HCA’s success.

Returning Money

“In the short term, the pace and progress of economic recovery will probably be more influential to the industry’s financial and operating trends than health-care reform,” Neuburger said in an interview.

For KKR and Bain, the timing of the IPO is crucial also because their clients want to see whether buyouts made just before the credit crisis can be profitable, before they commit capital to new funds. KKR is seeking to raise its 11th North American-focused buyout fund this year.

Buyout firms have been able to return some money to investors through dividend recapitalizations, as near-zero interest rates have spurred a demand for junk bonds. Borrowers sold $47 billion of debt last year, or 9 percent of offerings, to pay owners, compared with $11.7 billion in 2008 and 2009, according to Standard & Poor’s Leveraged Commentary and Data.

‘Unprecedented Amount’

Investors in Bain’s 2006 fund have received $1.6 billion in distributions so far, or about 20 percent of the $8 billion deployed. HCA’s dividends recapitalizations accounted for about $302 million of the total Bain paid out to the fund’s clients, according to an investor in the fund. The fund has generated an average annual loss of 6.4 percent, according to another person familiar with the fund.

“Investors committed an unprecedented amount of money over a short time period,” said Jeremie Le Febvre, the Paris-based global head of origination for Triago, which helps private- equity firms raise money. “Investors most likely won’t be as generous a second time, or even have the means to double down on a firm, as reputable as it may be, without first seeing money flowing back into their pockets.”

–With assistance from Lee Spears in New York and Christian Baumgaertel in 東京. Editors: Christian Baumgaertel, Larry Edelman

Here is an article LA put together earlier last year on a possible IPO: http://leverageacademy.com/blog/2010/04/11/hca-could-have-3-billion-ipo-4-years-after-kkr-bain-buyout/.

Check out our intensive investment banking, private equity, and sales & trading courses! The discount code Merger34299 will be activated until April 15, 2011. Questions? Feel free to e-mail thomas.r[at]leverageacademy.com with your inquiries or call our corporate line.


S&P 500 2011 Median Target – 1,535, Really?

Friday, March 4th, 2011

Investment bank earnings estimates are truly bullish for 2011.  Applying a 16x-18x multiple to these forward earnings brings you to S&P levels unseen since 2007.  Unfortunately, something not included in these estimates is that for every $10 crude oil increases, S&P earnings fall by $3.  This does not even factor in the fall in consumer confidence when citizens across the globe realize that they are soon going to pay $200 to fill up a mid-sized sedan, once QE3 is unveiled and Middle Eastern governments are overthrown once and for all.  After all this is done for, oil could easily reach $130+ on a supply disruption in Saudi Arabia.

Of course, BofA’s Bianco will not discuss this.  Neither will the analysts at Barclays, who just revised their S&P 500 earnings estimates up from 1,420 to 1,450.

Please view LA’s blog entry to see the S&P earning’s table below.

Predicted
Firm Strategist 2011 Close 2011 EPS RPF Model
Bank of America David Bianco 1,400 $93.00 1,535
Bank of Montreal Ben Joyce 1,300 $89.00 1,469
Barclays Barry Knapp 1,420 $91.00 1,502
Citigroup* Tobias Levkovich 1,300 $94.50 1,559
Credit Suisse Andrew Garthwaite 1,350 $91.00 1,502
Deutsche Bank Binky Chadha 1,550 $96.00 1,584
Goldman Sachs David Kostin 1,450 $94.00 1,551
HSBC Garry Evans 1,320
JPMorgan Thomas Lee 1,425 $94.00 1,551
Morgan Stanley**
Oppenheimer Brian Belski 1,325 $88.50 1,460
RBC Myles Zyblock $88.00 1,452
UBS Jonathan Golub 1,325 $93.00 1,535
Median 1,350 $93.00 1,535
Average 1,379 $92.00 1,518
High 1,550 $96.00 1,584
Low 1,300 $88.00 1,452

Goldman Values Facebook at $50 billion, Digital Sky Technologies Makes 400% on its Investment Since 2009!

Monday, January 3rd, 2011
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The New York Times announced today that Goldman Sachs and Russian Investor Digital Sky Technologies are investing $500 million into Facebook at a valuation of $50 billion.   According to Second Market, some private investors have bid up the Company’s shares to imply a value of $56 billion.  This bid comes soon after Google announced a $6 billion bid for Groupon a couple weeks ago.  Some call the Facebook valuation astronomical, and it theoretically doubles the net worth of founder Mark Zuckerberg to approximately $14 billion.  Two years ago Microsoft attempted to purchase a stake in Facebook at $15 billion, which at the time was deemed too high.  Digital Technology’s original 2009 stake in Google, which valued the company at $10 billion has since quintupled.  While Goldman is purchasing shares, VC firm Accel Partners is selling very aggressively at much lower valuations.  When examined more closely, with this purchase, Goldman may have bought it’s right to the Facebook IPO.  If Goldman is able to IPO shares of the company at a higher price, it could eventually simply divest of its shares in the open markets at a higher valuation and make a fat fee in the process.
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According to Reuters, “Goldman Sachs is investing $450 million of its own money into Facebook and that it’s bringing along $50 million from Digital Sky Technologies and as much as $1 billion more from its high-net-worth clients — all at a valuation of $50 billion.

The enormous sums of money involved here clearly ratify the valuation: this isn’t a handful of shares trading in an illiquid market, it’s an investment substantially larger than most IPOs.

It’s worth remembering here that only two years ago, when Microsoft bought into Facebook at a $15 billion valuation, that sum was described in the NYT as “astronomical”. But that said, Facebook’s multiples have clearly shrunk from those heady days: in 2007, Facebook could actually use Microsoft’s $240 million to fuel its expansion. Today, it’s reportedly earning $2 billion a year, which implies to me that this is a cash-out rather than a dilutive offering. Facebook has raised, in total, about $850 million to date, and there’s no obvious need for a massive new round of funding which would dwarf that entire sum.

If Goldman is leading the buyers, then, who are the sellers? VC shop Accel Partners has been selling Facebook shares quite aggressively of late, at lower valuations than this. They could easily provide all the shares that Goldman is buying and still be left with a stake worth some $3.5 billion. And it’s entirely conceivable that some early employees might well want to diversify their holdings and have maybe a little less than 99% of their net worth in Facebook stock.

As for Goldman, it has probably bought itself the IPO mandate, which could easily generate hundreds of millions of dollars in fee income. It has also become the only investment bank which can give its rich-people clients a coveted pre-IPO stake in Facebook: the extra cachet that brings and the possible extra clients, make this investment a no-brainer. Facebook doesn’t need to stay worth $50 billion forever — Goldman just needs to engineer an IPO valuation somewhere north of that, then exit quietly in the public markets. And that is surely within its abilities.

According to Dealbook, “the deal could double the personal fortune of Mark Zuckerberg, Facebook’s co-founder.

Facebook, the popular social networking site, has raised $500 million from Goldman Sachs and a Russian investor in a deal that values the company at $50 billion, according to people involved in the transaction. The deal makes Facebook now worth more than companies like eBay, Yahoo, and Time Warner.

The stake by Goldman Sachs, considered one of Wall Street’s savviest investors, signals the increasing might of Facebook, which has already been bearing down on giants like Google. The new money will give Facebook more firepower to steal away valuable employees, develop new products and possibly pursue acquisitions — all without being a publicly traded company. The investment may also allow earlier shareholders, including Facebook employees, to cash out at least some of their stakes.

The new investment comes as the SEC has begin an inquiry into the increasingly hot private market for shares in Internet companies, including Facebook, Twitter, the gaming site Zynga and LinkedIn, an online professional networking site. Some experts suggest the inquiry is focused on whether certain companies are improperly using the private market to get around public disclosure requirements.

The new money could add pressure on Facebook to go public even as its executives have resisted. The popularity of shares of Microsoft and Google in the private market ultimately pressured them to pursue initial public offerings.

So far, Facebook’s chief executive, Mark Zuckerberg, has brushed aside the possibility of an initial public offering or a sale of the company. At an industry conference in November, he said on the topic, “Don’t hold your breath.” However, people involved in the fund-raising effort suggest that Facebook’s board has indicated an intention to consider a public offering in 2012.

There has been an explosion in user interest in social media sites. The social buying site Groupon, which recently rejected a $6 billion takeover bid from Google, is in the process of raising as much as $950 million from major institutional investors, at a valuation near $5 billion, according to people briefed on the matter who were not authorized to speak publicly.

“When you think back to the early days of Google, they were kind of ignored by Wall Street investors, until it was time to go public,” said Chris Sacca, an angel investor in Silicon Valley who is a former Google employee and an investor in Twitter. “This time, the Street is smartening up. They realize there are true growth businesses out here. Facebook has become a real business, and investors are coming out here and saying, ‘We want a piece of it.’”

The Facebook investment deal is likely to stir up a debate about what the company would be worth in the public market. Though it does not disclose its financial performance, analysts estimate the company is profitable and could bring in as much as $2 billion in revenue annually.

Under the terms of the deal, Goldman has invested $450 million, and Digital Sky Technologies, a Russian investment firm that has already sunk about half a billion dollars into Facebook, invested $50 million, people involved in the talks said.

Goldman has the right to sell part of its stake, up to $75 million, to the Russian firm, these people said. For Digital Sky Technologies, the deal means its original investment in Facebook, at a valuation of $10 billion, has gone up fivefold.

Representatives for Facebook, Goldman and Digital Sky Technologies all declined to comment.

Goldman’s involvement means it may be in a strong position to take Facebook public when it decides to do so in what is likely to be a lucrative and prominent deal.

As part of the deal, Goldman is expected to raise as much as $1.5 billion from investors for Facebook at the $50 billion valuation, people involved in the discussions said, speaking on the condition of anonymity because the transaction was not supposed to be made public until the fund-raising had been completed.

In a rare move, Goldman is planning to create a “special purpose vehicle” to allow its high-net worth clients to invest in Facebook, these people said. While the S.E.C. requires companies with more than 499 investors to disclose their financial results to the public, Goldman’s proposed special purpose vehicle may be able get around such a rule because it would be managed by Goldman and considered just one investor, even though it could conceivably be pooling investments from thousands of clients.

It is unclear whether the S.E.C. will look favorably upon the arrangement.

Already, a thriving secondary market exists for shares of Facebook and other private Internet companies. In November, $40 million worth of Facebook shares changed hands in an auction on a private exchange called SecondMarket. According to SharesPost, Facebook’s value has roughly tripled over the last year, to $42.4 billion. Some investors appear to have bought Facebook shares at a price that implies a valuation of $56 billion. But the credibility of one of Wall Street’s largest names, Goldman, may help justify the company’s worth.

Facebook also surpassed Google as the most visited Web site in 2010, according to the Internet tracking firm Experian Hitwise.

Facebook received 8.9 percent of all Web visits in the United States between January and November 2010. Google’s main site was second with 7.2 percent, followed by Yahoo Mail service, Yahoo’s Web portal and YouTube, part of Google.

For Mr. Zuckerberg, the deal may double his personal fortune, which Forbes estimated at $6.9 billion when Facebook was valued at $23 billion. That would put him in a league with the founders of Google, Larry Page and Sergey Brin, who are reportedly worth $15 billion apiece.

Even as Goldman takes a stake in Facebook, its employees may struggle to view what they invested in. Like those at most major Wall Street firms, Goldman’s computers automatically block access to social networking sites, including Facebook.”

David Tepper Personally Earns $4 Billion for 2009 Performance

Sunday, December 26th, 2010

We thank Dan for his contribution to Leverage Academy, LLC and for writing this biography on David Tepper, of Appaloosa, who made $4 billion for himself last year.

David Tepper grew up in a middle class neighborhood in Pittsburgh, PA. He became interested in the stock market after observing his dad, an accountant, trade stocks during the day.  Following high school, he enrolled in the University of Pittsburgh, where he excelled. After Tepper graduated with a degree in economics, he found a job with Equibank as a credit analyst. He quickly became bored with the role and enrolled in the MBA program at Carnegie Mellon’s School of Business, now named after him. [1] Tepper’s experience at Carnegie Mellon helped him learn options theory at a time when there were no textbooks written on the subject. Kenn Dunn, the Dean of school of the school himself taught these option courses.[2]

After graduating, Tepper worked in the Treasury division at Republic Steel, once the third largest steel manufacturer in the U.S.  Soon after, Tepper moved onto Keystone Mutual Funds, and finally to Goldman Sachs.  At Goldman, Tepper focused on his original role as a credit analyst.  However, six months later, he became the head trader on the high yield bond desk!  Despite his successes, Tepper was not promoted to partner due to his disregard for office politics.  After eight years at Goldman, he left and started Appaloosa Management in 1992 with Jack Walton, another Goldman Sachs trader.

With his background in bankruptcies and special situations at Goldman, Tepper applied his skills and experience at the new hedge fund, and it worked out tremendously for him. Tepper is categorized as a distressed debt investor, but he really analyzes and invests in the entire capital structure of distressed companies, from senior secured debt to sub-debt and post-bankruptcy equity. His fund has averaged a 30% average return since 1993!  While that number is particularly high, Appaloosa has fairly volatile historical returns.  In 2008, Tepper’s fund was down around 25% for the year. For the investor that stuck with him, this certainly paid off with a 120% return after fees in 2009. [3] Tepper shies away from the typical glitz and glamour of the ostentatious hedge fund industry. Appaloosa is not based in New York, but in a small office in Chatham, NJ. It is only about 15 minutes from his house so he can spend more time with his family. The firm manages around $12 billion.

Tepper’s astronomical returns resulted from huge bets on the banking industry, specifically Bank of America (BAC) and Citibank (C). He bought BAC around $3.72 and Citi near $0.79. At year’s end, BAC ended at $15.06, a 305% return, and Citi ended at $3.31, a 319% return.  Appaloosa also has invested in other financial companies such as Wells Fargo (WFC), Suntrust (STI), and Royal Bank of Scotland (RBS). Other companies Tepper has investments in are Rite Aid (RAD) , Office Depot (ODP), Good Year Tire and Rubber (GT), OfficeMax (OMX), and Microsoft (MSFT).  He believes that valuations on stocks and bonds in the financial industry remain favorable, and he is now investing in commercial real estate, a place where many analysts expect huge losses.[4]

Tepper’s investment strategy involves finding value in these distressed companies and betting big. He is not very diversified in his holdings compared to most hedge funds. Investing in these distressed companies can be a very lonely business. David Tepper stated about his recent purchases of BAC and Citi, “I felt like I was alone. No one was even bidding.” While some don’t like being alone, Tepper’s contrarian approach helped him scoop up these companies at bargain prices. Tepper reminds himself that he needs a contrarian attitude every day when he walks into his office and sees a pair of brass balls on his desk, literally. “Mr. Tepper keeps a brass replica of a pair of testicles in a prominent spot on his desk, a present from former employees. He rubs the gift for luck during the trading day to get a laugh out of colleagues.”[5] While humorous, these brass balls represent his strategy of taking concentrated bets on these companies that the market does not see any value in.

David Tepper has not been without controversy. In his dealings with Delphi, an auto parts maker, his hedge fund along with other investors backed out of their exit financing agreement after Delphi sought additional funding from General Motors. His hedge fund believed accepting money from an automaker would hurt Delphi’s ability to win contracts with other automakers. The hedge fund also claimed that this funding arrangement broke their financing agreement. Delphi, in turn sued, declaring that the issue was a “story of betrayal and mistrust.” [6] It has since gone into Chapter 11 reorganization.

While most hedge fund managers who have made $4 billion in a year during one of the worst recessions since the 1930s would face scrutiny from the press, public, and government, Tepper has largely gone unscathed due to the lack of glitz and glamour of his lifestyle. Tepper lives in a New Jersey suburb in the same house that he bought in the early 1990s and coaches his kids’ sports teams. He is a family man is proud of raising three good children. He says, “It was much easier when they were younger. It’s harder now when they open the paper and see how much money I make.”[7]

Last year, Tepper told the business school magazine at Carnegie Mellon that money should be a secondary goal, while living an upstanding life and pursuing what you enjoy should be the top priority.[8] Tepper does not forget about his roots either. He regularly goes to Pittsburgh to visit his alma mater and to watch the Pittsburgh Steelers (of which he is now a part owner).  He also donates money to food pantries and other charities around Pittsburgh.[9] Tepper comes to Carnegie Mellon frequently to talk to students about what needs to be improved at the school. Students describe him as down to earth, friendly, and very candid. While he has been an extremely successful hedge fund manager, he does not lead an extravagant lifestyle and continues to deliver excellent results to investors. His philosophy is very simple: if you treat people right, run your business right, and run your life right, you will create a sustainable business.


[1] http://web.tepper.cmu.edu/tepper/about.aspx

[2] http://www.americanwaymag.com/carnegie-mellon-appaloosa-management-david-a-tepper-school-of-business-coo-and-president

[3] http://seekingalpha.com/article/179565-2009-s-billion-dollar-man-david-tepper

[4] ibid

[5] http://nymag.com/daily/intel/2009/12/david_tepper_made_7_billion_do.html

[6] http://dealbook.blogs.nytimes.com/2009/07/09/appaloosa-and-icahn-said-to-mull-bids-for-delphi/#more-85819

[7] http://www.tepper.cmu.edu/news-multimedia/tepper-stories/david-tepper/index.aspx

[8] http://www.independent.co.uk/news/world/americas/25bn-pay-packet-for-fund-manager-1847227.html

[9] http://www.pittsburghlive.com/x/pittsburghtrib/business/s_658849.html

2010 Top 10 Highest Earning Hedge Fund Managers
Rank Name Firm Name 2009 Earnings
1 David Tepper Appaloosa Management $4 billion
2 George Soros Soros Fund Management $3.3 billion
3 James Simons Renaissance Technologies $2.5 billion
4 John Paulson Paulson & Co. $2.3 billion
5 Steve Cohen SAC Capital Advisors $1.4 billion
6 Carl Icahn Icahn Capital $1.3 billion
7 Edward Lampert ESL Investments $1.3 billion
8 Kenneth Griffin Citadel Investment Group $900 million
9 John Arnold Centaurus Advisors $900 million
10 Philip Falcone Harbinger Capital Partners $825 million

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Check out our intensive investment banking, private equity, and sales & trading courses! The discount code Merger34299 will be activated until April 15, 2011. Questions? Feel free to e-mail thomas.r[at]leverageacademy.com with your inquiries or call our corporate line.


Quantitative Easing II: A Video Tale of Mr. Ben Bernanke

Thursday, November 18th, 2010

Today, Ben Bernanke defended his second economic stimulus package, using monetary easing to lower interest rates and spur both spending and lending.  The first $2 trillion package apparently wasn’t enough, so now another avalanche of capital will flow into the United States economy and abroad.  When criticized by China and other East Asian economies now being flooded with excess capital flows, Bernanke claimed that both growth and trade are not balanced and that emerging market currency pegs were to blame.  Now begin the currency wars between the mature and emerging economies…can anyone actually win?  Bernanke claims that emerging market growth will be stimulated as the developed nations recover; therefore, a weaker U.S. currency could be better for everyone.  Only time, our inflation rate, and the price of gold will tell. (Paulson’s gold fund has certainly been on a tear…)

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This video should provide some humor to the current situation.  The section on Mr. Dudley’s role at Goldman Sachs is pretty revealing…

[youtube]http://www.youtube.com/watch?v=PTUY16CkS-k[/youtube]

According to Bloomberg, “Federal Reserve Chairman Ben Bernanke, took his defense of the U.S. central bank’s monetary stimulus abroad, saying it will aid the world economy, and implicitly criticized China for keeping its currency weak.

The best way to underpin the dollar and support the global recovery “is through policies that lead to a resumption of robust growth in a context of price stability in the United States,” Bernanke said in prepared remarks to a conference later today in Frankfurt. Countries that undervalue their currencies may eventually inhibit growth around the world and risk financial instability at home, he said.

The Fed chief is confronting criticism from officials in countries including China and Brazil who say the Nov. 3 decision to buy $600 billion in Treasury securities has weakened the dollar and contributed to flows of capital to emerging markets. The policy has also come under fire in the U.S., where critics including Republican members of Congress have said it risks fueling inflation and asset bubbles.

“Globally, both growth and trade are unbalanced,” Bernanke said, with economies growing at different rates. “Because a strong expansion in the emerging-market economies will ultimately depend on a recovery in the more advanced economies, this pattern of two-speed growth might very well be resolved in favor of slow growth for everyone if the recovery in the advanced economies falls short.”

Group of 20

While Bernanke didn’t identify China, he took aim at “large, systemically important countries with persistent current-account surpluses.” Bernanke’s comments come a week after leaders of the Group of 20 developed and emerging nations meeting in South Korea failed to agree on a remedy for trade and investment distortions. At the summit, President Obama attacked China’s policy of undervaluing its currency.

Bernanke said that the “sense of common purpose has waned” after officials around the world united to fight the financial crisis. “Tensions among nations over economic policies have emerged and intensified, potentially threatening our ability to find global solutions to global problems,” he said.

China has tied the yuan to the dollar to promote exports that helped produce the fastest gains in gross domestic product of any major economy. China, which surpassed Japan’s GDP to become world No. 2 in the second quarter, recorded 9.6 percent annual growth in the three months through September. It holds about $2.6 trillion in foreign reserves, the most in the world.

International Panel

The Fed released the text of Bernanke’s speech in Washington ahead of the address scheduled for at 11:15 a.m. Frankfurt time at a European Central Bank conference on monetary policy. He will then speak on a panel at 11:45 a.m. with ECB President Trichet, International Monetary Fund Managing Director Kahn and Brazil central bank President Meirelles.

In the panel discussion, Bernanke will say that “financial conditions eased notably in anticipation” of the Fed’s stimulus announcement, “suggesting that this policy will be effective in promoting recovery,” according to a text released by the Fed.

It’s Bernanke’s first trip abroad since the Federal Open Market Committee made the decision, dubbed QE2 by economists and investors, to implement a second round of so-called quantitative easing. Bernanke said the term is “inappropriate” because it usually refers to policies that change the quantity of bank reserves, “a channel which seems relatively weak, at least in the U.S. context.”

Global Call

In the speech, Bernanke called on policy makers around the world to “work together to achieve a mutually beneficial outcome — namely, a robust global economic expansion that is balanced, sustainable and less prone to crises.”

German Finance Minister Schaeuble said Nov. 5 he was “dumbfounded” at the Fed’s actions, which won’t aid growth and will instead contribute to imbalances by driving down the currency. U.S. monetary policy is creating “grave distortions” and causing “collateral effects” on faster-growing economies such as Brazil, Meirelles said in October.

Bernanke said that different economies “call for different policy settings.” In the U.S., inflation has slowed since the most recent recession began in December 2007, and “further disinflation could hinder the recovery,” he said.

“Insufficiently supportive policies in the advanced economies could undermine the recovery not only in those economies, but for the world as a whole,” he said.

Jobless Rate

America’s unemployment rate at 9.6 percent last month is currently “high and, given the slow pace of economic growth, likely to remain so for some time,” Bernanke said. He said that “we cannot rule out the possibility that unemployment might rise further in the near term, creating added risks for the recovery.”

The asset purchases will be used in a way that’s “measured and responsive to economic conditions,” Bernanke said. Fed officials are “unwaveringly committed to price stability” and don’t seek inflation higher than the level of “2 percent or a bit less” that most policy makers see as consistent with the Fed’s legislative mandate, he said.

Bernanke, 56, also appealed to human concerns to justify the Fed’s policy.

“On its current economic trajectory the United States runs the risk of seeing millions of workers unemployed or underemployed for many years,” he said. “As a society, we should find that outcome unacceptable.”

The former Princeton University economist devoted the majority of his speech to discussing global policy challenges and tensions.

China’s Criticism

China’s vice foreign minister, Mr. Tiankai, said Nov. 5 that “many countries are worried about the impact of the policy on their economies,” echoing concerns raised across Asia over stronger currencies and possible asset-price inflation.

Bernanke used one of nine charts to show how countries including China and Taiwan are intervening to prevent or slow appreciation in their currencies. Allowing stronger currencies would help result in “more balanced and sustainable global economic growth,” Bernanke said.

The comments echo views of Obama administration officials including Treasury Secretary Geithner, who said Oct. 6 that “it is very important to see more progress by the major emerging economies to more flexible, more market-oriented exchange-rate systems.”

Depression Lesson

Bernanke, a scholar of the Great Depression, drew a comparison between the current period and events leading to the 1930s economic disaster. The U.S. and France maintained “persistently undervalued” exchange rates by preventing inflows of gold from feeding into money supplies, which created deflationary pressures in other countries and helped bring on the Depression, Bernanke said.

“Although the parallels are certainly far from perfect, and I am certainly not predicting a new Depression, some of the lessons from that grim period are applicable today,” Bernanke said. “In particular, for large, systemically important countries with persistent current-account surpluses, the pursuit of export-led growth cannot ultimately succeed if the implications of that strategy for global growth and stability are not taken into account.””

Waddell & Reed Guilty for Starting 1,000 Point Drop on May 6th, Barclays Executed Trade

Friday, May 14th, 2010

May 6th will be remembered as the day the DJIA dropped 1,000.  For days, market commentators blamed electronic traders and bulge bracket banks including Citigroup, but today culprit Waddell and Reed was discovered.  Waddell and Reed is one of the oldest mutual fund managers in the United States.  The firm sold 75,000 e-mini future contracts on the S&P500, throwing the market into a tail spin.  Barclays executed the trade in one single trade, instead of breaking it up into 100 or 1,000 different orders.  The negligence on Barclays’ part is mostly to blame, since one can’t blame Waddell for hedging.  We can see today, that Waddell was in the right, as the Euro fell past 1.24.

Waddell’s sell order briefly wiped out $1 trillion from the U.S. equity markets in a 20 minute period.  Over that period, over 840,000 e-mini contract futures were traded by firms including JPMorgan, Goldman Sachs, Jump Trading, Interactive Brokers, and Citadel.  Procter & Gamble fell almost 30% in 10 minutes, as shown above. (Source: ZeroHedge)

According to MarketWatch, “In response to inquiries and published reports, Waddell & Reed Financial, Inc.  today issued the following statement:

On May 6, as on many trading days, Waddell & Reed executed several trading strategies, including index futures contracts, as part of the normal operation of our flexible portfolio funds. Such trades often are executed in response to market activity, and are undertaken to protect fund investors from downside risk. We use futures trading as part of this strategy, broadly known as hedging. This is a longstanding and well monitored practice in certain of our investment portfolios. We believe we were among more than 250 firms that traded the “e-mini” security during the timeframe the market sold off.

Quotes attributed to executives at the CME and the CFTC note that Waddell & Reed has executed trades of this size previously, and indicate that we are a “bona fide hedger” and not someone intending to disrupt the markets. Further, CME noted that they identified no trading activity that contributed to the break in the equity market during this period. Like many market participants, Waddell & Reed was affected negatively by the market activity of May 6.

About the Company

Waddell & Reed, Inc., founded in 1937, is one of the oldest mutual fund complexes in the United States, having introduced the Waddell & Reed Advisors Group of Mutual Funds in 1940. Today, we distribute our investment products through the Waddell & Reed Advisors channel (our network of financial advisors), our Wholesale channel (encompassing broker/dealer, retirement, registered investment advisors as well as the activities of our Legend subsidiary), and our Institutional channel (including defined benefit plans, pension plans and endowments, as well as the activities of ACF and our subadvisory partnership with Mackenzie in Canada).

Through its subsidiaries, Waddell & Reed Financial, Inc. provides investment management and financial planning services to clients throughout the United States. Waddell & Reed Investment Management Company serves as investment advisor to the Waddell & Reed Advisors Group of Mutual Funds, Ivy Funds Variable Insurance Portfolios, Inc. and Waddell & Reed InvestEd Portfolios, Inc., while Ivy Investment Management Company serves as investment advisor to Ivy Funds, Inc. and the Ivy Funds portfolios. Waddell & Reed, Inc. serves as principal underwriter and distributor to the Waddell & Reed Advisors Group of Mutual Funds, Ivy Funds Variable Insurance Portfolios, Inc. and Waddell & Reed InvestEd Portfolios, Inc., while Ivy Funds Distributor, Inc. serves as principal underwriter and distributor to Ivy Funds, Inc. and the Ivy Funds portfolios.”

Dai-ichi Life Insurance Raises $11 Billion in Largest International IPO!

Tuesday, March 23rd, 2010

The equity markets having been roaring back in March, and equity underwriting has followed.  The largest global IPO was filed this week as Daiichi Mutual Fund Insurance filed an $11 billion IPO.  The last IPO of this size was the Visa IPO, which was $19.7 billion in March of 2008.  Daiichi stock was issued at a discount at 140,000 yen, instead of 155,000, ensuring a steady upward trend.  The stock is more expensive than T&D holdings, but less expensive than Soniy Financial Holdings.  Daiichi will use these proceeds to make acquisitions abroad.

According to Mr. Yamakazi of Bloomberg, “Dai-ichi Mutual Life Insurance Co. will raise 1.01 trillion yen ($11 billion) in the world’s biggest initial public offering in two years after pricing the IPO at the middle of its forecast range.

Japan’s second-largest life insurer priced 7.2 million shares in the demutualization at 140,000 yen each, according to a statement posted on the company’s Web site yesterday.

The offering is the largest since San Francisco-based Visa Inc. sold $19.7 billion in March 2008 and comes after money raised from IPOs in Japan fell to the lowest level in at least two decades last year. The price may ensure that Dai-ichi gains when it’s listed on the Tokyo Stock Exchange April 1, according to Ichiyoshi Investment Management Co.’s Mitsushige Akino.

“Most Japanese investors probably expected it to be 155,000 yen so it’s quite cheap,” said Akino, who oversees $450 million as chief investment officer of Ichiyoshi in Tokyo. “It’s the best scenario, where the price will rise bit by bit, rather than a short-lived popularity.”

The IPO by Dai-ichi, which will change its name to Dai-ichi Life Insurance Co., is also the biggest in Japan since Tokyo- based NTT DoCoMo Inc. went public in 1998, Bloomberg data show.

Dai-ichi’s market capitalization will be equal to 0.56 times embedded value, or the sum of its net assets and the current value of future profits from existing policies. That’s more expensive than T&D Holdings Inc., Japan’s largest publicly listed life insurer, and cheaper than Sony Financial Holdings Inc., the insurance and banking unit of Tokyo-based Sony Corp., data compiled by Bloomberg show.

‘Reasonable’

“The pricing seems reasonable,” said Yoshihiro Ito, a senior strategist at Tokyo-based Okasan Asset Management Co., which oversees about $8 billion. “The question is how well it will do the on the first day of trading, given the prospect for life insurers in Japan.”

Dai-ichi is switching from mutual to stock-based ownership to expand fundraising options for acquisitions and partnerships as it grapples with an aging society and the slowest-growing economy in Asia.

Nomura Holdings Inc. and Mizuho Financial Group Inc. in Tokyo and Charlotte, North Carolina-based Bank of America Corp.’s Merrill Lynch unit were hired to manage the offering. New York-based Goldman Sachs Group Inc. was a global arranger.

Overallotment

Dai-ichi will have 10 million shares outstanding, 5 million of which were sold in Japan and 2.1 million overseas, according to the statement. The Tokyo-based company will issue 100,000 shares in an overallotment and another 2.9 million will be distributed to policyholders.

T&D Holdings of Tokyo has a market capitalization of 684.9 billion yen, or 0.47 times its embedded value, based on a sale document distributed by banks involved with the Dai-ichi offering. Tokyo-based Sony Financial has a ratio of 0.84.

Prudential Plc of London, the U.K.’s biggest insurer, paid 1.69 times the embedded value of New York-based American International Group Inc.’s Asian life insurance unit in its takeover announced this month.

Japanese companies had raised $490 million yen in six IPOs so far this year, compared with 15 U.S. deals totalling almost $3 billion, data compiled by Bloomberg show.

The Dai-ichi deal will make this year the biggest for Japanese IPOs since 2006, when companies raised 2.14 trillion yen, Bloomberg data show. Sales sank to 56 billion yen last year as the collapse of New York-based Lehman Brothers Holdings Inc. froze credit markets and the Topix index posted the worst performance in the world’s 20 biggest equity markets.

Acquisitions

Dai-ichi, which had 8.2 million policyholders as of March 2009, will use proceeds of the sale to convert to stock-based ownership from policy-based mutual ownership. The switch will expand fundraising options for acquisitions and partnerships as the population declines, the company told policyholders in June.

Japan’s life insurers are struggling for new customers after the first global recession since World War II. The nation’s economy will grow less than 2 percent annually through at least 2012 after contracting 1.2 percent in 2008 and 5.2 percent last year, estimates compiled by Bloomberg show.

That compares with growth of 9.6 percent projected for China this year, while gross domestic product in the U.S. will rise at least 3 percent annually from 2010 to 2012, the estimates show.

Almost 23 percent of Japan’s 126 million people will be older than 65 this year, compared with 13 percent in the U.S., data compiled by Bloomberg show. Japan is the world’s oldest society, with a median age of 44, according to the United Nations’ World Population Ageing 2009 report.”