Friday, April 17, 2009

Carlyle Group's Twin Davids on PEU Regulation

Two Carlyle Group spokesmen relayed very different images of private equity underwriters (PEU's). David Marchick, Carlyle's PR man and ex-Clinton White House staffer, told the Wall Street Journal that PEU's pose little risk.

That doesn't jive with Carlyle co-founder David Rubenstein's talk at the Super Return Conference in February. A few of David's points are below:

1. More than a few of the best known and largest investments completed in the 2005-2007 period will have to be recapitalized in order to be preserved. (slide 17)

This means capital calls. What if investors don't want to pony up more money? What if they want to cash in on their investment?

2. Opportunities for exit have been reduced, resulting in lower returns and fewer distributions. PE firms will have to hold onto their companies longer or take prices far below their once anticipated exit levels; and provide less frequent distributions than once projected. (slide 16)

Investors were sold a projected rate of return and distribution schedule. How many will find the patience to remain, leaving their funds invested?

3. Some investors will continue selling their stakes in private equity funds; the sales will yield larger than normal discounts to NAV (net asset value). (slide 21)

Might there be a PEU run? Who will provide the recapitalization, if PEU's don't have current investors ponying up for capital calls? How will any dilution be handled?

4. PE firms have recognized the enormous difficulty of raising new funds for the foreseeable future. (slide 14)

5. Other investors will increase their private equity stakes, and some investors not yet in private equity will enter the private equity world. (slide 21)

6. More than a few well known investments will likely not survive (slide 22)

Is that why Treasury Chief Tim Geithner proposed backstopping non-banks? Will Uncle Sam help recapitalize PEU's?

After the usual comment about government regulation on financial firms constraining lending, David noted that many 2009 deals will be outside the U.S., in Europe and developing countries. But the future looks good:

7. Reduced prices will likely yield very high returns for private equity capital invested now and over the next 2-3 years. (slide 23)

In other words, the federal interventions and economic crisis will restart the greed cycle, with a bit less leverage. Maybe the federal government will partner with PEU's in public-private partnerships.

8. Government and others will increasingly see private equity as a solution to problems. (slide 24)

This would be tacit acceptance of taxpayers backing "very high returns". Greed restarted, with Uncle Sam providing the leverage. Now how to sell it?

9. Enhanced recognition that private equity was not a cause of systemic risk, not a cause of the economic decline. (slide 24)

Not a cause of systemic risk? Carlyle Capital Corporation, levered 40 to 1, imploded early. Blue Wave Partners followed. Carlyle lost SemGroup to bankruptcy for hedging or forward looking contracts. There was no mention of hedging contracts in the firm's SEC filings. Hawaiian Telecom and Edscha declared bankruptcy. Carlyle and its affiliates levered. They used some of the same risky financial instruments as Wall Street investment bankers.

Rubenstein contradicts his comments in Slide 2, where he cited increasing deal sizes, rising price multiples and greater use of leverage. The bidding frenzy he mentioned (2005-2007) reflects PEU systemic risk.

10. This is not your father's private equity world. (slide 26)

11. It is up to the industry to ensure that governments understand and value private equity. (slide 27)

12. The public needs to be treated as a partner if the industry is going to survive and prosper; and partners need to be informed about what is actually occurring on a timely basis. (slide 29)

The public needs to know because the PEU boys plan to suckle on as many nipples as possible of America's federal cash sow. The twin Davids, Rubenstein and Marchick, employed the same practices that brought America's financial system to its knees, greed and leverage. They want the system restarted ASAP.