It is a strange world; one in which the people who are closest to something are less able to appreciate its value than are strangers. But sometimes you can understand the big picture by examining the little picture in detail.
We were recently reminded of a deal in a business we think we understand. An old friend sold his company – for tens of millions of dollars, more money than anyone in the business would have paid for it. How is it possible that a business could be worth more to novices than to the people who are most likely to know how to extract its value?
Well, that’s the story of business in 2007. All over the country – and perhaps the world – businesses are being bought by investors, not by businessmen. And these investors then have an agenda that permits them to make a fortune – without ever learning the business or operating it.
Hedge funds, private equity, venture capitalists and investment bankers are buying businesses at a record pace. They then work their magic. Typically, they borrow a fortune against the business assets – and use the money to pay themselves millions of dollars in fees.
For a time, everyone makes money. The owners pocket millions more than they would have gotten otherwise; and the big investment pros, too, make a lot of money – in fees, commissions, special dividends and the like.
And then, the business is repackaged and sold to small investors through an IPO – with even more fees and commissions to the Wall Street professionals.
A real investor, like Warren Buffett for example, probably wouldn’t touch any of it; he wouldn’t want to get stuck with all those financial charges and wouldn’t want a company that is deep in debt because of them.
But the lumpeninvestoriat doesn’t know any better. Small investors just pretend to be real investors. They buy stocks at the wrong times for the wrong reasons. They recognize the company name. They’ve heard the industry is doing well. A broker recommends it to them. And as long as liquidity bubble keeps getting larger and the market keeps going up, who complains?
But on the banks of the Hudson…like on the banks of the Tiber…everything eventually melts. A company with a lot of debt on its books is not as healthy as one with no debt. When trouble comes, the debt-burdened companies are less able to manoeuvre. A whole market of such companies is fundamentally weak and vulnerable.
Markets and Money