Monday, January 28, 2008

Blame Game

I am going to go way out on a limb here, at the risk of stumbling into territory about which I know little. To my defense I will say only that occasionally, some of the observations with the most perspective, happen from afar. The subject is credit-card processor Alliance Data Systems (ADS) seen here left having shed approx 35% last week, before dropping another third today. Ouch. Fear of Blackstone not completing, followed by their actual walking prompted the horror show for those (presumably arbs) still long of the stock.

Like Harman before them, there is now a bit of pissing match over who did what to whom and when, with Blackstone citing onerous regulatory issues, while Alliance management (wealth now halved, Champagne now back on ice) retorted by calling Blackstone "pussies" (ok, they didn't actually say that). To the casual observer from afar, however, it looks decidedly as if not only was the arrangement of financing difficult, expensive and on terms that were less attractive than what the average Smartest Guy in The Room would countenance (for surely IF Blackstone has really wanted they could get the money if they met the terms), but that the recent market indigestion and their competitors' "runaway groom" tricks leaving targets feeling abused at the altar, has perhaps caused Blackstone to catch what is known as "contact vomiting". Any parent with children can tell you that there is a reasonably high probability that if one of your children up-chucks in the back seat of the car, that one of the others will involuntarily puke too from the mess and associated odor. Of course I don't have the details, but if Blackstone can avoid penalties by wagging fingers at regulators, they would be foolish to do otherwise.

But looking at the chart of Alliance Data Systems, I remain troubled (like HAR and SLM before) by what it might mean. Does it mean that ADS is VERY cheap now? Does it mean that the previous price was stupid? Does it mean that others who've not been so fortunate as to either NOT consummate their deals, or find a legally defensible excuse in order to walk away unscathed, are like the ADS risk-arbs, and management holders of stock options sitting upon 50% (or more) losses? Should we care that the cost of refinancing for the deals that have been consummated over the past 18mo will likely be meaningfully higher, or with substantially more restrictive covenants attached? If it was such a desired leveraged transaction at $80 share, why were there so few apparent buyers of stock between $80 and current levels? But the biggest irony is: Why is there such a tremendous notional wealth creation when something goes from the private VC market to the public markets, YET when the PE boys get cold feet and walk away from a deal the typical "private market discount" begins to invert and look like a 50% discount for remaining in the public market. I am trying to think of the type of investor or deal continuum that would yield these apparent non-singularities, but cannot. Anyone with some answers, please reply.


RichL said...

The ADS deal was struck in a bull market, and the current market is NOT a bull market. There are other stocks, not deal affected, that have had similar performances.

Not scintillatingly brilliant analysis, BUT - It's just a bear market

Charles Butler said...

1). 80 bucks is a mark-to-myth price for what was a 60 dollar stock even prior to July.
2). The case is really no different from a hypothetical IPO (and we know what you think in that regard) priced optimistically on the basis of conditions several months prior, with the added attraction of forced selling from players irrevocably pre-committed to a price made even more mythological through the passage of time due to regulatory stuff.

The two, IPO's and buyout withdrawals, are essentially the same.

"Cassandra" said...

Richl...I am not sure I understand what the bull market has to do with the logic of a deal. If a deal makes sense shouldn't it make sense under all economic conditions? IF they don;t make sense under all conditions, what does that say for all the deals that were done when folks were more optimistic, and paid prices, higher? I've not heard of PE Funds droppping short S&P500 overlays, or range-forwarding their portfolios with index options on the short side and bonds on the long side.

THe interesting point is that PE deals tend to be undertaken on a certain type of company - "cheap"-ish on ev/ebitda basis (well less than 10x anyways if you call THAT cheap), generally smaller, with reasonable economic sensitivity, after which the enterprise is saddled with debt, placing it in the bottom decile in terms of capital structure conservatism when compared to R2000 peer group. What I am hypothesizing is that the listed sub-group of enterprises that share these characteristics have been hammered WAY MORE than the market, which is somewhat sympathetic with Campbell & Vuoltaheeno's research (on Good beta and bad beta) as the risk of recession and market wide earnings increases.

If they were public companies bought on margin, one would have been margin-called into oblivion, or would have hhad to pony-up in equity the 2/3 of market value that evaporated. The fact that their [now] private companies bought on long-dated margin loans just means the day of reckoning is perhaps in the future, but if you were peering into the sextant trying to triangulate the current portfolio value, it seems like it wouldn't look pretty.

Anonymous said...

See Yves smith's post on this subject today, re: comptroller of the currency rejection of the takeover of the bank embedded in this deal.

Ian said...

Isn't part of it the fact that the longstanding institutional shareholders have already packed up and left and the only people left owning the stock are merger arbs?

"Cassandra" said...

anon...saw Yves post and the NYT excerpt. Tnx. The articel reported that BX & Mgmtm were working hard to complete, but one must wonder how hard BX was really working. IIt certainly looked like Mgmt were pointing the finger at BX saying "Foul!"

Ian, yes the arbs probably owned most of the stock. That provides an answer for one of my many questions, which in any event were not specific to ADS, but more that the dataset of PE takeovers is uncharacteristic of the market as a whole, an din fact, more like the things that have cratered, rather than the the buoys for the market index (, commods, fertilizer, oil service, thematic growth in general and large-cap growth in particualr).

Charles Butler said...

Re-reading, I realize I may have not entirely finished my argument about the similarity, rather than the distinction, between this and an IPO...

When the bid was accepted, ADS effectively ceased to exist except in the world of arbitrage. The removal of the bid recreates it, as if it were in fact an IPO, and what we see is the market attempting to set an initial price - clearly not the normal procedure but the case nonetheless. The value of this specific issue? Factor out the actual buyout premium. Factor out the premium built into its pre-buyout price and owing to its attractiveness in this regard. Factor out the mere bull market premium. Factor in an economic slowdown (sic) and its effects on a place that makes money off credit card transactions. Factor in what may be a bear market. Do all that, adding your own bits, and tell me at what price ADS would attract a crowd were it being hatched today. 40 bucks, say?

As for the value of some of the completed investments of PE funds - do the same, add debt liberally, and try flogging it.