February 28, 2008
Educators have long been concerned over the heavy loan debt carried by students once they leave school. Their primary concern is that the loans constrain the work choices the students have once they graduate. In other words, students cannot take "public interest" jobs and must, horrors, go to work in private industry to pay back their loans. Like most redistributive arguments from the left, the argument assumes the existence of the loans. That assumption is now in question. One of the largest student loan agencies, the Penn. Higher Educating Assistance Agency, is suspending student loans, even if backed by the federal guarantees. The collapse of the securitization market makes it impossible to cash flow the business. In the past the loans were packages and resold and the new money was used for new loans. Now the loans cannot be resold at reasonable rates and there is little new cash for new loans.
So now students may not have to worry about repaying loans; they may not be any. Students that do not have the cash to go to school must work before school in, I daresay, private industry, to raise cash to go to school. Public service jobs will not support future tuition just as they did not support past tuition.
Educational institutions could attempt to take up the slack by turning into loan companies, a task for which they are not designed and will not do well, but the amount available will be slight compared to the amounts that were available in the private market. Government could step in the loans and we would have another huge, very expensive government system to fund and monitor all in a time when government budgets are stretched to the breaking point. Higher taxes anyone?.
Another hard lesson for the left--be careful what you complain about you may lose it.
February 27, 2008
Wachovia's Lawsuit Against Providence Equity
Providence Equity Partners, a private equity firm, signed a deal to purchase television stations from Clear Channel. Wachovia agreed to finance the $500m deal. Providence and Clear Channel agreed to a reduced purchase price because the stations revenues were down. Now Wachovia wants out, arguing the price reduction is not enough and that the deal should be canceled. Wachovia is arguing that the price reduction itself is a material adverse change, triggering the MAC condition in the deal agreement and, incorporated by reference, a similar MAC condition in the financing arrangement. This case is odd because Wachovia must convince a judge that a reduction in price (and thus in the financing commitment) is an "adverse" change. The case is representitive of the new kind of "hardball' being played in the buyout financing markets. Reputation (for honoring one's word) be damned; save the ship.
The Take-Two Offer
Electronic Arts has made a hostile bid for Take-Two Interactive. The Take-Two board has decided to take the low road. It immediately awarded the company's managers, who have not done well, generous severance packages contingent on any control change and then rejected the bid calling it "ill-timed and low-priced." Managers also received pay package increases. The managers said the pay increases were not stimulated by the EA offer. Yeah right. The offer is for $26 a share, a healthy premium over the pre-announcement price. The shareholders, and the board, should thank Electronic Arts for the bid, ask for a buck or two more a share, and take the money and run. The irony: The managers and the board are new, representing the new management put in by a group of dissident shares last year because the company was struggling. Apparently was is good for the goose is not good for the gander.
The debate last night in Cleveland Ohio between Barack Obama and Hillary Clinton featured a discussion about the Ohio economy. Apparently both candidates blame NAFTA and other free trade agreements for the decline in manufacturing jobs in Ohio. Both candidates featured, therefore, promised to "re-negotiate NAFTA" in the debate in an effort to win votes in Ohio. Yes the Ohio economy is struggling: Unemployment last measured in December was at 6%, a full percentage point higher than the national average; mortgage defaults in the fourth quarter of 2007 were at a 1.44% rate, compared to a national average of .87%; over the last eight years, real median income has dropped from over the national average to $2,300 below the national average (a drop of around 10%); and over the last eight years Ohio has lost over 275,000 manufacturing jobs (a drop of about 25%). But some other facts are notable: 1) Nafta took effect in 1994 and from 1994 to 2000 there was income and job growth in Ohio. Nafta is not the cause of the recent drop, which dates from 2000. 2) Nafta did not greatly reduce tariffs on Mexican goods, they were already low. The inevitable conclusion is that trade with China (and India and other emerging Eastern Europe economies), which grew dramatically after 2000 (China's admission into the WTO dates from 2001) is a more likely cause. Indeed, the stump speeches of both candidates now routinely attack China. Any long-term solution for Ohio, however, has to involve investment incentives that induce private companies to locate or grow here. This takes time and careful planning. However, the other routine parts of the candidates stump speeches -- Attacking corporate profits or the pay of corporate executives or the decrying the pay and benefits of workers is not consistent with a plea for corporations to locate or grow businesses here. Ohio needs to invest in infrastructure (roads, power sources, and cleanup of abandoned factories) and to invest in education and incentives for local talent to stay in the state; the state and the federal government need to reduce corporate taxes and dividend taxes (to eliminate once and for all any double tax on earnings); and the state needs to give up protectionist support (in its many forms) of industries that are not competitive. We need to drop our takeover protections, for example. We could also follow Indiana's example and privatize some of our government functions (Indiana sold its northern toll road to Australians who overpaid a whopping $6 B and used the money to attract three new Japanese car manufacturing plants).
Loser Pays Rule?
On Valentine's Day Rep. Jeb Hensarling re-introduced a bill that Rep. Richard Baker has been pushing for at least two years--the Securities Litigation Attorney Accountability and Transparency Act. Inter alia, the bill states that "(A) DETERMINATION REQUIRED- If the court in any private action arising under this title enters a final judgment against a plaintiff on the basis of a motion to dismiss, motion for summary judgment, or a trial on the merits, the court shall, upon motion by the defendant, determine whether--
`(i) the position of the plaintiff was not substantially justified;
`(ii) imposing fees and expenses on the plaintiff's attorney would be just; and
`(iii) the cost of such fees and expenses to the defendant is substantially burdensome or unjust.
`(B) AWARD- If the court makes the determinations described in clauses (i), (ii), and (iii) of subparagraph (A), the court shall award the defendant reasonable fees and other expenses incurred by the defendant and impose such fees and expenses on the plaintiff's attorney."
Inter alia, the bill would also require each plaintiff and plaintiff's attorney in a private action to provide sworn certifications, filed with the complaint, that identify any conflict of interest, including any direct or indirect payment, between the attorney and the plaintiff.
The bill has never gotten out of committee, and although I am inclined to favor the objectives (if not the method) of the legislation, one might think that in the current economic environment this bill has zero chance of getting out of committee this time around. The "loser pays" rule is, of course, the difficulty here; the conflicts portion could probably survive on its own.
Posted by: Paul Rose
February 26, 2008
Deal Are Down But Litigation Over Deals is Up
The number of deals has fallen dramatically this year but litigation over pending deals is way up. As note by Karnitichning, Rappaport & Ng in today's Wall Street Journal in a timely piece, collegiality it out and "law of the jungle" is in. No only are deal principals suing each other, purchasers and financiers are also suing each other. It points up to a well-tested truism: The document language, sweated over by lawyers and mocked by clients anxious to close, matters, really matters, when times get tough. The language contains a client's downside protections.
Visa's Public Offering
Visa has announced plans for the single largest intial public offering in American history. It plans to sell $17.1 billion in stock in March. The announcement is both good and bad news, in a way. It is good news in that Visa, and its advisers, have given a strong vote of confidence on the condition of the stock markets. It is bad news in a way because the ratio of stock to debt in capital raising is a negative indicator of overall market health. When the market is sick, more companies have to raise money in stock offerings.
A piece in the New York Times by Andrew Ross Sorkin today castigates CEOs for not doing more M&A deals in the current, volatile stock market. Sorkin notes that many deals fail and that those that are successful are often at the beginning of a "deal" cycle. Deals that are done in "follow the leader" markets are most likely to not be successful. His conclusion? CEOs should do more deals now, when the market is unsettled and M&A volume is down. This from the paper that in the past has routinely lambasted deal makers. While I am on this tack one should note that after the paper's many attacks on the dangers of hedge funds last year it is the main line investment banks and brokerage houses (and often their internal hedge funds) that have disgraced themselves in the sub-prime loan mess. The main line banks have inadequate risk controls on a process that separated incentives from long term quality; the private hedge funds have, as a group, done somewhat better.
February 25, 2008
Profitable Government Buyout/Bailouts
Whenever a market is in severe distress, we can be sure that several commentators, many of whom are economists, will argue for a structured government buyout, bailout. "The government should buy.... and then resell the assets slowly over time. The government will stop the bleeding and may even make a small profit." The government showed a profit when it bought failed Savings & Loan assets and when, in the thirties, it bought mortgages in default (the HOLC, Home Owner's Loan Corporation). Remember also that government support of Chrysler by buying bonds also showed a profit (Chrysler paid off all the bonds). The blank is filled in today by 1) failing CDOs, 2) defaulting sub-prime mortgages, and 3) struggling insurance companies that provide credit default guarantees. All three industries have advocates for government buyout, bailouts. Can government develop a clear ear for deciding when to do buyout, bailouts and when to pass? Political pressures should not determine the choice; can government resist choices based on raw political pressures? I am skeptical (but believe that a buyout, bailout of credit default companies may make some sense).
New evidence suggests that the substantial drops in interest rates by the Federal Reserve have 1) not aided substantially the stock or debt markets and 2) have enhanced fears of inflation. The Fed can have four interrelated goals: help the securities markets, control inflation, keep unemployment rates low, or boast gross domestic product. The first, third and fourth have substantial political overtones, the second-- controlling inflation, does not. Our Fed, seemingly heavily influenced by savage criticism from the financial sector (who have called for Bernanke's head) and by a pending national election, appears too focused on the securities markets. The European Central Bank, isolated from State political influences by top level of multiple state administration, has shown much less sensitivity to political trade winds and is focused more on controlling inflation. Have we taught the financial markets that over-the-top criticism of the Fed will have an impact on Fed actions? If so, we are in for some tough times.
Club Deals in Private Equity Buyouts
There has long been a question about whether potentially competing private equity firms all after the same company could agree amongst themselves to make a joint offer, a club deal, rather than compete with each other on price. Is the joint offer a version of "price fixing" or "auction rigging" in violation of state and federal antitrust style statutes? A federal court in Seattle says no. The court dismissed an antitrust action brought against Vector Capital and Francisco Partners for a club deal to buy Watch Guard Technologies for $151 million. Several other similar actions are pending on other buyouts. Until clear antitrust standards are developed for club deals, the threat of antitrust litigation may well discourage deals that otherwise could close. These actions ought to be difficult to win because the public nature of any auction means than all buyout firms, as well as strategic acquirors, are potential bidders. A club deal for a discount price should, in theory, tempt other bidder to ante up. Strong evidence of a heavily constrained bidding market ought to be required to stop any given club deal.
Competitiveness & Debt Markets
At last week's ALI-ABA conference on corporate governance, Hal Scott (who leads the Committee on Capital Markets Regulation) announced that his Committee likely would expand its review of U.S. competitiveness to include private debt markets. Meanwhile, Scott produced data indicating that the U.S. was still slipping relative to foreign markets with respect to public equity offerings. He noted that U.S. markets did not host any of the 20 largest initial public offerings in 2007 (compared to hosting 8 of 20 in 1998). That statistic should change for the better in 2008, however, with Visa's pending IPO of up to $17 billion in stock.
Scott also noted that historically the average number of U.S. companies going abroad for their initial public offerings was about 0.1 percent. In 2007, 4.2 percent of companies went abroad.
Posted by: Paul Rose