“We’ve kind of woken up” - Gosh

From The Times February 12, 2010

Private equity hit as Blackstone shelves Merlin IPO

Helen Power, Dominic Walsh and Marcus Leroux

Extract

“However, the shelving of the IPO plans will reinforce how hard it will be for private equity firms to convince sceptical institutional investors to subscribe to their issues.

Andy Brough, the manager of Schroders’ FTSE 250 fund, said: “Personally, I just wouldn’t buy anything off private equity — they’ve had their chance.”

Several other leading fund managers have said privately that they would not back private equity issues because of the “Debenhams effect”, a reference to the retailer that was taken private on the cheap by TPG and CVC, then refloated laden with debt.

Mr Brough said: “What does private equity do? They arbitrage the ignorance of fund managers. Well, we’ve kind of woken up.””

Gosh, “we’ve kind of woken up.”

Well, it’s all a little bit late, mate. Here you all are, very highly paid “expert fund managers”, in whose hands lie our pensions, savings and insurance funds, and you have “kind of woken up”. Our pensions, savings and insurance funds have all shrivelled under your expert care for which you continue to charge “management fees” even though, to judge from the results, there seems to have been precious little effective management going on. And now, you have woken up – and yet there is no evidence that you have understood the foolishness in which you have been such active participants. The only learning appears to be at the school playground level – “I shan’t trust little Jimmy any more”. Oh dear.

We told you so in this blog – nearly a year ago -

TUESDAY, 31 MARCH 2009

M&A thinking may still be common, but does it make sense?

So we will say it again -

The only way out from this shallow unthinking herd behaviour is to return to a solid focus on tangible wealth creation – to get back to Common Sense. The only reliable indicator of tangible wealth is deep underlying sustained long term profitability – the investment criteria upon which Warren Buffet patiently, steadily and lengthily, built his own and many other’s fortunes.

The most reliable determinant of massive financial strength, potentially solid wealth, is Excellence. Robust academic research has proved beyond reasonable doubt that the very best businesses in the world can deliver financial returns that are 50% to 100% better than the average.

All of this in the week in which, yet again, a massively debt laden corporation takes on even more debt, which will become secured against the assets of its target, to seize control of a healthy well run company. The same old “Big is Better” nonsense has been trotted out. The same old greedy “experts” have grabbed their millions. The same old workers face uncertainty and fear. There will be tears in the next few years. Great, and for what? Who is going to "have woken up" and when. this time?

Too many in the Financial World cannot tell the difference between Big and Excellent - and this is destroying capitalism.

If something does not change, then nothing will change.

If you want to know more about all this alternative point of view, how you can spot the tangible wealth creators in advance and why Common Sense pays off handsomely, please have a look at our website where you will find out about - Competitive Strength, what this is and why it is crucial to financial performance – and about Changeability, the essential attribute for Excellence.

Capitalism or .... Common Sense is brought to you by Steve Goodman and Tony Ericson. It is one of our "Excellence Quartet" of blogs promoting the cause of Excellence as the key to prosperity. Each blog has a new article each month using a recent business/financial topic to highlight different perspectives and conclusions from those obtained using conventional thinking and techniques. You can read the other three blogs at “Exceeding Expectations", "You're having a laugh ... Seriously?", "Business Bloop of the Month Award".

Turning Forwards – Getting Back to Common Sense

Where does Capitalism stop being Common Sense?

In our last post “I’m Walking Backwards to Christmas …” we talked about wealth creation. And, being a bit ambitious, we offered a definition of real wealth . There was too much else to address in that post but we think we left some assumptions hanging. And we think that these assumptions are central to our Capitalism or Common Sense theme.

First and foremost, we assert that there is a fundamental difference between the creation of wealth and the acquisition of wealth.

§ The creation of wealth means that the sum total of real wealth is increased regardless of anything to do with possession.

§ The acquisition of wealth means that the sum total of real wealth is not increased, merely shifted from one possessor to another.

This reflects the Laws of Thermodynamics, the first of which states that a simple Perpetual Motion Machine is scientifically impossible. In other words, you cannot have Output without having Input – and that isn’t just science, it’s Common Sense. This principle is not limited to just physicists’ Energy; we can take the view that wealth is, in fact, the sum total of the economic energy within our eco-sphere. Extending the metaphor, wealth is what drives our economic world just as a battery can drive an electric circuit, and where scientists measure potential energy in Volts, the economic world uses units of exchange - currencies - money.

And this tells us quite simply that "money" is not wealth, it is just the numbers on the ruler.

Isn’t this all a bit obvious? We wish that we could believe that it was. We feel like the little boy watching the Emperor preening in his new clothes – are we alone in seeing the nakedness?

We argue that for decades a lack of intellectual rigour in financial, business, economic and political thinking has failed to distinguish between the acquisition of and the creation of wealth. We believe that this is a major contributor to the confusion, chaos, disasters and distress that are the outcomes of the Credit Crunch. It has all happened because so many of the people that matter, not least our Prime Minister and Chancellor, do not appear to have the slightest clue about real wealth – they really seem to think that it is money. Possibly this is because politicians’ only interest is spending other peoples’ money (they do not even bother to acquire it first, they merely borrow it regardless). The absence of adequate challenge to their impoverished and sloppy thinking is an indictment of the world of Finance, and all its acolytes, who have lost the ability to distinguish between the acquisition and the creation of real wealth. We wonder if the Opposition parties have too, we have heard little profound insight from any of them.

The sad reality is that a very high proportion of those that seek to become wealthy, or want to control wealth, understand only the acquisition of wealth – because they think that wealth is money. They have no idea where real wealth comes from, but they can be infinitely creative when it comes to grasping hold of someone else’s money. Many acquire large amounts of money to gain the power and influence that they are driven to pursue (no, it is not “a want”, it is more desperate and more dangerous than that) and they think that the result is “wealth”. And idiots fail to ask “Where does it all come from?”

If money isn’t wealth nor wealth, money – what is it?

We repeat, from Walking Backwards, our definition of real wealth is solid sustainable human, intellectual, technological, physical, market, and financial assets and resources that deliver benefit to the future of the whole community.

This single sentence contains a big load of ideas and to try to discuss them all here would need a book, and not a blog post, so let’s just highlight a few

solid sustainable = long lasting and robust

benefit for the future = not just today but tomorrow and next year

whole community = what it says on the tin – everybody, not just a few

The easiest way to illustrate the difference between wealth creation and wealth acquisition and its connection with our theme of Capitalism or Common Sense, is with this parable about a farming community –

The corn merchant sells seeds to the farmer who sows it in his land and tends the fields then pays the villagers to help harvest the crop. The farmer sells the grain to the corn merchant who sells portions from his granary to the miller who, in turn, sells flour to the baker who makes and sells the bread for the whole community to eat. The corn merchant sells the surplus grain to other customers outside the community.

If there are Good Harvests, then extra grain can be traded outside the community and the corn merchant obtains extra resources that he can choose how to use.

The effect on real wealth all depends on what the corn merchant really wants to achieve – let’s look at two alternative examples –

Edward who is determined to create wealth

Fred who is determined to acquire wealth

Edward could choose to use these extra resources to help the farmer to obtain more land and manure to grow a bigger and better crop, so he could build more cottages to house more villagers, generating more income for the miller, the baker and the villagers. The miller might mill more varieties of flour so that the baker could offer a choice of different loaves. Edward could then build the bigger granary they all would need. He might also be able to create new benefits for the community such as a school and a doctor. The community’s real wealth, the totality of tangible and intangible assets, would have increased. Everybody would enjoy increased personal choice. And, if all the villages in all the land had an Edward, the real wealth of the whole Nation would increase.

Fred could choose to use these extra resources to acquire assets in other communities – perhaps to buy out corn merchants in other villages - this would increase his acquired wealth. The overall wealth, the community’s totality of tangible and intangible assets, would not increase. If, in a short term rush to maximise the number of other corn merchants he can buy, he were to sell all the grain from his granary, the community’s totality of tangible assets, its real wealth, would have decreased. He might claim that stocks in his other granaries provide greater wealth for all. However, the majority in the village would have no gains in personal choice. And, in this case, if all the villages in all the land had a Fred, at best the real wealth of the whole Nation would remain unchanged, i.e. not increased.

As soon as there are one or more Bad Harvests, there will be a marked difference -

Edward would find that there was no surplus grain to trade and therefore no way to support the community’s next expansion. However, his good husbandry of granary stock would ensure that the farmer’s next sowing could proceed and the community did not starve. Its real wealth would not decrease in hard times. People would continue to have personal choice but would see that it was limited. If all the villages in all the land had an Edward, the Nation would remain steady on its feet, its real wealth undiminished.

Fred, who had not husbanded his stocks, would find that was not enough grain in his granaries for either the farmer’s next sowing or the community’s bread, and certainly none to sell elsewhere. The community would suffer real hardship, the farmer would have much less crop (if any), the miller might go out of business, and the baker and the villagers starve or migrate. Its real wealth would decrease in hard times. The people would find that they have no choice left, only survival. If all the villages in all the land had a Fred, the real wealth of the Nation would be reduced.

However, it can then get much worse.

Fred’s cousin, Shredder Fred, takes over and decides to “maximise quarterly returns” by selling all the remaining grain from all Fred’s multiple businesses. Then many communities would be left to die. Shredder Fred may then use his "acquired wealth” to buy up the now devalued assets of all the bankrupt farmers, millers, bakers and the cottages, in all the villages. He might then install overseers to drive the smallest possible number of villagers to work for the least possible amount of bread in order to create surpluses to enable him to acquire other assets. There will be no personal choices beyond survival left in these communities. There will be widespread human casualties and waste of resources.

And, if every village had a Shredder Fred, then after they had exhausted their resources trying to buy out each other, there would be little else left except a much smaller number of Shredder Freds, each using his own acquired wealth to try to obtain influence and power over the Nation. The real wealth of the Nation would be decimated.

So where does Capitalism stop being Common Sense and become Nonsense?

Here are our questions for you –

1) Looking at the quality of life for the Nation as a whole and for each community -

Who do you think

a) Improves it? b) Makes no difference? c) Ruins it?

2) Thinking about the "socially useless" argument about some banking activities –

Who do you think is

a) Socially useful? b) Socially useless? c) Socially destructive?

3) Looking at the real wealth of the Nation as a whole and for each community -

Which type of Capitalist, Edward, Fred or Shredder Fred, do you think is

a) Productive? b) Unproductive? c) Destructive?

Which choices are more likely to lead to long term prosperity, stability, security and a good quality of life for the most people in the Nation?

Final question -

Do you think that this parable supports our assertion that the lack of intellectual rigour in financial, business, economic and political thinking that has failed to distinguish for decades between the acquisition of and the creation of wealth is a major contributor to the confusion, chaos, disasters and distress that are the outcomes of the Credit Crunch?

Do you think that, very possibly, this may be one of the causes of the whole disaster?

Our Comparative Competitive Strength point of view is based on the robust research that has proved that businesses that achieve true Excellence generate real wealth and withstand setbacks better than others.

This is not just “an interesting fact”. It is important. If we are to truly prosper again as a Nation, then we need to outperform all others. And to do that we need all of our communities to fully understand and apply the lessons and insights of the Comparative Competitive Strength point of view and to become genuine creators of wealth. We need Capitalism with Common Sense.

How might we reconcile Capitalism with Common Sense?

We can start with wealth acquisition. This is where Common Sense is most commonly disregarded, because the focus is too often on short term and self, both of which prove not to be Common Sense in the longer term. We asked in August if the prohibition of any trading in assets which are not actually directly owned could remove unwanted speculation? Could market damping (also suggested in our August blog) by means of share transaction delays and/or voting rights time embargoes (as Sir Peter Cadbury has just now proposed), and/or transaction taxes (proposed by Sir Stelios Haji-Ioannou), make a significant difference? Can we change the quarterly performance obsession of so much of the financial and investment world that inevitably drives out Common Sense from management decisions under this pressure?

Do we need to reward wealth creation by more generously enabling added personal wealth for those that take the risks and effectively manage them to create wealth? Should we actively reward good husbandry and punish reckless exploitation? What might happen if we had a tax and financial regulation regime that favoured the Edwards, disadvantaged the Freds and actively proscribed and prosecuted the Shredder Freds?

Could the government/regulatory role in a free market change to rebalance the current implicit bias that favours short term wealth acquisition by introducing incentives towards long term wealth creation in the economy, with corresponding rewards for the effective long term risk takers who create wealth? The implications for fiscal and economic management are at least thought provoking. The storm of outrage from the Shredder Freds, the Freds, and all their many agents, would be deafening, even through they are such a tiny minority. As Winston Churchill never said, “Never have so many owed so much to so few with so little good reason”. A true test of our political classes would be the extent to which they could demonstrate through action that they are not “owned” by these manipulators of money and brokers of power.

If you were to be brutally honest with yourself – do you think you are an Edward or a Fred?

§ Have you been seeking to create wealth by adding to the nation and the community’s assets and resources?

§ Have you been seeking to acquire wealth by securing a greater share, either for yourself or others, from the community’s assets and resources?

R W Emerson said that we should be very careful about what we wish for because, more than likely, we are going to get it.

We state again that our Comparative Competitive Strength point of view is based on the robust research that has proved that businesses that achieve true Excellence generate real wealth and withstand setbacks better than others. If you would like to know more about these ideas please look here or contact us here.

Capitalism or .... Common Sense is brought to you by Steve Goodman & Tony Ericson, partners in ChangeWORLD & Achievement Coaching International. It is one of our "Excellence Quartet" of blogs promoting the cause of Excellence as the key to prosperity. We publish a new article on one of these blogs every month or so using a recent business/financial topic to highlight different perspectives and conclusions from those obtained using conventional thinking and techniques. You can read the other three blogs at - Exceeding Expectations - You're having a laugh ... seriously - Business Bloop of the Month Award .

I’m Looking Backwards to Christmas, across the ICA

(with apologies to the late Spike Milligan)

The Institute of Chartered Accountants is running an advertisement intended to recruit new entrants which states that

80% of FTSE 100 Companies have an ICA member on their Board.

How does this look from the Comparative Competitive Strength point of view? Do ICA members actively contribute to performance that consistently exceeds expectations and generates world beating performance? Do they strengthen and reinforce outstanding business success and wealth generation? Or have they helped handicap the pursuit of excellence and been a contributory factor in potentially avoidable failures? Have they, perhaps, helped erode Capitalism by obscuring Common Sense?

Only a very few companies achieve the highest level, Free, of Comparative Competitive Strength (i.e. are the Very Best in the World in their field). A high proportion of these businesses are privately owned by shareholders or proprietors who are focused on the future, who know how to take decisions about long term risks, who are not scrabbling around for short term “prizes” without heed for the consequences, and who have the operational flexibility and sustainability to continue to prosper in hard times. It may be no coincidence that this is also the profile that seems to attract Warren Buffet. These are the companies that generate real wealth – solid sustainable human, intellectual, technological, physical, market, and financial assets and resources that deliver benefit to the future of the whole community. One of the keys to their success is their relentless focus on the future – what we call “Forward Facing Thinking”.

As we all can see, there is a continuing avalanche of business failures, of companies that are falling from the lowest level, Constrained, of Comparative Competitive Strength down into The Abyss. Do there really have to be so many? Have ICA members contributed, perhaps unwittingly, to the scale and severity of this bloodbath?

We have commented before in our “Excellence Quartet” blogs about the pernicious antics of the M&A “pirates” who, sometimes without permission, use their valuation of the assets of the purchased as collateral for the loans they need to complete their, often unwelcome, acquisition. A significant proportion of the continuing flood into The Abyss are companies that have been critically weakened by the debts incurred by such financial engineering. Many of these businesses were generators of real wealth and reservoirs of skills and knowledge vital to the future sustainability of our Nation State (such as nuclear power station design and manufacture). Far too many, especially in manufacturing and science based sectors, have been eviscerated by the decades of under-investment imposed by the muddled short term thinking and self-serving manipulation of numbers by their financial “experts” and bankers (now there’s a basis for comparison that might give the ICA serious pause for thought).

The ICA may trumpet the influence of their members. However, in the spectrum of real wealth generation (solid sustainable human, intellectual, technological, physical, market, and financial assets and resources that deliver benefit to the future of the whole community) they qualify to evaluate only one of those assets, the financial. Worse still the majority of their disciplines, and the primary basis upon which they seek to exercise influence on others, are based on looking backwards, “Backward Facing Reaction”. Sadly, too often they have been perceived “to know the price of everything and the value of nothing”.

The tragic and scandalous question is whether, in too many circumstances, that narrowness of view and understanding has been all prevailing and used (or abused) for the acquisition of personal power? Has that in turn led to over active collaboration in the City’s desperate “games culture” of financial engineering, reckless M&A, and the overall collapse of intellectual rigour in financial and business thinking that has brought us all to the brink through the Credit Crunch?

Sir John Rose of Rolls Royce, talking about the future needs of our economy in early November 2009, said there should be “less emphasis on social engineering and more on wealth creation”. We find ourselves “having a Heated Agreement” (to use the treasured words of the late Bill Carpenter, also of Rolls Royce) and paraphrasing those words as

“less emphasis on financial engineering and more on wealth creation”

Is ICA membership only about “What’s In It for Me?” Is, as the advert implies, the ICA focused only on dangling the prospect of power and authority for its members? Is this the moral and ethical leadership we look for and expect from our professional classes? Are the ICA really aligning themselves only with politicians, lawyers, bankers, financial advisors, estate agents and other perceived “professional” victims of public opprobrium? Or do the ICA want to be seen as professionals who are more vocational in flavour, like the engineers, the scientists, and the medics, most of whom seek to add to the overall well being of the nation, not just to find out the best way to grab more for themselves?

Wealth creation is driven by a focus on the future, not the past. It is centred in Forward Facing Thinking, not Backward Facing Reaction. We hope that ICA members might want to competently add real value by helping to generate real wealth, and not just manipulate numbers and words to serve either their own interests or those of close colleagues. If so, they will need to develop the ability to evaluate the future as rationally as the past and to articulate their understanding on a broader business basis than the judgement laden and perilously temporal fabrications of financial analysis. There has not been any truly objective tool to do this until recently. More often than not, the chosen solution has been a massive and time consuming investment in strategy management consultancy – perhaps even by a major accountancy company (more ICA members?) and, by definition, never truly objective!.

So how would it be if ICA members had access to a powerful and genuinely objective evaluation of how a leadership and management culture compares with the very best performers in the world, where its main constraints lie and what choices it must make to secure the future? Would it be better still if that assessment delivers these outcomes better, faster and cheaper than any other route?

• Cheaper? – now there’s a word with nasty ambiguities – we mean something that takes much less of business leaders’ valuable time, as well also as being comparatively inexpensive.

Wouldn’t that just be an opportunity to help create wealth, instead of risking being seen to be party to its dissipation? Could it be their chance to strengthen Capitalism with Common Sense.

You can find out more about the Comparative Competitive Strength point of view on our website here or contact us here.

Capitalism or .... Common Sense is brought to you by Steve Goodman & Tony Ericson, partners in ChangeWORLD & Achievement Coaching International. It is one of our "Excellence Quartet" of blogs promoting the cause of Excellence as the key to prosperity. We publish a new article on one of these blogs every month or so using a recent business/financial topic to highlight different perspectives and conclusions from those obtained using conventional thinking and techniques. You can read the other three blogs at - Exceeding Expectations - You're having a laugh ... seriously - Business Bloop of the Month Award .

Loan to Lenders ratio

The big finance and business story on the Lloyds/RBS bailout and its consequences has rather overshadowed the intriguing story about Yell’s planned £500m rights issue.

Yell, the publisher of Yellow Pages and yell.com is heavily indebted, to the tune of £3.8bn. It urgently needed the rights issue and an extension of debt maturities to avoid the risk of a covenant breach.

However what really caught our attention is that Yell’s debt involves over 1,000 lending commitments! Can you believe that, over 1,000 for a business with current market capitalisation of just £390m! However when you consider how the sum per lender looks so much smaller than the total indebtedness perhaps the rest of us are missing a trick here.

There are a number of financial ratios used in the lending to assess the viability of a lending proposition, loan to valuation, multiples of earnings etc. Yell seem to have come up with a new one here, loan to lenders ratio. For example if you could achieve the same number of lenders as Yell on a mortgage of £100,000 you would only owe £100 per lender, hardly worth any of them asking you repay it!

Or, taking the average unsecured loan figure (credit cards, overdraft etc) in the UK of £3,000 this same ratio means you would only owe £3 per lender. However carrying around 1,000 credit cards each with a credit limit of £3 would be a challenge.

What also surprised us is that there was very little comment on the number of lenders, other than to give the figure of 1,000, in any of the articles we have read on this story. Are we only ones to think this is all a bit odd, that it doesn’t make sense? Did the lenders themselves not notice how the room was getting a bit crowded and was this such a good idea?

What about Yell itself. Did they wake up to just how many there were when they started the negotiations on the rights issue? If they actually deliberately accumulated this number of different loan commitments what possible rational reason was there for doing so? It not only complicated the rights issue process. - “ …. collecting their acceptances has been a huge logistical exercise” (John Davis Yell Financial Director) – it threatened to derail the issue completely and with it the company.

So this may be an example of capitalism at work, but does it make sense? Simple is always better but of course complicated demonstrates how clever you are. A final thought though.

Amazingly Yell have managed to gain 95% acceptance from their lenders of the terms they needed to allow the rights issue to proceed. Whoever achieved this is wasted in a publisher of directories and should be transferred immediately to sort out the Israeli/Palestinian problem. Move over Tony and let someone who really knows how to negotiate the impossible from the improbable take over!

Capitalism or .... Common Sense is brought to you by Steve Goodman & Tony Ericson, partners in ChangeWORLD &Achievement Coaching International. It is one of our "Excellence Quartet" of blogs promoting the cause of Excellence as the key to prosperity. We publish a new article on one of these blogs every month or so using a recent business/financial topic to highlight different perspectives and conclusions from those obtained using conventional thinking and techniques. You can read the other three blogs at -Exceeding Expectations - You're having a laugh ... seriously - Business Bloop of the Month Award .