Friday, October 05, 2007

Bain Submits To Foreign Security Review But Will Investors Benefit

Bain Capital Partners needs to submit a proposed $2.2 billion buyout of the networking equipment maker 3Com for a national security review. Government scrutiny was anticipated because of a minority stake in the deal held by a Chinese telecommunications company, Huawei Technologies, which has close ties to China’s government.

Most large private equity players have developed extensive relationships with foreign investors. After all they have the money needed to make the deals close. Have the private equity players pre-screened their partners before they make an offer. Imagine the controversy if the government disapproves of an announced deal.

So when there is a foreign partner, has the private equity firm presumed that the President of the United States is OK with the specific deal. Hmmm

When a specific foreign investor invests in a transaction that privatizes a publicly traded company there is a strategic intent. Otherwise why put up big bucks for an illiquid minority position.

While the government may determine that the United States is not getting screwed what about the investors? When these acquisitions finally go public again and a strategic investor has benefited from an information flow who will have the advantage. Foreign strategic investors will be able to hide behind a different legal structure that will not recognize governance the way a domestic investor expects.

Be careful who you do business with. Will the investor remember this when they try to take this one public again?

Thursday, October 04, 2007

NutriSystems Not Enough Calories

NutriSystems (NTRI)served up some very low fat financials and informed everyone that results will be much worse than expected. The official results are not out yet; this is just a preliminary release. Something like Chinese water torture drip drip drip. The stock is dropping like a stone.

Too much of the press release deals with the stock buyback program. Its as if the executives are playing against the shareholders. They have found a bank to give them $200 million. The loan facility has an accordion feature which takes it to $300 million. Its priced at LIBOR plus an undisclosed spread tied to leverage. The company has total book equity of approximately $150 million so the leverage will be high. (Banks will look at book equity) What other covenants are there?

The old client acquisition costs excuse seems to be the primary culprit. NutriSystems has been extensively advertising (CNBC of all places got a lot of the ad business) So the investment community sees the sin in the marketplace and pretty well misses it.

Management's first mistake was to not let the market know these ads were going to cost a lot. Now investors are all surprised. Management's second mistake is to focus exclusively on the stock buy back and levering the company to a crazy gearing ratio just to prop up the share value.

Management was spooked by the short interest ratio which is about 47%. To the point where its probably all they can think about. One thing you have to think about is the CFO James D Brown who was selling while he was negotiating with the banks to put the fancy LIBOR deal into place.

These guys are playing roulette and are not minding the store.

Wednesday, October 03, 2007

Diebold Restatement Consequences & Integrity

Diebold (DBD) will change the way revenue is reported after its accounting practices came under SEC scrutiny, the company said in a press release issued Oct 2.Diebold may now record sales only after its products are delivered or installed, said spokesman Mike Jacobsen.

A quick scan of their financial statements includes this note to financial statements that defines revenue recognition.

"Revenue Recognition The company's revenue recognition policy is consistent with the requirements of Statement of Position (SOP) 97-2, Software Revenue Recognition and Staff Accounting Bulletin 104 (SAB 104). In general, the company records revenue when it is realized, or realizable and earned. The company considers revenue to be realized or realizable and earned when the following revenue recognition requirements are met: persuasive evidence of an arrangement exists, which is a customer contract; the products or services have been provided to the customer; the sales price is fixed or determinable within the contract; and collectibility is probable. The sales of the company's products do not require production, modification or customization of the hardware or software after it is shipped."

Kudos to the SEC for finally protecting the investor. The corporate press release makes mention that while they are still figuring it out, they will have to restate previous financial reports, but do not believe that the cash position will be affected. This is universal corporate baffle gab. Investors are supposed to be quiet if the cash position does not change, everything else is not so important.

Essentially Diebold was not following its publicly stated policies. Diebold was not following accounting standards that investors should be able to rely on. KPMG the auditors in this case certified the statements when they should not have. The Board OK'ed everything. Governance! Governance! Governance!

What consequences will Diebold executives have for this inadequacy? Many in the political arena contend that their voting machines cannot count correctly. The SEC has definitively determined that the corporate accounting was not counting correctly.

Does Diebold have a corporate culture problem? With the counting thing?

Tuesday, October 02, 2007

Wal-Mart One Trick Pony

Wal-Mart (WMT) announced price cuts on toys two weeks earlier than last year. The news media story is that they made the announcement two weeks earlier than last year. In some reports there is mention that Wal-Mart has stepped up their safety inspections. We will see if they kick something out of the line up. But as we all know the orders have been placed months ago.

The toy industry and Wal-Mart by association have a credibility problem because of "Made in China" safety issues. Most concerned parents want additional assurances as to why a particular toy is still a good idea. When your child is poisoned; a cheap price tag will only stimulate class action lawsuits as to why Wal-Mart induced me to buy something bad with a cheap price when they should have known better.

Wal-Mart is pushing the only button they know how. Cheap cheap prices. Credibility in safety issues is not solved by cheap prices.

If Wal-Mart continues this thinking they will soon get into their own discount lifeboat. Wonder if it floats properly?

Sunday, September 30, 2007

UAW VEBA Jumping Monkey

The UAW VEBA for lack of a formal name should be operating within the next twelve months. When you include all three Detroit automakers they will cover approximately 500,000 retired auto workers and have approximately $65 billion in obligations. To date the auto industry and most businesses have treated health care as a cost. The car guys wanted to make cars and really never said health care was a core competency.

Once you get past the set up process you have to consider how this VEBA will conduct itself. The UAW VEBA is being born out of severe economic necessity. Health care has been sucking money out of everyone’s pocket. It is possible for millionaires to go bankrupt because of personal health problems. That’s how powerful the black energy of health care costs has become.

Will VEBA eventually accept or seek a significant role in shareholder activism in general and in the health care and pharma industries in particular? Most individuals do not have the resources. Most corporations view the health care exercise in a cost containment context. They do not have the will or resources to become proactive.

VEBA to ensure its financial integrity will need to learn how to brawl and rumble in the health care field. The union DNA will serve it well. The UAW will want to ensure its members are well taken care off. The auto companies will want to make sure the funding checks they write are the last ones. The auto companies are more than willing to let go but will the UAW step back and let the VEBA executive manage their own problems. Some governance issues need to be addressed. Union executives are not health care administrators; they most likely do not have the necessary skills to actively manage the VEBA.

What will happen to the capital markets if we know a new player is coming on board with fresh new capital in the range of $65 Billion which needs to start working now. Actuarially the core investments should be highly predicable. They will be waiting for you.

Here are some dynamics which will influence the VEBA’s eventual power.

1. With approximately 500,000 retired auto workers they have automatically organized a very large buying group.

2. Given the location of auto plants they probably are concentrated in the same geographic regions giving them political and economic clout. Not everyone moved south.

3. I suspect that the health care issues have common themes as a result of common work histories. This will concentrate focus on certain drugs and therapies.

4. If VEBA does not like what it hears or sees from the health care or pharmaceutical industry it will have a huge amount of on hand documentation to support legal fights and class action lawsuits.

5. The trust arrangements under which they operate will influence their shareholder activism in the health care and pharma worlds. The VEBA memorandum of agreement and other incorporating style documents will be scrutinized closely by defendants as to legitimacy and cause of action.

This monkey may be off the auto industry’s back but will it crawl up on the back of health care and pharma companies.

GM VEBA Clarity Please

General Motors (GM) negotiates a landmark deal with the UAW. By establishing the VEBA they move approximately $51 billion of unfunded liabilities from the corporate balance sheet to the VEBA structure. GM will kick in approximately $30 billion to fund the program. So it looks like GM made $21 billion plus solved the problem forever. Ford (F) and Chrysler supposedly will arrive at something similar. On the surface that’s a nice day’s work and the shareholders have declared there is now more value in the stock than several weeks ago.

The VEBA is being set up by way of a memorandum of understanding between GM and UAW. So it will be separate from the official labour contract that is negotiated every four years. The union membership is supposed to be happy now that their rich retirement benefits are taken care of.

Other than the respective GM and UAW negotiators has anyone else seen this memorandum? Maybe it’s just me and my inadequate research skills but I cannot find it on the UAW or GM website. Everyone is buying into the big solution but can we read it somehow.

This is too big a deal to just flip it off the balance sheet and pretend it will never ever again be a factor. While there is no doubt that the VEBA will go a long way to solving the problems the market place has become delusional that it its really gone forever.

The market is still dealing with documentation problems in the sub prime mortgage mess. So why not make the document public? Clarity, transparency would all be well served. When will Moody’s and Standard & Poor cast their eye over the mystery document and make a prognostication about quality of cash flow and interest coverage ratios. You know the stuff that ratings are made of.

Here are some of the confusing items out there.

1. How much is GM putting in? I have seen estimates from $29.9 Billion to $35 Billion.

2. Will GM actually guarantee the VEBA? This item has been dangerously quiet. Will there be three VEBA’s with three separate guarantees from three car manufacturers?

3. I have seen commentary that GM is guarantying the VEBA which means that there will be one hell of a footnote to the financial statements. If GM is guarantying after they put all the money in what is the difference from the current and conflicted set up? GM will have a bite me big scenario if the VEBA goes wrong.

4. Speaking of big bites, the VEBA needs to beat inflation in the health care sector which is currently running at approximately 10%. So when Hillary Clinton promises to reform health care some Wall Streeters and retired auto workers may be her biggest fans. Imagine those two groups cheering for the same thing.

5. The VEBA is supposedly going to be regulated by the SEC, according to many reports even in the financial press. The VEBA is really a health care insurance vehicle. More like an insurance company I reckon. The SEC regulates securities. (SEC= Securities Exchange Commission). I believe a host of other entities are tasked with regulating insurance vehicles. Who will be the lead regulator on this one?