Meditations on Investing Under Quarantine for a World Still Unknown
Published on Linkedin PPGV website 4.13.2020
I compose tonight from a small desk in a cottage in Berkeley where I am under self-quarantine for another 6 days due to exposure to Covid19 while in New York one week ago. Even more so than when I wrote early last month, I travelled through empty airports, on empty planes and stayed in all-but-empty hotels. Like just about everyone I know, I am wrestling with interpreting the changes to the American landscape and the international community on the social and economic level that are as profound as any in my lifetime. But the return of market volatility has already increased opportunities for investors, not diminished them. And with all this in mind, I believe it is worth attempting to think through what might be reasonable to expect for the next twelve to thirty-six months from investments.
On the somewhat positive side, it appears that the pandemic’s curve of new infection in the US is beginning to hint at flattening and I think we stand a good chance of coming in at the low end of expectations given by the administration of 100,000 to 250,000 lives lost. My back-of-the- boarding- pass estimate now expects for the initial wave of mortality in the US (through August) to be somewhere between 70 to 100K. This is nothing to celebrate. We are still talking about a loss of life greater than the US suffered during twelve years in Vietnam. Like Vietnam, there is no way for anyone, no less this administration, to claim victory.
My week in NY brought me face-to-face with the human toll this is putting American’s families through—starting with my own. On March 30th my mother, approaching her 87th birthday in June, was rushed to Long Island Jewish Hospital in New Hyde Park with high fever and Covid 19. Alice is one tough lady and I am pleased to say that she survived the short trip to hell and back but not without a terrible struggle and lasting impact to her lungs. She was discharged late last week and is at home resting. Unfortunately, while I was in transit to NY my 92-year-old father was already facing a pneumonia and other health issues that would also lead him to the emergency room of LIJ before I had unpacked my bags or been in NY for a full day. He is now recovering at a rehabilitation facility near home in Queens. NY Hospitals today are like military bases—locked down tight with armed police standing watch as ambulance after ambulance disgorge those suffering from the virus day and night. No family may enter buildings. Staff inside are rushed off their feet and hopes for loved-ones outside in the parking lots on their cell phones of learning the condition of those inside are up against communication networks full-to the-point of failure. With cases now exceeding half a million, there are literally millions of family members facing these challenges. New York is our Wuhan.
The economy has been hit with a body blow not seen in 90 years. The 16.8 million human beings that have filed for unemployment on our shores translates to a rate of about 13.5% currently, and I expect that to rise by more than 3% before the next monthly reckoning of the rate is posted. Of course, that will not be the high—looks like we will break 20% before this contagion passes. It is unreasonable to expect the majority of workers to be back at their jobs in short order without a vaccine, universally-available (rapid) testing, and a proven therapies on offer. I know first-hand how little the hospital system has today, in short: Plaquenil and an array of antibiotics to battle the chest infections that come with the virus, oh, almost forgot, and prayer. That’s it, and the serious scientists inside the best hospitals, unlike the orange- faced clown on TV, will tell you they are very, very uncertain about Plaquenil’s efficacy. For all the shouting to produce the darn things, most estimates indicate that at least two-thirds of Covid19 patients who are put on ventilators will not survive. So, if you are lucky enough to be healthy today, best to focus on social distancing as a survival strategy because ventilators are more of a Hail Mary pass than dependable ground game.
While the $2 trillion already committed by congress to soften the blow has some hope of deflecting the punch, the US should still expect to get hit hard in the economy’s solar plexus. Fed head Powell, while early to the party with his cuts to interest rates, has used up much of his available ammo. He has taken to Bernanke’s playbook of spraying liquidity on the financial system like flame retardant and while it will surely help money-center banks, insurers, and i- banks, don’t count on it reaching small business quickly enough. Already on my isolated drives and bicycle rides through NY and NoCal I can see that many of the stores that closed their doors in March will not be opening them. The Paycheck Protection Program may help more established small businesses with solid prospects and good relationships with their banks but, small business that were already struggling are now all but toast. Many storefronts that were active a month ago are already boarded-up and ‘for rent’ signs have been placed in the window. Among the vast ranks of the homeless in Oakland, I see new faces in the last 30 days who, though marginally better turned-out than those who have been in this desperate condition for years, are on the street not by choice. My heart goes out to them. I was encouraged two weeks ago to hear that a restaurant group that our family office has backed had been approved for SBA funding. But, when it came time to process the paperwork, those charged with that responsibility at government agencies would not accept the electronic signatures, like DocuSign, which have become standard in the private sector. This stupidity will add days of delays in processing claims and for some businesses that will be time that they don’t have. Also, it should be said, the speed that most lenders move in the best of times is glacial. If you imagine that institutions like tone-deaf Wells Fargo, recently infamous for cheating its clients and blaming its staff, is going to step up to those in need—think again.
Most large business will survive and it is worth looking at the listed market first before I turn to the private equity market in my next piece. First thought: watch your timing. After last week’s gains some are already proclaiming an end to the bear market. Unlikely. According to a Merrill Lynch report quoted in the WSJ on April 8th, “bear markets that are accompanied by a recession tend to be more pro-longed and last about 11 months.... The US stock market has never reached its bottom in less than 6 months after falling more than 30% and facing a recession.” I am going to bet that ML is correct in this case. And if Minneapolis Fed Governor Neel Kashkari is even half right about 18 months of rolling shut-downs until a vaccine is ready, it will be a really great recession, and maybe more.
That said I think there are parts of the market that are beginning to look attractive, while other parts will not be back to 2019 form for years. Since the tenor of my remarks has been pretty somber, let’s talk about what I am inclined to put funds into. While I think drug stocks will come through this in good shape, and a reasonable case can be made for shares of Pfizer based on valuation, I would not chase Gilead based on Remdisivir alone. I have added Teva to the portfolio, I am convinced that the entire system of drug manufacturing and sourcing is set to change and Teva’s efficiency and quality will help it to come out of this mess a winner. That said, like all the buys I suggest, it could also make a new low first so squeeze the trigger ever so slowly. Likewise, I believe that the current vulnerability of the labor force to disease will only serve to accelerate manufacturing automation. With that in mind, businesses like Japan’s Fanuc, which is now at less than half its high, seems worthy of consideration. I thought of investing in Siemens as well, but their business is broader in range and far less focused than Fanuc. I also believe that the global manufacturing and supply chain, so impacted by this crisis, will be more important than ever. With that in mind, companies like Singapore-based Flex seem worthy of consideration.
I think the travel and leisure industries, which are down, but not-likely out for the long run. After the crisis, and a little time for healing, it is just possible that the businesses of Expedia, Marriott, Cheesecake Factory, and Delta Airlines will be return in better shape than before the current misery. After all, how many of us are not dying for a return to life as normal and who isn’t excited about the pleasures of a good meal served by someone other than your blood relatives.
Of course, there are many businesses that won’t be back. WeWork is a model that doesn’t work-- especially now that CBRE’s Hana makes that model available to every landlord in the world almost risk free. Hoping that Uber and Lyft will return to past glory? Think again. Nothing good is coming their way and competitors have virtually no barrier to entry. I don’t think any of these companies will qualify as essential or deserving of a bailout. Likewise, the big automakers are in a world of hurt—though they are likely to be considered probably too-big-to- fail. Internal combustion fanatic Dan Neil this weekend penned a piece is in the weekend Journal titled: Do Temporarily Clear Skies Presage Our EV Future? Ford is already showing signs of stress and the dividend has been pulled. But the problems for the auto sector are much deeper and reflect the reality that registrations were already high and heading down on our way into this crisis. By the time we are heading out of this crisis most buyers will expect their cars to go 400 miles on a charge and produce next to no tail pipe emissions; little wonder Tesla remains the stock of the future in the group.
Of course, I own many of the names I mention above but, it is worth repeating that it doesn’t necessarily mean I think we have seen the lows yet. So, I strongly suggest that you be patient. Buy when others are panicking. Take advantage of brokers who no longer charge even a penny to process a trade ticket and break up your trades into four and five tranches. We are in completely uncharted territory with this virus. I will also wager that developed Asia, which has weathered the impact of Covid19 with greater resilience and better government-led execution than the US, will outperform our market for several years. According to Statista’s data, at the end of February 2020, the US represented greater than 54% of global stock market capitalization—but as of calendar year 2019 we were less than 25% of the planet’s GDP. Expect governments and economies with more rapid and effect responses to the pandemic to rise in value relative to valuations here at home: Korea, Taiwan, Singapore...and probably Japan. So, while this piece represents an attempt to start the process of thinking of what is around the blind curve ahead, so much of the future of economies and markets is still reassuringly still unknown. Just don’t get silly and think the volatility is all behind us—that is peace of mind that the administration, congress, and the Fed won’t be able to buy for all those trillions.
Stephen in the Elmwood District, Berkeley, CA
Late at Night 4.12.2020
Independent Sponsor Spotlight: Stephen Leist of Piedmont Partners Group VenturesMarch 12, 2020
Q: Why did you decide to become an independent sponsor?
Stephen Leist: I spent 16 years inside large investment banks in the listed equity divisions as a research analyst, salesman and division head, and I have always been fascinated by corporate capital formation and investment management.
After leaving Wall Street, I was a chief operations officer for a number of absolute return investment management firms, but by 2005, I could see that outperforming the market for hedge funds was becoming increasingly rare. I could also see that the private equity (PE) business had far more available alpha.
In 2009, I started to work on an investment project with Warren Hellman, co-founder of Hellman & Friedman. He asked if I would be interested in joining his firm. When I hesitated — after all, I had spent most of my career inside big organizations — he suggested that I start my own investment group and his firm could invest in opportunities that we identified. Hellman was a mentor and my hero, so that's how Piedmont Partners Group Ventures (PPGV) came about.
Q: How long have you been operating as an independent sponsor and how long did it take you to get your first deal closed?
SL: PPGV launched in 2010 and it took over two years to close a transaction. We got to within a signature of closing on our first deal in that first year, but complex deals can fall apart at any point. That was a painful lesson.
Q: What are some of the most impactful reasons you think the independent sponsor model has grown so robustly and what changes do you envision in the future?
SL: In 2000, the United States had roughly 8,000 listed companies. We now have about half that amount. A number of factors have caused this, such as the Sarbanes-Oxley Act and several severe market corrections, but it is also important to recognize factors like the growing creativity and flexibility of the private debt market and the massive expansion of capital and range of focus to the PE market. When PPGV started about 10 years ago, the number of serious investors who invested on a deal-by-deal basis could be counted on your fingers and toes. Today, I expect there are several thousand institutions that take this approach.
Q: What are the most common misconceptions about the independent sponsor model?
SL: There are so many misconceptions. Where do I start? Many of the large PE firms have changed their stripes as the amount of capital they have under management has mushroomed. Most now expect the deals to come to their door by way of a black car accompanied by a banker and followed by an auction.
As an independent sponsor, we don't take the meetings with bankers or hear roadshow presentations. We go out to visit with more than 300 companies a year from our offices in Oakland, California, and in Denver, New York, London and Tokyo, with a goal of finding 15 good ideas in companies that we can help. We don't expect that we will be successful in working with more than two or three of them.
The biggest misconception: C-suite executives who think they will find meaningful resources focused on them inside investment banks or big PE firms. I-banks are coin-operated, and chances are you don't have enough money to interest them. Big PE lacks the time to problem-solve for the small- to mid-cap corporate community. Most are best served by working with a good independent sponsor team.
Q: Recognizing every deal is different, what are some of the most important considerations for you when choosing a capital partner for a deal?
SL: The biggest issue for us is trust. Big PE and so many other capital resources are under the illusion that assets under management and visibility will bring quality transactions to their door. They could not be more wrong. There is more money sloshing around in the system than there are good ideas. Counterparties that keep their word and respect their deal partner's intellectual property (IP) get our first call. We come back to dependable, reputable firms again and again. This is the main reason why Hellman & Friedman is still the gold standard.
By contrast, if you keep us busy for a month marking up the nondisclosure agreement with your expensive outside counsel, chances are we won't show you a deal again. If you wine and dine us to get access to our deal flow and then take off for a three-week trip to Italy when it comes time to pull the bid together, we won't be calling on you again. If you start to treat our IP as your IP, or threaten to circumvent us, you will not be top of mind for our best ideas.
Q: What do you envision as the future for the independent sponsor model?
SL: I think PE as an investment sector has a long way to go. PPGV expects to see further declines in the number of listed equities, not just in the United States but in international markets. We hope that services to the independent sponsor industry continue to grow as the industry expands. There is currently too much focus on services to the blind pool funds community and not enough focus on independent operators. Banks and lenders have done a pretty poor job in connecting with this market and serving small- and mid-cap companies as their focus remains on the brand-name PE firms.
Meditations on Empty Airports and Hotels and a Day in the Air
• Published on March 3, 2020 on Linkedin – Stephen H. Leist, Managing Partner, PPGV •
Yesterday my alarm went off around six AM in NYC. I ubered to JFK to find the Delta Terminal all but vacant and the TSA agents chatting among themselves. But as my plane lined up for takeoff the day really got started with the Fed’s ‘surprise’ 50BP cut in rates. Lord knows why they did it. CNBC’s talking heads said they didn’t want to look like they were “getting behind the curve” ... whatever that means. Investors remained impressed for the first 120 seconds when the Dow peaked up more than 300 points— but then reversed a brutal 1300 points before a tepid bounce into the close. With Fed Funds now in a range of 1 to 1.25% there is a diminishing store of ammunition left in the Fed’s arsenal before rates are as low as they can go. No red-blooded American wants to really talk about the unpleasantness of negative rates.
The current problems of financial markets and the global economy demands creative fiscal responses to current policies. Cheaper money isn’t going to encourage people to come to the airport or fill up empty hotels around the US or anywhere else. Luxurious lodging in NY this past weekend could be had for just $100/night. While I love a room upgrade as much as the next man, the seriousness of the predicament for the world markets and economies is not lost on me. There is a wide range of responses a government can develop to counter a shock like the looming pandemic but inoculation by money supply is likely to have limited impact. While places like Hong Kong has taken a number of thoughtful measures, the US congress is still just pondering the possibility $8BN stimulus, a fraction of the stimulus post Katrina. Measures to address the liquidity and integrity of parts of the economy most impacted: hotels, airlines, and supply chain infrastructure, strike me as ideas worth considering. How about paid emergency sick leave for those whose jobs don’t have that benefit and are inclined to bring their illness to work? I tend to agree those who feel that the consensus to take action in monetary policy among the world’s central banks is a reflection of the desire to appear ‘active’. They aren’t offering any real hope beyond brute force that they can offer economies the flexibility and clarity-of-mind needed to address this global crisis.
Meanwhile in DC, the Trump administration rattles on about its beloved wall instead of all the meaningful places dollars could be spent to stimulate and improve US infrastructure, such as roads, bridges, tunnels, rail, even schools. These would have long-term effects of improving US business competitiveness, though the investments now amount to deficit spending. The clumsiness of the response to the potential pandemic has been comic: less than one million test kits in the US, pathetically undertrained care workers endangering themselves and potentially spreading disease. The White House is still more concerned about censoring John Bolton’s book than it is in effective crisis response.
It seems to me that balloons can’t burst unless they are filled with air. In this case, most forecasters expect a lackluster year of profits, at best. As market’s rose faster than profits over the last few years, even after days of damage, we are surely closer to over-valued than to a bargain price. Tariffs and trade wars have had meaningful negative international economic impact. According to data from the World Economic Forum, global merchandise trade by value declined by 2.9% when most of 2018 is compared with the same period of 2019. No one is enriched when trade shrinks. Today the US is run by a man who behaves in a manner more like the real-estate-developer-in-chief than a commander-in-chief. Like a property speculator, he has borrowed money, such as $1TR deficit last calendar year, to keep the economy humming, albeit at below 2% growth. But unlike a RE developer, the federal government will not be able to shelter in bankruptcy when the debt bill comes due. Inevitably, as the response to 2008 shows us, the US will be forced into a Keynesian posture when the economy fully grinds to a halt. That could mean a single year may be coming soon in which the deficit soars as high a $2TR due to the need for stimulus. On the positive side, the banks are in much better shape than last time around, so at least the shock is unlikely to be amplified by a collapse in the banking system.
In my mind, it would be best to rule out the V-shaped rebound. With the spread of the virus in the US still in front of us, not behind, a quick rebound seems overly optimistic. Those who own or are partners in small businesses, like me, will keep getting on planes and checking into hotels. But the corporate class is staying home according to reports of Ford, Nestle, Amazon and dozens of others. After boarding, the woman in the row behind me vigorously wiped down her seat disinfectant wipes, and took one last call from the office about margin calls. And as we taxied away from the gate most seat- back entertainment units turned to CNBC to watch the chaos of bond markets making new highs and share markets breaking down. Headwinds were strong and the pilot announced that it would take most of seven hours JFK to SFO on my half-empty flight, normally full to bursting. As we took off, NBC news announced that many schools in Westchester sent students home for fear of spreading the Coronavirus and it seemed that half the airplane groaned. Well thanks for the upgrade I thought as I took it on board that there is likely a lot of turbulence, and probably downside, for markets and travelers ahead.
Stephen H. Leist, Managing Partner, PPGV Tuesday March 3, 2020
Sheryl is on her book tour.... Tightrope: Americans Reaching for Hope. Released Jan. 14, 2020 and already on the bestseller list!
https://www.nytimes.com/2020/01/13/books/review/tightrope-americans-reaching-for-hope-by-nicholas-d-kristof-and-sheryl-wudunn-an-excerpt.html. Here is an excerpt of the New York Times bestseller,
Tightrope, co-authored by Sheryl Wu Dunn, Partner at PPGV