I had a long chat the other day with a long-only global fund manager. He observed (correctly I think) that conditions for private-equity takeouts of companies are as good as they have ever been. Debt is very cheap (low interest rate loans with weak covenants seem readily available) and many private equity funds have plenty of money which they have to spend or give back to their investors.
He was putting together a basket of stocks which he thought private equity would buy.
I tried thinking this way and whatever basket I came up with contained some very unattractive stocks.
Private equity has been doing some strange deals and indeed we are reversing several private equity takeovers in the hope (probably vain hope) that the private equity firm will come to its senses and not close the deal. Private equity firms are buying frauds at an unprecedented rate - which is not much fun if you are short the said fraud. (And it is not just in China.)
But for the last 18 months being long a bunch of things that might get taken private has been a winning trade - those stocks have appreciated irrespective of whether they actually caught a bid.
And being long a bunch of things that have no hope of being taken private (eg large cap techs, family controlled German companies with dual voting structures) has under performed.
And I have been (at least on the long side) with the under-performers. But it feels safer to me...
A fundamental difference in the view of how you make money in markets...
Underlying this is a fundamental difference in view about how you make money in markets. I always had embedded - deep in my psyche - the notion that the best place to look for investments is where nobody else was looking. You wanted to buy what was unfashionable but better than current fashion suggests - straw hats in winter because summer would come - and in that case you would only need to wait six months. The best response to competition was to avoid it rather than compete with it.
My friend's basket of stocks contained only businesses that the new power on the street (private equity) was looking at.
My friend wanted to buy what was going up in price - and what was going up in price was what the private equity firms (who were loaded) were going to purchase next.
My friend's attitude to competition is buy what they want to buy and sell it to them later at a higher price.
And so far he has been right.
And I have been wrong.
The new "value" is in stocks that are too big or too difficult for Private Equity. Microsoft and Cisco both have cash adjusted PEs well below 10. They are too big. Target and Walmart are about 12 times earnings. Same story. The German family concerns could also be purchased at low levels. Coca Cola - the definitive Warren Buffett stock is back at 12-13 times earnings for the first time since Warren Buffett originally purchased it.
And frankly nobody is interested - these stocks under perform.
And if you buy something that is cheap you might find even more problems come out of the woodwork (try Yahoo and Alibaba for a recent high profile example).
Many of the great value orientated investors are having a bad time this year. If it were not for our shorts we would have not had a fabulous time either. I don't think the value guys are wrong here - but it has not been fun - and it sure is getting frustrating.
Maybe out performance will be if the market turns really sour and the value stocks only drop 15 percent whilst the stuff private equity never got around to buying drops 45 percent. But that is hardly the fun form of out performance.
We have had very strong performance and not done great on longs because our shorts have been so accurate. But many of the best investors I know are having a hard time - and I keep imagining and hoping their (and their client) suffering is temporary. Because I don't think I am going to buy my friend's long stock basket. Too hairy for me.
Meanwhile I am becoming totally reliant on the short book for out performance. I wish I had more arrows in the quiver.
The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.