The crystal balls seem particularly cloudy as this year ends. Some money managers say the investment scene is the worst since the Persian Gulf War in 1990, while others say there will be no recession, so no worries.
In the gloomier camp is Ken Funsten, founder of Famco LLC, a hedge shop in Marina del Rey. The slow-footed Federal Reserve Board, despite its assertion last week that it stands ready to cut interest rates to keep the U.S. out of recession, is undermining a shaky economy, said Funsten.
“What really irks me is that I not only see blood on the streets of the Nasdaq, and a bad junk bond market, but I see a banking system not responding to customer needs,” he said. “It is very difficult to borrow money, and increasingly so.”
Banks have become wary of lending to growth companies, and of financing corporate mergers, and even extending normal business credit. That tightness is a result of weaker business sentiment, and the Fed’s restrictive money policy, so the Fed should ease up, Funsten believes.
Market investors may soon agree. Next year, lower earnings will again throw cold water in the faces of many investors who got used to only making money on Wall Street, said Bill Mason, a Pepperdine University professor and manager with Cullen Fortier Asset Management in Woodland Hills. “Everybody says they are long-term investors. We will find out how many really are,” said Mason, who believes the Dow Jones Industrial Average should retreat to 8,500 by June and the skittish Nasdaq won’t fare much better.
What to do? Big investors might want to buy index “puts” (a way of shorting the overall market) on the way down. Individual investors might want to stay on the sidelines, and then buy blue chip stocks on the cheap come March, April and May, said Mason.
Far more cheery sounding is Charles Biderman, chief executive of Santa Rosa-based Trimtabs.com, a stock market information service. Investors are still putting money into equity mutual funds witness the $20 billion net inflow in the first half of December, points out Biderman. Meanwhile, billions of investor dollars are flowing into money market funds and other cash depots, awaiting a change in sentiment. And tax revenues are still robust.
“Last year at this time, federal income tax receipts (based on withholdings) were up 15 percent from the previous year. That was the boomiest part of a boomy year,” Biderman said. “This year receipts are up 6 percent. Still a good year.”
Next year will see a slowing economy, he predicts, but no recession, so any hint of a market rally might prompt lots of cash to jump off the sidelines and join in, sustaining the upswing.
Mezzanine Power
Corporate dealmakers these days talk constantly about tight credit markets, and the “mezzanine funds” that are making out like bandits.
Modern-day mezzanine funds such as Libra Mezzanine Partners in Beverly Hills usually lend to growth companies or to finance an acquisition, and the debt is considered to be sandwiched below the more senior bank debt but above the equity. Typically, a mezzanine fund will not only lend cash but also “take warrants” (the right to buy equity) in a company.
As mentioned by Funsten, banks are loath to hand out loans right now, and if they do, terms have tightened. The result?
“The mezzanine funds have the capital, and so they are in the strongest position they have been in years,” said Greg Range, managing director in the Los Angeles offices of Duff & Phelps LLP, a financial shop that performs evaluations and arranges mergers and private equity financing.
Banks today will only lend about 2.5 times a company’s annual EBITDA (earnings before interest, taxes, depreciation and amortization), down from four times EBITDA at the start of the year, said Range. Most private businesses can sell for between 6 and 12 times annual EBITDA, sometimes more, depending on circumstances.
Obviously, buyers of businesses today either pony up more equity or borrow more from other lenders and the mezzanine boys are about the only other lenders out there. “Valuations are down too, by about 20 percent, again depending on the situation,” Range said.
Concurring with Range is Jeff McKenzie, head of the M & A; practice at Century City-based financial shop Houlihan Lokey Howard & Zukin. He said some mezzanine funds are now targeting 30 percent total returns, about 10 percentage points above their traditional range.
“Well, 30 percent is a high return for the mezzy funds, but they are as important in the marketplace as they have ever been. And we will see what returns they actually get, when they exit (exercise their warrants),” he said.
Back on His Feet
The irrepressible Clay Womack, founder and chairman of Santa Monica-based Direct Stock Market (dsm.com), the online purveyor of private equity deals, is literally back on his feet and buying other financial shops.
Womack was in a car wreck in his native Texas six months back, but last week was freed of his cast and crutches and is now walking with the assistance of canes. Evidently, that was enough for Womack to get his game back, and he confirmed that he has acquired the San Francisco-based boutique investment banking house Coast Partners Financial LLC.
Womack, who has created an online marketplace for his private equity deals and those of others, will now add middle-market debt deals to the mix.
“Coast Partners has been doing up to $100 million in structured-debt deals (private placements of debt). So we will be coupling the private placement of equity with debt online,” said Womack.
Word on the street is that Womack has shrewdly acquired a profitable banking operation to support his online dsm.com site and radically decrease the burn rate at Direct Stock Market, while simultaneously getting a pipeline of new product to sell online.
“We have cash in the bank, we have revenues, and while other dot-coms meltdown or lay off, we are growing,” said Womack. “And I have a bigger (joint venture or merger) deal in the works.”
Contributing columnist Benjamin Mark Cole writes about the local investment community for the Los Angeles Business Journal. He can be reached at [email protected].
