November 2008


brollyI’ve been reading some of the reactions to the announced plan to backstop certain obligations of Citigroup, Inc. (Citi)  Many people seem to be, potentially rightly, outraged that their tax dollars are being put to work to prop-up U.S. financial institutions without taking a pound of flesh — i.e., firing senior management, putting compensation caps in place, etc.   Further, people are running through the streets screaming “where’s the plan, where’s the plan”, a reference to the log jammed proposed bailout of the U.S. automotive industry.  While I do not begrudge people for their level of disdain as it relates to what is going on, I do think that some of the commentary shows a lack of foresight and a misunderstanding as it relates to the nature of our underlying economic systems and importance that money centered banks play relative to industry.  That said while salvaging our banking system is a fundamental choice that must be made, that is not to say it is a better one.

First, I think it is worth laying out my view that absent rampant speculation and the rapid media syndication of fear, Citi would not have needed any government support, even though it might be in the best interest of equity holders.  One could argue that Citi’s balance sheet is stronger now than at this same time last year.  In fact, if not for shortsellers and fear mongers, we might not have seen Bear Sterns and others go under (likely Lehman, but not Washington Mutual, Wachovia and the like).  Generally speaking, financial contracts if fulfilled or unwound in an orderly fashion allows for reasonable matching between assets and liabilities and inflows and outflows.  Where financial institutions experience a deluge in counterparties seeking contract enforcement in an accelerated fashion, the system can become materially imbalanced and confidence can dissipate.  Many of the surges we have recently experienced have been the result of speculation, as opposed to material fact with confirmation, that emanated from those who stood to profit from such turmoil.   This is a referendum, in my opinion, on the evolution of our greed is good immediate gratification culture that reacts based on half truths and ask questions later.  Greed at the expense of what is in the best interest of our financial system makes me a little ill. Exhale.

So why bailout Citi without hesitation while holding the automotive companies feet to the flame?  In short, because the first is essential to the stability of our financial system and therefore our economy and the second is not.  While this is a painful realization for many who were raised in another era, it is in fact true.  Until recently, Citi was the largest U.S. financial institution (today it is 4th by market capitalization (excluding Canadian deposit institutions listed on the NYSE); 5th by deposits), the symbol of the new financial order that married banking with brokerage and insurance.  The deal was so significant that the U.S. government set aside the Glass-Steagall Act to get it done.  As a result, Citi was allowed to grow into a behemoth, commanding over $2 trillion in assets and employing 300,000 people in 100 countries.  What I find somewhat ironic is that the Democratic party inherits a mess made by the last Democratic president.

If Citi were to be allowed to fail, or forced to, it would undermine a, if not thee, central pillar of the U.S. financial system,  not run by the government, even if it is one that is fatally flawed (net, net the deal that built Citi should have never been allowed to happen).  A Citi collapse would lead to a run on countless U.S. banks and foreign financial institutions, the result of which would meaningfully undermine credit based commerce, globally.  Further, Citi, as one of the largest issuers of credit cards, could be forced to bring down a healthy percentage of the U.S. consumer population with it.  That is not good for business.  If savers do not believe financial intermediaries are sound, they won’t save.  This is why the government regulates these bodies and provides depositors insurance.  A run on Citi would recreate the 1930s all over again.  Given the fragility of the U.S. economy, spooking savers and consumers would not be in our best interest.

So why not see off company senior management and the board as part of the stabilization of Citi?  I’ll take the second question first (I’ve always wanted to say that).  There should have been government mandated changes to the Citi board.  The person who put Citi squarely in this mess was Charles Prince.  Passed over by Sanford Weil during these years was Jamie Diamond, now head of J.P. Morgan Chase.  You don’t see him with his hand out.  Further, the board, namely at the behest of Robert Rubin, pushed the bank to expand into more risky trading activities as a means to fuel growth.  It was these very trading activities which ultimately created Citi’s toxic balance sheet.  Finally, board also failed to push current Citi CEO Vikram Pandit to enact significant cost cutting measures on an accelerated timeframe.  The board is large, unwieldy and needs to be held accountable.  They lack a connection to reality.

As for management, broad sweeping changes and a removal of financial incentives would result in significant chaos at the bank.  At this point in time, that would be a counterproductive measure.  Capping bonuses and the like would only deincentivize managers from pursuing what is in the best interest of shareholders.  If such incentives are removed, and management departs as a result, the company’s ability to attract high caliber talent to replace departing employees will be serverly hampered.  Afterall, why would you want to inherit this mess? Rhetorical question.

In contrast to Citi, the U.S. automotive industry has been trying to get its seat at the bailout buffet, but has been, shall we say, re-buffed.  Congress wants Detroit to hatch a plan for utilization of the funds that shows it would make them economically viable.  The problem is that no amount of money is likely to make that a reality.  U.S. auto companies are woefully behind their foreign peers in manufacturing efficiency, engineering acumen and, most importantly, an understanding of consumer demand.   No amount of money will be sufficient to change the mind of U.S. consumers who have long abandoned our auto industry.  A friend of mine came up with the great idea that consumers should be offered significant tax credits to buy U.S. autos.  We seemed to agree on $5,000, when challenged he made no movement to get his keys.  When I raised the ante to $10,000 he did not twitch.  Maybe I should have simply offered to give him the car.

Yes, a failure of the big three will cost jobs and bring about regional and national economic malaise and generally be bad for organized labor and national morale, but a failure to bailout the automotive industry will not result in global thermo nuclear financial meltdown.  In fact, I could make a strong argument that the auto industry should be saved and Citi should be allowed to fail (uber economist Robert Reich seems to agree), but the risk of this flip-flop, assuming one not the other, is just too great.  Bankruptcy is a viable option for Detroit, but not the banking community.  Ultimately, I think this is where they will end up. 

The above is not to gloss over the serious flaws in our economy, our economic system and our core financial institutions.  There are and they will need to be addressed.  Peter Schiff is grinning a mile wide while Ben Stein is frowning (see herefor context). U.S. industry is is going to need to find ways to create sustainable economic advantage.  In the mean time, we should expect to move sideways or slowly trend down.  I’m sorry to inform folks that the Internet economy ushered in by Greenspan was in fact one big asset bubble, in case you missed the memo.  We will need to rebuild our fundamental cash flow base.  Namely our manufacturing base need to be rebuilt and our service sector demphasized. Asset values will need to be reset and consumer credit reigned in.  As I have stated elsewhere we need to take our medicine and the pain with which it is associated.

/bryan 

goggie1It’s been a while since I wrote about pets (no that is not a picture of a bat to the left), primarily because there has not been too much to talk about.  That said, there are many people who read my blog for my insights on that market and nothing else.  As such, I need to do a refresh for my fan base (yuk, yuk, yuk).  Over the past 45 days I’ve cobbled together some bits and pieces, that when laid out on a canvas makes a mural, a mural which doesn’t quite look like the one I painted 6 months ago.  Here is a substantive update on the current industry as I see it.  Alternative perspectives welcome.

Pet Businesses Get the Flu Too

Many pundits, myself included, put forth a view that the pet market was recession proof.  The view was that pet spending would be one of the last areas to go.   While we have not seen a collapse in the sector, we have certainly seen significant compression from a valuation perspective.  PetSmart, our public proxy for the retail channel, has seen its market cap erode by 40% based on a diminished retail outlook.  However, the company today reported that it met third quarter estimates but took down EPS projections for 2009 and used a very cautious tone with respect to forward prospects.  Overall a basket of pure play pet companies is down +/- 30%, and 50% from their highs in September, still slightly better than the S&P 500.

pet-industry-index-vs-sp-5001

The reality is consumers are trading down on food (except for me since now my dogs are eating “the ancestral diet”, I need to talk to my wife about that one), mass merchants are on the market share hunt, and price increases in the services sector are not going to be sufficient enough to offset falling demand.

With respect to food, prices have increased 15% – 25% across the board vs. a 4.9% increase in the Consumer Price Index.  This is putting the pinch on consumers pocket books.  Forty percent of pet owners claim to be economically sensitive with respect to pet food.  Therefore, it is no surprise that major producers are reporting declining sequential sales at retail and a mix shift from specialty brands to grocery and private label (gaining 2% points of share in 2008; however sales of Rx dog food, the top top end are accelerating, though from low comps).   Both PetSmart and PETCO have noted softening sales in their discussions., but have seen less trading down than diversified distributors.  Pet services passed on price increases of between 3% – 10% earlier this year.  However, Packaged Facts sited professional pet care and pet grooming as 2 of the top 3 areas for consumer cut backs in a recessionary environment. PetSmart reported slowing growth in pet services from 21.5% in 1Q2009 to 15% in 3Q2009.

Net net, pet businesses may not be feeling the same heat and other consumer discretionary, but they are still feeling a pretty big pinch.

Changing Face of Pet Retail

The current retail paradigm is set to see an overhaul in the pet market.  We expect the economic downturn to result in significant rationalization of the pet boutique market, especially in the more economically sensitive Midwest and South.   A contraction of 20% – 40% would not be unprecedented given the capitalization of these businesses and their exposure to discretionary items, include pet fashion, the top area for cutback in tight economic times.

Additionally, higher energy prices and a desire for bargains will push people to one-stop-shop alternatives at the expense of boutiques.  Purchase occasions for pet owners is expected to drop ~ 3% in 2008.  PETCO is attempting to skim off boutique customers by expanding their product lines to include natural and high end product alternatives, while at the same time compressing the lower end of the market by offering store labeled products.  My dogs don’t seem to mind PETCO branded rawhide.  PETCO is also expanding their service offerings to include third party insurance.  Services are an additional point of differentiation vis-a-vie boutiques.

That being said, PETCO and PetSmart will face stiff competition for core staples from WalMart.  In October, WalMart CEO, Eduardo Castro-Wright upgrade WalMart’s focus on the pet industry to a WIN category (categories that are growing, have scale and where WalMart can be the market share leader).  If in fact consumers continue to trade down, WalMart will be the beneficiary.  WalMart’s Ol’ Roy line (technically made by Nestle Purina) is the nations top selling dog food, and WalMart has aggressively moved into the premium market with its Natural Life brand.   PetSmart said they were not worried about WalMart back in May 2008.  I wonder if that sentiment has changed.

While WalMart and PETCO/PetSmart fight for the commodity and mid-tier, I expect to see considerable growth within and the evolution of regional specialty pet food and products chains.  Mud Bay, Muttropolis and emerging brands like Embark are, in my opinion, the wave of the future.  These chains offer a wide selection of better for you foods and staples and back it up with the acumen to sell it.  Their focus on service and building community will keep them well situated.   The demographic they are targeting comprise 33% of pet owners who purchase 43% of pet food and 51% of pet supplies and 62% of pet services (Packaged Facts).  This demographic seeks out natural and organic products and is willing to pay more for them.

The Businessman Trumps the Enthusiast

During the early stages of the pet growth cycle, the business landscape was cultivated by pet enthusiasts, people who had a strong affinity for the pet market and who wanted to find a way to blend their love of animals with a career.  In a market where a rising tide floats all boats, this was a salient strategy and produced nice outcomes for many business owners.  However, that landscape is changing.  Company formation around the pet space now centers on people who view the pet market as a business first and as an affinity play second.  That’s not to say that these folks are not pet owners and advocates, but rather they are not in the business because of their pets.

Some salient examples of this include, webvet, a new media play aimed at being the WebMD for the pet space.  Founder William Zacchero was an Executive Vice President with American Interactive Media, a developer of an marketer of entertainment content and programs.  VetSource provides outsourced services that enable veterinary clinics and animal hospitals to better meet the needs of their clients by extending their pharmacy services to include home delivery and continuous replenishment.  David Laurance, CEO of VetSource and his team have been together through two prior pharmacy companies.  Laurance was a seasoned Omnicare executive before he target the veterinary market as a big opportunity for outsourced services.  The team behind Embark, a next generation pet retail concept, includes serial entrepreneur Landon Pollock. Embrace Pet Insurance, which was recently closed its Series A, was founded by Laura Bennett, a 16 year veteran of the human side of the insurance industry.

If you think about venture capital and the prototype companies they back, investors tend to focus on experienced management teams.  As outside capital has become more focused on the industry it has attracted seasoned professionals to the business of pets.

Pet Products Get the Green Sheen

The organic movement within the pet space is morphing outside of food and deeper into products.  Nearly every corner of the U.S. product economy is spawning companies trying to benefit from the “greening of America”, and the pet space is no different.  Environmentally and health conscious consumers are driving this proliferation, sparked, in part, by the 2007 pet food recall.  The food scare provided everyone a wake up call and the desire to understand the underlying ingredients within and composition of a product has never been higher.

The potential lift in the pet organic space is substantial, as only 7.3% of consumers purchase organic dog products, flat from a year ago, versus the consumer population which, according to a market survey from BIGresearch, 52% of the time purchases organic products occasionally and 10% purchase organic products always.  Nearly half (48%) of pet households seek out natural and environmentally friendly products (Packaged Facts), in their personal lives.  Natural supermarkets are providing an additional access point for consumers to buy organic pet products.

Long term I expect organic and environmentally friendly products to play a fundamental role in the pet industry, but a much more subtle level.  Ingredient origins and product composition will standardize around inputs that are safe and natural.  The market, at its center, will demand it.  It will become the de facto standard.

Let’s Make a Deal

The key unknown is how the transaction environment will impact the pet space over the near term.  While I continue to believe there is venture funding for pet start-ups and private equity capital for lower middle market pet food and product companies, the question is what is going to happen to  companies like Dogswell, Ruff Wear, Zukes, Simplyshe and other leading companies in the industry.  In all likelihood they will simply keep on keeping on, creating generous annual profits for their shareholders.  However, at some point a strategic buyer population must emerge for this cycle to become self propelling.   Attractive exits must be realized for funding events to accelerate at the venture level.  The Furminator and Castor & Pollux transactions were a good start, but more data points are necessary to derive a solid regression.

/bryan

allied5In the leveraged buyout run up of the past 5 years, there was a never ending search for debt to finance transactions.  While equity multiples reached into the stratosphere, relative to historical norms, the ability of private equity funds to utilize cheap debt to underwrite deals seemed to provide a justified rationalization for paying significant equity premiums.  Where senior debt and senior stretch ran out, second lien loans were tapped to get deals done with minimum equity contributions.  Second-lien loans, due to their secured nature, were preferred to unsecured or subordinated debt (read — they were cheaper).   Second-lien lenders used to say, “mezzanine is for suckers.”

Second-lien loans made a lot of sense in many deals.  Prior to the credit crunch, private equity sponsors could secure second-lien debt for LIBOR  + 400 – 500 bps.   In the first half of 2007, lenders issued $2.65 billion worth of second-lien loans to finance middle market deals, up significantly from 2006, when $204 million in second-lien debt was issued to finance these same types of transactions.

During all the euphoria, speed to close became a significant differentiator for sponsors, and while second-lien was a great tool to get equity contributions down, it often elongated the process to close, due to the fact that the lender often needed to assess the collateral base at a detailed level so as to ascertain any overflow from the senior secured that would accrue to it in the event of default.  To provide private equity firms a means of overcoming this obstacle, unitranche debt was birthed by Allied Capital, a publicly traded business development corporation (BDC), in 2005.

Unitranche debt combines traditional senior and junior debt terms into a single senior debt facility.  This allowed parties to sign a single loan agreement, involving a single interest rate from a single lender.  The unitranche structure also offers simplified documentation, reduced amortization requirements, and the ease of future add-ons and modifications.  Unitranche was an excellent tool for companies with sub-$15 million EBITDA, whose loan size often did not reach into the syndication market.  Unitranche facilities are floating rate and tend to range in price from LIBOR + 500 – 750 bps.  While this is more costly than parsing the debt structure, the ease of use and speed to close, in many cases, offset the more expensive relative cost.

On the backs of its success in unitranche, Allied began making a name for itself with “one stop buyouts”, providing the equity underneath its simplified debt structure.  As an agent, Allied and its chief competitor American Capital Strategies became first calls for those seeking a stalking horse in a competitive bid process.  Both Allied and American Capital were perceived to have the ability to pay higher equity multiples due to their inputted IRR from providing the debt financing.

As deal velocity increased so did Allied’s stock price.  Offering investors a handsome dividend yield of ~ 8% which it funded using a combination of current interest and asset sales.  Allied raised new pools of capital by issuing new equity through secondary offerings.  In December 2007, the unitranche movement peaked when Allied Capital and GE Commercial Finance raised $3.6 billion for Unitranche Fund, LLC.   Prior to the financial meltdown, Unitranche Fund closed two deals, backing Carousel Capital’s acquisition of Brasseler USA and The Riverside Company’s acquisition of Central Power Products.

Despite its simplicity, unitranche and one stop buyouts have their detractors.  In a one stop, the lender splits the loan between secured and unsecured tranches.  Often times these tranches are funded from different vehicles and commingled pursuant to an inter creditor agreement that is negotiated by the funding entities without consultation of the borrower or sponsor.   This can create some adgeda when it comes time to do additional add-ons.  However, may people state that the speed and simplicity to close over come this obstacle in spades.

The other common criticism of one stop buyouts, is that it puts the lending organization directly in competition with the equity community.  In effect Allied and American Capital, an others of that ilk, drive up equity multiples for other bidders, who are also their customers.  Allied is careful to disclaim this notion by being very cognizant not to compete as a standalone bidder in a multiparty auction process.   In my experience they have always toed this line gracefully.  I’ve never heard a sponsor make a substantive complaint, thought I am sure it has happened.

So if unitranche/one stop buyout makes so much sense, why is Allied stock yielding ~ 87.5%, American Capital ~ 66.4% and Gladstone Capital (a smaller version of the two) ~ 20.4%?  The answer to that is the perception that the model is clearly broken, for now (for the purposes of this discussion we will leave aside Allied’s tussle with David Einhorn, which you can read about here).

Long short, Allied and its ilk face liquidity challenges caused by the current market turmoil.  Remember, these funds fill their coffiers through secondaries, but at their current valuations such issuances would be highly dilutive.  Their other option for liquidty is through asset sales of companies that it own equity in through one stop buyout transactions.  Yet, selling assets in this environment is surely to be disadvantageous given the prevailing multiples.  Sort of a dammed if you do, dammed if you don’t scenario. Further, if these unitranche players had captive liquidity, the option of buying fully collateralized senior debt on the open market at 60% of face value or repurchasing their own stock, seems like a much better use of capital than issuing new debt at par.

That all being said, I don’t see unitranche or one stop buyouts going the way of the dodo bird.  There are several reasons to support this assert.  First, unlike the investment banks, publicly traded BDC are largely underleveraged.  Allied’s current debt to equity ratio is less than 1.0x.  Further, due to the nature of regulations in their business,  Allied and other BDC’s cannot count preferred equity investments in their equity base, so their real leverage is, to an extent, over stated.  While Allied is going to have issue with its tangible net worth covenant related to its current third party indebtedness, lenders are likely to work with Allied given its current position in the industry.  Additionally, Allied will likely cut its dividend in order to preserve capital.  The stock is currently trading in anticipation of such an event.  While this would be a downer for investors, it is in the best interest of long term equity value.  Third buying senior debt on the open market appears to be a realitvely good risk reward tradeoff for capital, with the potential to create real returns for shareholders.  Finally, I think BDC play a significant and valuable role in the middle market for both companies and private equity firms alike.  This ability to deliver long term value will likely be their saving grace.

/bryan

obamaI don’t know about you, but win, lose, or draw, I am happy to have the recent election behind us.  It’s not so much that I wake up every morning with a sense of great anticipation over a Barack Obama presidency (I voted for the man for the record), but rather I’m ready to get back to business.  Imagine how much productivity was lost to water cooler conversation and the like over this election.  As part of getting back to the task at hand — getting this country back on track —  I thought it might be worthwhile to consider what an Obama regime might mean to the transaction environment and the economy for the next 4 – 8 years.  I think we can parse these in to what we know, what we think and what I hope.

Economy

One of the big selling points for Obama during this election cycle, was his command of economic issues, especially relative to the opposition.  During his stump speeches, Obama pointed the finger at Bush era policies (Rush Limbaugh’s opinion notwithstanding) for having caused the current financial maelstrom — erosion of consumer protections, lack of regulation and misaligned incentives.   So I take it, the president elect is not a fan of the Gramm-Leach-Bliley Financial Services Modernization Act.  To an extent, I believe Obama’s appeal on this issue was not that he was so economically facile, but that McCain was all thumbs when it came to the economy.

That notwithstanding, what can we expect from the new regime?

What We Know: What is clear is that there will be a return to government intervention in business.  Democrats, as a rule, tend not to believe in efficient market theorem. How and in what form(s), we don’t quite know, but this you can take to the bank.  We should expect large investments in modernizing industries to make them environmentally friendly.  We should expect a green “boom” as well as  large investments in core domestic industries that provide jobs to the middle class — manufacturing, automotive and health care.  You can also call it money good in Vegas that Obama will reduce taxes on small business, and small business investment.  This is a sensible approach as small to medium sized businesses provide for a significant portion of the job and tax base in our economy.  Providing these companies more operating runway, absent directly lending to them, should be good for the economy.

What We Believe: One of Obama’s fundamental campaign pillars was tax breaks for the middle class offset through taxes of the uber wealthy.  After all taxes are patriotic.  However, what we don’t know is where the break points will be.  We’ve heard $200,000 in income, $250,000, $275,000, etc., etc.  Tax breaks for the middle class should stimulate spending, given our anemic savings rate.  We should also expect Obama to take unprecedented steps to stimulate the economy outside of the tax code.  However, unlike the Bush administration, we don’t think he will put that money directly into the hands of consumers so they can go spend it at Wal Mart.  Rather, Obama will favor funding programs that provide people relief by offsetting contractions in benefits and services that states might otherwise engage in as part of balanced budget initiatives.

What I Hope:  My most sincere hope is that Obama finds ways to pay for all of this intended intervention and stimulus.  Taxing the wealthy is certainly a lucrative proposition, but uncollected taxes (estimates range up to $300 billion) dwarf, the amount that could be created by taxing excess income, at least based on the numbers I have seen.  Further, people will find ways to offset income in order to avoid tax thresholds.  After all that is the American way.  Ultimately, to bring long term stability to the U.S. economy, Obama’s policies must do more to restore our balance of trade, bring the federal deficit under control and stem inflation.  Easy to say, hard to do.  Much of the campaign promises we have seen from both sides were attempts to capture the voting preferences from niche demographics.  If we had to pay for all those programs, it would likely bankrupt America, twice.  Net net, we need to cut spending and increase our tax base.  This will cause pain, but it is a necessity to getting back to a normalized economy.  Everyone is looking for a pain free path to normalcy, which is not going to happen.  I hope Obama respects this reality, but more importantly that people respect this reality and don’t play the blame game too quickly.  You can only play the cards you are dealt.  Tough decisions will have to be made and the consequences endured.

Transaction Environment

The transaction environment continues to be impaired.  A lack of available debt capital will keep, to a large extent, transaction velocity involving the private equity community at anemic levels.  Sellers who don’t need to sell, and who were targeting private equity, are doing what you might expect, staying away.  Strategic sellers, are marshaling their resources and hunting for bargains.  I believe we should prepare for 12 months in the doldrums, a la 2001.

That notwithstanding, what can we expect from the new regime?

What We Know:  At the highest level, Obama has a more narrow view on issues of antitrust than the prior presidential regime.   After all he is a Democrat (see Clinton v. Microsoft).  Obama will ask regulators to take a harder look at monopolies,  duopolies, oligopolies and the like.  However, any efforts to really do anything about this will be hampered by Republicans on the bench who will toe to historical norms. Expect some gridlock.  Further, the Obama regime must look at deals through the lens of what is best for the job market.  Absent cost effective debt or equity a number of businesses would otherwise fail and might be better off in the hands of corporate consolidators.  The first litmus test will be the automotive industry, which might be more cost effective to rationalize then save on a case-by-case basis.

What we also know is that Obama will change the capital gains rates related to proceeds from sales of corporations and corporate equities, treating them as ordinary income.  This is expected to have a chilling effect in the private middle market as there was a rush to the exits in light of the possibility the capital gains rates would be altered.  For many it will be hard to stomach sending more to the government today, as opposed to waiting a cycle and hoping the pendulum will swing in the other direction.  That said, now would be a great time as a business owner to set up a charitable foundation while you can justify the allocation of equity securities at a reduced price.

What We Believe: On the flip side of the above, we are hearing about tax breaks on capital gains for investments in businesses with enterprise values below $50 million.  This would be favorable to the venture community, which puts money to work in companies that are long on top line growth and short on profitability, and lower middle market private equity.  However, this could simply lead to a gerrymandering of initial investment basis to get below the valuation threshold.  This, in my view is not good for business or the transaction environment.

We also expect changes in the tax treatment for carried interest, which has historically been taxed as capital gains.  This is not so much an initiative spearheaded by team Obama, but rather a function of the changing dynamic in the balance of power within Congress.  Retiring Congressman Tom Reynolds was a significant factor in pushing aside/sweeping under the rug the issue last year.  Since the Democrats did not have the votes necessary to enact wholesale changes, they were left with only one option — back down, for now.  Due to election gains, they now have the votes, and we should expect the issue to resurface and changes to be enacted.  This will effectively change the value proposition for private equity pros.  While it is unclear how this will carry through to fund formation, structure and limited partner agreements, it may manifest itself in lower valuations for sellers as funds try to drive IRRs higher so as to offset the tax implications.

What I Hope: Most of the topics discussed above are expected to have a cooling effect on the transaction environment.  In order to offset these impacts, we need a robust initial public offering market and a strong equity market, that allows for strategic buyers to make up for a decline in leveraged buyouts.  However, a healthy thawing of the credit markets would provide ample incentive for private equity funds to get back to putting money to work.  I hope Obama leaves both capital gains and carried interest alone.  I don’t expect either to happen.  I should be put in a straight jacket for just thinking the thought.  As such I hope, Obama does more than his predecessors to offset the impact of these policies for small business owners.  After all, many of them will get trapped by the income tax increases at the personal level Obama is proposing.  Beneficial changes could include simplification of the code to lower the cost of compliance, finding ways to lower the cost of health care for these companies or programs such as the Advanced Manufacturing Fund and Manufacturing Extension Partnership.  Net net, business owners are going to get squeezed as individuals even while their companies receive relief.

With the arrival of Barack Obama there is renewed optimism in this country, after the last few years of ever increasing doom and gloom both here and abroad.  I have high hopes for an Obama presidency, but tough choices will need to be made.  I suspect how Obama manages himself on the field of foreign policy will have a significant impact on his ability to tend to his own backyard (I know I am full of more cliches than junior league hockey coach).  Of signficance will be weather the Federal Reserve can get the bailout right and pull out injected liquidity before it results in significant inflation.  That all being said, I feel that we as a nation are better off economically with an Obama presidency despite the fact his policies should have negative implications on transaction velocity involving private capital.

/bryan

wheelIf you have not noticed, or if you had assumed the turtle or ostrich position recently in light of the macro market conditions, deals are cratering left, right and center.  If we were on the Chinese calendar this may have been the year of the “retrade” or “material adverse change” (MAC) out, though the later is a mouthful.  Some of the deals that are floundering are quite interesting.

Take the fate of the Chicago Cubs and Wrigley Field.  In September, we learned the that Tribune Co. and its owner Sam Zell had narrowed the field down to two potential buyers for the historic franchise, field and interest in their cable affiliate.  A deal was to come shortly after the World Series.  Mark Cuban was the leader in the club house after the first round, valuing the asset package at a cool $1.3 billion, though many believed that Major League Baseball would never welcome Cuban into the fraternity, so his only hope was to put an unbelievable price tag on the business.   Just two months later and the conversation has taken a remarkable u-turn.  Zell is talking about selling a minority stake, offering seller subordinated financing and pretty much saying he is open to anything at this point.  Zell has limited options as he needs asset sale proceeds to paydown debt at the Tribune, which is soon to come due without the prospects of a full refinancing.  Brings new meaning to the term “lovable losers”, the common Cubs moniker.

Then their is the case of the “American Idol” rights franchise owned by CKX, Inc.  Management had found backing to lead a buyout of the company at $13.75/share, valuing the franchise at $1.33 billion dollars.  The genesis of this deal dates back to November 2007, when 19X, backed by the Chairman and CEO of CKX and Simon Fuller, yes that Simon, made their first bid to buy the business that also owns the  image rights to Elvis Presley, Muhammad Ali and Victoria Beckham, among others.  A year later and after two definitive agreements in the round circular file, Credit Suisse Group and Deutsche Bank pulled their $650 million financing for the deal.  Deal over, at least for now.

Another handful of deals have ended in a much less becoming fashion  Take for example Cleveland Cliffs  Mining Corporation’s $10 billion acquisition of Alpha Natural Resources.  The deal values Alpha at $128.12,  just a slight premium to today’s $26.16 trading price.  The deal went south from the get-go when a major shareholder in Cleveland Cliffs went postal saying the company should be a seller not a buyer.   The fallout is Cleveland Cliffs, now traveling by the moniker Cliffs Natural Resources, has adopted a poison pill to repel the recalcitrant shareholder and Alpha is suing to force a shareholder vote from Cleveland.  Forgive me, but I can’t see how this ends happily ever after.

Then there was the curious JDA Software press release, asking that i2 Technologies, whom it had agreed to acquire for $346 million, to adjourn its shareholder meeting  without a vote so that is could negotiate a new deal due to the fact that its financing was “in jeopardy” and that closing the deal as contemplated would have “unacceptable risks and costs to the combined company”.  Wisely i2 ignored the request, met and approved the transaction as previously contemplated.  I’m sure the last chapter on this deal has yet to be written.  Who ever crafted JDA’s strategy should be given a leave of absence.

The deal demise with the greatest potential for permanently altering the deal landscape, by far, is the proposed acquisition of Huntsman Chemical Corporation by Hexion Specialty Chemicals.  This deal interests me in part because I grew up in Salt Lake City, attended high school with a Huntsman, attended graduate school with a different Huntsman (there are lots of them), enjoy a birdseye view of the Huntsman Center (home to the University of Utah Running Utes) from my childhood home and have family friends who work at the Huntsman Cancer Research Center.  I even once pitched to represent Huntsman Chemical in a debt restructuring.  Apparently they found out I was a little short on my tithing balance of payments.

Hexion/Huntsman established a healthy track record of turbulence during the year Apollo Management, owner of Hexion, tried to close the transaction.  In June 2008, Apollo asked the Delaware Court of Chancery to excuse Hexion from buying Huntsman for $6.5 billion, citing a material adverse change in Huntsman’s business as a means for not closing the deal (their only real avenue for breaking the deal, see below).  They argued that Huntsman was insolvent.

Mr. Huntsman responded as follows: “Huntsman Corporation is strong and profitable today.  Of course, our business has been considerably damaged during the nearly year long period that Apollo should have used to get this transaction closed.  Apollo’s recent action in filing this suit represents one of the most unethical contract breaches I have observed in fifty years of business.  Leon Black and Josh Harris should be disgraced.  Our company will fight Apollo vigorously on all fronts.  First and foremost, we shall protect the interests of our shareholders.”

The problem for Apollo, is that the Huntsman definitive agreement was well crafted, or at least highly favorable to the seller.  The agreement called for Hexion to use best efforts to enforce its debt and equity financing letters.  It also called for specific performance for Hexion to draw down on these financing commitments to close the deal.   The specific performance clause here only obligates Hexion to draw on its financing, but the agreement also gave Huntsman the ability to go after Hexion for economic damages for any willful breach of the agreement.  Huntsman could argue that under this clause, if Hexion breaches the merger agreement, due to its inability to enforce its financing commitments or its unwillingness to draw down on those commitments, it is required to pay the lost deal premium, and perhaps more, to Huntsman.

On the eve of closing Credit Suisse Group and Deutsche Bank (theme anyone?) said they would not fund into the deal.  Huntsman is suing for specific performance, and winning.  A solvency opinion for the combined company was rejected by the lending group.  An earlier court ruling rejected the MAC out.

Apollo now faces a daunting challenge to close the deal or find a loophole out.   An attempt to sue the banks to honor their commitments appears doomed based on Apollo/Hexcion’s assertion that Huntsman is insolvent.  This has Texeco/Pennzoil written all over it, and could all but scuttle Apollo’s planned public offering.  The more likely scenario, is Apollo will try and get Huntsman to agree to a reduced purchase price so it can close the deal as contemplated, only at a lower valuation.  After all Huntsman trades at a 70% discount to the contemplated deal price.

It must be hell being an arb trader right now.

So why is it that so many deals are going south today?  The primary reason is that many of the deals contemplated a transaction at a time where debt was abundant and the global economy was not considering cratering in on itself (does anyone remember DOW 11,000?).  Many of the deals that are now being retraded are no longer economically viable due to the forward prospects of the business that is being purchased.  The problem is when the deals were struck, either the buyer, lender or both agreed to terms and conditions which they now deemed to be unfavorable, but do not provide them real options to walk away.  As such parties are turning to the courts to attempt to enforce previously agreed to term sheets.  This is the problem with asset bubbles, the back sides can be mighty steep.

Another reason you are seeing deals repriced is for liability reasons.  When financing for a transaction is put in place, the borrower often makes a representation with respect to the forward financial performance of the business on a “conservative” case scenario.  Given the uncertainty associated with the forward economic climate, owners are uneasy about making this representation, even against “worst case” numbers.  The consequences of missing numbers could result in their credit becoming more costly, at the low end of the pain threshold, to being pulled all together, higher end of the pain continuum.  If debt continues to be difficult to garner for an extended period, a lost facility could materially harm the equity value of company that relies on such financing to operate its business.

Lastly, deals are dying due to acrimony between buyers and sellers.  Often times management is caught in t he middle between sellers trying to enforce obligations, whether real or otherwise, on buyers and buyers trying to bully sellers.  Management is like a wishbone, trying to support the interests of shareholders while trying to engender themselves to their new potential owners who will be determining their compensation going forward.  At times, things boil over and the best thing to do is move on.  However, when the bid to value ratio becomes so wide, and the buyer lacks true avenues for exit, expect the courts to be the true venue for settling differences — a reality that was, for the most part, previously unthinkable.

Then again, a lot has changed in a short time.

/bryan

pedudeAs I indicated previously, I have been talking to a number of private equity pros about the future of their industry.  With the election of Barack Obama as President of the United States some additional implications are surely to arise (carried interest as ordinary income anyone?).  What I have been trying to glean is how will private equity cope with a lack of cheap money to finance a transaction and how will they convince sellers to take lower purchase prices or structured deals.  I have also been asking about what private equities legacy will be when the dust settles with the financial crisis.

Here are some of the early returns:

How Will Private Equity Cope With a Lack of Available Debt

“The sunny side of the street says that good deals will continue to get funded. If debt costs continue to increase, you will find [private equity groups] holding more parts of the balance sheet, either because the returns on senior and mezzanine debt are too high or unavailable. The hold could be short term until markets thaw, or could be long term if necessary.  For those who seek an exit, I am sorry. If debt costs remain high for the long run, and liquidity remains low, valuations will drop. You might want to also consider seller finance and earn outs. We had not used seller paper in five years, but we have put it into our last three LOIs.”

“This is a time when firms that have been in business for a long time can rely heavily on solid lending relationships. As Warren Buffett said: ‘When the tide goes out, you see who’s been swimming naked.’ We are seeing a number of firms and lenders who have been swimming naked because the tides have been high. Also, in a market like this, I take some comfort knowing that some of our best lenders are also LP’s in our firm. We can fall back on these partnerships, and they provide good sources of debt financing along side our equity.”

“History is a good indicator of the future in this regard.  During the last credit crunch, after the collapse of the dot-com bubble, equity contributions to transactions rose from the low-30’s as a percentage of total purchase price to the mid 40’s.  During the transition from low equity contributions to high equity contributions, few transactions were completed.  Once the transition had occurred, however, deal flow began to emerge once again, albeit it at higher required equity contributions and lower purchase multiples.

“In our view, these cycles are painful but could present a win/win for the equity sponsor, the business owner and his/her team.  So long as the seller is rolling over equity into the new entity, the business owners will benefit from the second bite at the apple, when markets ultimately recover; and, with a more conservative capital structure in place, the management team will be able to more aggressively pursue its goals along the way.”

“The near-to-medium-term unavailability of cost-effective debt capital will, among other things, drive the private equity industry to meaningfully over-equitize transactions as compared to historical levels, where acceptable returns are still perceived to exist. It will also refocus efforts on growth investments less dependent upon debt. And finally, it will slow the pace of investment.”

“To truly understand how private equity will cope this time around, we need to know whether 2009 will bring at least some liquidity to the debt markets so that multiples and pricing become the ‘only’ challenges. If liquidity returns, will warehouse lines be available to those new lenders who want to enter the market? And how will mezzanine lenders and other debt providers working from committed funds (versus their own balance sheets and the capital markets) react in terms of creating – perhaps – one-stop-shop structures priced attractively enough to drive transaction volume? Finally, how rapidly will sellers adjust to the new realities of pricing?  Even with some or all of the ‘adjustments’ – and even with meaningful improvements in the debt markets – the economy (whether it’s in a recession or something worse) will still be the primary driver of transaction volume over the next 12 months.”

What Will the Private Industry Look Like in 2 Years? In 5 Years?

“Predictions at the time of the last slowdown earlier this decade failed to play out. People said there would be meaningful consolidation, structural changes and a step-function in regulation – but, for the most part, it never happened. As a result, this time around, I would only cautiously predict that LP’s will continue to improve their ability to back the higher-quality private equity funds, which will drive some level of consolidation. I also think hedge funds will still be involved, but they will find it increasingly difficult to play effectively in private equity investments. And, finally, I see regulation being increased for private equity – but in a rational manner.”

“There will be ample capital for high quality companies for many years to come.  In the end, our view is that the private equity industry is no different than Main Street industries insofar as competitive forces driving innovation, improvement and differentiation.  Emerging from these more challenging times will be a wider spectrum between high quality private equity firms and low quality firms.  As our industry matures, private equity firms with industry focus, value-added capabilities and cultures focused on the customer (the management teams of the portfolio companies) will thrive.  As this process unfolds, business owners will more easily be able to identify the high quality private equity firms from the others.”

“We might have some quiet times at the beginning, but after two years, this will all be behind us, and credit will be flowing again. In all probability, though, we won’t see levels like 2006-2007. It will be a slow return to some level of normalcy within our industry. Long term, without a doubt, there will be a shakeout. It will be tougher for first-generation funds to raise money, and some firms are just not going to make it. There will also be rough times for businesses with lots of leverage in a deep recession. It’s going to be hard for them to raise money.”

“In two years, I think private equity will be viewed as opportunistic capital. Our equity will be used in different structures and in different parts of the capital structure – not just in plain-vanilla buyouts. In five years, I would expect private equity to be an integral part of the investment landscape and proportionally larger than it is today. There will continue to be a real role for private equity.”

“Lower middle market focused private equity group (those with $10-200 mm worth of enterprise value) will be more important to investors than ever.  The larger deals with the big fund returns between 2005 and 2007 were dependent on junk bonds and club deals, as well as the ability to go public and take out debt-based dividends.  Those options are gone. Middle market deals allow room for operational improvements, value creation through M&A, and commodity pooling (especially in healthcare, shipping, office, telecommunications and property casualty insurance); and these deals will create higher value than mega transactions.”

What Will Private Equity’s Legacy Be Post Crisis?

“Thus far, private equity has been relatively unscathed in the recent financial meltdown.  As the economic downturn shifts from the capital markets to the real economy, however, you will see many of the large levered transactions completed in the 2006-2007 period encounter challenges.  While many of these transactions were completed with favorable debt terms and flexible covenant packages, eventually these transactions will suffer along with their private equity sponsors.  That said, private equity portfolios will rebalance over the next 18 months with lower purchase price investments, and cash-on-cash returns will likely be okay, but not great.”

“Private equity will be viewed as having made some industries much more efficient and some even stronger. In other situations, people will see that it has helped entrepreneurs and family owners get access to growth capital or transfer wealth on a generational basis. Overall, it will be seen as an important tool. And with the dislocation in the public markets, I believe private equity will become even more valuable.”

“I don’t see a change in legacy.  A proven asset class continues to be important to investors; this is an important way to create wealth for shareholders, and it creates more efficient growing companies.  It’s been said that the PEG process has become commoditized, but the ability to attract investors, lenders, intermediaries, management and sellers, in addition to handling deal selection smartly, are not part of a commodity process. The hard times ahead will test the constitutions of those involved.  Those that will flourish will show that it takes special abilities to be a great private equity investor; and I believe those groups will be rewarded.”

“Unfortunately, there will be lots of finger-pointing. Some people will say that private equity is responsible for some of the ills that have come upon us. But I think, at its essence, private equity is good for the economy. It provides capital to the economy that’s important. It’s also been proven – and there’s tons of data that show – that private equity-managed companies are operated better. Management has incentives to perform better. It’s not all just financial engineering.”

“Thus far, private equity has been relatively unscathed in the recent financial meltdown.  As the economic downturn shifts from the capital markets to the real economy, however, you will see many of the large levered transactions completed in the 2006-2007 period encounter challenges.  While many of these transactions were completed with favorable debt terms and flexible covenant packages, eventually these transactions will suffer along with their private equity sponsors.  That said, private equity portfolios will rebalance over the next 18 months with lower purchase price investments, and cash-on-cash returns will likely be okay, but not great.

A more interesting debate, in my mind, is the extent to which the rising tide of increasing purchase price multiples over the last decade hid poor investment and management performance.  By one firm’s estimation, approximately 80 percent of their returns were generated by purchase price expansion.  Was this because the sponsor actively created a higher quality business or because of purchase price inflation?

As we enter a period of increasing risk premiums and commensurate lower valuations, this question will likely be answered.  Again, high quality private equity firms will distinguish themselves and others will not – just like more conventional Main Street companies.  This is a good thing for good private equity firms.”

dots2David Chen, founder of Equilibrium Capital Group, interviewed me with respect to my perspective on the Ben & Jerry’s transaction and what it means for sustainability companies raising money going forward.  Below is the substance interview.  It appears on David’s blog Conscience & Commerce™: Mission Driven Commerce. Equilibrium Capital Group and Cascadia Capital have joined forces to try and help mission driven organizations solve their funding challenges.

conscience & commerce:  grappling in the real world with capital market realities

a case example:  ben& jerry’s

in the area of sustainability, we find a set of entrepreneurs who were counter-culture rebels who went on to create a new type of business model that aligned their core values and aspirations with their business objectives and products.

one can argue that the success of these companies is the execution this set of core values and beliefs about sustainability into products, their internal business practices, and therefore into their brand.  in other words, every where you scratch in these companies, in their relations with partners, vendors, customer, you find consistency and authenticity.  the core values are so real, they are a decision support system for their employees.

the irony is that with success, even these firms need to deal with founder/owner transitions, expanding the shareholder base, shareholder liquidity, expansion capital, strengthening the balance sheet, and insuring long term access to capital.  yet paramount in these capital decisions and structures are those core values and aspirations.  even the words “exit & exit strategy” are antithetical to their objective: to create an enterprise that is both financially sustainable, but also a platform for impact and change. the traditional options don’t seem to fit:  selling out to a PE firm, selling to a strategic corporate buyer, IPO, or becoming a consolidator (and that begs the issue of capital access).

we have an opportunity to probe this topic with our good friend bryan jaffe from Cascadia Capital, a leading middle market investment bank with a focus on technology/media, sustainability, and renewable energy sectors. bryan brings deep industry and product expertise in the food industry.  in particular, we are interested in bryan’s perspective on Ben & Jerry’s sale to Unilever, executed by his prior employer Gordian Group, LLC.  in that transaction we learned first hand the need to ensure that capital and company share a common ethos and what it takes to protect the founders and corporate missions from traditional shareholder restrictions. how can you preserve and propagate the very values that created the success and the value in the brand.

Q?:  what was the compelling reason for considering this transaction?   where were founders ben & jerry during this transaction?

BRYAN: Ben & Jerry’s had both a great product and a loyal customer following, but it was an operationally challenged company.  It lacked the case volume or financial muscle to underwrite its own distribution system, which put them at a competitive disadvantage.  As the business matured, earnings growth did not keep pace with investor expectations, and the stock price languished.  There were also stumbles on the mission side of the business, which brought negative publicity.  Shareholders became restless and the directors began to feel the pressure associated with being fiduciaries.

The board brought in a new CEO and hired an investment banker to evaluate alternatives.  While a number of options were pursued, ultimately the market spoke and a strategic sale was deemed to be in the best interest of shareholders.  Unilever could solve the distribution problem.  While Ben and Jerry were both active in the business and influential board members, their voice became somewhat muted due to the public company governance structure.  Net net, the price Unilever was willing to pay was so high relative to the prevailing equity price that the board and founders were hamstrung.  It wasn’t any great secret that Ben and Jerry were opposed to the sale.  Jerry Greenfield’s recent interview in The Guardian confirms that he still has regrets despite the structure of the deal, which was designed to ensure continued adherence to the company’s mission.

Q?:  from where you stood, what were the core values and aspirations in this company?  what did ben & jerry’s stand for? what were the values in the brand? how much had changed with the departure of the founders, ben and jerry?

BRYAN: Ben & Jerry’s was the first real double bottom line company.  They took the concept of balancing social responsibility with economic responsibility to a new scale.  The brand stood for more than just great ice cream.  While they were interested in profitable growth, they felt they had a larger responsibility to the environment in which they operated.  The social mission was the enterprise mission and it drove the corporate, business and functional strategies for the business.  That customers remained loyal over time served to validate this operating model, since consumers were not wanton for choice in the category.

Ben & Jerry’s core values centered on a symbiosis with partners, employees and the community.  Ben and Jerry utilized their company platform to redistribute wealth and help partners who were also trying to achieve a social good.  Ben and Jerry, as individuals and as a collective, stood for a balanced ethic, creating harmony between self-interest and ones obligation to others.  It was a “yin and yang” between values and creating value.

Ben & Jerry’s has continued to perform under the Unilever ownership.  However, I believe some of the authenticity of the mission has been compromised.  At the very least some of the irreverence is gone, since you can’t play the David v. Goliath card anymore.  However, the erosion of the mission started before the sale, when the company was forced to modify its salary cap structure to attract professional management.  The public company ownership structure also undermined the mission.  Unilever continues to adhere to the tenets of the deal, but to them it is a business.  They haven’t expanded the mission beyond their contractual obligations. The question is what will change if the business under performs.  A deep consumer recession may test that theory.

Q?:  what did each party think they were buying or selling?  what were the differences in the ethos?

BRYAN: Unilever was buying a brand and the opportunity to exploit that brand with their distribution and branding muscle.  They approached the transaction from a traditional public company ethos – the ability to accrete earnings and therefore drive value for their shareholders.  Unilever took on the social responsibility aspect as a means to get access to the brand; it was part of the purchase price so to speak.  At the same time, they believed that owning Ben & Jerry’s would enhance the perception among consumers that they were socially emancipated on some level.   You will note that Unilever now features a “values” section on their homepage, which includes addressing environmental and social concerns.

Ben & Jerry’s thought it was buying a solution to their distribution challenges and a means to perpetuate the social mission of the business.  Unilever convinced Ben and Jerry that this was an opportunity to grow the company’s social commitment.   The difference in ethos was evidenced in the structure of the deal.  If this was a marriage of like minded enterprises Unilever would not have had to take the steps they did to convince stakeholders their interest was authentic and their intentions were pure.   On its face, some people might wrongly conclude that at a high enough price, the social ethos could be made malleable, but that was not the case.

Q?:  what happened after this transaction? and with your “evolved” insights on sustainability, what would you have done differently?

BRYAN: For the most part it appears that Unilever has lived up to their end of the bargain contractually – “letter of the law”.  But again, Ben & Jerry’s has performed for them as an asset, so there was not a substantial incentive to deviate from that strategy.  However, they have done little, if anything, to expand the mission of Ben & Jerry’s.  That is where people should be disappointed.  In 2005, Walt Freese, CEO, acknowledged some softening of adherence to the company’s true mission.  What is interesting is that some a smart such branding organization would not see this as undermining the brand.

With respect to what I would have done differently, in short I would have never taken the company public, not on the terms that were implemented.  At the very least, I would have established two classes of common and kept voting with respect to a change of control in the hands of the founders. That was a viable option at that time.  I’m not sure that is true to today.  Additionally, I would have kept the board small so as to limit dilution of the founders influence.  Ben & Jerry’s had a large unwieldy board.  That all being said, I think ultimately there was not an appropriate construct available to raise the monies necessary to grow the business while fully insuring adherence to the mission.  This is why you haven’t seen more double bottom line companies go public.  A new solution must emerge for this class of companies.

Q?:  what new framework would you apply to these unique mission balanced firms as they consider the issues of founder/owner transition and shareholder liquidity?

BRYAN: Over the past five years we have seen health and wellness and sustainability emerge as investable categories and pools of capital have been raised to fund companies with missions that fit within these industries.  At the highest level, the market is moving in the right direction.  Yet, firms like DBL Capital and TBL Capital don’t have access to the funds necessary to help larger sustainable companies reach the next level.  They are also seeking venture like returns and institutional governance structures.  This does not work for many mission based organizations.

It is my view that today there are pools of capital, outside the institutional context, that would invest in later stage sustainable businesses without receiving the rights afforded to shareholders of public companies or venture capital/private equity firms.  Eventually, I think there will be institutional funds that fund later stage deals on these same terms that emerge as well.  However, more success stories are necessary before that happens at scale.  The question is through what means to organize the existing pools of capital, how to match buyers and sellers and what rights to offer each side to clear the market.   At the base level, you have to consistency of ethos between issuers and investors.