dwarfEarlier this week it was announced that Mars Petcare had acquired Whistle Labs, designer and marketer of activity monitoring and asset tracking solutions for small companion animals.  The deal was valued at $117 million (or $119 million depending on the source of information).  Whistle had raised $25 million in outside capital, including $21 million in two institutional rounds, including a $15 million Series B round in January 2015, led by Nokia Growth Partners.  The Series B also including participation from, among others,  Melo7 Tech Ventures (the equity fund of Carmelo Anthony, NBA superstar) and QueensBridge Venture Partner (the equity fund of Nasir Jones, world famous rapper).  The post-money on the Series B was reported to be $26.65 million, meaning these investors made a ~ 4.5x cash-on-cash return on the sale and triple digit internal rate of return based on the short duration.

When Whistle launched its solution set the market was bifurcated between activity monitoring and asset tracking.  The asset tracking side was being addressed largely by companies that were re-purposing technology that had been deployed in more traditional markets, such as logistics, automobile tracking, or human tracking (yes these do exist).  However, these companies did not necessarily recognize the emotional engagement aspects of the pet space, and did little to build community.  The network costs of these businesses were high, and the user base was small.  Given that the initial hardware purchase was subsidized, these businesses lost money, sometimes large amounts of it.  Further, there was no effective retail channel for this class of products as the major pet specialty retailers were not well situated to sell a $200 device with a monthly subscription attached thereto or explain the value proposition effectively to customers, and therefore the market was slow to emerge. Traditional channels, such as consumer electronics and mobile phone centers, were no more effective at attracting pet owners let alone articulating the purchase rationale.  It did not help that most of these solutions had large form factors and minimal visual appeal.

In contrast, Whistle brought to market an activity tracker with a high level of aesthetic appeal at a much lower cost.  Of significance, gone were the monthly subscriptions.  The problem was the market wanted asset tracking as the linkage between the activity monitor and the benefits use case was just not obvious to pet owners.  In short, there was data but not much to do with it and sharing it was cumbersome.  Much like the early human activity tracking sector, the real value of these devices did not emerge until the ecosystem and community aspect developed. Whistle would use part of its Series B financing to acquire Snaptracs, the Qualcomm based asset tracking solution that it spun out in 2013.  Using their industrial engineering acumen, Whistle combined the two solution sets into a best of breed offering and the business began to accelerate.

About the time of the Series B, Whistle began collaborating with Mars on the use cases of its device.  The challenge became how do you balance the venture capitalists agenda — drive brand, drive sales, drive community — with the Mars agenda around linking the data to wellness outcomes and product sales.  In the end, we believe Mars acquired Whistle to enable its agenda to become central to the future of the business.  Given that the lifetime value of a subscriber was high as the revenue was recurring, shareholder value increased exponentially.

While the acquisition and the prevailing purchase price will certainly give momentum to the connected pet space, the perceived rationale is somewhat vexing to rationalize.  Connected pet solutions that have been funded and launched into the market over the past few years have focused more on emotive connections (remote viewing, remote treating, automated feeding) than wellness outcomes, and here we have an acquisition rationale that we believe is tied more to healthcare outcomes than humanization. That is not to say the deal won’t be effective in catalyzing more investment and further M&A; the return profile will ensure that happens.

This deal very much validates the space, and we have been on record suggesting more large consolidators get into connected pet since 2013, when we marketed the Snaptracs business for sale.  We believe other large players will have to take notice and find avenues to take a position in connected pet. Further, we think the Mars acquisition rationale is specific to them and does not require a pivot by other operators to enhance their focus on wellness.  Mars is unique in that it is the only enterprise that has both veterinary hospitals and branded companion animal consumables, and therefore could view Whistle in a unique way and justify the purchase price as a result. It does help that they are a very large private enterprise and do not have to kowtow to outside shareholders.

One of the key themes we witnessed at the most recent Global Pet Expo was a proliferation of solutions aimed at connecting owners to their pets wherever they were resident at the time — the home, the grooming salon, the daycare or dog walker, the boarding facility. etc.  Expect the Whistle deal to give them all more conviction and attract a host of new entrants seeking to capitalize on the market opportunity. Ultimately, pet owners stand to benefit most.


Note: This blog is for informational purposes only. The opinions expressed reflect my view as of the publishing date, which are subject to change.  While this post utilizes data sources I consider reliable, I cannot guarantee the accuracy of any third party cited herein.




They say there are two certainties in life, death and taxes.  That’s not entirely accurate since death comes at the end of life, but that is probably just quibbling.  Taxes are a certainty however, whether of not you choose to pay them.  If the 2012 presidential campaign has illuminated anything definitive to date, it is that not all income streams are equal from a tax standpoint; those who make the majority of their income through buying and selling investments (the Mitt Romney’s and Warren Buffet’s of the world) have much lower effective tax rates because their income is treated as capital gains instead of ordinary income — 15% versus 35% at the highest level.  Some form of equity is looming on the horizon.

In 1993, the Clinton Administration sought to tackle a $300 billion federal deficit through government spending cuts and increasing personal income taxes on top earners.  This resulted in a budget surplus in 1998, which grew to $230 billion by 2000. The surplus was a central discussion point in the 2000 presidential campaign.  George W. Bush suggested America was “owed a refund” and campaigned under a promise to lower taxes on the wealthy if elected.  The net result was the 2001 Economic Growth and Tax Relief Reconciliation Act and 2003 Growth Tax Relied Reconciliation Act, collectively referred to as the “Bush Tax Cuts”.

The Bush Tax Cuts lowered ordinary income tax rates 3%-5%, phased out the estate tax, reduced the marriage penalty, lowered rates on income from dividends and capital gains, and increased exemptions.   Critics argue over the long term impact of these changes, but two things are hard to dispute: a) the Bush Tax Cuts resulted in U.S. government losing billions of dollars of revenue over a 10 year period and b) keeping the cuts in place have become a central political platform for the Republican party.   While I am no political handicapper, the combination of a swelling U.S. deficit (and therefore the need for more revenue streams), the growing income gap between the wealthy and the middle class (as evidenced by the “Occupy” movement), and the clear improbability of the GOP winning both the White House and the Senate, mean the Bush Tax cuts are all but dead on the stroke of midnight December 31, 2012.

The implications of Cinderella leaving the ball are meaningful, as evidenced by the table below:

Estimated Changes Upon Expiration of Current Tax Program
2012 2013E % Increase
Ordinary Income 35% 43.4% 24%
Long-Term Capital Gains 15% 23.8% 59%
Qualified Dividends 15% 43.4% 189%
Estate and Gift 35% 55% 57%
Source: Moss Adams LLP Year-End Tax Planning Guide, November 2011

The question many are asking is whether these changes may light a fire under M&A for family owned businesses in 2012.   After all, if you own a business worth $100 million and  you sell in 2012 versus 2013 you save yourself at least 8.8%, but possibly much more if the”Buffet Rule” is enacted into law, which would put a minimum tax rate of 30% on all income streams if you make over $1 million annually.

History would tell us that taxes alone are not sufficient enough to push people towards transactions they would otherwise defer.  However, history has not seen this level of increase in the capital gains rate since the 1967 – 1972 period when rates increased 11.5%, but over a period of five years.  Here we are talking about 8.8% over night.  Further, the market has never enjoyed the levels of liquidity currently in the marketplace, from both strategic acquirors and private equity firms.  Excess liquidity tends to correlate with rising purchase prices.  Throw in a pinch of uncertainty regarding Europe over the next 24 months and you might have a convergence of circumstance strong enough to call some to action.

Despite the stars aligning only a subset of the market should be interested in this reality, and that would be companies on the larger end of the spectrum.  Yes, as enterprise value increases the impact of the capital gains rate changes increases, but more importantly so do transaction market multiples.  According to GF Data Resources, the spread between the multiples garnered by businesses worth greater than $50 million is a fully 2.0x in a leveraged buyout versus those with lower enterprise values.  The data shows that the “size premium”, so to speak, increased a full 1.0x in 2011.  Absent attractive purchase prices, people tend to sit on the sideline no matter how their tax bill changes from one year to the next.

Net net, I think 2012 will be a strong year for M&A because of the total market dynamics, but I don’t think taxes alone are going to stimulate a plethora of activity that would not otherwise be there on other merits.


Some 15 years ago (maybe more) I read “Diet For A New America”, the expose of America’s factory farms, written by John Robbins, the then heir to the Baskin-Robbins fortune.  The book opened both my eyes and mind with respect to the agriculture industry in the U.S.    While the book did little, at the time, to change my dietary habits, it was central to shaping my relationship with food, for the better, in the long run.    This blog post is unlikely to do much to actually change our circumstance in the short term, but, like Robbins,  I believe we need to begin with a recognition and acceptance of the problem; from there change can emanate over a realistic time horizon.   With that I offer up my plan for saving capitalism as we know it:

1.  Tort Reform – I suspect you are now scratching your head.   This plan begins here? Yes it does.   I  don’t purport to know who is telling to truth when Rep. Tom Price says the cost of unnecessary litigation taxes the health care system $650 billion annually or if this figure is only $56 billion as Harvard Public Health Professor Michelle Mello estimates, and in fact I don’t really care.  What I do know is your unhindered ability to bring a lawsuit drives up the cost of nearly everything.   More significantly, it undermines all sense of accountability in our society.   We have become a nation that expects something for nothing; our sense of entitlement is, for lack of a better word, gross.   Procedural limits and damage caps would not only reduce costs but it would change the way we view ourselves.   Tort reform would restore the concept of work ethic in America.  Consider it the end of the free lunch, with apologies to Harry Butler (you can Wikipedia that one).

2. Address Obesity – The cost of obesity to the American economy is huge — hundreds of billions of dollars.   However,  for me it is less about the direct cost to the health care system (again), and more about the indirect cost, which are borne by employers in the form of higher costs and lost worker productivity.  Let’s face it, the average American is going to have to work both harder and longer in the future to pay for our nations debt.    We can’t do that if society is unable to return to a reasonable health standard.   Further, the high cost of health care dissuades innovation and new company formation.   We will not solve obesity as its roots are genetic, but we can promote industry and incent individuals to address the problem.  Maybe if we, as a nation, can reduce our dependency on processed foods, it will provide a necessary injection to our domestic agriculture base let alone help us do our jobs better.  Productive workers are happy workers.

3. Term Limits/Return of the Welfare State – I have a political science minor, but I am no expert on government; I haven’t lived through enough political regimes to be credible.  However, our political system has clearly become a soap opera that is equal parts partisan politics and tomfoolery.   The net effect is we end up with policies that address the lowest common denominator.   Further, long standing incumbents in key positions of power act like they know what is in the best interest of the people who are telling them to do just the opposite.   Our life has been reduced to 90-days of negative campaign ads every other year.   We need new ideas and responsive political representatives in government.  Term limits favor meritocracy, encourage competition, reduce bureaucracy, and control the influence of interest groups.   However, term limits are not enough, we also need to return significant rights to our states.   We are no longer a homogenized population whose needs can be universally addressed by policies at the national level.  States are better situated to devise and implement policies that meet the needs of its residents.   By empowering people to deal with problems locally you build a sense of community.

4. Underwrite the New Manufacturing Economy – Currently, capital flows follow collateral and cost effective business models.   Without ties to a deep pocket, capital intensive businesses have little hope of getting off the ground.   Capital expenditure has become a “dirty word”.  However, the manufacturing base is a critical employer of our middle class population, and it is vanishing because of our adversity to invest in real assets.   Our need for instant gratification limits our growth.   Further, the current labyrinth of federal grants currently funding the manufacturing industry favors those who are well enough off to pay for lobbyist to influence policy development and employees to process the paperwork to garner it.  The rich are simply getting richer.  The poster child of the current regime is Tesla Motors, hardly a start-up manufacturing business but your tax dollars are paying to build their manufacturing facility and Tesla’s venture investors thank you.  We need real venture capital for fundamental manufacturing innovation and micro-lending to leverage the available equity investment.   Re-energize manufacturing and you begin to address America’s unemployment problem and restore our sense of self worth.

5. Reign in Consumer Credit – Let’s face it, we are a consumer driven economy and one that is prone to spending beyond our means, well beyond our means.    In fact, as a nation we have over $950 billion in credit card debt and  14% of disposable income goes to service that debt — just service it, not repay the principal.  The average household with credit card debt has a revolving balance of $15,788.  Credit card companies and consumer lending organizations help facilitate over indulgence by enabling people to borrow beyond levels that they can reasonably pay — zero down mortgages anyone?   Further, credit card fees and adjustable rate mortgages penalize low wage earners who do not have collateral or the track record to get the most cost effective credit or refinance.  Reign in credit and you increase accountability, you also reduce a regressive economic force in our society thereby narrowing the  wealth gap.   Cheap credit also creates asset bubbles which influence our economic cycle to the negative when they burst.  Finally, the fees that would no longer be going to pay for monthly interest charges could go to actually paying the backlog of unpaid taxes ($300 billion annually).  When you care about your country, you actually don’t mind paying your fair share for what it provides you.

If we boil this down my Rx for America comes down to restoring our nation’s pride.  Pride in yourself, your family, your role in your community, your role in society, and your ability to positively impact the economic system.   Pride that comes from doing an honest days work and receiving a fair and honest wage in return.  Pride from doing the right thing for society by accepting responsibility for your own health and actions.  Pride in paying your own freight.  Pride from the fact that your elected officials actually represent your interests.  From pride comes trust and from trust comes a sense of purpose that extends beyond the individual and to the collective.  Together we can move mountains.

Pie in the sky?  In totality yes, but saving our economic system a trillion dollars annually is not easy.  If you look at each of these issues in isolation, they are winnable battles.  Win them all and you save America.  And no I am not running for office.



I’ll readily admit that I don’t know much about inflation.  It’s hard for my generation to appreciate the concept since the majority of our wage earning years have been characterized by a general absence of an inflationary cycle.   Since I graduated from business school in 2000, inflation (as measured by the Consumer Price Index for all urban consumers (CPI-U)  has not breached 5%.   In fact, over the course of 2009, we experienced considerable deflation, with negative growth in the CPI-U for eight months of the year.

So why is it that I am holding inflation indexed bonds in my portfolio?  That is a good question.   The reason I went into TIPS six months ago, was my belief that inflation was inevitable.   The unprecedented amount of liquidity that has been injected by the U.S. government in an effort to stabilize and re-energize the economy requires it.   Or does it?

As a general rule, when excessive liquidity is injected into the market place with an rapidity it leads to an inflationary cycle.  The logic equation is that the recipients of that cash will find themselves with an excess inventory of funds and bid up the prices of goods and services.  The sellers of those goods and services find themselves cash rich and pass along the favor.  The declining value of the currency causes people to part with these excess funds as opposed to holding on to them.   As evidenced by the graphs below — M1 (the money supply) and a trade weight currency exchange index (DTWEXM) — these very conditions are in play right now.  The money supply expanded by more than $1.7 trillion in 2009, more money than is necessary for transaction purposes.

So why is it that we find ourselves with sustained low inflation despite excess liquidity?  Notably, the process of inflation is not precipitous, especially in a complex economy and during a period of economic decline.  It is not hard to fathom an entity, be it a person, business, fund, etc., holding excess liquidity (read: hoard cash) out of fear despite the erosion of value resulting from falling currency rates, because the alternatives are less attractive.   The media often refers to this as the “money on the sidelines”.   Despite a strong economic recovery as measured by the stock market, people remain fearful of future problems stemming from the bloated balance sheet of our economy, and, as a result, they continue to be more than happy to hold onto their monies, even if they are less precious tomorrow than today.    One only needs to look at consumer spending figures and read about wage stagnation to see evidence of this pattern of behavior.

Additionally, economic meddling exacerbates the realization of inflation by delaying capital outlays.  Bailouts of individuals and institutions mean they can postpone deleveraging events and calls on collateral.   Notably stimulus packages spread out spending over a longer time horizon which prolongs the effect.   Further, much of the current stimulus sits on bank balance sheets in the form of excess reserves — money that provides savers assurance that their collateral is safe.  Because this money is sitting idle, since banks are not lending, the drop in the velocity of money has offset the dramatic increase in the supply of funds.

Despite these realities, the conundrum will not last.  We are talking monetary physics here after all.   If one is to believe the great economist Milton Friedman, the peak effect of on economic growth of excess liquidity will be felt between 18 – 30 months after the rapid expansion of the money supply.  Further, the impact on consumer prices will then be felt a further 12 – 18 months downstream, meaning, in monetarist terms, the inevitable spike in inflation would occur sometime in late 2011.

Whether you subscribe to Freidman’s paradigm or not, it is easy to conclude that that when banks start to lend, the velocity of money will increase and inflation will follow as a result.  Since the recovery is expected to be slow and bumpy, it is not hard to envision that the velocity of money will remain low throughout 2010, keeping inflation in check until late 2011 at the earliest.   Further, high unemployment and excess production capacity will keep wage growth in check (not hard to imagine) further muting inflationary pressure.   Finally, if you believe Bernanke the government could, at its discretion, unwind the special lending programs, pull back the reserves and sell of the securities it has purchased, thereby avoiding the problem of monetary expansion all together.

However, in my opinion inflation will likely be realized sooner than Freidman would  have predicted.    Notably, the Fed cannot put the brakes on the program as contemplated without risking pushing us back into a recession.  This is highly political, so nothing will be done until it is clear that we are out of the woods.   As a result, the money will remain in the system allowing for velocity to increase sooner than anticipated.  Further, I expect there to be political pressure both from within and abroad for us to inflate our way out of our current deficit.   This would be achieved by the Fed allowing inflation to increase while holding interest rates low.  The net impact would be negative cost of borrowing on an inflation adjusted basis.  This would stimulate both borrowing and spending.  Further, wages would increase, which in turn would increase the tax base, thereby enabling the government to pay off its massive deficits.   This is too seductive a solution for politicos to keep their hands off, especially if the President’s approval ratings continue to dwindle.   However, this program is hard to enact in a periods of high unemployment, so the recipe is not ideal.

That all being said, it seems clear we are not headed for double digit inflation anytime soon.   Our current deflationary cycle is still in effect and the combination of other factors — falling commodity prices currency valuations, fear, low velocity of money, high unemployment, etc. — will insulate us from significant systemic shocks.  However, expect modest inflation to return in the medium term and be seen in markets were capacity is constrained first.


poohIt’s hot, too hot for my liking.  I’m sleeping in my basement with my dogs, while my hometown enjoys a record heat wave.  While laying awake at night stewing in my own juices I began running through some old blog posts in my head and thought it might be worth revisiting the status of the financial markets.

Over the past three weeks, we have seen another unprecedented run in the DOW and S&P 500.   On July 10th, I began to ask myself if we were headed back into the abyss as the DOW seemed intent on testing the 8,000 barrier once again.   On its way there, it apparently got spooked and went the other direction, breaking through 9,000 with ease.   On a percentage basis, the DOW ran 12.6% from July 10th to July 31st.   This move is rather consistent with the way stocks behave during significant economic contractions, in that they are prone to high levels of volatility and can swing excessively.

To understand the reason why that is, we need to review what a stock price really is.  We know it is the discounted value of all the future earnings associated with that ownership instrument.   Those projected streams are subject to two main risks — macroeconomic risk and company execution (let’s exclude investor sentiment for the moment), to be revisited in another entry).  When stocks as a herd run down, the causation is usually macroeconomic uncertainty, as opposed to company specific factors.   Since the impact of macroeconomic conditions on forward earnings is a science lacking a high level of precision, corrections can be significant as clarity increases.   Said differently, as our financial system was melting down with great rapidity last winter you had an over correction to the downside as equity analysts predicted a massive impact of our structural problems on forward corporate earnings.   As second quarter (2009) earnings were released these past two weeks they came with a number of “positive surprises”.  However, these were not surprises at all in my estimation, but rather poor forecasting to begin with.   Coupled with some positives on the consumer confidence (consumer confidence index has doubled off the lows; new home sales increased 11% in June), treasury spreads have increased (spread between 10-year and 3-month increased nearly a full percentage point, meaning people were beginning to favor longer term instruments) , unemployment (job loss increased, but the pace of job loss slowed), economic growth (ISM manufacturing index topped 50, above which means growth) and banking system stability, the market ran quickly to its current position — aided of course by the media.

With that explanation behind us, we can no turn our attention to where does the DOW go from here.   The truth is, I don’t know, but my inkling is that we don’t have much room for upside right now.   My basic premise rests upon the reality that corporate earnings surprises were largely based on the realignment of costs with revenue opportunities; there was no real growth of the top line.  As such, we continue to contract, albeit at a slower rate.  Until we can truly rightsize consumer sentiment, we will struggle with generating real growth.

Further, there are significant structural hurdles.

  • Industrial Production.  Based on Federal Reserve disclosures, nearly one-third of our manufacturing capacity remains idle.   This is the lowest rate of production since the Fed started to record this data.  The last parallel we can find was 70.9% in December 1982.   The picture is just as bleak on a global level.  Such excess capacity cannot be rationalized quickly and is more likely to result in price based competition, which can only lead to further calamity.   On the plus side there appears to be very little inventory in the channel, as companies have moved aggressively to cut cost.  However, until trade and inventory credit loosens further, it will not rebound.
  • Tax Base.   Across the board the domestic economic system is facing an economic shortfall of catastrophic proportions.  The U.S. government has spent nearly $2.7 trillion this year, versus collections of $1.6 trillion.   In cumulative, state government deficits total $120 billion.   Forty nine states require balance budgets however. (Vermont is your holdout).  Personal income taxes have dropped by over 25%, with no quick path to renewal.   Yet, we somehow need to find ways to underwrite huge government programs and keep the lights on at the local level.  The imbalance is massive and budget gaps will result in further market disruption.
  • Consumer Sentiment.  As the consumer goes, so goes the economy given our asset lite service based model.   The problem is the consumer is underwater and expected to remain so for some time.   Jobless rates have reached double digits and it will take years for reabsorbtion.   Over 4 million Americans have been looking for work for more than six months, an unprecedented level.   Retails sales were down a further 5.1% in June versus a projected 4.5%.    We have yet to experience the wave of personal bankruptcies that will surely arrive as people walk away from their mortgages and face the music on their mountain of personal credit card debt.
  • Banks.  The banking system remains unhealthy, though the risks of a full scale collapse remains unlikely.   Deep skepticism with respect to real estate will result in regional and local market lending dislocation.   Rather than facing loan losses head on, banks are preferring to extend and pretend on the consumer level.   Without dependable credit consumers and businesses cannot grow.

Net net, it is not at all clear where growth is going to come from.   However, it is clear that we have found bottom, as evidenced by the slowing declines.  More than likely we are in for an extended period of sideways, with growth coming from stimulus and government programs (e.g., cash for clunkers, health care reform).     This will be jobless recovery with  companies surviving on lean diet of capital expenditures.   No one is forecasting robust growth.   In short I can’t see much upside.  Further, if this downturn has fundamentally changed consumer behavior, than the market will continue to shrink and stock prices will follow it down.


simonIt’s been a while since I posted about the current state of our economy, its prospects for recovery and how that is impacting the transaction environment.   It hasn’t been for lack of interest, but rather the pace of play with the dynamics changing at an alarmingly fast rate.   Further, with the recent market up tick, I have been enjoying the sound of silence.

As the market was shedding hundreds of basis points daily between late January and early March, a number of educated parties with whom I have regular contact were search for flavor of the moment remedies to advocate on behalf of, sometimes with true relentless vigor.  The most consistent was the call to nationalize the banking system, based on the Swedish model for de-levering financial institutions.    Never mind that that the parallels between the two systems don’t match up well — at all (let alone that neither political party wants to be responsible for wiping out shareholders completely, a symptom of the myopia brought on by our political system), it was sensible that people wanted to see a quick shift in the paradigm in order to stem the flow of red on their brokerage statements.  Unfortunately, it is just not that simple given the gravity and scope of what we are facing.

While I do not believe the fundamentals of our situation have changed more than at the margins, I do see signs that things are beginning to improve, maybe only for the interim.  Most significantly is that we have broken the negative media cycle that the sky is falling and we are all going to be crushed under its weight.   News stories from sources who stood to benefit from undermining the stability of our financial system appear to have tapered off, or at the very least people have begun to tune enough of it out to limits its implications.   The sad part is that what turned the tide was a leaked memo from Citibank with really no corroborative substance.   In place of constant negativity we have begun the fine art of finger pointing, pouncing on issues of fairness as opposed to issues of fundamentals.   The stupidity of AIG paying bonuses and people taking them is just that — stupidity.  If we were facing certain demise I don’t think it would dominant the headlines and be the source of job security questions around the Secretary of the Treasury.

Beyond our changing media pH, there are most tangible signs of life.  Most significantly, in my view, and largely unnoticed by most is that a number of second-lien deals are drawing interest from buyers.   While the tranches are small, relatively speaking (hundreds of millions of dollars), the willingness of lenders to stand behind the asset based lenders/senior secured is significant.   Second lien deals tend to have longer maturities and lighter covenant packages  in return for healthy economics.   The ability of a company to trade out of expiring term debt and in to a longer maturity instrument is favorable under these conditions.   Combined with continuing robust high yield issuances and you have yourself the makes of the base of a debt market in absence of air ball or cash flow loans.

Assuming you don’t read the Gold Sheets or have access to a GE finance professional to feed you all the latest loan data, there were other, more overt signposts that one might view as favorable.    Unexpectedly, February new home sales rose (4.7%), the first uptick since July 2008, as did durable goods orders (3.4%).   I take less comfort from the former, as it likely reflects the builder community liquidating inventory to free up cash to enable them to start projects whose permit limits would otherwise be lost.   These are distressed or quasi-distressed sales, based on the percentage decline in price (-18%).  Further, favorable evidence of improvement can be seen in the narrowing spread to LIBOR, the taming of the VIX index and the stability of energy prices.  It is worth noting that, you can pin some of the tail on the donkey due to overly cautious economic forecasting on behalf of a community which has been much maligned recently for its overly optimistic viewpoint.

Lastly, we continue to see a solid flow of opportunity from our little slice of investment banking.   While deals that would be characterized as “b” or “c” deals are not getting done,  many very well situated companies are looking to see how they may in fact get ahead by using this down cycle as a buying opportunity.  Equity players are eager to see good deal flow and multiples have not fallen significantly due to the flight to quality.

Dead cat bounce?  I don’t think so.  More like a bear market rally which will fizzle around 8,000.  The gains made from 6,600 back to the 7,500 level were not based on any tangible data, but rather hope.   The market had become way oversold and therefore the slightest bit of favorable sentiment sent the market soaring.   What a difference a few months makes.   The last time we saw Tim Geithner make a major policy announcement, the market sank like a stone.  Upon the unveiling on the Toxic-Asset Plan it soared.   Expect the market to tread water here until we get more consistent solid economic news as opposed to mere drops in the bucket.   Weak GDP data and corporate earnings should keep a ceiling on any rally.   A spike in energy prices would also be  a very big deterrent.  Then again, the leading edge is always the most hard to call.


wholeI’ve had a love hate relationship with Whole Foods Markets, Inc.  I love what they provide for me, but I hate the crowds and the customer experience.   In my household we refer to it as “Whole Paycheck”.   I was lucky, in a sense, when I lived in New York, the first Whole Foods  went in just a few blocks from my apartment, providing a working guy an oasis of healthy food options, that stood in marked contrast to everything I could procure within a 10 block radius of my doorstep.   I moved to Seattle and, thankfully, Whole Foods was just a few exits up the freeway, and I was able to conveniently procure my produce, protein and staples that served as the basis of our healthy lifestyle.

I first learned about Whole Foods when I was a traveling management consultant at Price Waterhouse (pre-merger with Coopers & Lybrand).   Back in the early days of Fast Company (circa 1996), the magazine featured an article on the company (article here) calling it the future of democratic capitalism — decentralized team based work environment, financial transparency, and consensus hiring.  At the time, I thought it was interesting model (multi-functional teams were all the rage in the reeingeering world), completely counter cultural within the grocery industry, but I was fairly out of tune with the natural foods movement at the time.

As I graduated from consulting to investment banking, my proximity to Whole Foods became closer,  and not only as a consumer.   Perry Odak, who was a Gordian Group, LLC (my previous employer) relationship, from the Ben & Jerry’s deal, had been brought in to turnaround Wild Oats Markets, Inc., the second largest organic market chain in the country.  While we were never engaged, to my knowledge, we were routinely bouncing ideas off of Perry and providing him valuation insights.  It was clear that an M&A exit was in their future.  I spent more time understanding the industry and business model and walking the isles of Whole Foods.  By then I was pretty much living in the prepared foods section.

While Whole Foods enjoyed a healthy run, driven by expansion of the store footprint, accelerating consumer sentiment around natural and organic foods, and the strong economic environment, the run began to lose steam in late 2006.   With the stock trading at $65/share in November 2006, the company announced results which included a projected slowing of their growth rate.   Comps were off, margin compression was evident, and square footage ramp was below expectations.  The era of 20%+ annual growth for Whole Foods had sunseted many believed.  Applying more conservation price-to-earnings assumptions yielded implied stock prices nearly 50% the prevailing share price.  By January, the stock was trading at $43/share, or better than expected according to analysts.

In February 2007, the inevitable happened, Whole Foods offered to purchase Wild Oats via a tender offer for would turn out to be approximately $752 million ($586 million if you net out the stores sold to Smart & Final post close).  If you can’t build it any more, than buy it.  Given Wild Oats historical operating challenges and Whole Foods  execution acumen, it was thought that considerable value enhancement could and would occur.  Whole Foods has a strong track record of turning around under performing natural foods retailers, and  it appeared there were significant opportunity for both overhead cost savings and store-level productivity gains to be had at Wild Oats owned stores.   The analyst community believed the merger will be a significant earnings driver for Whole Foods over the next several years.

A funny thing happened on the way to the alter however — the Federal Trade Commission  (FTC) filed a lawsuit to block the proposed acquisition, taking a very narrow view of the antitrust market, given that nearly every grocery store now sells organic and natural products.  This had negative implications for the stock, as uncertainty now was a compounding factor on top of eroding performance in the core business caused by cannibalization, competition and price reductions.   At the very least management would be distracted and integration delayed.

Whole Foods did not sit on its hands and wait for the FTC to mess with its future.  Instead they took their case to court and received a preliminary injunction against the FTC, setting the stage for an imminent closing.  In the background, it came to light that Whole Foods CEO John Mackey had been posting negative comments  under an anagram of his wife’s name (Rahodeb, when unscrambled would be Deborah) about Wild Oats and glowing comments about his own organization on the Yahoo! Finance message board for seven years, referring to himself in the third person.  Additionally emails from Whole Foods executives expressing their disdain for Wild Oats and their desires to “crush them at any cost” came to light.   That notwithstanding, on August 27, 2007 the deal was finalized and the merger effected.

Case closed? Not so fast.

After closing the deal with Wild Oats, Whole Foods stock price continued to erode.  Earnings misses followed by failed integration milestones blurred in to an economic crisis where consumers were trading down and, ultimately, suspension of the dividend.   Facing both a confidence crisis and a liquidity crunch, Whole Foods took a $425 million investment from Leonard Green & Partners (LGP) through their Green Equity Partners Fund.   While very successful, LGP is not known for paying peak market multiples.

Then things started to get very strange…

On July 29th,  a three-judge panel ruled that a district court judge had erred when he refused to grant an FTC request for an injunction to block the merger of Whole Foods and Wild Oats.  On November 21st, Whole Foods lost a decision to have that ruling reviewed by a larger panel of judges.   Despite the fact that most Wild Oats stores have been closed or absorbed, the FTC is now moving to have the merger invalidated.  A hearing on the merger is scheduled for February 2009.  Whole Foods has launched a new suit, claiming their right to due process has been violated.

In an effort to make a compelling case that Whole Foods is not a monopoly they have subpoenaed the records of 93 competitors in the natural food space (note: the number quoted in the popular press is 96, but in a recent court motion, the number was stated as 93).  Their inquiry focuses on 29 markets in what is terms are the “premium organic retailing space”.   Parties were given until November 4th, 2008 to respond. Financial records, weekly sales figures, marketing plans, store opening schedule, inventory reports, and more.  Most of these entities are in fact private, making these records proprietary.  Amazingly, 50 of 93 entities have complied in whole or in part without a peep.  The squeaky wheel in the machine is New Seasons Markets, a nine store chain of natural markets located in Portland, Oregon.

New Seasons CEO Brian Rhoter naturally took issue with the subpoena and is taking his case to court.  In his blog Rhoter points out not only the burden complying with the order is having on his business financially, but also, aptly,  that the FTC motion does not, in his mind, provide for adequate protection of its information or remedies upon breach.  Basically, Rhoter is saying we don’t have a dog in this fight, so why are we unnecessarily being burdened and our business information being put at risk.   The fact that Whole Foods had fronted the argument that none of their employees would see the data, and then went to court to get it sent to their Austin headquarters, raises eyebrows.

While I feel for New Seasons and side with Rhoter on this issue, my sense is that Whole Foods will prevail in court.   Antitrust does not work without competitive information and Whole Foods is following the common protocol, at least at a high level.  What boggles my mind is that others being impacted by this legal morass are not lining up behind Rhoter, at least in an attempt to greatly narrow the scope.   And what of the 42 odd companies (sans New Seasons) who have made no production in this case?  What action is Whole Foods going to take against them?  It is possible if New Seasons would have quietly ignored the subpoena that they might be better off in the short run.  After all I don’t think Whole Foods has the necessary runway to successful compel “groupo 42” to produce and then internalize that response and incorporate it by February.

I can’t also help but let my mind wander, to the actions of Mackey and the emails of key employees that painted a win at all costs culture within the corporate center, and wonder if secretly Whole Foods is loving this part of the process.  Essentially this is antitrust as a business strategy.  I’m not saying that anything Whole Foods is not above board or that they have any intention of misusing anyone’s information, but the reality is you can’t see this information and then wipe the slate clean of it when making decisions.  Sure, pursuant to the protective order, key executives would never see this data but there are a cadre of individuals who will and invariably there will be data leakage, there always is.  Further, this case is central to the future of Whole Foods, its executives and board have to be exposed to  some of the information in order to make decisions on legal strategy.  Even if data reaches them in summary form, or at a high level, it is information they would otherwise not  have had access to in absence of this case.  This only leads me to be more sympathetic to Rhoter, as it points to a lack or organization among independent organic retailers.  If only they had known they would need their own lobby.

The last great example of a company that used antitrust as a business strategy was Gemstar-TV Guide International.   The fate of that entity and its executives was not so favorable.  That said, I value Whole Foods role in the market and I hope it prevails in its case against the FTC.  A break-up of the company would do more harm than good.   Organic food retail is a highly competitive market place once you consider how much of the product can be obtained in  mainstream supermarkets and club warehouses.  However, I wish Whole Foods approach to business was more indicative of its role as senior statesmen for the industry and consistent with what we might view as its mission.


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