Could Private Equity Solve Pro Hockey's Problems?

(Corrects name of the company that took Bauer public in ninth paragraph.)

When private equity firms go shopping for a takeover, they look for certain qualities. Weak management. Underachieving revenue. Opportunities to expand by taking on debt. Problems that are driving down value, but could be solved by a fresh set of outside managers.

Sound like any professional sports you know?

Private equity firms like to buy distressed properties, and right now the National Hockey League—fourth of the four pro sports, nonentity on SportsCenter, and days away from its second work stoppage in seven years—is as distressed as it gets. Fans have long fantasized about new league management (booing Commissioner Gary Bettman has become a tradition at the Stanley Cup ceremony), and the idea of private equity swooping in to the rescue is actually not as far-fetched as it sounds. In early 2005, with players and owners at an extra-bleak moment of a season-ending labor dispute, Bain Capital made a surprise offer to buy out the entire league for $3.5 billion.

Three men—Stephen Pagliuca of Bain, and Robert Caporale and Randy Vataha of Game Plan LLC, a sports consultancy—made the pitch to a meeting of the NHL’s board of governors at a New York hotel that spring. By buying out all 30 teams and combining them into a modified single entity, they argued, they could streamline operations, boost TV revenue, and negotiate down player salaries from a position of absolute strength.

“They actually clapped at the end of the presentation,” Caporale says. “Which was interesting, because part of the presentation, the part that my colleagues asked me to give, was the one where we said, ‘You’re running this business all wrong.’”

The bid failed after a number of owners made it clear they were unwilling to part with their franchises—which, to some, hold far more emotional value than real worth. Still, the episode offers a useful window into how private equity operates: spotting troubled entities, using leverage to buy them out, and renovating the business. Then, and again today, the NHL is a surprisingly good fit.

“This certainly fits all the characteristics of what a distressed asset is,” says Tobias Moskowitz, author of Scorecasting and a finance professor at the University of Chicago’s Booth School of Business, where students are fond of blowing off exam steam on the ice.

With more capital, the NHL could use the National Basketball Association’s template for expanding into Europe and other markets, Moskowitz says, and outside managers could drive a harder bargain on player salaries. Not surprisingly, salaries are the league’s highest cost, but at 57 percent of league revenue they are also higher than those of the National Football League (47 percent) and the NBA (about 50 percent). Meanwhile, “the NHL certainly has cash flows that it will spin off almost immediately. You’ve got merchandising, you’ve got ticket revenue. So I think that would make this very attractive.”

Private equity is no stranger to hockey. Phil Falcone, the founder of Harbinger Capital Partners, skated for Harvard before playing professionally in Sweden, and today owns a minority stake in the Minnesota Wild franchise. The St. Louis Blues were until recently owned by TowerBrook Capital Partners, a private equity firm with offices in London, New York, and San Francisco. Providence Equity Partners, a Rhode Island firm, considered a bid for the Toronto Maple Leafs last fall, Bloomberg reported. And Kohlberg & Co. took equipment giant Bauer (BAU), whose skates are worn by two out of three players, public in January 2011 after three years of ownership.

Susan Chaplinsky, who teaches private equity at the University of Virginia’s business school, says a buyout firm that found itself in control of the NHL would be able to wring value out of everything from selling off assets to buying goods—peanuts, pucks—at scale.

One aspect, though, might pose a challenge to the usual private equity way of doing business. “In an airline industry, I can see a private equity shop going in and taking out or reconfiguring the contracts for the bag handlers,” Chaplinsky says. “You can replace them with technology, or with other workers. But if you go in and redo the contract for Sidney Crosby, is he going to play as well? The problem is, although there’s a lot of seemingly physical assets around this, in the stadiums and all that, at the heart of this there’s one huge intangible asset, which is the players.”

Valuing the NHL fairly remains a challenge. In 2005, Bain upped its offer to $4 billion, Bloomberg reported, before the deal fell through. Since then, attendance is up. “Revenues are higher,” Caporale says. “They’ve grown every year. There’s a new TV contract. The owners certainly believe it’s worth more, and to a certain extent I may agree with them.”

Does this mean another private equity effort could be under way?

“We’re thinking about it,” says Caporale. “Thinking only.”

Summers covers Wall Street and finance for Bloomberg Businessweek.

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Chinese Private Equity Firms Flex Their Muscles

Not that long ago, Blackstone Group (BX), TPG Capital, Goldman Sachs Group (GS), and other foreign buyout specialists had little trouble muscling out local rivals for deals in China. Today, Chinese firms dominate the private equity landscape. Investments by Chinese firms in the world’s second-biggest private equity market rose to $7.8 billion last year, overtaking for the first time the $7.4 billion that came in from U.S. and European funds, according to Asian Venture Capital Journal.

The shift coincides with China’s stepped-up efforts to develop homegrown private equity firms such as Beijing-based Hony Capital. Local firms enjoy privileges over foreign rivals when it comes to regulations and access to funding in yuan, also known as renminbi. “Renminbi fund managers have a huge advantage in terms of speed of execution as well as easier exit opportunities within China,” says Chris Meads, Hong Kong-based global head of investment at Pantheon, a London private equity company that has invested $2.7 billion in Asia. “Deal flow is being diverted to renminbi funds because it’s just easier for them.”

The Chinese government treats local businesses that receive capital in U.S. dollars or other foreign currency as foreign-invested enterprises, which means additional layers of required approvals from regulators, even for actions as routine as opening a retail store. “Many Chinese companies realize taking money from any foreign-currency fund will result in more restrictive scrutiny, and they just can’t stand the red tape,” says Jessie Jin, a Shanghai-based partner at venture capital firm GGV Capital in Menlo Park, Calif.

To counter this challenge, Goldman Sachs announced its first yuan fund in China in May, followed by Morgan Stanley (MS) a week later. In February, TPG Capital, the Fort Worth-based buyout firm, said it raised 4 billion yuan ($630 million) in a first round of fundraising for its renminbi fund, 90 percent coming from private investors in China. “For the global players aiming for a large market share in China, without renminbi funds, you probably feel more or less insufficient,” says Eric Zhang, a Beijing-based managing director at Carlyle Group, which runs a private equity fund with the Beijing municipal government.

Whether renminbi investments by foreign managers get the same regulatory treatment as domestic private equity funds is subject to interpretation by local authorities. China hasn’t formulated nationwide rules governing the private equity industry because there is little cooperation among regulators, including the National Development and Reform Commission, the China Securities Regulatory Commission, and the People’s Bank of China, the central bank. Global funds also have been tripped up by currency-conversion restrictions, GGV’s Jin says. Companies receiving investments in foreign currencies can’t exchange them for yuan all at once. They need separate approvals to convert portions of those funds to pay employees or buy equipment, she says.

Domestic private equity firms have an edge over global rivals because they’re more focused on just one market, says Hony Capital Chief Executive Officer John Zhao, who raised 10 billion yuan last year for the firm’s second renminbi fund, doubling the size of a previous one in 2008. “Our decisions will be quicker” than foreign funds, he says.

Executives from Carlyle and Goldman Sachs counter that big Chinese companies still prefer to deal with well-known foreign investors because of the expertise they provide in listing abroad as well as orchestrating cross-border acquisitions. “To stay competitive, we need a local fund and a local team, but we always have to deliver value on top of capital,” says Stephanie Hui, a Hong Kong-based managing director at Goldman Sachs’s private equity unit.

Despite the increased local competition, executives at global private equity firms say they’re still finding opportunities to invest in transactions that give them managerial control. Buyout deals in China more than doubled last year, to the highest level ever, data compiled by consulting firm Bain show. Leveraged buyouts increased to $7.5 billion, from $5.9 billion in 2010, according to Preqin, a London-based data provider.

While global firms face multiple bidders for good businesses in China, the number of target companies also is rising, says Goldman Sachs’s Hui. “There are still attractive deals for foreign investors in China,” Pantheon’s Meads says. “They have to work a lot harder than they have in the past to get them.”

The bottom line: Since 2008 the number of Chinese private equity firms has almost doubled to 129. Foreign firms face regulatory and funding challenges.

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Mitt Romney's Private Equity Nightmare

The Randy Johnson-Ampad video has landed, and that could be bad news for Mitt Romney.

Back in February, we profiled Johnson and gave Bloomberg Businessweek readers a heads-up that he would star in an Obama campaign assault on Romney’s past as a private equity mogul and the Republican’s claims that his years at Bain Capital were devoted to job creation.

Well, the assault began last week with an ad about a former Bain-owned steel company called GST, and today the Obama team sent Johnson into the fray with a video about another ex-Bain property, office-supply manufacturer Ampad, a name that’ll be rocketing around YouTube and the political blogs.

The theme of this attack is familiar: Romney has claimed that during the time he ran Bain Capital in the 1980s and 1990s, the financial firm created tens of thousands of jobs. On occasion, the candidate has even boasted that his financial engineering added 100,000 jobs—a claim that, to put it politely, he has never adequately documented (as my Bloomberg News colleague Lisa Lerer explains here). To the contrary, according to the Obama campaign, Bain under Romney destroyed a lot of jobs when it took over struggling companies, like Ampad, squeezed “efficiencies” out of them (via factory closings and layoffs), and then watched them tumble into bankruptcy.

Randy Johnson, a plainspoken union organizer who once worked for Ampad in Marion, Ind., embodies the blue-collar case against private equity, Romney-style. As we reported in February:

Back in 1992, Bain acquired a manufacturer called American Pad & Paper, or Ampad. Bain then used Ampad as a vehicle to buy and restructure similar companies. Following standard “roll-up” strategy, Bain closed factories and laid off workers in anticipation of selling off a leaner, more profitable company via an initial public stock offering.

Two years into the roll up, Bain had Ampad acquire an office supplies plant in Marion, Ind., a manufacturing town 70 miles northeast of Indianapolis. At the time, Johnson worked the night shift making hanging files. “We come back from the July 4th holiday, and this is what we find posted,” Johnson says, producing from the Romney box a one-page notice: “As of 3 p.m. today, July 5, 1994, your employment with SCM Office Supplies Inc. will end.” Most of the 258 employees were allowed to reapply for jobs at reduced wages and benefits. Johnson’s pay fell 22 percent, he says, from $10.05 an hour to $7.88. Dismayed to see their old union contract torn up, the Marion workers negotiated with Ampad management for several months, then called a risky strike. In early 1995, Ampad called the union’s bluff, closed the plant, and laid off the remaining workers.

Ever since, Johnson has been haunting Romney with the memory of Ampad. The union man helped defeat the former buyout executive during his very first run for political office—an unsuccessful bid to unseat the late Senator Ted Kennedy in 1994. Now Johnson is back, and he makes a formidable foe. He tells his story affectingly and makes what sounds like a simple, straightforward argument.

As we noted when we looked deeply into the Ampad story with Johnson as our guide, that company’s demise is far from a simple morality tale, however. The office supply industry was struggling and consolidating by the time Bain got into the game. As so often happens with a brutal private equity makeover, workers lost jobs they may well have lost anyway, with or without the assistance of the financial engineers. This is the weakness in the Obama campaign’s one-sided and, in a sense, unfair broadside against private equity.

On the other hand, as Randy Johnson astutely observed in our profile, Romney has brought this problem on himself:

“None of what happened in Marion in the 1990s would be very interesting,” Johnson notes, “if Mitt Romney had not built his entire political career on the claim that he’s a job creator.”

We also interviewed Marc Wolpow, a former Romney colleague at Bain, who defended the buyout business as promoting American competitiveness. The main goal at buyout firms, however, is never maximizing employment, Wolpow told us. It’s maximizing returns for investors. “The facts,” Wolpow said, “tend to get lost in the political spin.”

Oh, and there’s one other thing. The optics of Bain and Romney taking millions in profits away from a deal like Ampad, while workers like Johnson lose their modestly paid jobs, just seems … well, unfair. That’s the message the Obama campaign wants to convey.

Barrett is a senior writer for Bloomberg Businessweek.

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Taking a Whack at Romney's Private Equity Past

Even before Mitt Romney was the presumptive Republican nominee, President Barack Obama’s political advisers made it clear that their reelection effort would center on attacking Romney’s tenure as head of Bain Capital. Now we know what they had in mind. On May 14 the campaign rolled out a brutal ad depicting Romney as a rapacious figure of greed whose firm bought, and then bankrupted, GST Steel in Kansas City, Mo. Airing in several swing states, it features a laid-off steelworker calling Romney “a vampire.” A day later, another attack: Priorities USA Action, the pro-Obama super PAC legally forbidden from coordinating with the campaign, launched its own nearly identical ad painting Romney as the sinister capitalist destroyer of … GST Steel.

This ugly portrayal of Romney and private equity first took shape in the GOP primaries, when Newt Gingrich and Rick Perry labeled their rival a “vulture capitalist.” Obama will amplify this message, backed by what’s likely to be the richest campaign in U.S. history. In the next few weeks alone, the president’s team plans to spend some $25 million on ads, hoping to cement this impression of Romney before Memorial Day, when many voters tune out for the summer. “We expected that the general election would bring new attention to private equity,” says Ken Spain, vice president of public affairs and communications for the Private Equity Growth Capital Council, the industry’s Washington lobbying group. “But what is lost in the politically charged debate is the fact that the private equity industry has pumped hundreds of billions of dollars into the U.S. economy, supporting and strengthening tens of thousands of businesses in all 50 states.”

Spain is right to be concerned. Romney won’t be the only one damaged by this onslaught, because most voters won’t distinguish attacks on Romney’s private equity career from attacks on private equity generally. One byproduct of the presidential campaign is bound to be that many Americans will come away with a deeply negative impression of the industry. Despite the enormous wealth of top private equity executives, it can’t possibly match the level of spending of a presidential campaign expected to raise $1 billion.

One false impression in business circles is that Romney, the private equity manager par excellence, will come to their rescue, deploying his campaign’s resources to defend his old industry. That’s not likely to happen. “A campaign’s objective is to protect your candidate at all times and at all costs,” says Steve Schmidt, who ran John McCain’s 2008 presidential campaign. “The art of throwing allies under the bus in pursuit of political victory is a time-honored tradition in American politics, and to the extent that the private equity industry is an impediment to that goal, they’ll go undefended.”

Sure enough, the Romney campaign’s initial response to the ads hasn’t been to defend Bain, but to establish that their candidate left the company two years before GST Steel declared bankruptcy. Later, Romney’s team released an ad of its own, highlighting another, more successful Bain portfolio company, Steel Dynamics (STLD). The ad conspicuously avoids mentioning the term “private equity.” Instead, it says Romney headed a “private sector leadership team.”

That leaves the task of defending private equity to its Washington trade group. Earlier this month, the PEGCC unveiled an ad that seeks to rebut the negative portrayal of the industry by explaining in simple, rosy terms what it actually does. But only a fraction of the people exposed to Obama’s ads will see this one, because the industry lacks the resources of a presidential campaign. Spain emphasized that the group’s aim is “to educate key audiences such as those in the media and policy makers.” He wouldn’t say where the ad would air or how much money would be put behind it. To date, the Campaign Media Analysis Group, a firm that tracks political advertising, has not registered a single broadcast television ad from the PEGCC—an indication of how badly the industry is being outspent.

The cost of this demonization could be steep. According to the PEGCC, public and private pensions supply 42 percent of the capital for private equity investments. “Public pension funds don’t want questions being raised about their investment strategy,” says Heather Slavkin, senior legal and policy adviser for the office of investment at the AFL-CIO. “Hearing terrible stuff about what private equity does will force the trustees to reconsider their allocations.”

And beyond investors, private equity’s business model could soon come under scrutiny. Congress will take up tax reform as early as December, with an eye toward raising more revenue. In addition to the carried-interest deduction, two more provisions dear to the industry will be reexamined. One is the ability to shelter profits offshore. The other is the tax code’s favorable treatment of corporate debt—the very foundation of private equity. Right now, 100 percent of such debt is deductible, one reason for the industry’s huge profits. A bipartisan Senate bill would limit this deduction to 75 percent, which would raise revenue to reduce the federal deficit, but squeeze private equity profits and force firms and their investors to put more of their own resources on the line.

Getting that through Congress will become easier if Americans come to view private equity managers as a scourge of the middle class. Some of these breaks would be tough enough to defend in the best of circumstances. They could be impossible to defend under the worst.

The bottom line: The Obama campaign plans to spend $25 million depicting Romney as a rapacious vulture capitalist. Private equity is likely to go undefended.

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The Top 5 Reasons Why You Should NOT Invest Your Home Equity

Smallest S&P 500 Gain Since 2005 Seen by Equity Strategists

January 03, 2012, 6:50 AM EST By Inyoung Hwang

(Adds Morgan Stanley forecast in second paragraph.)

Jan. 3 (Bloomberg) -- Forecasters at securities firms are more conservative on U.S. stocks than any time in seven years, predicting the Standard & Poor’s 500 Index will rise 7.2 percent in 2012 as budget deficits around the world limit gains.

The benchmark gauge will climb to 1,348 after it was virtually unchanged in 2011 and the U.S. beat every equity market in the developed world except Ireland, according to the average forecast of 12 strategists tracked by Bloomberg. That’s the smallest predicted return since 2005. Adam Parker of Morgan Stanley, whose estimate for 2011 proved the most accurate among current analysts, forecast a loss of 7.2 percent as Europe’s debt crisis will keep volatility above historical levels.

Bulls at Oppenheimer & Co. and Citigroup Inc. say record profits and improving U.S. economic data will propel stocks after the S&P 500 advanced 86 percent since March 2009. Parker and UBS AG’S Jonathan Golub say the prospect of a global slowdown will curb investors’ appetite for equities and keep the rally from gaining momentum.

“The question we pose is, ‘Do you want to be buying it now?’” Golub, the New York-based chief U.S. market strategist at UBS, said in a phone interview on Dec. 29. “A year is a long time. Will there be better entry points than right now? We think the answer is yes.”

Smallest Change

Shares fell last week after an expansion in the European Central Bank’s balance sheet stoked concern the region’s debt crisis will worsen. The S&P 500 lost 0.6 percent to 1,257.6, erasing its 2011 gain and leaving the measure with the smallest price change for any year since 1947. Financial companies led the retreat in 2011, declining 18 percent, and utilities advanced 15 percent.

Golub says the S&P 500 will climb to 1,325 in 2012, the same forecast he gave at the beginning of last year. Credit market conditions, including yields on the 10-year Treasury note that are below 2 percent, are signaling Europe’s crisis may worsen in the first half, slowing earnings growth, he said.

The S&P 500 ended 2011 about 8.3 percent below the 1,371 average strategist estimate from 12 months earlier, data compiled by Bloomberg show. The gap compares with a 13-year average of 7.2 percent and is the biggest miss since 2008, when the index’s 38 percent retreat left it 45 percent below the mean projection. Wall Street firms underestimated the measure’s close by 2.7 percent in 2010 and 3.4 percent in 2009, the data show.

Pared Estimates

Forecasters pared their average 2011 prediction from 1,401 on Aug. 2 after S&P stripped the U.S. of its AAA credit rating, President Barack Obama and Congress struggled over deficit cuts and Europe was forced to bail out Greece. The index moved 1.3 percent a day since April, compared with 50-year average of 0.6 percent before the collapse of Lehman Brothers Holdings Inc.

“Volatility carried the day,” Jeffrey Schwarte, a money manager who helps oversee about $231 billion in Des Moines, Iowa, at Principal Global Investors, said in a telephone interview on Dec. 29. “The market was very top-down, looking at the macro drivers, and assumed everybody’s going to have poor earnings going forward. That’s certainly not the case from our perspective.”

Stock advisers are counting on the same things to spur this year’s gain as they did in 2011: profits that are exceeding analyst estimates, record low interest rates and prospects for an expanding economy. The S&P 500 rallied as much as 102 percent from its low in March 2009.

Stock Valuations

The benchmark index tumbled 19 percent from its April high through Oct. 3 as more than $3 trillion was wiped from U.S. equities. For the year, the S&P 500 traded at an average price- earnings ratio of 14.1, compared with the five-decade mean of 16.4. The measure is trading at 11.6 times forecasts for 2012 profits, with analysts calling for a 9.7 percent gain to $108.38 a share for S&P 500 earnings, the highest level ever.

Earnings multiples will contract in 2012 as investors concerned about the outcome of the U.S. presidential election, growth in China and Europe’s debt crisis refuse to pay more for profits, according to Parker, U.S. equity strategist at Morgan Stanley. Last year’s 5.5 percent gain in the Dow Jones Industrial Average compares with an average of 12 percent in years prior to elections since the measure’s creation in 1896, data compiled by Bloomberg show.

“You don’t want to pay a higher multiple for today’s earnings knowing that there’s this negative skew as to what can happen,” he said in a telephone interview on Dec. 28. “About half of getting a stock right these days seems to come from bottom-up issues and half seems to come from macro issues.”

Profit Estimates

Parker predicted at the beginning of 2011 the S&P 500 would end the year at 1,238, 1.6 percent from the close. His forecast was the lowest in a survey of 12 strategists’ estimates compiled by Bloomberg and compared with the average projection of 1,371. In a report to investors dated yesterday, he wrote the benchmark will close the year at 1,167. His forecast isn’t included in the average of 12 strategist calls by Bloomberg.

Bulls say rising profits mean the S&P 500’s earnings yield will expand, fueling gains in prices. Strategists are more pessimistic than equity analysts about how much earnings will climb in 2012, forecasting $102.31 a share. That would still represent the highest level ever.

Brian Belski, Oppenheimer & Co.’s New York-based chief investment strategist, said he’s never seen investors more influenced by the economy and government than now. That’s a bullish signal because it means there are more people who may change their minds and buy stocks in 2012, he said.

Equity Bull Market

Belski says the S&P 500 will climb 11 percent to 1,400 in 2012. He forecast the index would rise 5.4 percent last year to 1,325. When he gave his prediction, the average strategist projection for the end of 2011 was 1,379, according to Bloomberg data.

“We’re at the cusp of the next great equity bull market,” Belski said in a telephone interview on Dec. 28. “The U.S. is not just the best house in a bad neighborhood anymore. It’s the best house period. This has all been led by the structural change that corporate America has undergone in the last 10 years.”

The S&P 500 had the tenth-best performance in 2011 among the world’s stock markets. China’s Shanghai Stock Exchange Composite Index and Brazil’s Bovespa slumped 22 percent and 18 percent respectively. Japan’s Topix lost 19 percent, while the DAX Index of German stocks erased 15 percent. Ireland’s ISEQ Overall Index climbed 0.6 percent, the only benchmark to beat the S&P 500 among 24 developed markets.

Corporate Cash

Companies built reserves as stocks sank and forecasts for growth in U.S. gross domestic product in 2012 slipped from 3.3 percent in February to as low as 2 percent in October. Cash at companies excluding banks, utilities, truckers and automakers rose to a record $998.9 billion in the third quarter, according to S&P.

Low investor expectations for earnings growth will help stocks rise when companies beat estimates, Citigroup’s Tobias Levkovich said in a Dec. 27 interview on Bloomberg Television’s “Street Smart.” He sees the S&P 500 climbing to 1,375 in 2012.

S&P 500 companies have beaten Wall Street profit estimates for 11 straight quarters. An average of 73 percent of corporations in the index exceeded analysts’ estimates in the first three quarters of 2011, with earnings-per-share topping projections by 5.3 percent, according to data compiled by Bloomberg.

“Markets are going to be moving higher,” Levkovich, the New York-based chief U.S. equity strategist at Citigroup, said. Clients who are money managers speculate earnings in 2012 will be about $95 a share, he said. “So if it’s comes in at about $100, that’s better than what investors believe.”

--Editors: Chris Nagi, Michael P. Regan

To contact the reporter on this story: Inyoung Hwang in New York at ihwang7@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net

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The People vs. Private Equity

By Jonathan Keehner and Jason Kelly

Steven LeBlanc Photograph by Jay B. Sauceda

It’s almost 10 p.m. on an October Tuesday at Brasserie 8?, a French restaurant on 57th Street in Manhattan, and the Texan in the back corner is just warming up. Steven LeBlanc, former real estate executive and senior managing director of a $110 billion pension fund, is holding forth at the lone occupied table. The restaurant takes its name from the iconic concave tower above it known as 9 West. The building has breathtaking views of Central Park and houses some of the world’s largest hedge funds and private equity firms.

A senior executive from private equity firm KKR, arguably 9 West’s most powerful tenant, has just left LeBlanc’s table, where he had been auditioning for more of LeBlanc’s business. Apollo Global Management, another huge buyout shop with offices upstairs, will have LeBlanc to breakfast the following day to make its case. LeBlanc is shopping for money managers; a few weeks later his office will announce an unprecedented $6 billion investment with the two firms on terms that reduce fees to the benefit of LeBlanc’s fund, the Teacher Retirement System of Texas.

LeBlanc, 54, is responsible for allocating $35 billion in private investments for the pension fund, which has 1.3 million members. The way the private equity bigwigs have been courting the likes of LeBlanc for his investment dollars is a major reversal from how things used to be, when pension funds were practically begging private equity funds to take their money, at whatever terms the funds were offering.

LeBlanc has another appointment waiting at the bar, the head of a Connecticut investment firm. First, though, he wants to talk about “The Texas Way,” a manifesto of sorts he’s put together in PowerPoint format. It’s sitting on the table, detailing how he and his staff are pressing private equity to deliver better profits to their investors, with fewer of the lavish fees that have made private equity managers some of the best compensated—and most criticized—individuals on Wall Street. Under the Texas Way, buyout firms such as KKR and Apollo must vie for a place on LeBlanc’s “premier list,” a group of top-performing managers that’s reevaluated every six months. The best of this group may gain access to even more of his pension dollars, while the bottom tier faces expulsion. It’s the opposite of the old days, when everyone, it seemed, got an investment.

The private equity business is one of the most lucrative in finance, and one of the most controversial. Investment funds buy out companies, often instituting layoffs, piling on debt, and extracting rich payouts for themselves in the process, with the ultimate goal of selling the companies for a profit. Less appreciated is that the biggest sources of private equity funds are the pension funds of working-class Americans—teachers, firefighters, and other public employees.

For years private equity has set the terms—and fees—of the arrangement. But as returns diminished after the boom and suspicion of Wall Street grew, pension fund managers began to reassert themselves. LeBlanc is among those leading the charge. He is calling for more money to be allocated to fewer managers, and for more data from those managers to be shared with investors. He’s intent on making sure everyone has the right motivation. With the recent KKR deal, management fees are lower, while better performance earns higher payouts. “He has certainly made managers think about what they’re doing and what they ought to be doing,” says Thomas C. Franco, a partner at Clayton, Dubilier & Rice, one of the oldest private equity firms. “He asks a lot of questions.”

It’s a crucial time for pension funds. Britt Harris, LeBlanc’s boss and the chief investment officer for the Texas teachers’ fund, told his state legislature in April that the fund had a return of 14.7 percent in 2010 but an annualized return of 4.8 percent for the decade ended Dec. 31. That’s barely half the fund’s assumed 8 percent annual return. To maintain a level of funding to cover its liabilities (what it owes retirees), the Texas teachers’ fund would need an annual return of 21 percent for the current fiscal year, Texas officials told the lawmakers. There is not much chance of that happening, and the Texas fund isn’t the only one in such a bind. Public pensions nationwide are grappling with about $3.6 trillion in unfunded liabilities, according to a 2010 study by Joshua Rauh of Northwestern University and Robert Novy-Marx of the University of Rochester.

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LSE Equity Evaporates as TMX Deal Shows Scant Profit: Real M&A

May 24, 2011, 10:35 AM EDT By Nandini Sukumar and Rita Nazareth

May 24 (Bloomberg) -- No company’s stock is worth less as currency for takeovers than London Stock Exchange Group Plc, according to traders who profit from mergers and acquisitions.

The value of the bourse’s offer to buy TMX Group Inc. with equity fell 4.9 percent below the price of the Toronto stock exchange operator’s shares yesterday, according to data compiled by Bloomberg. The gap is the widest of any all-stock deal over $1 billion, indicating to arbitragers that LSE’s equity alone won’t be enough to fend off a higher bid from a group of Canadian banks and funds trying to keep TMX in local hands.

While TMX’s directors last week rejected the unsolicited cash-and-stock offer by Maple Group Acquisition Corp. in favor of LSE’s $3.1 billion all-share proposal, owners of the Toronto bourse stand to get equity in a company that’s 39 percent less profitable than the average market venue by selling to LSE, the data show. Without the deal, Europe’s oldest independent bourse risks being left out of the industry’s biggest round of consolidation. In the past decade, exchanges from Hong Kong to Singapore and Sao Paulo have eclipsed LSE by market value.

“There are two ways to look at this: Is TMX currently trading at a premium or is LSE trading at a discount?” said Frederic Ponzo, managing partner at London-based GreySpark Partners, which advises financial institutions. “The problem for LSE is the same for the last 10 years now. They are big, but not big enough. They are still in a difficult position.”

Long-Term Value

Carolyn Quick, a spokeswoman for TMX, didn’t immediately respond to voicemails left at her office or an e-mail requesting comment yesterday as Canadian financial markets were closed for a national holiday. A voicemail message left on her mobile phone seeking comment also went unanswered.

“The LSE-TMX merger is just that -- two strong, successful businesses with complementary assets and brands combining to create a leading international exchange group,” David Lester, LSE’s director of information services, said in an e-mailed response. “Anyone can deliver cash on day one through saddling a business with debt, but few deals can offer the long-term value for shareholders that LSE-TMX will create.”

Based on the terms of LSE’s takeover, each TMX shareholder will get 2.9963 LSE shares for every share they own in Canada’s largest exchange, according to data compiled by Bloomberg.

That valued the deal at about C$42.06 a share yesterday, about two Canadian dollars below TMX’s closing price last week.

Today, TMX declined 1.1 percent to C$43.58 as of 10 a.m. in Toronto. LSE rose 1.4 percent to 901 pence in London.

Maple Bid

LSE faces competition from Maple, a group of four Canadian banks and five pension funds that’s trying to block the largest foreign takeover of a financial services company in Canada.

While TMX Chief Executive Officer Thomas Kloet, 53, said in a telephone interview May 20 that the combination will create a bourse “whereby our shareholders continue to share in the growth of the company,” the C$3.6 billion ($3.7 billion) proposal from Maple this month values the Toronto exchange at a premium to LSE’s bid and will be paid mainly in cash.

“It’s pretty clear the domestic bid in Canada is real and it’s likely superior financially,” said Andrew Ross, partner and global equity trader at First New York Securities LLC, a New York-based proprietary trading firm that bets on stocks, commodities and derivatives. “I don’t think that shareholders at LSE would look very favorably upon LSE really aggressively attempting to outbid this Canadian group.”

LSE’s deal for TMX in February was part of more than $30 billion in takeover offers for exchanges in less than six months, as bourses try to cut costs and generate more revenue from trading in stocks, options and futures.

Exchange Acquisitions

The deals began in October, when Singapore Exchange Ltd. bid A$8.35 billion ($8.3 billion) for ASX Ltd. of Sydney. LSE followed with its own offer for TMX on Feb. 9.

Less than a week later, Frankfurt-based Deutsche Boerse AG announced its takeover of New York-based NYSE Euronext, which Nasdaq OMX Group Inc. of New York and IntercontinentalExchange Inc. of Atlanta countered in April.

Singapore Exchange’s acquisition of ASX was rejected by Australia’s government last month, while Nasdaq OMX and ICE dropped their bid for the New York Stock Exchange this month after U.S. regulators threatened to block the deal.

“They either need to salvage the TMX deal or find another deal quickly,” said Dirk Hoffmann-Becking, a London-based exchange analyst at Sanford C. Bernstein & Co. “Shareholders in the end look for money today.”

Xavier Rolet, LSE’s 51-year-old CEO, will cut 35 million pounds ($56 million) a year in costs as part of the deal and expand into businesses such as derivatives as competition increases.

Earnings Growth

LSE earned 23 cents for every dollar of revenue in the past 12 months, versus an average of 37 cents for exchanges worldwide, data compiled by Bloomberg show. TMX had a profit margin of 34 percent. Analysts estimate LSE will increase per- share earnings by just 3 percent next year, while TMX may boost profit by 5 percent, data compiled by Bloomberg show.

Earnings at NYSE Euronext and Deutsche Boerse, which may save as much as 550 million euros ($772 million) by combining, will climb 16 percent and 12 percent, respectively, the projections show.

A takeover of TMX would create a $7.2 billion exchange, leapfrogging Nasdaq OMX, ASX and Singapore Exchange among the world’s biggest trading venues.

Losing out would leave LSE, which traces its roots back to the coffee houses of 17th century London and has a market value of $3.9 billion, further behind.

Standalone Value

Deutsche Boerse and NYSE Euronext are creating the world’s largest exchange with a market value of $24.2 billion. Hong Kong Exchanges & Clearing Ltd., currently the biggest bourse with a market value of $23.6 billion, is six times the size of LSE, data compiled by Bloomberg show.

Sao Paulo-based BM&FBovespa SA, the operator of Latin America’s biggest securities exchange, is three times as big.

“As a standalone company LSE faces pretty aggressive competitors,” said Adam Sussman, New York-based director of research at Tabb Group LLC. “So the stock is more difficult to use as a takeover currency.”

Sachin Shah, a merger arbitrage strategist at Capstone Global Markets LLC in New York, says that LSE can boost shareholder value more by putting itself up for sale instead.

Shares of LSE jumped 6.8 percent on May 16, the biggest advance in 17 months, on speculation that Nasdaq OMX would pursue LSE after dropping its bid for NYSE Euronext. Nasdaq OMX has previously tried to acquire the London exchange three times.

Nasdaq OMX’s Frank De Maria declined to comment.

‘Not Over’

“Nobody wants to own LSE as a standalone company,” Shah said. “The market is anticipating that a deal with TMX may not occur and a standalone value is not as attractive. The consolidation with exchanges is not over.”

Instead, “the market is sensing that LSE is not going to be around” because it will become a target, he said.

Overall, there have been 9,737 deals announced globally this year, totaling $957.2 billion, a 22 percent increase from the $786.7 billion in the same period in 2010, according to data compiled by Bloomberg.

--With assistance from Whitney Kisling, Justin Doom and Sarah Rabil in New York. Editors: Michael Tsang, Daniel Hauck.

To contact the reporters on this story: Nandini Sukumar in London at nsukumar@bloomberg.net; Rita Nazareth in New York at rnazareth@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net; Nick Baker at nbaker7@bloomberg.net.

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