04.23.2024
The first draft of this post contained an homage to Ben Graham; then I realized that no one really gives a crap about timeless wisdom.
No, what everyone craves at the moment is privacy. As in: private jets, private clubs, private circles, private tours, private security, private banks, private placements, private equity and, now, private assets. Today let’s examine the last three privates.
A terrifying sobering article in yesterday’s Wall Street Journal observes that asset managers now control twice as much money as banks do. This is a reversal from before the 2008-9 financial crisis, when banks ruled the money universe. One could argue that the Great Financial Crisis was a result of bankers acting like asset managers rather than risk managers, but that’s muddied water under the bridge now.
The hyping of exclusivity over quality is what’s happening in finance. This portends another and bigger calamity. Maybe they’ll call it The Greatest Financial Crisis?
How do I know? Because, over the past three decades, I’ve learned to be scared when smart people do facially stupid things with other people’s money—and get away with it.
Case in point, a bit of financial engineering called Hipgnosis, which by February of 2021 had bought about $2 billion worth of popular music rights and securitized the royalties—just like investment banks were packaging and securitizing subprime mortgage, car and credit card payments back in the early 2000s. Early on Hipgnosis told its investors that it could buy premium music (if that’s what you call Justin Bieber, Shakira, et al) for around ten times their annual royalties, i.e. a yield of 10%. Later the company admitted that it had actually paid around 16 times royalties for its music, because competition for private assets. This implied a yield of just six percent—before administrative expenses, which should have become immaterial as it scaled since music is digital these days. Anyway six percent still seemed fine, when interest rates were near zero.
Then in its latest financial report, the yield on Hipgnosis’ music was revealed to be just two percent or so; which was enough to pull many of its investors out of their collective hypnotic stupor. And this even though the company now owns $3 billion of music. In other words, the more it scales, the worse its margins. Eesh.
No surprise that Hipgnosis was able to deceive its investors by dangling an exclusive private asset in front of their eyes. Sadly, no. The twist is that Hipgnosis remains a hot commodity among asset managers. Indeed, it’s now at the center of a bidding war between major private equity firms, including Blackstone, the world’s largest private investor. Based on Hipgnosis’s latest, star-studded earnings report, Blackstone’s bid implies a negative 5% return based on earnings and a positive 4% return based on free cash flow—before fees. This in a world where Blackstone’s customers (and anyone else) can make 5% by doing nothing.
So why would “smart money” chase such a terrible deal? Well, here’s a clue from that Wall Street Journal article:
As the funds grow bigger, their founders make more money. Private-equity fund managers took 41 spots on Forbes magazine’s list of U.S. billionaires published this month, more than any other profession. The investors make up 5.5% of all the country’s billionaires, almost twice the 3% they comprised just 10 years ago.
The surge could continue. KKR Co-CEO Scott Nuttall—a 2022 addition to the Forbes billionaires list—told shareholders at a meeting this month that KKR will double the money it controls to $1 trillion by 2029. Only 2% of wealthy individuals currently invest in alternative funds and that will jump to 6% by 2027, he said.
In other words, asset managers need assets to grow, and no matter the cost to customers, because one must grow at all costs. Growth is what mints billionaires, after all. Therefore, Hipgnosis song catalogue must be priceless. The end.
Now it’s true that I don’t have insight into Blackstone’s plans to make its customers money from a pop music catalogue that could age well (or not so much). I’m confident that it has a team of b-school alumni who, unlike myself, excelled in Assumptions Decision Sciences, who have mindlessly confabulated carefully engineered detailed projections on voluminous Excel spreadsheets that show ample future revenue increases and cost savings that will eventually justify a deal at whatever price the deal is consummated. But the more optimistic the bankers are, the more removed from reality they become. And we have been through this dance before in a big way, when it was the bankers’ turn, which is something I wrote about extensively before the shit hit the fan in 2008-9 because it was not just obvious but inevitable.
This time it will be different, of course, because it’s always different enough that the architects of the calamity can say that no one could see it coming and be correct in a narrow sense. Will it be better or worse? Well, asset managers are far less regulated than banks, so they can keep the game going a very long time by simply refusing to sell, which will also allow them to keep earning fees ad infinitum, as long as the money they borrow to keep those fees flowing can be serviced or refinanced.
As one private equity executive warned last week, “You can’t just get your money back on demand.” Pray for inflation, y’all.
Full disclosure: I have no more insight into the black boxes of private equity than the dark pools of today’s big trading firms. But all the more reason to rely on what one can see—Hipgnosis’ own financial statements, for example.
Ultimately, Hipgnosis will go down as a red flag or else a symptom of the disease du jour: the fetish for exclusive, aka private, assets. Why these assets are considered intrinsically more desirable than their public counterparts is an even bigger mystery; the only culprit has to be groupthink amplified by a frantic media. Some people like to order off the menu, I guess.
Big mistake because finding assets that yield more than 4% per year is no great feat these days, even within an historically expensive stock market. You could open a money market account, for example. Or dive into one of those dark pools. A cursory look at any stock market index will reveal a lot of stocks with price-to-earnings ratios below 25, i.e. yields in excess of 4%, the P/E being the inverse of yield. None of these assets will charge you a fee to buy or sell or hold. Some even pay cash dividends in excess of 4% a year.
If you need more inspiration to do it yourself, feel free to drop me an e-mail. If you’d prefer to fall under the spell of celebrity and adjusted financial metrics, click here. The choice, as ever, is yours.