FINANCIAL PARASITES VS. GORDON GECKO

Hollywood has taken great liberties and made a great deal of money in its portrayal of the “Wall ,Street Master of the Universe Tycoon” character. There was Richard Gere playing Edward Lewis
in the film Pretty Woman, (a Disney film about a hooker…Gee, it’s too bad and a wonder they didn’t make an attraction about that film at the Magic Kingdom) the corporate raider who used his
power and influence to dismantle companies, until the “Hooker with a Heart” convinced him to build ships. In Bonfire of the Vanities, Tom Hanks played Sherman McCoy, the haughty bondtrader
that gets into all sorts of trouble when his mistress runs down a minority with the Benz.

There are plenty more but probably the most infamous of them all is Gordon Gecko of the film Wall Street.

There is a scene in Wall Street where Gecko is speaking at the shareholder meeting of Teldar

Paper and is pretty upset with the company and its executives for their dismal performance…

“Now, in the days of the free market when our country was a top industrial power, there was accountability to the stockholder. The Carnegies, the Mellons, the men that built this
great industrial empire, made sure of it because it was their money at stake. Today, management has no stake in the company! All together, these men sitting up here own
less than three percent of the company. And where does Mr. Cromwell put his milliondollar salary?

Not in Teldar stock; he owns less than one percent. You own the company. That’s right, you, the stockholder. And you are all being royally screwed over by these,
these bureaucrats, with their luncheons, their hunting and fishing trips, their corporate jets and golden parachutes. Teldar Paper, Mr. Cromwell, Teldar Paper has 33 different vice
presidents each earning over 200 thousand dollars a year. Now, I have spent the last two months analyzing what all these guys do, and I still can’t figure it out. One thing I do know is that our paper company lost 110 million dollars last year, and I’ll bet that half of that was spent in all the paperwork going back and forth between all these vice presidents. The new law of evolution in corporate America seems to be survival of the unfittest.

Well, in my book you either do it right or you get eliminated. In the last seven deals that I’ve been involved with, there were 2.5 million stockholders who have made a pretax profit of 12
billion dollars. Thank you. I am not a destroyer of companies. I am a liberator of them! The point is, ladies and gentleman, that greed, for lack of a better word, is good. Greed is right,
greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge has marked the upward surge of mankind. And greed, you mark my words, will not only save Teldar

Paper, but that other malfunctioning corporation called the USA. Thank you very much.” Let’s get this straight; Gordon Gecko was a liar and a cheat. He used insider information to make
money and got what he deserved in the end, however, his occupation, “corporate raider” like Edward Lewis served a purpose. Hollywood loved using the cold-hearted Wall Street caricature
in their films, depicting them as destroyers of companies, responsible for job losses, etc.

The reality is that the old-time 1980’s corporate raider had a necessary function, they served a purpose; he or she forced companies to be accountable, efficient and profitable.

Did companies get broken apart; did people sometimes lose their jobs? Yes, however these changes were inevitable, the raiders sped up the process, cut out the cancer,
and allowed companies to grow and hire again. These raiders created shareholder wealth.

Fast-forward to today…

Corporate raiders are back! They come in the form of new packaging with the moniker private equity, buyout firms or financial engineer’s. I call them parasites. The only similarity between the
modern day raider and the 1980’s version is their ability to enrich themselves. It used to take buyout firms and corporate raiders years of work, reorganizing, and fixing companies they bought before they would take them public and get a return on their investment. Today, the work, the effort goes by the wayside, for a quick profit that leaves the company in a worse condition laden
with debt. The definition of a parasite is an organism that grows, feeds, and is sheltered on or in a different organism and contributes nothing to its host. What I believe today, is we have a
modern day parasite that is feeding on corporations, layering them with debt, hurting bondholders, and hurting America with a result that is yet to be determined, but appears bleak at
best.

Three weeks after giant private- equity firm Thomas H. Lee Partners agreed to buy an 80% stake of Iowa Falls ethanol producer Hawkeye Holdings this past May, Hawkeye filed
registration papers with the Securities Exchange Commission to go public. The buyout deal hadn’t even closed yet, but Thomas H. Lee was already looking forward to an initial
public offering expected to generate a huge profit on its $312 million investment. The firm didn’t just cross its fingers and wait; however, it took $20 million from Hawkeye as an
advisory fee for negotiating the buyout and a $1 million management fee, and $6 million for its own tax obligations. When all is said and done Thomas H. Lee will collect payments
of $27 million by the end of the year, not including what will be made from the IPO.

Hawkeye earned $ 1.5 million in the first six months of the year.

Buyout firms have always been very aggressive, however, Business Week reports that the “ethos
of instant gratification has started to spread through the business in ways that are now coming
into view.” Firms are now sucking record dividend payments mere months after buying out
companies, which are in turn financed by loading them up with enormous amounts of debt. Many
of these raiders are “going back to the till” constantly collecting various arrays of fees. For
example: Bain Capital, DLJ, J.P. Morgan, and Thomas Lee collected $27.4 million from
pharmaceutical maker Warner Chilcott as compensation for terminating a deal. Warner Chilcott
is an unprofitable company. Blackstone collected $45 million from Celanese for its advisory work
on its own deal.

Corporate raiders and buyout firms have always been associated with job losses, but the
rationale was that the cuts were necessary to strengthen the company. Business Week reports
that there is no way to defend what some critics have alleged is a new weapon in the private
equity arsenal: intentionally driving target companies into bankruptcy to seize control of their
assets. The weapon is called “loans to own.” By making a secured loan directly to a company, a
firm can vault itself to the top of a company’s capital structure.

Another tactic being used which has been recently reported on in The Wall Street Journal is
possible bid-rigging. The private-equity arm of Merrill Lynch has just received a request for
information from the Justice Department as a part of its inquiry into anti-competitive behavior in
the private-equity world. This unit produced a $300 million profit last quarter for Merrill Lynch.

The Justice Department is investigating deals where various parasites get together to ingest a big
host. This close relationship between the parasites in these multiparty deals have led to
accusations of information sharing, and bid rigging. In other words, when these large parasites
get together and share information they can suppress bids and keep their costs down.

Private equity owners Apax Partners, Apollo Management, MDP Global Investors, and
Permira Advisors accumulated $576 million in dividends and fees in multiple installments
within a year of buying satellite operator Intelsat Global Services for $513 million in 2005;
this, despite the company posting a $325 million loss. Intelsat has $360 million in cash,
while its debt has doubled, to $4.79 billion. The new load led to multiple cuts in the
company’s credit rating. In February, Intelsat said in fillings with the SEC that it reduced
its workforce by 20%, to “optimize margins and free cash flow.”

Steven N. Kaplan, finance professor at the University of Chicago stated in an interview with
Business Week that the industry is trending toward a historic period of excess. “It feels a lot like
1999 in venture capital.” Currently some of the largest firms are flush with cash; some of the
largest have as much as $30 billion. Business Week concludes that the fast money days could
spell trouble.

Love them or hate them, intentionally or not, yesteryears corporate raiders did beneficial things
for our economy and the business world at large. They were there to make money for
themselves and generate substantial returns, however, they more often then not added value to
the distressed companies they bought. They actually scared corporate America into righting the
ship which in turn benefited our nation’s competitiveness and strength. The modern day
corporate raider, the parasite version, has left many companies worse off. Business Week also
reports that the stocks of companies buyout firms have taken public are way off the historical
pattern. From 1980 to 2002 buyout-backed IPO’s, outperformed non-buyout backed IPO’s
according to a study by Josh Lerner of the Harvard Business School and Jerry Cao of Boston
College. They also have beaten other IPO’s from 2003 onward, by four percentage points
according to Thomson Financial. In 2006, buyout backed IPO’s are trailing other IPO’s by ten
percentage points. When the parasites are feasting on a host to such a degree with the “get rich
quick gotta flip this company” mentality, there is no value created, no honest purpose behind the
deals.

Another egregious example of the parasitic nature of our modern day financial engineers is with
the car rental giant Hertz. This deal has been the gift that keeps on giving for Merrill Lynch. This
past month Merrill Lynch took the company public a dollar below the expected range at $15 a
share, and at the time of this piece the stock had fallen below the IPO price. One would think that
an under subscribed IPO trading below its opening price would be bad news for Merrill Lynch.
Well…one would be wrong. Merrill Lynch participated with three other buyout firms last year to
purchase Hertz from Ford for $15 billion. Merrill put up $748 million investment in cash, which
has subsequently doubled at the time of the IPO.

Who cares? Merrill Lynch has the right to make money.
I would agree if they were not using their retail clients to buy out their investment. It doesn’t take
a brain surgeon to see the enormous conflict of interest taking place at Merrill and the other Wall
Street giants. As a fiduciary to your clients how can you recommend a company that has doubled
in price within twelve months, yet nothing has fundamentally changed at the company except that
it is now laden with hell of a lot more debt?

All aboard, the Hertz parasitic gravy train! Only $2.3 billion in cash was put into the transaction
with the remaining $12.7 billion financed with debt placed on Hertz’s balance sheet which has
dramatically increased the company’s interest payments. All the private equity groups behind the
deal also paid themselves a $1 billion dividend this past summer. Hertz had to take out a loan to
finance the dividend. Adding insult to injury, the proceeds from the IPO went to pay off that loan
and to fund an additional $222 million dividend. As the lead underwriter of the deal Merrill
Lynch’s investment banking arm will earn the fees as well.

Back in 1998 I made the comment that it was insane for individual investors to have their
portfolios managed by the major wirehouse brokerage firms, I added that it made far greater
sense to own their stock. These firms are incredible at making money for themselves and will do
anything and everything short of selling crack to increase shareholder value. This past month
Bloomberg columnist, Christine Harper, reported on bonus pay for Goldman Sachs, Morgan
Stanley, Merrill Lynch, Lehman brothers and Bear Stearns with a total reaching a record $36
billion. This doesn’t even include Citigroup, Bank of America, and JPMorgan Chase. The firms
admit their incredible success is due to takeovers, equity trading and credit derivatives, all three
of which being self-serving endeavors. I am a capitalist. I have no problem with people making
money. I would have no problem with the money making activities of these big firms if they did
the right thing and spun off their retail brokerage units, thus eliminating the inherit conflicts of
interest that plague individual investors.

In 2005 the cosmetics maker Bare Escentuals took on $412 million in debt to mostly pay
its owners two private equity firms, Berkshire Partners and JH Partners, a total of $309
million in dividends and “transaction fees.” The payments were a stretch for Bare
Escentuals that earned only $24 million. Standard and Poor’s revised its outlook for the
company to “negative” from “stable” citing its aggressive financial policy. Yet, despite
S&P lowering the credit rating from B to B-, Bare Escentuals borrowed more money to pay
another $340 million dividend payment, $218,000 in management fees, and $1.8 million in
stock for arranging the dividend.

John Glover and Cecile Gutscher of Bloomberg address the issue of the impact on bondholders
and the modern day corporate parasites. They state that bondholders worldwide are suffering a
double whammy because more than 80 companies controlled by the buyout firms have borrowed
at the expense of workers and debt investors just so they can pay themselves dividends. Andrew
Wilmont, who helps manage $65 billion of fixed-income assets at Axa Investment Managers in
London states, “The more you leverage up the company, the less the company has to fall back on
if things turn bad.” Firms have completed $269 billion in buyouts this past year by borrowing at
least $166 billion according to Bloomberg. Companies owned by the buyout firms also sold an
additional $30 billion of debt to pay dividends according to S&P. These payments have allowed
the buyout firms to recoup close to 90% of their investment in less than two years, which is
unprecedented.

Wall Street has always been successful in convincing the public that gravity does not exist, up is
down, down is up. In other words with every latest and greatest method of making money, Wall
Street has managed to convince people that they have found a way to defy economic physics.
The piper must and will eventually have to be paid, whether it is the dot com fiasco, inflated real
estate, tulips, or in this case, corporate debt, payday is inevitable. What’s interesting is who ends
up paying. It is certainly not the Wall Street firms and raiders that have benefited from all the
financial engineering. Joe Public always pays the bill, sure Wall Street ends up paying some
parking ticket-like fine, but the public always foots the bill.

Does Joe Public deserve some of the blame? Absolutely.

Wall Street is like a magician that has one trick. They just run different variations of the same
illusion. “Look everyone! Look at all the money we can make, no risk, no consequence, this is
different, new economy, earnings don’t matter, you can never lose money on real estate,
adjustable rate mortgages, annuities, yada, yada, yada…Unfortunately, Joe Public buys into it
over and over. Like a bunch of stoners watching Pink Floyd’s The Wall, Joe “oohs and ahhs” at
the genius of the financial engineers that can defy economic reality and logic.

This latest buyout craze is making me very uneasy. These parasites are sucking these
companies dry, and adding no value. This could have serious implications for the overall health
of our nation’s economy as well as the worlds. Ironically…I am not one to heed the warnings or
attention of the United Nations about anything; in fact, I must admit I take pleasure at making fun
of the organization. That is why I found it a bit unnerving when, on October 16, the U.N. issued a
warning about the economic dangers facing countries because of private equity firms.

STOP THE PRESS!! The Watchdog and the U.N. Seeing Eye to eye…like Pink Floyd’s The Wall
pigs must be flying.

SOURCE MATERIAL
Gluttons at the Gate Business Week Cover Story October 30, 2006
Buyout Firms Hurt Bondholders by Gorging on Dividends Bloomberg John Glover & Cecile Gutscher November 1,
2006
Bonus Pay for Wall Street Big Five Surges to Record $36 Billion Bloomberg Christine Harper November 6, 2006
Hertz Plans IPO of 28% Stake To Finance Dividends to Owners The Wall Street Journal Lynn Cowan October 28
2006
Merrill Arm Draws U.S. Questions In Informal Probe of Private Equity The Wall Street Journal Dennis K. Berman
November 6, 2006
Merrill’s Shiny New Lemon The Street.Com Mathew Goldstein November 28, 2006