Saturday, April 14, 2007

I would like to consider myself to be an strident capitalist---the kind of fellow who says, with sheer confidence, "Nothing trumps the market. In the end, it always knows best." In fact, as a businessman , I try to apply tested market principles to my life, and they are ancillary only to my faith in The Word. That said, though, I am a bit thunderstruck when I hear that the new masters of finance--the private equity guys---want to take an institution like Sallie Mae to a clubby frat party. Suddenly, the concept of "too big..." lifts all sorts of red flags in my head.

Private equity players, to be sure, are great at what they do, by buying up pretty stale businesses and squeezing out value for their own coffers and limited partners. A lot of times, they turn around business models that have begun to move on the downward slope. Or they bust them up, and kill off units that no longer perform at their best. Yes, it is not pretty when you consider that, often, the "going-private" model means jobs will be lost in all of the streamlining, but one has to wonder, if left alone, just how long the company or those jobs would have sustained. Nevertheless, after tweaking, what comes out of a few years of work is a polished vehicle for the PE players, who then sell it off for profit and move on for another target to add to their portfolio. Consequently, it is a purely a numbers game, and it's one that requires an acute level of skill and the ability to make deals happen. If they understand it, most people wanna jump right into it. Hell, even I hope to join the PE/VC lot, one day down the road, after I finish killing myself turning
AxSA into the next Accenture.

But, knowing what I know, I have to say that some deals are not just too ambitious; they are too nonsensical and can lead to a lot of hell for the limited partners of these PE firms and, ultimately, (in this case) for the student borrowers, as well. Be/c a colossus like Sallie Mae provides a hedge to lenders issuing student loans (by buying up those loans and repackaging them as
securities for resale on the markets), a new set of PE owners might find it advantageous to spruce up its offering, and cut back on some of the types of loans (tanslation: risks) Sallie Mae will buy. That could drive up borrowing rates for, say, some less creditworthy parents who want to send their child to a good school. Or, worse, in the event of a broader economic downtown, in order to keep the loan mill running, these PE owners might put the screws to the federal government for a bail out, and that means the taxpayers will be left with the tab. Granted, a bail out would be inevitable, irrespective of owner, but I would contend that it is better that the money goes to the current structure than to monied titans and their limited partners in the NYC.

The PE players would be better served sticking to real companies in real industries with real growth or breakup potential. There are some good buys out there; look at the infotech sector or some of the small biosciences companies. I would even venture to say that these guys should look at rolling up some of the smaller industrial companies with $25M or less in revenue. Combining these smaller companies will drive incredible economies of sale and capture good
market share. The reason this will not happen, unfortunately, is be/c the PE players have
gotten too big for their own good. They are raising investment pools that are in the billions of dollars, and that is largely out of vanity. Now the headache is not getting the money; it's finding the right way to make an outsized return. The fact is, though, when you are at that size, it's harder and harder to find investments with real value, so you have to get creative, like pitching
a deal to Sallie Mae. But too much creativity, to the detriment of discipline, will knock an investor on his ass every time.

Well, that noted, maybe nothing trumps the market, after all...

Moral: these guys need to dispense with the grandiose gestures of greed and more greed, lest the next great buy on the list could turn out to be Freddie Mac. And there is absolutely nothing great about Freddie Mac.

Matt 5:16


Blackstone, Rival Group Compete In Bid to Get Control of Sallie Mae

April 14, 2007; Page A3

Blackstone Group and a group consisting of JC Flowers & Co. and J.P. Morgan
Chase & Co. are each in talks to acquire control of SLM Corp., or Sallie Mae,
the nation's largest provider of student loans, in a deal that could be valued
at as much as $20 billion.

The deal is complicated, and a person involved put the odds of a successful
sale at 50/50. "The talks are somewhere between the fourth and the fifth
inning," this person added.

The idea driving the deal revolves around using financial engineering and more-
efficient management to improve Sallie Mae's balance sheet, as well as
deploying leverage more efficiently, said people familiar with the matter.

Blackstone's rival, Chris Flowers, is considered one of the savviest investors
in complex financial transactions. A former head of the financial-institutions
group at Goldman Sachs Group Inc., he is best known for leading an investment
into Long Term Credit Bank of Japan, alongside Ripplewood Holdings. That bank
now is named Shinsei Bank. Mr. Flowers recently raised a fund believed to total
roughly $8 billion.

For its part, J.P. Morgan has been rapidly expanding its student-loan business.
The big New York bank had $10.3 billion of student loans on its books at the
end of 2006, up from $3 billion in 2005. In a meeting with investors and
analysts last month, James Dimon, J.P. Morgan's chief executive, singled out
the business as a growth area, although it still contributes relatively little
to the bottom line. The bank doesn't break out earnings for the business. Mr.
Dimon last month said he hoped it could contribute $300 million to $400 million
in annual profit in the next few years. J.P. Morgan earned $14.4 billion in

J.P. Morgan has a long -- and sometimes bumpy -- history with Sallie Mae. Their
nine-year-old joint venture fell apart in 2005 after J.P. Morgan sued Sallie
Mae, contending that the rival lender had essentially started competing with
the joint venture by originating its own loans. The two firms dissolved the
pact, but Sallie Mae still services some of J.P. Morgan's student loans. Last
year, J.P. Morgan beefed up its presence further with a $633 million
acquisition of Collegiate Funding Services Inc., which specialized in student-
loan servicing and consolidation.

Mr. Flowers and a spokesman for Blackstone declined to comment. Tom Joyce, a
Sallie Mae spokesman, declined to discuss talk of a deal. Private-equity firms
and investment banks have periodically approached Sallie Mae and found that
management was more receptive than the lender's board.

In the hugely competitive private-equity world, partners at rival firms say
this is a tough time to be looking at this lender, even without government
inquiries about questionable student-loan practices.

There are a number of complexities to the deal, which was reported earlier by
the New York Times. Financing a buyout wouldn't be straightforward. Private-
equity firms typically load up target companies with debt as part of the deal's
financing. That could be a potential hazard at a lender such as Sallie Mae, and
the buyers would want to maintain a high credit rating. And while Sallie Mae is
a publicly traded company, the government has a role in guaranteeing many of
its loans and it isn't clear what the fate of those guarantees is amid the
current political environment.

Lawmakers -- and President Bush -- already have been looking to reduce the
billions of dollars of taxpayer subsidies to Sallie Mae and other lenders and
use the savings to make college more affordable. These plans have taken a toll
on Sallie Mae's stock price. U.S. Rep. George Miller (D., Calif.), chairman of
the House Education and Labor Committee, has scheduled a hearing about student-
loan abuses this month. Both the House and Senate have launched industry

Friday, Mr. Miller expressed reservations about any possible deal. "In the wake
of this investigation, the possibility of Sallie Mae -- the largest student
lender in the country -- becoming a private company raises significant concerns
that even less information will be disclosed to the public," he said. "The
American people must be able to hold lenders and schools accountable to ensure
that federal student-aid dollars are being properly used to help students and
families pay for college."

Sallie Mae manages $142 billion in student loans, with 10 million customers. It
offers loans through 5,600 schools.

This past week, the company settled deceptive sales-practices allegations with
New York Attorney General Andrew Cuomo, who is investigating what he considers
widespread corruption in the industry. Sallie Mae agreed to pay $2 million to a
fund to educate high-school seniors and their parents about financial aid.

--Robin Sidel contributed to this article.

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Digger said...

You must have forgotten the Gecko edict, G:

Greed is GOOD!

Leonadro A. said...

I often enjoy reading your missives on business and politics, but the business issues are really an area that I understand. I do have one question on this particular missive: if the buyers of Sallie Mae decide to take a leveraged buyout approach, and if they load the institution with even a marginal amount of debt in the process, what will be the market impact on Sallie Mae's ability to sell its pools of student loan-backed securities? I would think that the market would deem the institution more risky, as the Journal correctly notes, but that would mean Sallie Mae has to add a premium to get its securities sold. Do you think, as I do, that a higher yield on those securities would have to trickle back into the loan market, where the borrower would have to pick up the tab? I mean, though these loans usually get deferred, even a quarter-point increase in the interest on a student loan could be a big cost to the average middle-class borrower. In short, this buyout does not just spell potential problems for overzealous investors or their limited partners (which you have said here), it also could come at an added expense to borrowers like me. Therefore, I am unsure that I would oppose any government effort to block this buyout. It simply goes too far.

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