“Phipps Stock Market — a Miracle of Wall Street”

by Travis Johnson, Stock Gumshoe | August 22, 2007 2:22 pm

Apologies for those who were unable to get in to the site this morning — some technical problems with my host really messed things up. I hope to be able to fix it soon so that doesn’t happen again.

Anyway, on with the work at hand:

This teaser has been circulating for a few months, but I’m still seeing it pretty frequently so I thought I’d take a little stab at it here. As we’ll see in a moment, this is actually probably a more interesting time to look at most of these companies than a couple months ago, though that doesn’t necessarily mean there’s anything worth buying here (that’s up to you, of course, the Gumshoe just digs — he can’t tell you what to do with your own money … and if he could, you probably shouldn’t listen).

But anyway, this is all about the secret “Phipps Stock Market” — yet another one in a long line of invented titles by newsletter publishers that obscure the names of relatively common investments. And I appreciate that, it gives a little flair to the emails and gives us something to talk about — and of course, it gives the Gumshoe something to uncover.

This one’s from The Oxford Club[1], a newsletter I haven’t done much snooping into in the past, though I know several folks aver at the forum have been generally complimentary of the service (if you disagree, please let us know[2] — knowledge is power!). I believe it’s currently on sale (as are almost all newsletters, almost all the time) for $79 a year.

And along with the subscription, they’re hawking their special report: “America’s Private Stock Market: How to Make 2,441% this Year from the Coming Private Equity Boom.”

That is, clearly, what the Phipps Stock Market is — the private equity market. Steelmaker Henry Phipps, a contemporary of Andrew Carnegie, is the Phipps discussed in the letter (and the Phipps fortune is still around, for whatever that’s worth). His “private equity” fund, the Bessemer Trust funded by J.P. Morgan’s buyout of their company, U.S. Steel, for a then-unimaginable amount of money, acted not unlike the buyout firms of today (though maybe a little more like Berkshire Hathaway than the LBO flippers of the 1980s, I suppose). That’s mostly in the ad letter, so no big secret there.

The crux of the argument in favor of private equity, according to the Oxford Club in this ad, is that these companies can proceed without regard for public market pressures, can keep all their capital gains or distribute them as they see fit, can issue large dividends[3] to owners if they want to, etc. … all the same arguments that I’m sure the private equity guys still use when trying to convince a public company to accept a private buyout today. Certainly, being a private company is easier in most respects.

The Oxford Club[4]’s promise is that, “while these private funds generally require investment minimums well into the millions, you could soon sidestep all the red tape and grab 2,441% in combined gains over the next 12 months… not including dividends … starting with just a few hundred dollars.”

And they’ve got four investments to allow you to participate in the private equity market. As we’ll see in a moment, if you’re someone who bought into these even last month you’re probably a little grumpy about it, but who knows, maybe we’ve got some bargains here. Just to warn you, this is a little bit of an atypical Gumshoe writeup — the clues are very sparse, so I’m only really sure about two of these, the first and last ones may be worth discussing but I don’t know if we can pin them down exactly (or at least, not without lots more work by the already beleaguered Gumshoe).

Of course, I can already hear your complaints — “private equity is dead!” … “Hedge funds are ripoffs” … “moribund debt markets mean an inexorable decline for highly leveraged private market transactions”

That last one was an accountant sneaking in … sorry. I don’t necessarily disagree that this isn’t the right time to buy private equity firms or targets, though I think those who “know” that timing is perfectly wrong are, themselves, often perfectly wrong. I will note that James Stewart has a good article on the Ivy League endowments in the latest SmartMoney (sorry, I don’t think the article is available for free online yet), and those big guys continue to emphasize alternative investments, including real estate[5], timber[6], energy etc, but they also still put a lot of money into market neutral investments (hedge funds[7]) and private equity, especially compared to their holdings in the more prosaic stocks and bonds that the rest of us typically favor. So, maybe in the long term a little private equity could be good for us even at these prices … I dunno.

So what are the four investments?

“PHIPPS STOCK #1 – The ‘Fund of Funds'”

They call this a conservative fund that invests in 27 “Phipps Market” investments. From the description, it has to be either a closed end fund or an ETF. Priced at “less than $50.”

This one is, unfortunately, a little tough — the most likely candidate here, the relatively new (less than a year old) Powershares Listed Private Equity ETF (PSP), doesn’t quite fit the clues — it’s priced around $25, so the $50 clue doesn’t make much sense, and it actually holds 30 stocks (as does the index it is designed to track, the Listed Private Equity index[8] by Red Rock Capital Management).

So that’s out there, for folks who believe that private equity is the wave of future profits … and it’s quite a bit cheaper than it was last month, down roughly 15% at the moment.

So I suppose that’s a possibility — I don’t think the fund had exactly 27 investments in it at any earlier point in its existence, either, though that’s possible, so I suppose we may be dealing instead with some kind of Closed End Fund. Unfortunately, there are at least dozens of these thanks to the popularity of hedge funds in recent years — there are 30 or 40 in London alone. There are also quite a few mutual funds[9] that offer hedge fund like strategies or that buy hedge funds as part of their portfolio, and some Rydex ETF products that attempt to mimic hedge fund strategies without buying hedge funds (their Sphinx ETF, which was more of a hedge fund of funds product if I remember correctly, got smoked by the Refco scandal and I believe no longer exists).

So, I hate to say it, but if you want to track down all the various fund of funds CEFs, you’re on your own on this one — that’s far too boring for the Gumshoe. If that’s what you want, probably the Powershares ETF is more liquid and offers the kind of diversification that’s being teased here, whether or not it’s the investment they had in mind. I expect the expense ratio is likely much smaller, too. The ETF holds the big guys like Fortress Investment, as well as the non-Hedge fund private equity companies like Leucadia and American Capital, and some other interesting investments — including Affiliated Managers Group, which owns Third Avenue and a bunch of other small, well respected money managers, including some who advise or run private equity and hedge funds. I expect they probably hold Blackstone by now, too.

“PHIPPS STOCK #2 – Invest Like a Barbarian”

This is a fund that’s a child of a “specialty financing firm”a behemoth of the private equity world.

The parent “put modern private equity on the map with its buyout of RJR Nabisco on the “Phipps Stock Market” for $36 billion back in 1989.”

This is a spin-off of that well known parent.

“Toys R Us, Sealy Mattress and Neilsen Ratings are churning out profits for investors in this fund”

8.10% dividends.

They call this a perfect pure investment in the private equity market … so what is it?

Well, clearly the parent is Kohlberg Kravis Roberts, of “Barbarians at the Gate” fame. And the spinoff publicly traded fund must be …

KKR Financial (KFN).

That counts as an “oops” as far as July recommendations go, since KKR Financial is pretty heavily into residential mortgages and also has a REIT subsidiary (or something like that), and therefore fell just like all its compatriots pretty dramatically in recent weeks. The shares plummeted to about $10 (from $25) very briefly, and are now trading around $15. The dividend last year was just over a dollar, so the indicated dividend of 8.1% makes sense.

So, what else have we got?

“PHIPPS STOCK #3 – Make 1,118% on the IPO[10] of the Decade”

This is a private equity company that went public “not long ago.” They’ve at least updated the teaser, since when I first saw this one they were saying it was “about to go” public.

“We love the fundamentals here, and this offering is unique: It gives you a cut from the enormous dividends this fund collects from its holdings every year.”

They say that they’ve “discovered a simple, safe way to play it for swift capital gains of 1,118%. plus dividends.”

I have no idea what kind of time frame they’re talking about, or whether their “simple, safe way” includes options[11], but 1,118% is a pretty stiff promise to make to investors.

They also say that “some investors will likely get clobbered by playing it the wrong way.” Whatever that means.

So, they may have some kind of mysterious trading strategy around this investment, but it’s pretty clear that, given the time frame for when it went public, that they’re talking about …

Blackstone (BX).

I have no idea what they mean by “playing it” the right way. It is certainly much cheaper than it was back when they went public to much fanfare, thanks to the fact that private equity firms can’t sell their debt so easily these days, but it may well recover. The sentiment seems to be that Blackstone managed to sell out at the top, further burnishing the reputation of Stephen Schwarzman[12], but of course I have no idea if that’s true or not. They did just manage to finish funding a massive new investment pool of over $20 billion, so they’ll have plenty of fees coming their way, and they did beat earnings expectations in their first public quarter.

The expectation is that Blackstone will indeed have the potential to pay some pretty significant dividends — but keep in mind that, as a partnership, I think it’s also possible [warning: this is not tax advice and I probably don’t know what I’m talking about] for you to be taxed on earnings that you haven’t received. They can keep earnings for investment, I think, but you still have to pay your taxes on them. Might be something to investigate, as well as your tolerance for handling a whole different kind of tax form if you do your own taxes and haven’t dealt with partnership income before, but as a partner you do also certainly have some rights to ongoing earnings — which is what I expect they mean by that “gives you a cut from the enormous dividends this fund collects from its holdings every year” bit.

Time to close this out … what else is in this “Phipps Market?”

“PHIPPS STOCK #4 – The Coming 1,223% ‘Takeover Target’ Windfall”

This is a company that they expect to be taken over by private equity (though they’ve been saying that they expect this “over the next few weeks” for well over a month now).

“This takeover announcement could hand investors in the target company 10-bagger gains.” (That’s got to mean options — unless they’re insanely optimistic).

So, what’s this company that’s due to be taken over, according to the Oxford Club?

It’s a software firm that’s flooded with cash and helping Fortune 500 companies solve an extremely challenging problem: getting their “in house” software programs to talk to each other.
So, discounting for the moment the fact that many rumored buyouts — and even agreed upon buyouts — are off the table now that the market has gotten so much worse for these deals, is it possible to determine which company this is?

Maybe not precisely, since they don’t give any specifics. It could have been Affiliated Computer Services if I was writing this in 2006, since last year they agreed to a buyout by Cerberus, but folks are so pessimistic about that that the shares are trading well under the buyout price.

I’m going to have to stick to guessing on this one, I think — there are plenty of private equity rumor mills, so if someone has a better idea for us, please let us know, but I think it’s pretty likely that they’re talking about either Computer Sciences Corp (CSC) or EDS (EDS). Both are IT outsourcing companies that do pretty much what the teaser says they do, both have been rumored private equity targets in the past (for years, in the case of CSC) and are pretty richly valued already as a result, and both have quite a lot of cash (though not that much net cash, in either case).

I could easily be wrong on this, so I’d be happy to hear your thoughts on this potential takeout target … though I think the days of profitably speculating on takeout targets may have receded into the rearview mirror for at least a little while.

I don’t know if the huge backlog of investable cash that the private equity firms have on their books will be good or bad for the market, or for the firms themselves. Certainly buyouts have been expensive in the last year as the big firms have competed for the choicest companies, but even as things turned south this Summer the firms were completing massive investment funds — there remain untold billions that are held by the big private equity firms and that are not yet invested, so that’s clearly going to have some kind of impact somewhere, whether good or ill I don’t know. It’s true that the buyout firms are having trouble getting financing lately, but if that clears up there’s no telling what they might buy (and if they get desperate, I suppose they could always pay cash…).

So … I thought I should look into this one, since I’ve been seeing it flash across my screen for months now, but I’m finding this conclusion terribly dissatisfying — it’s not so fun to sleuth out companies that have fallen on hard times in between a teaser’s first occurrence and my efforts, but who knows, maybe those of you who still have a yen for private equity and hedge funds will find a bargain in this muck.

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