Here's why. Profits in 2006 reached $2.27 billion, more than double that of
the previous year.
"That means," says the FT, "each of its 770 workers produced an average of
$2.95 million in net income. By comparison, employees at Goldman Sachs Group
Inc. - the largest U.S. investment bank - each averaged about $360,000 for
the company in 2006."
And now, more news of a fabulous offer by the same Blackstone Group. We say
'fabulous' because it is the stuff of fable…a morality tale telling itself.
Blackstone, this fabulously sucessful firm of private equity investors, now
will offer 10% of its shares to the public for $4 billion. We asked 'Why?'
earlier in the week.
We will endeavour to answer today.
The facts: The Blackstone Group is the largest private
equity firm in the world. According to the report in the
Financial Times, Blackstone's assets have grown from $14 billion to $78
billion in less than 6 years. That is, it has multiplied its assets under
management more than 5 times in 6 years.
Even more remarkable has been the incredible profitability of the firm. Its
annual rate of return is better than Warren Buffett's. Since 1987 it has
averaged 23% a year, while Buffett's rate of return has been 22% -- though
over a much longer time. Blackstone's real estate holdings have done even
better – up 29% per year since 1991.
But now cometh these uber money shufflers with an offer to shuffle some
money to the public.
Or from it?
How does it make so much money? We turned for an explanation to our
colleague, Eric Fry, who is sitting next to us:
"Private equity can mean a number of things. But what a company like
Blackstone does, typically, is to buy a company from the public, reorganize
it and sell it back to the public. Or, sometimes it will buy a private
company and sell it to the public. The paper almost always ends up with the
public."
Today, we stop to marvel at the chutzpah of it.
Associated Press describes the deal:
"Consider this: Blackstone is a great firm. Going public will bring even
greater riches to those at the top. That said, great riches have already
been captured by those up and down the management hierarchy. This is not the
case of a go-go high-technology firm that generates little free cash flow
and requires an IPO or a sale to crystallise value for its shareholders.
Blackstone has been and will continue to be a cash machine that can
distribute substantial sums to its minions every year. Therefore, either an
IPO or a leveraging of the balance sheet is simply a means of extracting
even more cash from the business. Given the friendly nature of today's
equity markets, going public offers the best risk/reward decision for
Blackstone's existing shareholders. This is an opportunistic step driven by
the state of today's equity markets and other considerations such as the
state of the private equity market."
Yes, but what does that mean?
The Financial Times comments:
"These self-motivated, intelligent individuals are trying to tell us
something important. The question is: do we have the ability to look beyond
their words and actions and intuit motivation? Greed, uncertainty and fear.
What are the implications? That the equity markets are in trouble?
That the credit markets are on the verge of a sharp sell- off? That we are
at the dangerous stage of a private equity bubble?"
There is no magic to the Blackstone Group or other private equity firms.
The genius of private equity prime capital is no different from the genius
of subprime credit. When liquidity rises…both ride high.
But money and credit are no different from bananas or lovers; the more you
have, the more will go bad on you.
This is what economists call the Law of Marginal Utility.
Each additional increment, of whatever it is, is less
valuable than the one that came before.
We find in the Fed statistics that the total credit market debt has been
increasing five times as fast as GDP for the entire 21st century, or at
least, what we have seen of it so far. Subprime lenders had so much money
to lend that they gave it away to people who couldn't possibly pay it back.
There are only so many good borrowers. And there are only so many good
private equity deals. And a credit bubble lasts only so long.
AP again:
"What will happen when the debt markets grow less friendly and additional
equity is required to get deals done?
Returns will fall. What will happen to those who have invested in private
equity funds? They will not be happy.
And those who have invested in common shares of the private equity
management company? Unhappier still.
More news:
--------------------------------
Adrian Ash, just trying to make the repayments in Tunbridge Wells:
- Hands up for a housing crash! What's not to love about falling property
prices?
- Bill Gross at Pimco, for instance. He forecasts "an ongoing bond bull
market of still undefined proportions"
to follow the subprime collapse in the US.
- Manager of the world's biggest bond fund, Gross thinks lower house prices
will force the Fed to cut Dollar interest rates. His model puts US interest
rates back at 4%, down from the current 5.25%, if the Fed's going to keep
home prices stable.
- And if the Fed doesn't cut? Average home prices may fall by one fifth,
says Gross.
- "Investigate the Fed's own study," he advises, "written in September of
2005 [and] covering housing cycles in aggregate and individually for 18
countries over the past
35 years. This study's important conclusion...is that if home prices in the
US have peaked, and are expected to stay below that peak on a real price
basis for the next three years, then the Fed will cut rates and cut them
significantly over the next few years in order to revigorate an anemic US
economy."
- Here in the UK, cheaper housing would save the Bank of England from having
to raise Sterling interest rates, too. Which explains why the Old Ladies
keep wishing away their own property bubble, too. Mervyn King told a
Treasury Committee on Tuesday "there are now some signs that the housing
market is beginning to slow."
- Ha! You should be so lucky, Dr. 'Blin' King! Perhaps the chief pooh-bah is
reading different data from everyone else. Because average national asking
prices have risen 12% from this time last year, according to Rightmove. That
estate agency website covers half of all properties for sale. In March
alone, it shows, average asking prices rose £3,381 ($6,626).
- You call that beginning to slow?
- And while Mervyn King shuts his eyes, sticks his fingers in his ears and
cries "I can't see you! I can't hear you!", would-be buyers are starting to
demand home- ownership as part of their human rights. No, really.
- "Everyone has the right to own property alone as well as in association
with others," says Article 17 of the UN human rights declaration. It's
quoted by a regular blogger at PricedOut.org, the website where first-time
home buyers yet to enjoy their first time gather to bewail their lack of
mortgage debt.
- "No one shall be arbitrarily deprived of his property,"
the UN goes on. "Everyone has the right to a standard of living adequate for
the health and well-being of himself and of his family, including food,
clothing [and] housing..."
- The UN doesn't mention mortgage indemnity insurance or stripped pine
flooring from Ikea. But never mind. That lower house prices will soon prove
obligatory, we have no doubt. The first-time buyers will get what they want,
just in time to dive into negative equity.
- "Legislation must be bought into place to control the market," says Carron
Miller, a young mother and teacher.
She's now threatening a BBC chatroom that she'll emigrate if she can't buy a
house soon. "People need to be put before profit."
- Over in Tokyo, meantime, it's the Bank of Japan praying for slower
real-estate inflation. Incredibly, after 17 years of depression, land prices
in Tokyo finally turned higher in 2006 according to official data last week.
Trouble is, rather than just picking up, land prices in some parts of Tokyo
leapt 46% higher. How the gods must be howling with laughter!
- "We aren't yet in a situation in which land-price gains warrant concern of
excessiveness," said Toshihiko Fukui, governor of the BoJ to the Japanese
parliament Tuesday.
"But we'd like to keep a close watch on them."
- Commercial land prices in Japan's three biggest cities rose 8.9% in 2006.
With interest rates still next to zero, why not? The fastest property gains
came in the Omotesando Hills of central Tokyo, a retail and residential
development that opened in Feb. last year.
Amid the developers' scramble, the city's tallest building is now due to
open on Friday. A 42-storey skyscraper will open in front of Tokyo Station
next month.
- Still, there's a long way to go before Tokyo, Osaka and Yokohama catch up
with Glasgow, Baltimore, Derry, San Diego, Pula, Beijing, Buenos Aires,
Reykjavik, Jo'berg, Auckland and the rest of the planet. Japanese land
values for commercial and residential property now trade for half the price
of their 1989 peak.
- But what a peak! And what a mess Japan's had to endure trying to unwind it
ever since. Gearing up to speculate on the wasting asset called real estate
cost Japan more than a decade of recession, depression, banking defaults and
deflation.
- "The buy to let market," says the young British teacher who can't get a
mortgage, "is responsible for a lot of misery." We don't doubt she's right.
But it's not created half as much misery yet as it will when house prices
really do start slowing down.
- Beware what you wish for, Dr. King...
--------------------------------
And more views?
*** Well, at least we know the fire alarm works.
We were sleeping soundly last night. Then, all of a sudden, at about 3AM, we
became a victim of modern technology. A fire alarm interrupted our dreams.
Was the place on fire?
It didn't seem likely. But we couldn't sleep with the screeching alarm
going off…so we dressed and went downstairs.
It is one thing to turn on an alarm. It is another to turn it off.
Pierre was already at the control panel when we got downstairs. He was
pushing buttons. But the noise continued for another 10 minutes – until
everyone was wide awake.
What could we do, but open another bottle of wine?
*** We know we left you on the edge of your chair, last week, with our
theory of modern politics.
Why has collectivism triumphed everywhere, we asked.
But for today, we have to cease with our views. We're attending a conference
and we need to pay attention; maybe we'll learn something. More tomorrow,
dear reader…
FOLLOW THE SILICON TRAIL TO GLIMPSE THE FUTURE OF MEDICINE
Michael Orme
Set your sights on medical diagnostics as the next big thing. The bloated
$3-$4 trillion global healthcare industry shows itself overripe for radical
disruption and the alchemists of Silicon Valley have set their sights firmly
on it.
When they home in on an industry, the game changes and wealth creation
amounting to hundreds of billions or even trillions of dollar can result.
And sometimes be destroyed, it should be added, when a bubble bursts, like
the Internet 1.0 bubble in 2000, only to bubble up again as Web 2.0.
Here, though, we're in at the creation. So let me give you a sense of what's
being spawned. Today, doctors are overwhelmed by administration and
forceably moved far beyond their main function of old of the laying on of
hands and offering a comforting bedside manner. In prospect, is a medical
world where they will be superseded by medical knowledge and expertise
captured in silicon, software and algorithms and delivered cheaper every
year.
It's been called 'rebooting your doctor.'
In prospect are diagnostic tools that will detect early signs of plaque in
arteries or tiny clusters of cancer cells to enable preventive therapies—all
without the need for hospitals, prima donna specialists or blockbuster drug
treatments. We don't have to speculate about weird nanobots cruising through
our gizzards and blitzing incipient cancer cells en route to get the picture
and see that radical change is afoot.
If you want to glimpse where medicine's going, best to talk to those silicon
alchemists rather than medicos, biotech scientists or government policy
makers. Better still, perhaps, to a truly switched on venture capitalist
with a technology background. I sat next to Don Valentine, the doyen of
Silicon Valley venture capitalists a few years ago at a dinner in Menlo
Park, California.
Formerly, a top executive at National Semiconductor, he is worth over a
billion dollars and put seed corn into CISCO and Google when each was little
more than a couple of bright sparks from Stanford with a business plan. I
asked Valentine his secret. "Follow the silicon'' was his brusque reply as
he turned to his other neighbour.
The one thing I learned in 20 years tracking the technology business, first
as a journalist and then as a consultant, is that once silicon focuses on
something you only have to wait for the big markets to be created from
almost nothing - witness PCs, mobile phones, digital cameras and iPODs.
The master mantra is 'better, faster, cheaper, smaller.' Silicon gets
cheaper by 30% every two years and halves in price roughly every two years.
If you find something that works today, more or less, but is too expensive,
then wait a bit and the fireworks start. Look at PCs, routers, mobile
phones, iPODs, search engines, GPS systems for cars, digital cameras. Under
the lash of this relentless mantra, silicon integrated circuits get better,
faster, cheaper, and smaller with every shortening product cycle.
The same cycle of innovation is about to hit medicine, which contrary to
everything in information technology, gets more expensive, more muscle bound
and less satisfying to its customers every year. This is why medicine meets
the criteria laid out by Professor Clay Christensen of the Harvard Business
School, author of best seller, The Innovator's Dilemma, and the chief
theorist of disruptive forces in business, for being 'ripe for disruption'
from the bottom-up.
This is why Andy Grove, the legendary ex-chief honcho at microprocessor
giant Intel, talks of the need for medicine to move "from the mainframe to
the PC era''.
He is talking metaphorically. He means that technology must now be deployed
to undermine the current medical establishments and their ways of doing
things, not least to evaporate the crippling fiscal burden of healthcare on
governments across the world.
In his recent book, End of Medicine, a sprightly but profound study of the
scene, Wall Street veteran and ex-hedge fund manager Andy Kessler points to
what he calls "the cholesterol cancer conspiracy'' as the main culprit. He
argues that hospitals, specialists, and insurance and drug companies have
combined to put the medical focus on costly 'cut and drug' treatments for
chronic conditions, mostly around 'the Big Three', heart disease, stroke and
cancer. But this 'conspiracy' and this focus on costly late stage treatments
is on the point of being subverted by new breeds of diagnostic tools - real
time 3D scanners, biomarker chips to scan for cancer cells, neural networks
to read mammograms, portable ultrasound kits and expert system GPs etc - all
built around silicon.
Rather as the mainframe and minicomputer cultures were subverted by silicon
dominated and defined PCs, and by employees smuggling them into their places
of work twenty years ago, so these diagnostic tools will surround, squeeze
and suffocate medicine's old ways of operating. And they will keep on
improving in lockstep, just like mobile phones or digital cameras do now,
with the remorseless power of siliconomics.
Let's quickly look at what's happening with CT Scanners (Computerised
tomography scanners: a diagnostic medical imaging technology) to round all
this out and make it tangible.
You're a baby boomer and you may have a heart attack, but then again you may
not.
How about having a look in your arteries to see if there's a blockage?
The test is doable with the current generation of 64 slice CT scanners but
is still too expensive and perhaps still not a good enough test.
Coming next is the new generation of 256 slice scanner making its way to
market. They can scan your heart in 4/10ths of a second or less and create a
colour 3D image of it of sufficient quality that you and a medical
professional, not necessarily a heart specialist, can look at to identify
any clogged arteries. Following that, in two to three years time, will come
new and improved volume produced scanners costing less than $200. They will
become a mainstream product and heart attacks will be a lot less common.
Same for strokes.
With cancer, the development of 'molecular imaging' will be able to detect
tumours 3-5 years earlier when they are easier to treat. Antibody chips
costing 10 cents or less will scan your blood or urine for unique proteins
of circulating cancer cells. The current medical establishments hold on late
stage treatment will be increasingly undermined by technology driving
medical practice to the front end, to early detection and preventive
therapy.
As Grove, looking back on over 40 years in the tech business, remarks:
"technology always wins''. Nobody is forecasting root and branch change
overnight in medicine.
But as Kessler puts it: "even if the things budge slightly from chronic to
early detection, waves of change like a Cat 5 hurricane will rip through
medicine.'' And they will.
Regards
Michael Orme
for The Daily Reckoning
Michael Orme is a financial journalist and former stockbroker.
Editor's Note: A Cambridge philosophy graduate, Michael Orme has worked in
the UK Treasury and in stockbroking, the latter under the legendary fund
manager Nils Taube. He was Mr Bearbull on the Investors Chronicle in the
1970s, then a tech journalist covering Silicon Valley for various journals
in the 1980s, including Management Today, Computing and the Mail on Sunday.
He is currently an Associate at Westhall Capital, a investment house
specialising in Asia.
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