Thoughts for the Day: AIG, Private Equity and Venture Capital

AIG: Maurice Greenberg’s piece in today’s Wall Street Journal nearly provoked an attack of apoplexy. I’m not sure if I’ve read such a slanted, self-serving editorial in a long, long time. I’m pretty shocked that the WSJ would publish such pandering drivel. Be that as it may, we all know that the Big Mo controls gobs of AIG shares both directly and through his management of CV Starr, so let’s just say that we know where he is coming from. While he starts out with the bailout-inconsistency argument, he kind of had my ear. But when he went on to praise the Citigroup package while chastizing the AIG deal, I couldn’t help but call bull$hit.

To date, the government has shown everything but a consistent approach. It didn’t give assistance to Lehman Brothers. But it did push for a much-publicized and now abandoned plan to purchase troubled assets. The government also pushed for a punitive program for American International Group (AIG) that benefits only the company’s credit default swap counterparties. And it is now purchasing redeemable, nonvoting preferred stock in some of the nation’s largest banks.

The Citi deal makes sense in many respects. The government will inject $20 billion into the company and act as a guarantor of 90% of losses stemming from $306 billion in toxic assets. In return, the government will receive $27 billion of preferred shares paying an 8% dividend and warrants, giving the government a potential equity interest in Citi of up to about 8%. The Citi board should be congratulated for insisting on a deal that both preserves jobs and benefits taxpayers.

But the government’s strategy for Citi differs markedly from its initial response to the first companies to experience liquidity crises. One of those companies was AIG, the company I led for many years.

The maintenance of the status quo will result in the loss of tens of thousands of jobs, lock in billions of dollars of losses for pension funds that are significant AIG shareholders, and wipe out the savings of retirees and millions of other ordinary Americans. This is not what the broader economy needs. It is a lose-lose proposition for everyone but AIG’s credit default swap counterparties, who will be made whole under the new deal.

The government should instead apply the same principles it is applying to Citigroup to create a win-win situation for AIG and its stakeholders. First and foremost, the government should provide a federal guaranty to meet AIG’s counterparty collateral requirements, which have consumed the vast majority of the government-provided funding to date.

The purpose of any federal assistance should be to preserve jobs and allow private capital to take the place of government once private capital becomes available. The structure of the current AIG-government deal makes that impossible.

The role of government should not be to force a company out of business, but rather to help it stay in business so that it can continue to be a taxpayer and an employer. This requires revisiting the terms of the federal government’s assistance to AIG to avoid that company’s breakup and the devastating consequences that would follow.

Hank, you’ve got to be kidding me. The U.S. taxpayers saved Citigroup’s life, and for that we may get up to 8% of the company. THAT is called a “punitive program” in Hank’s parlance for the U.S. taxpayer. In my world when you save a company you own ALL the equity, not 1/12th of the equity. The fact that the taxpayer gets up to 80% of AIG – now that starts to make sense. I agree with the Big Mo’s contention that “The purpose of any federal assistance should be to preserve jobs and allow private capital to take the place of government once private capital becomes available.” But that has nothing to do with post-restructuring equity ownership. He then pulls on the heartstrings by saying “The maintenance of the status quo will result in the loss of tens of thousands of jobs, lock in billions of dollars of losses for pension funds that are significant AIG shareholders, and wipe out the savings of retirees and millions of other ordinary Americans.” Well, Hank, that is 100% on you. YOU should have thought things through before building a company and a culture that gambled it all – and lost. You tell that retiree, that pensioner how you screwed them. That’s called integrity. This thinly-veiled call for personally getting bailed out is both insulting and offensive. And I’m not buying it. I’m sure that my fellow U.S. taxpayers aren’t, either.

Private Equity: The daisy chain of secondary sales of PE L.P. interests will almost certainly accelerate. It is one of those slow-motion train wrecks that is painful to watch. The calculus is easy to understand: public equity values plummet, PE values are stickier and fall more slowly, PE as a percentage of overall assets rises to unacceptable levels, precipitating a wave of sales of PE L.P. interests. An interesting feature of this dynamic is autocorrelation, where PE values are slow to adjust notwithstanding the public market comparables that are available. If industrials are down 40%, then don’t you think a portfolio of PE holdings in the industrials sector should trade well beyond 40% down due to illiquidity? This isn’t the way many PE funds choose to see the world, however. Regardless, the secondary market is just that – a market – and the discounts being placed on marquee funds like KKR and Terra Ferma reflect this reality. Pensions and endowments have to dump stuff, and are trying to do so at a fraction of their basis. But even at fire-sale prices it is hard to move the merchandise. In the next few months we’ll see just how desperate these investors are. Might we see KKR trade at 30 cents on the dollar? It’s possible. And frightening.

Venture Capital: I attended an interesting brownbag today with my pals at betaworks. A big part of the discussion was around funding in today’s hostile environment. Here are a few of the tidbits that came out of the dialogue:

1. Be prepared to live with your current investment syndicate.
2. If possible, have a deep pocketed investor as part of your syndicate.
3. Raise 18-24 months of capital, no less. This can be done through a combination of capital raised plus a reduction of operating burn.
4. Restructurings are getting ugly. Investors, whether inside or outside, are demanding both haircuts from the last round plus and a priority return of capital such that they are fully repaid before anyone else gets anything. Looks, smells and feels like a cram down. This is why having 24 months of capital in the bank upfront is so important.
5. In these down times coalitions get formed between Management and New investors vs. Old investors. This mis-alignment of interests can lead to gridlock and push a company to the brink.

There was much more but these were the high points. Even with today’s difficulties there was still a lot of excitement about new companies and new ideas, with the confidence that money would come to those that truly deserve it. In short, there’s hope.

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