Welcome to the Circulus Newsletter. This is a monthly newsletter dedicated to uncovering the best investment perspectives and frameworks for family office executives and family members. Through podcasts, articles and events, we will learn about how sophisticated investors view markets and manage portfolios, how entrepreneurs build businesses, the intricacies of business models and how family offices could be optimized. My plan is to use this newsletter to continue my long exploration of the psychology of wealth and investing.
I am on the editorial board of Family Wealth Report, which has two excellent conferences coming up in New York. Click to find out more:
Ted Seides
Today’s guest is Ted Seides from the Capital Allocators podcast. I first did a print interview with Ted exactly seven years ago, when he had just completed his first book So You Want to Start a Hedge Fund? and had just started his podcast. Since then he has written two more books, Capital Allocators and today’s topic, Private Equity Deals, and now has one of the top investment podcasts in the world, with over 400 episodes. Private Equity Deals is a set of engaging case studies derived from his podcast series and is an excellent and detailed read, delving deeply into fifteen different deals.
Ted on active vs. passive investing: “So I would rather invest in an active manager net of fees that matched the market than buy the index fund, because if I have a relationship with that manager, they might introduce me to another investment opportunity. They might introduce me to another manager. They might tell me something that enhances my life. I don’t know how to quantify it.”
Ted Seides is the host of Capital Allocators, which includes podcasts, gatherings, and advisory. He was formerly co-founder of Protege Partners, which was a leading multi-billion dollar hedge fund seeder, where he was president and co-CIO. Ted is also well known for his famous bet with Warren Buffett, a charitable wager pitting hedge funds against the S&P 500. Ted began his career under the tutelage of David Swensen at the Yale University Investments office. Ted graduated with honors from Yale and received an MBA from Harvard Business School.
I’m grateful to Ted for getting me into podcasting. He told me it was fun and easy, and you get to talk to really interesting people and he was absolutely right. Please enjoy my conversation with Ted Seides.
Private Equity Deals Excerpt:
The Perfect Buyout
CHI Overhead Doors by KKR
An ideal private equity acquisition target is a high-quality business with great management that can operate efficiently with debt on its balance sheet. Some of these business characteristics include the following:
• free cash flow generation;1
• consistent, steadily growing revenue;
• insensitivity to economic cycles;
• pricing power;
• diverse customer base;
• efficient cost structure or low-hanging fruit to reduce cost; and,
• outstanding management or readily available new management team.
Great businesses are coveted by private equity firms. In theory, they might want to own these businesses forever. In practice, the average private equity holding period is three to five years.2 Private equity fund vehicles typically have ten-year lives, which prevents managers from investing
with a longer duration.3
As a result, great businesses may change hands from one private equity firm to another. 806 companies have changed hands at least three times between GPs over the last 23 years, including 173 four times, 29 five times, and one each six and seven times.4
KKR has been at the center of the private equity industry since the firm’s founding in 1976. It gained prominence from the purchase of RJR Nabisco in 1989 for $24 billion, in a year when the entire industry raised only $12 billion.5 Today, KKR is a public company that oversees over $500 billion in assets and is one of the leading private equity firms in the world.
KKR’s purchase of CHI Overhead Doors in 2015 is a deal right out of the private equity textbook. CHI manufactures custom garage doors—a business that has grown steadily for decades. Homeowners buy from CHI when they move into a new house or when a garage door needs to be replaced. Volumes from new ownership are sensitive to economic conditions, but replacements generally aren’t. When a garage door breaks, a homeowner tends to buy a replacement quickly. CHI runs operations efficiently, holding little excess inventory and generating lots of cash.
KKR was the fourth private equity owner of CHI, following three successful investments by prior owners. Warren Buffett says, “I try to invest in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will.” Pairing a business as good as CHI with great management teams (that aren’t idiots) has been a repeated recipe for profits.
You might think that these private equity firms are passive winners, handing off CHI from one lucky owner to the next. But that wouldn’t explain why CHI became one of the most successful deals in KKR’s history.
KKR seeks to buy businesses it can transform through faster growth, higher profitability, and innovation. At CHI, KKR saw an opportunity to improve the engagement of the workforce and increase operational efficiency.
Pete Stavros, KKR’s global head of private equity, described in our conversation on July 21, 2022 that KKR introduced broad employee ownership to CHI. This structure provided alignment and incentives for everyone down to the line worker to benefit from the success of the business.
And benefit they did.
When KKR sold CHI to a strategic investor in 2022, it paid out more than $340 million to CHI’s employees. That payout was more than the $250 million KKR paid in equity for the entire business seven years prior.
KKR’s CHI deal is an example of a company private equity firms love to buy: a strong foundation with upside optionality that came from KKR’s operational improvements and ownership works model.
1 “Free cash flow” is defined as cash from operations on the statement of cash flows less maintenance capital expenditures and working capital requirements. Other common definitions include “owner earnings” or earnings before interest, taxes, depreciation and amortization less capital expenditures.
2 Private equity firms regularly seek to find ways to extend the duration of their ownership of great businesses. Continuation funds and permanent capital vehicles came about in part to solve for this challenge.
3 Fund terms are specific in the offering documents and vary. A standard term has a ten-year life with options for two to three year extensions.
4 Proprietary data sample from PitchBook compiled by HarbourVest includes US domiciled companies with at least 200 employees that have had at least three sponsor-to-sponsor buyout transactions between 2000 and 2023.
5 Private Equity International (PEI) Annul Fundraising Report, 1989.
Circulus Summit
Our first face-to-face family office meeting is in New York on September 19th. The most valuable information source is other people, and I think we can only create and build enduring relationships in person. Family offices are an important part of having a dynamic economy, and we want to create information and sharing networks at Circulus to engage the best thinking.
We have just added Rebecca Patterson, former chief strategist at Bridgewater, who will have a discussion with Torsten Slok of Apollo about the macro picuture. Steve Tananbaum of GoldenTree will keynote, and I will be interviewing Zoe Cruz, former president of Morgan Stanley.
For more information about the conference and to apply for an invitation see here.
Cybersecurity
My former podcast guest Mark Hurley has a new white paper outlining the threat to wealth management firms from cyber attacks. One of the primary threats involves data theft, which may be lifted without anyone noticing. This is a concerning issue with family offices, where cybersecurity is often low on the list of priorities and often assumed to be a problem for their providers. Mark and his expert co-authors provide an easy to understand framework for getting ahead of these attacks, and outlines the new risk of remote work, which makes money managers a “compelling target.”
Links
Family offices are about to surpass hedge funds, with $5.4 trillion in assets by 2030. Robert Frank of CNBC writing about the recent Deloitte family office report. The figures are interesting, but it is hard to discern the methodology of the barrage of recent guesstimates of the number of family offices globally. The most compelling research I saw was from Wealth-X, which estimated 50,000 people globally now have at least $100 million. That would put the number of family offices possibly higher than any current report. $100 million is not enough to run a family office, but it is where you develop the complexity that begins to justify one. The real number is probably around 20,000. Which is also a guess, but does underpin the idea that families have become a major new investment bloc adjacent to institutions.
Succession in Asset Management. Ted Seides had a recent discussion about how money managers handle succession with Sarah Samuels of NEPC. There are many parallels to family business and generational transitions in family offices. “There's a great deal of personal identity wrapped up and really one sense of self, as well as just a passion for the company that they've built. So when we think about a couple of analogs, one would be comparing this succession analysis in the asset manager context to succession analysis in terms of founders of VC backed portfolio companies.”
Thanks for reading! Look forward to more next month, with a wrap-up from the Circulus Summit and interviews with Michael Weisz of Yieldstreet and Mark Gerson, founder of GLG, on the power of community.
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