Two examples of operators who were strong on the capital side of the business expertise triad, but weak in just about everything else.
The flip side of these two examples I would argue is Kodak.
Kodak entered into the 2000s with several very strong legacy businesses via which had absolutely zero prospects for growth but could still be relied upon to extract monopoly rents for potentially decades, leading to an incredibly strong cashflow balance sheet. In its arrogance as a public company, the CEO Antonio PĂ©rez thought that this could be used to pivot Kodak into new relevance and, according to ChatGPT, torched a stunning amount of capital into a bunch of ill-fated projects:
All of them were flops and the company entered Ch11 in 2012.
A âgoodâ PE firm would have taken Kodak private in 2003 and slowly bled Kodak dry using all the conventional âvulture capitalâ techniques where there was just enough cash left in the business to operate but not any more than that to tempt the CEO into doing something dumb (to be clear, âdumbâ in this context would include things like buying employees new office chairs vs forcing them to scavenge from leftover corpses or IT modernization away from a legacy system riddled with security flaws that have already leaked user data and for which ransomware was already paid, I donât know how you convince a CEO not to do those things except literally not have enough room in the budget for them). Kodak would have been the ultimate hateable company in America by ruthlessly taking advantage of its customers, its employees, the US Government and its legacy but it also would have unlocked a vast tranche of capital that could have been redirected to more profitable purposes.
Even if you look at Kodak in 2023:
Itâs still a place full of long time employees with âgood cultureâ that âwant to do right by their customersâ and âhas the old Kodak cultureâ which is all code for transforming a bunch of cash into goodwill that can definitely never be transformed back into cash vs the âenshitificationâ style framework Doctorow loves to tout so much but is the objectively correct answer to how to run Kodak in this scenario.
Iâve asked experienced investors over the years whether there has ever been a public company like Kodak that has gone on to do the ârightâ thing and Iâve never gotten a convincing positive answer. It seems like, structurally, US capital markets need PE firms to take over firms like Kodak and run a ticketmaster business model where they absorb all the blame in exchange for a Scrooge vault full of arbitrage gold and everyone inside is aware of this devilâs bargain.
I think before you can judge whether any PE firm is good or not, you need to know what their goals are and Payless and ToysâRâUs are also plausibly examples of PE firms recognizing another Kodak and correctly stepping in and performing their job function. We can never peek into the alternate universes so we will never know for sure.
This is a somewhat odd analysis, given that PE firms are subject to a 3x minimum return bar over a 10-15 year period, and squeezing a company for cash flow â whilst perfectly rational for the reasons youâve mentioned â is highly unlikely to generate IRR in excess of that return bar.
PE firms do not have a mandate to just return capital to their partners. They have a mandate to generate a return above the hurdle rate of an illiquidity premium. Harvesting a declining business for cash falls far below that hurdle rate.
If you want an example of a capital allocator CEO who did this for a publicly traded business in secular decline, Iâd recommend looking into Bill Anders at General Dynamics, which happens to be Chapter 3 of The Outsiders. But your overall point still stands: such rational âwind the company down and return the capital to the marketsâ is remarkably rare, though perhaps for obvious reasons.
I found your take intriguing & wanted to explore the parameters of the needle to be threaded by Kodak, or the capital allocators of a company in a comparable situation. For ease of discussion, Iâll call your proposed course of action as âcontrolled declineâ (I think itâs a bit more neutral than âvulture capitalâ), and Iâll call what Kodak management actually did as âattempted pivotâ.
My assumptions about the key elements of âcontrolled declineâ:
inelasticity of the revenue to the âcontrolled declineâ playbook
1a) Why I think it matters: Deep cost cuts (on the income statement) and returning unused cash to shareholders (on the balance sheet) are the key drivers to releasing a âScrooge vault full of arbitrage goldâ. I can definitely see how this helps increase the total amount of capital returned to shareholders, while reducing the relevant denominators to give you better ROA, ROE, and IRR. However, none of the benefits materialize if revenues decline faster than costs.
1b) Why I think itâs hard to do: I imagine a great deal of operational expertise would be required to know which cuts are aimed at excess fat and which cuts might hit an artery. If youâre cutting staff who have been around for decades, I think itâs unlikely theyâll willingly provide you with the right information to know the difference.
At the same time, if publicly listed, these actions will correlate with a drop in share prices. While Iâm aware that in the (current) timeline, share prices dropped anyway, in the counterfactual timeline I suspect the overall drop in share prices will exceed the capital returned to shareholders.
âI know our share price dropped by 10 dollars, but at least you got 7 dollars in dividendsâ is going to be a tough sell for investor relations, especially if you need to hold the course for many quarters.
access to debt capital at a cost below the return on assets, for an industry visibly in decline
2a) Why I think it matters: Actually, it matters a little less for management; I think the net amount of capital returned to shareholders would be about the same for an unlevered company. However, for any PE firm, as Cedric pointed out, there are strong expectations to deliver the kind of returns that can only be attained by funding the 60-80% of the purchase price with debt.
As for the relationship between cost of debt and return on assets, any delta between the ROA and interest cost is additional profit to the PE firm; any time the ROA drops below the interest cost, financial leverage starts working against the owners.
2b) Why I think itâs hard to do: Assuming that a zero sum transfer of wealth from lenders to PE operators isnât the goal of this entire exercise, you would have a relatively accelerated repayment profile, to match diminishing revenues. I donât know what kind of covenants are typical for these arrangements, but some very precise forecasting is going to be needed to ensure debt service ratios and debt to book value ratios donât tie your hands too much. Plus, the entire enterprise becomes vastly more fragile as the debt load grows as a proportion of balance sheet.
(in the instance of a PE firm stepping in) a cooperative shareholder base which is willing to accept a fair offer, instead of anchoring on the substantially higher prices that they paid in the past
3a) Why I think it matters: Change of control is a necessary condition in the PE driven scenario.
3b) Why I think itâs hard to do: The board, management, and shareholders have spent many years, if not decades, of thinking of their stock as a blue chip. While itâs clear that a storm is coming over the horizon, the board and management are telling the shareholders (and themselves) the âattempted pivotâ narrative. To take some liberties on my end, if they engage an impartial third party such as a top tier consulting firm for advice, theyâre also likely to hear about how they can transform their company, disrupt & reinvent themselves, use their cash cow to invest in more promising adjacent segments, etc.
In our present time (their future), we happen to know that these efforts represent tossing âa stunning amount of capital into ill-fated projectsâ, but in that moment the shareholders and management only see the flop, and the turn & river are yet to come.
Enter âgoodâ PE firm, who has crunched the numbers and secured financing at a decent rate. They make a fair offer, at a slight premium to current market cap while still leaving some gains on the table for themselves. This fair offer, though, is a huge discount from the entry price for nearly all shareholders. Will they take it?
In the case of management willing to make the hard choices, they will have to hurdle the first element and simultaneously placate investors; in the case of a PE firm, they might have an easier time with the first element but a harder time with the second and third.
Itâs possible that these elements were present in the Payless and ToysâRâUs scenarios, too; Iâm not intimately familiar with the details.
All things considered though, it seems to me that the âcontrolled declineâ playbook seems to rely on just as much optimism and guesswork as the choice to throw money at adjacent lines of business with some unknown chance of redemption.
The key difference is that in the controlled decline scenario, you experience a huge gush of cash upfront (offset, if not exceeded, by declines in market cap), and the uncertainty is around how long before revenue shrinks to nothing; in the attempted pivot scenario, you burn a huge amount of cash upfront, with (hopefully) positive expected returns, and the uncertainty is presumably mitigated to the extent that you possess Operations and Market expertise.
With these two uncertain options at hand, itâs unclear to me that framing controlled decline as âdoing the right thingâ is completely justified.
Iâd like to know if you think Iâve missed any key elements that are salient to analyzing such scenarios, or if the three Iâve proposed are flawed in some way!
What evidence do we have that these PE firms were even strong at capital? It sounds like they were bad at everything.
And even if you look at capital allocation as a skill, allocating the profits to rewarding the PE firms while driving the companies bankrupt doesnât feel like a good capital allocator, unless we define that as one that primarily uses capital to enrich oneself, rather than using capital to create more capital flows, as the rest of the Capital series seemed to indicate. Itâs not even clear they had special access to capital to fund their acquisitions, as it was primarily funded by debt.
Just curious about the article title, and what youâre seeing that Iâm not.
I burst out laughing at this!
I was mostly talking about the deal-making and the capital raising aspect of Capital Expertise, not the capital allocation aspect. These PE firms could negotiate the deal, recap the company, figure out a mixture of debt that (in the case of Paylessâs first transaction â seemed perfectly reasonable) and set it on a path for recovery ⊠and then botched up said recovery. The Toys âRâ Us story seems less defensible, I agree.
I will say that I canât do any of these things, even if you held a gun to my head.
You know, I was thinking about your response today, and I realise that âcontrolled declineâ can really only be done in the context of a long term holding structure. Or, to invert that:
But using debt in the context of a holding company actually makes it possible, because you no longer have the time limit. Iâm also assuming that such a holding structure would be ok with a lower than PE rate of return, but this is certainly no recipe for passing Buffettâs test.
The other thing I was thinking about was just how damn hard it is to be in retail. No wonder Buffett seems to be biased against it!
I canât do these things either but I guess I understood âStrong at Capitalâ to be strong at the skill relative to other capital allocators, not compared to the general business population. The comparison population matters - a terrible NBA player is still among the top 500 basketball players in the world. But I get what you mean now - they had enough of the skill of capital to make the deals, which you and I couldnât. Thanks!
If Iâm not misremembering, this isnât quite the example youâre intending to make. Kodak invented digital cameras, back in the 70s. But they got worried that digital photography would eat into the extremely profitable film and chemical business, and self-sabotaged. By the time they realized that digital would kill film for all but niche markets, competitors had already cornered the market. This reads like a rhyme for Bell Labs and Xerox PARC. Eventually, they sold their digital sensor business to a PE firm and after Ch11 bankruptcy, shifted to leveraging their chemical operations.
Similarly, EasyShare was launched in 2001, 3 years before Flickr was founded.
And the medical imaging operations isnt as farfetched or a brand extension: Konica Minolta (RIP) and Leica were/are both lens/sensor companies that get a lot of mileage from healthcare technology. Similar to how Phillips and GE have very robust healthcare operations, or how Rolls Royce makes jet engines. These moves make a lot of sense because enterprise sales have a lot more price insensitivity and maintenance or use-based contracts (thinking of the case study on Invisalign now). Those areas of the business end up being the workhorses that subsidize the more well known consumer brands. (Speaking from personal experience in healthcare, seeing a lot of DTC competitors expand into insurance and B2B contracts because they cant make the DTC unit economics work out, without publicizing it too much as a brand).
Iâd argue that Kodak was repeatedly both ahead of its time and self-sabatoging when it came to making the âdemandâ side of the house work.
tldr: PE is only good at capital/financial engineering, and almost never in operations.
PE relies on levering up companies with as much debt as possible & taking cash out of the company via fees & dividends i.e. recapitalization. If they take on too much leverage, the PE firm can simply walk away.
There is no evidence that PE improves operations. Private Equity Operational Improvements â Measuring Value Creation in LBOs
PE, as an asset class, is a levered small cap strategy without the daily liquidity.
Its Sharpe Ratio looks great because of volatility smoothing / volatility masking /volatility laundering via its mark-to-model tricks. RE, VC, and other illiquid asset classes have the same performance measurement issues.
I would contend that is a feature not a bug to GPs & LPs/capital allocators because capital allocators get to sleep better, report a higher Sharpe to their own beneficiaries, and get paid better, so a win-win-lose for GP-LP-beneficaries respectively. See: The volatility laundering, return manipulation and âphoney happinessâ of private equity
Other good reads on PE
Re: Kodak, what a âgood PE firmâ could have done:
â these moves boost IRR, so extracting cash early is important for PE.
The nature of PE transactions is that they are highly leveraged with very small amounts of PE cash inputted relative to deal sizer so a 3X return is actually less difficult than it seems from the outset.
One way to think about it is that PE buys a box full of future cashflows for a present day price and then, similar to a CDO, tranches those cashflows out and sells senior claims to banks by âloading the company with debtâ and retains the âjunk bondâ style assets for themselves. This allows for high risk/high reward plays from very little capital.
The nature of working in a declining industry is that all of your customers are well known and their walkaway reasons are overwhelmingly secular which means you know to a much greater degree of specificity the exact minimum requirements to keep a customer.
Share prices have already priced in expectations of future decline. In an efficient market, they only move due to genuinely novel decisions/occurrences.
I think viewing these as conventional debts (where the goal is to repay the debt) is a mistake. I think more accurate to view them as perpetual debts, where you transform a stock of cash into a flow of cash stream for an indeterminate period of time until the company is forced into Ch11.
This is why the golden age of PE was in the 80s when hostile takeovers were more easily a thing.
Yes, every option has risk involved and skill required to best manage that risk. Iâm not saying this is some magic money machine that is just sitting out in the open.
I think maybe what youâre missing is just how durable some of these legacy cashflows are. We can look at Kodak, 20 years from when they should have âgiven upâ and 10 years after they actually gave up (and filed for Ch11) and look at just how many customers they still have and why. Decades after Hollywood completed the âshift to digitalâ, Nolan and Tarantino are still shooting on film. Oppenheimer and Killers of the Flower Moon were both major motion pictures put out this year shot on Kodak film. Kodak is still a public company (300M market cap) so the monopoly margins theyâre earning on projects like these are still being spent in public company ways and not private company ways.
One way to test this is look at the fates of the principals involved after the incident. Were they drummed out of the industry in humiliation after such a devastating failure or have they continued to have successful careers in the industry? Iâm not familiar with the principals involved
This wasnât my example, this was straight from ChatGPT (potential hallucinations and all). I remember following all the ill fated examples Kodak was trying to do at the time to try and remain a relevant company but have lost all the concrete specific memories so Iâll defer to anyone who has a more detailed recollection but the overall mood was one of doomed arrogance.
What evidence do we have that these PE firms were even strong at capital? It sounds like they were bad at everything.
I had the same question as @eric. It seems like the skill of capital needs to be a lot more than just getting access to capital to be meaningful. Present-day Elon Musk has a ton of access to capital, while young John Malone had very little capital to access; I have no hesitation in saying which one is a better allocator of capital.
The example I would like to see is someone (maybe a PE firm) who comes up with a creative way to make the financing work for a deal, and structures the deal in a way that the company is not leveraged to the point of fragility, and has a good strategic direction, but fails to execute on the strategy and thus gets out-competed.
For instance, the Payless story would have been a lot more convincing if the new ownership structure resulted in a significant increase in capital expenditure on technology, but they failed to manage the implementation of their new e.g. ecommerce system.
I have an on-topic response that Iâll write in a bit, but Iâve added a staff notice to your original post.
Iâd like discussions in this forum to be educational, informed, and biased towards usefulness + action. Using ChatGPT to make up an example in support of a point goes against this spirit. If you want to make an argument, do the work to back it up.
Iâm making this a public call out to set the tone for the rest of the forum.
Consider this an unofficial warning. (Unofficial here means no consequences, so donât worry about it, just donât do it again).
This is going to be a long reply, but I think itâs going to be worth it. At some point Iâm going to extract this and turn it into a synthesis piece for the Capital Expertise concept sequence.
A few notes:
One last note: I was helped in this analysis by @johannoh and @Drayton â Iâve asked them to post corrections if they find any after I post this reply. Both have Capital Expertise; I assure you that they donât back up their arguments with ChatGPT. Any mistakes in this reply are mine alone.
More details and sources below. Sections match the numbers in the BLUF above.
Thereâs a key question thatâs underpins this thread:
I was clearly wrong. They can. I thought that PE firms really only made money when the acquired company succeeds because:
Johannâs response also provides a first principles explanation of why this seems unlikely:
And he made one big assumpton:
Of course, as @Drayton soon corrected us:
I highly recommend this link that Drayton provided above: Private Equity Operational Improvements â Measuring Value Creation in LBOs.
The entire argument is excellent, but to just quote two bits:
In the year the transaction is completed, both metrics drop sharply, creating a V shape in both charts. We hypothesize that major LBO transactions are distracting to management and lead to suboptimal outcomes from a sales and margin perspective during the deal year.
Once the deal has been completed, growth and margins recover, but do not on average return to pre-deal levels. In the three years after the deal, revenue growth is on average 1.1% above industry standard, 60bps lower than pre-acquisition. EBITDA margin averages out to exactly the industry standard, 50bps lower than pre-acquisition. While PE firms are typically praised for their efficiency and cost-control, the graph on EBITDA margins shows a negligible difference in actual profitability. The supposed efficiency and cost-cutting isnât showing up in the numbers.
The industry mythology of savvy and efficient operators streamlining operations and directing strategy to increase growth just isnât supported by data. Instead, there is a new paradigm to understand the PE model, and itâs very, very simple.
By and large, as an industry, PE firms take control of businesses to increase debt. As a result, or in tandem, the growth of the business and the rate of spending on capex slows. Thatâs a simple, structural change, not a grand shift in strategy or a change that really requires any expertise in management.
Thereâs also the following bit:
I cited Plunder: Private Equityâs Plan to Pillage America as a source in both the Payless and Toys âRâ Us cases. In fact this playbook is 100% covered in the book, though the author picks the most heart-wrenching story possible to illustrate this:
Carlyleâs a large private equity firm. It bought HCR ManorCare, which was once the second-largest nursing home chain in America and then executed a number of tactics that are pretty playbook in private equity land. They executed a sale-leaseback, which means they sold the underlying assets of the nursing home chain and had the chain lease it back for a quick hit of money, but now theyâve got a long-term obligation. They executed whatâs called a dividend recapitalization, so ManorCare had to borrow money to pay Carlyle and the other investors a profit. Ultimately, staff needed to be laid off, complaints and health code violations spiked. Unsurprisingly, a resident of one of these facilities dies. Without sufficient staff, she has to go to the bathroom by herself. As alleged, she slips, hits her head, and ultimately dies. But when her family sues for wrongful death, Carlyle gets the case against it dismissed.
PE defenders might say that such cases are rare, but the overarching point is not rare: PE owned companies that are treated in this manner are more fragile. You have optionality and resilience if you actually own your own real estate (you may sell it later, or you may borrow against it, etc). But resilience isnât the point, is it?
This has been a huge story for a few years now. Drayton and I are financial history nerds; we were talking about how the 80s takeover boom was driven by the rise of high yield bonds (aka junk bonds). In that particular case, there were a lot of conglomerates that could be taken over, and then sold for parts â thus creating instant profits (since conglomerates tend to be valued at lower than the sum of its parts, so selling off each part one by one usually nets you a windfall).
But our current PE boom is powered by private credit, not junk bonds. The rise has been an uncanny parallel.
The following Odd Lots podcast is an excellent primer: Why Private Creditâs Been Booming Even as Interest Rates Go Up.
And I found the Oaktree podcast I linked to above quite revealing (all emphasis mine):
Armen Panossian: Yeah, in private credit, itâs been a huge growth industry for the last 10, 15 years. A lot of private credit managers that are large today didnât exist before the Global Financial Crisis. They have grown with the growth of the private equity universe and an expansion of their lending practices and capabilities and assets under management have helped fuel private equity returns as well. Now, I think private equity will experience more of a challenge in the next few years than private credit will, but I think private credit transactions that were highly levered may have some problems in old vintages because when base rates were at 25 basis points and the spreads were at 550, that cost of that leverage was 6 to 7%. Today, that same loan, even without a refinancing, is now costing the borrower 11%.
And so, what is going to happen with that company? Can it make its principal and interest payments when it comes due? If it cannot, where will the incremental capital come in to de-lever the business? There is risk in the rearview mirror in private credit, but with that risk creates opportunity out the front window, which for fresh capital, for experienced investors having invested through cycles, there will be some great buys. There are some great buys even now, but I think itâs going to accelerate in terms of private capital being deployed into a dislocated environment where there are banks and other private credit funds that were probably a little too long in their pro-cyclical lending and investment behavior. And now thatâs going to need to be retracted a bit.
Howard Marks: I think the point is the tide has never gone out on private lending. Itâs never been tested. Credit analysis may seem like a pedestrian activity, but the truth is there is such a thing as superior credit analysis, average credit analysis, inferior credit analysis. And the people who did inferior credit analysis in the last 15 years and maybe who scooped up too many assets to invest in, in the interest of asset growth, weâll find out who they were, I think, and maybe the list will be winnowed.
Iâm not 100% sure what Panossian is talking about when he says âNow, I think private equity will experience more of a challenge in the next few years than private credit willâ â but perhaps someone with more capital expertise than I have can chime in.
The key thing is that lending discipline in this market is questionable. Itâs easy to make money when you can borrow lots of it.
Yes. At least I think so. Drayton put it to me like this:
PE is a high leverage small-cap/mid-cap portfolio strategy, where the downside risk is masked by mark-to-model accounting, & negative returns on individual investments do not trigger a margin call on the rest of the portfolio (individual investments are siloed)
The bit about the âmark-to-modelâ accounting is important to expand upon. Unlike investors in the public markets, private equity (and VC, and real estate), can make up the valuations of the assets that they own. (To make this more polite they call this âmark-to-modelâ, which means they come up with some valuation model and then say that their companies are valued at whatever the model says.) Contrast that with public investors, who are âmarked-to-marketâ.
This is valuable if you run a pension fund or a university endowment. Over the past 30 years, pension funds and endowments alike have increasingly run their portfolios according to something called the âYale modelâ â that is, a large chunk of their portfolios in âalternativeâ investments like VC, PE, hedge funds, and so on. The idea is that these investments would hopefully be uncorrelated to returns in the public equity and bond markets.
But the nice thing with these alts is that they donât have to update the valuations of their portfolios that often, which means the âreturnsâ look smoother, or at least less volatile. You could say that PE and VC has benefited from this tailwind over the past 15 years, in addition to cheap credit.
So, you need expertise to:
Or, as federal prosecutor Brendan Ballou, author of Plunder puts it:
the basic issue is if you look at the biographies of the people that run private equity firms â and this is no slight against them â generally, theyâre not folks with experience in engineering, product development, sales or marketing, logistics, or anything like that. They have experience in finance, and so the expertise that they bring to an acquisition is financial expertise. Just as to the extent that I would bring expertise to something, it would be legal expertise. You wouldnât want me running the company. The challenge that weâve got is, oftentimes, when private equity firms think that they do have operational experience, it sort of blows up in their face.
The thing that strikes me about all of this is just how much this is no-lose for the PE folks.
You can say that this is morally repugnant, and I would agree with you. But I also think itâs useful to separate recognition of expertise from moral judgment â people can also do morally bad things on the Operations and Market side of the triad.
As an aside, I thought this entire episode was a pretty good illustration of expertise. I come from the Operations and Market side of the triad; I have little Capital Expertise.
Johann worked at a fixed income desk circa 2016. His mandate was investment grade bonds; he wasnât allowed to touch junk. As a result he didnât understand what was going on in the current PE meta. Drayton worked in finance across trading, corporate development at a mining company, fintech underwriting, and now runs a hedge fund. He was more in tune with the shenanigans you can get up to with PE. But when discussing these things, Johann understood what Drayton was saying faster than I did, at a level of granularity that I didnât, and faster also â by the way â than someone aping Matt Levine but with no actual experience of dealing with capital structures.
I think I wonât do so badly if you talked to me about capital structure on the equity side of things. Iâve negotiated a few things on that end, so at least I have my hands dirty there. But I have never dealt with the debt side of things and it shows!
Concrete example: both Drayton and Johann commented on how vastly I underestimate the impact leverage can have on returns. Drayton sent me this screenshot, (from this remarkable textbook by Stowell)
Iâll leave this to you to decide. My take is:
I know there are a few PE folk from top-tier firms here, and I welcome any corrections. If you donât want your comments to be tied directly to your name (or your firm) â feel free to message me and Iâll post your comments anonymously.
Special thanks again to @johannoh and @Drayton; again, feel free to chime in if Iâve made any mistakes. I thank all of you for being my continued business education vehicle.
Wow, thanks so much for this deep dive. Helpful for me to see the capital expertise I was missing in my earlier flippant comment. I do think the Marks quote is relevant - the shenanigans of making these deals in ZIRP land are a skill, and they can extract profits by doing these deals, but the people who had no other skills of evaluation of good business opportunities and operations are going to be destroyed in the coming years. Insert Warren Buffett quote about the tide going out.
To make an analogy to personal finance, anybody that took an adjustable rate mortgage in recent years with the assumption they can always refinance when it comes due is likely to lose their house. In the short term, it may have looked like capital expertise to save on their monthly payments, but it was picking up pennies in front of a steamroller, to use the common expression. I wonder how many recent PE deals will look similarly disastrous when the debt comes due.
Actually this makes me question again whether to call this expertise. It feels like somebody can learn this skill by copying the structure of other deals, but without true expertise, they will not understand how to adapt to a changing environment. It feels like what Shane Parrish calls âchauffeur knowledgeâ Two Types of Knowledge: The Max Planck/Chauffeur Test where somebody can mimic the output but not actually understand what theyâre talking about. Does doing these deals constitute expertise, or is it just copying what others have done?
Great synthesis. I think the phrase âtransfer of wealth from private lenders to PE firm partners.â might be too loaded/strong; itâs better to say that, generally, PE firms are arbitraging the difference between cost of debt and cost of equity.
Franco Modigliani & Merton Miller of ModiglianiâMiller theorem fame, had decent upper middle-class success as tenured finance academics (Miller even shared the âNobel in Economicsâ).
However, each of the partners of LTCM all walked away with 9-figure fortunes. John Meriwether actually went on to start 2 more hedge funds.
What lessons to take from this is left as an exercise for the alert reader.
