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Company Valuator

An exclusive monthly news report for private company CEO's
July 25, 2007
Sign of the Times
Did You Know
Ask the Expert
Market Stats
Helpful Links
Quote of the Month:

"Why do we have to come here when all this stuff is on the internet?"

American Tourist on vacation overheard at the Musee d'Orsay, Paris.

Sign of the Times

A monthly market commentary

“Life at the beach, Barry Bonds, and YouTube/CNN”

It's late July and you can't be human and live in the United States without feeling like summer signals a time for a little relaxment. I just returned from a 6 mile run I do every year in Santa Cruz. 15,000 runners. It always?sells out?as it is a top notch event. The?course meanders along the coast with several bands playing along the way ending on a nice downhill slope into the town of Capitola. This year brought temps in the high 80's and the beaches were packed. Great fun. If roller coasters are your thing, this is the place to be. The Giant Dipper is a 2 minute ride that is a thrill. Add to that hot dogs, soft pretzels, cotton candy---well, you get the idea.

Now that we have our feet firmly planted in the warm sun, break out a book...For summer reading, I recommend "The Measure of a Man" by Sidney Poitier, "House of Mondavi" by Julia Siler, "Better"..A Surgeon's Notes on Performance by Atul Gawande, and "The 4-Hour Workweek"..Escape 9-5, Live Anywhere, and Join the New Rich by Timothy Ferriss. Umm, you probably don't want to bring that last book to the office.

Movies. A good combination of balance?for healthcare issues in the U.S. would be the Gawande book and Michael Moore's new movie "Sicko". As usual, Moore is at his controversial best, but there is no escaping the fact that our healthcare system is in tatters. As I am writing this, service and quality?are eroding and prices are rising. Every day. Scary stuff. Next movie--"Waitress"--a comedy/drama very well done. "Paris, Je T'Aime"--an unusual but interesting film made up of 18 different vignettes that last 5-7 minutes each. Cmon, pick one, grab a friend or your?mate--and GO!

Barry Bonds. If you live in the bay area, chances are you like Bonds and?you're rooting for him. I am. Attend any Giants home game and it's a Bonds love fest. Lots of energy, lots of fun.?Yesterday was a mega day of sorts for Bonds. He turned 43,?Bud Selig announced he would attend the games leading up to the home run record (Yeah!), and Bonds former girlfriend announced she would reveal all (and I mean ALL) in the November Playboy magazine issue. Whew.

Heartbreak of the week???? Sergio Garcia losing the British Open. You can't help but?love the guy but he just can't close out the big ones. He is one of the world's top golfers but has yet to win one major title. Personally, I think he just finds himself having so much fun that he gets caught up in the excitement and loses his focus.

Did anybody catch the YouTube/CNN Democratic debate? Slick concept and it worked amazingly well. Old media out. New media in. Katie Couric out. Anderson Cooper in.

Gotta run. I need sunscreen. Enjoy August.


Did You Know

“Stopping Fraud at Private Companies”

The Association of Certified Fraud Examiners (ACFE) recently stated that 42% of all fraud and employee theft occurs at private and family-owned companies, a much higher rate than for public companies.

Fraud and misconduct can drain earnings, expose your company, management and you to criminal and civil liability; and, it simply goes downhill from there. All the hard work and previous successes can largely be overshadowed by diminishment of a very important asset--the company reputation in the market.

Effective fraud management programs almost always provide significant cost savings. The ACFE estimates that U.S. companies lose 5 to 7 percent of their annual revenues to fraud and, more important, studies show that companies receive a 7:1 return on preventative and detective antifraud programs.

An example of putting an antifraud program in motion is a private candy manufacturer which trained its business unit finance directors on a broad range of fraud management issues, including its overall benefits. Attention was given to common fraud schemes? affecting consumer companies, identifying and assessing fraud risk, developing transaction-level antifraud controls, fraud monitoring and auditing with?incident response and remediation. Where suggestions for enhanced controls were not practical, periodic auditing was substituted.

As companies and their business landscape change, so does their vulnerability to fraud. Most fraud is detected by chance and chance is not exactly a sound business strategy. Fraud management will hep your company maintain confidence in the integrity of its financial results, reduce costs, improve profitability, protect its reputation and mitigate liability.

Ask the Expert

“So You Want to Start a Winery?”

One of my favorite quotes about making money in the wine industry comes from Tom Jordan, founder of Jordan Winery, which has enjoyed considerable success since the early 1980's. When asked how to make a small fortune in the wine business, Tom thought for a moment and replied, "Start with a large fortune."

Another successful winery in the Napa Valley is Groth. It wasn't an overnight success story. Dennis Groth had developed an affection for wine stemming from his entertaining of clients, all part of his responsibilities as a partner with Arthur Young. He began looking at the possibilities of buying a premium vineyard and eventually got a life changing call?from a Napa realtor who?advised him of a very special property that was up for sale. The year was 1981 and the vineyard was 121 acres known as the Oakcross Vineyard, planted by 2 other Napa Valley legends, Justin Meyer and Ray Duncan. It was in the heart of the Oakville appellation and it was prime Cabernet Sauvignon land. Some of the grapes found their way to Justin's Silver Oak bottlings in the 70's and to other successful Napa Valley bottlings.

It could be considered quite an audacious leap of faith for Dennis as drinking wine and making wine are decidely different pursuits. Nonetheless, he plowed full speed ahead. Never mind he was already knee-deep in his second career as CFO at electronic-games pioneer Atari, which at the time was on a roll. Groth parlayed his accounting background and Atari's success into bank financing to start the operation. Within months, the overheated video-game industry crashed--and so did Groth's financing.

But instead of pulling out, the 64 year old left Atari and moved his family onto the farm. Armed with only a building permit to construct a wine making facility, he got creative, opting to outsource his grape growing--a common practice today, but unusual in 1984. "We put off constructing our building," he explained. "We wanted to first demonstrate we could make good wines."

The gamble paid off. Although it took Groth Winery and Estate two years to sell all 10,000 cases of its 1983 cabernet sauvignon, word spread. Then, in a stunning development, critic Robert Parker gave the 1985?Groth Reserve Cabernet a 100 rating--the first California wine ever to receive the perfect mark. Suddenly, business skyrocketed, with sales doubling and then tripling.

Last year, Groth Winery and Estate sold 65,000 cases. While larger concerns have expressed interest in buying his operations, Dennis and his family seem quite happy doing what they are doing at the moment.

Recently, Dennis and his wife Nancy were looking back at some of the early risks they took getting the winery started. They looked at each other and?Nancy said, "What?EVER prompted us to take such a risk? We literally put everything we had into it."

Market Stats

“Private Equity versus Hedge Funds...What's the Difference?”

Most of you know?who have followed me for any length of time?are aware I've long?been a proponent of private equity funds as vehicles to consider in any potential transaction related to the sale of a private company.

Interestingly enough, I get a lot of questions about the differences in how hedge funds operate from private equity and what the challenges/rewards are of being involved in both. So, let me try to explain.

First, hedge funds and private equity groups have one thing in common. Both charge considerable fees- typically 2% of assets under management and 20% of investment profits. Beyond that, the differences are huge.

Private equity is a heavily geared, "long only" investment in illiquid assets (whole companies), with high levels of control and a multi-year time horizon. Hedge funds, by contrast, typically invest in liquid securities, with no control. They have the flexibility to take both long and short positions and their performance, because it is more transparent, is judged almost constantly by investors.

So which of the two asset classes is more valuable when a management company goes public? The answer is private equity.

First, assets are tied up long-term. Kohlberg Kravis Roberts, which plans an IPO, says 73% of its assets are committed for as much as 18 years. While KKR is highly unlikely to hold any investment for that long, it does give huge flexibililty to ride out tough terms. And it provides a steady stream of cash from the 2% management fee- alongside the bigger and more volatile 20% share of investment gains.

By contrast, hedge fund investors can pull their money quickly if performance is bad, making the underlying fee less secure. In addition, poor investment returns can quickly inflict a double whammy on a hedge fund manager's earnings- of weak performance fees and falling assets under management as investors withdraw money.

To many, private equity firms have a more secure feel than a typical hedge fund. They have established brands such as Blackstone and KKR, they buy full control of businesses people know, and buy-outs have largely avoided financial trouble in recent years. Hedge funds, for some, conjure up images of whiz kids rolling the dice on behalf of their clients, leading to high profile blow-ups such as Amaranth and recently some mortgage funds at Bear Stearns.

Finally, private equity firms have a "cookie jar" of unrealized gains on their illiquid investments that should emerge as cash flow when the businesses are sold. At least, that is the case in today's strong market.

But dig a little deeper and hedge funds also have their charms. They mostly lack the protection of long lock-ups. But in good times their assets under management grow naturally because, unlike private equity, they do not constantly hand cash back to investors when they exit investments.

Hedge funds are more geared to good performance. If they generate strong returns they enjoy handsome performance fees. The assets on which they can charge future fees also grow by that amount and the good performance attracts further inflows.

In the end, both models live and die by their returns. Private equity groups have longer to prove themselves, have real control over their portfolio companies and can ride out most market storms. Hedge fund investors, meanwhile, can see the real performance each month because most securities are listed. If that is bad, it can spark a rush to the exit and cause real problems for the management company.

The coming IPOs of Och-Ziff, a pure hedge fund, and KKR, a pure private equity manager, should give a clearer idea of relative valuations. Assuming hedge funds do not lengthen lock-ups significantly, private equity should usually command a higher multiple.

Helpful Links

“Not Google, but Google NEWS

We all know Google, but Google News is still a relative unknown--and it's really good. . A bold endeavor in online journalism, Google News provides you hundreds of news sources (typically) for each of the major stories of the day. Just find the story that interests you on the main page, and you will see something like "227 related" or "535 related" just beneath it. Click this to see the extensive range of news sources available for the story you are after! (Its database of past news is also searchable.)


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