Archives for the month of: August, 2011

I just finished reading two books on private equity and hedge funds, respectively. The first was “King of Capital”, a book about how Steve Schwarzman founded Blackstone and grew it to be one of the largest private equity firms in the world. In case it’s the first time you heard about private equity firms, they are professional money managers similar to venture capital firms (this is why people often time lump those two together and call them VCPE), but different in the types of companies they invest in. While VCs invest in high-tech startups, PEs invest primarily in industries that have established business models that makes it easier to predict future cash-flows.

PEs usually target companies that seem under-valued, buy them at a cheap price, manage them for several years, and re-sell them at a higher price. Safeway, one of the major grocery stores in the west coast, is a huge success case for Blackstone. Safeway was a family-owned business that had the potential to be much bigger and better managed, but the family owners were interested in merely maintaining the status-quo. Blackstone offered them a sweet price, turned them private and later went public again to rack in a huge profit. This kind of buying activity is called “leveraged buyout (LBO)”. The reason is that PE firms leverage heavily (basically borrow a lot of money) to cover the cost of buying an entire company. This leveraging is the key ingredient behind astronomic profits of these PE firms. For example, let’s say company A is worth $1B and a PE firm is trying to buy 100% of the company. Let’s say they put in $100M out of their pocket and leverage the rest, $900M. Let’s say the PE firm does a great job turning the company around and a year later company A is sold at $2B. Assuming the interest on the $900M was 10%, the PE firm needs to pay $90M to the banks, and the rest of the gain, $1B – $90M = $910M, goes to the PE firm. Basically they get a 910M/100M = 910% return with heavy leveraging compared to 200% return without leveraging.

Blackstone was very successful in these deals until the 2008 financial meltdown. Schwarzman would rack in over $300M in salary and compensation in a good year (but in a bad year get just over $300K). Most PE firms have very few employees (Blackstone has 1400), allowing even the lower ranking people to enjoy good compensations. No wonder a ton of MBA graduates line up for VCPE firms.

The second book was “Money Mavericks”, written by a ex-hedge-fund manager about how he founded and grew his first company, Holte Capital. He is not as famous as Steve Schwarzman and his company was also much smaller than Blackstone, managing about $500M-1B (Blackstone has $150B asset under management, AUM, as of 2010). What attracts me to hedge-funds, although I have no intention of joining one after my PhD, is that they seem like a no bull-shit industry. They don’t care about where you went to school, whether you have a PhD or not, whether you have a network of influential friends. They just care about your quarterly performances (or maybe monthly). If you earn a lot of money through trading, you can be a multi-millionaire at a young age with little to no experience. I got the same impression reading other books about the hedge-fund industry such as the “The big short” by Michael Lewis. It’s a place where your success is entirely based on how you perform. No bull-shit, meritocracy rules.

These two books are primarily about professional money managers, but also contains strong messages about entrepreneurship. I have read a few finance related books (More money than god, The big short, Too big to fail, Wall street meat, Running Money and the two books in this post), and the reason I keep reading them is because I can feel the entrepreneurial energy and the adrenaline of running your own company. I am basically relying on books to feel this before I can actually have the chance to feel it in the real world =) The initial days after starting financial firms seem very similar to those of high-tech startups. Lars Kroijer founded Holte Capital when he was 29 years old, after working at Lazard (a PE firm) for two years, studying at HBS for two years and working three years at another hedge fund. Having no track record of running his own fund, he and his buddy from Harvard had so much trouble raising the $5M to take his company off. Even after they somehow raised that money, the management fee they could get from $5M (2% x 5M = 100k) was too small to cover even their basic expenses like office rent and Bloomberg terminal fees. They were in the brink of shutting down their fund. All the major investors would say they were interested, but wanted to join once another major firms committed. After hundreds of meetings with potential investors, getting embarrassed and humiliated, hard work (and a little bit of luck) paid off. They were finally able to secure a >$10M investment and the rest was history. Sounds a lot like a high-tech startup scrambling for funding. I’ve heard a lot of stories about VCs investing in groups to reduce risk, waiting for their friends in other VC firms to commit to the funding round. Moreover, the spirits of the founders are remarkably similar. They have a strong will to run their own show even though their firm might have a name that no one recognizes.

Lars Korijer was 29 when he started Holte Capital, and was 37 when he quit, by which time he earned enough money to send his twin daughters to private schools while never worrying about money again. About to become 27 this coming November, I was wondering what I have accomplished compared to this guy who had 5 years of experience and financial firms (with >$200K salaries) and a Harvard MBA under his belt at my age. I’m not saying my PhD was not worth my time. This book gave me a chance to look back and think whether I did what I could to make the best of my time. Maybe I could have tried harder to become more professional about what I’m doing instead of acting more like a student. Reading these books make my desire to go out to the real world stronger than ever. I can’t wait to use my skills that I learned from my time at Harvard to run my own show. I need to first work hard to graduate next year =)

One last thing. Although hedge funds like Holte Capital seemed to have an academic working atmosphere, Blackstone had a completely different one. An impressive part in the book was about the conversation between Schwarzman and Callahan after Callahan had mis-managed a telecom company deal, leading to a huge loss. “Where’s my fucking money, you dumb shit?” were the first words out of Schwarzman’s mouth. I wonder what it would be like to work in such a competitive environment =)

I was talking with my wife about her internship at Xerox Palo Alto Research Center the other day. She was talking about how much she likes the atmosphere there, working on a wide variety of research topics. When we started talking about the history of Xerox, I got interested in the history of Xerox’s stock price. I also found Eastman Kodak, which is another old-name company. I’m sure most people have heard of these two companies.

(click to enlarge)

Yellow line is Eastman Kodak, blue is Xerox and red is Dow Index from 1978 to present. Xerox and Kodak both dropped compared to 30 years ago, while the Dow Index rose close to 1300%. This means if you bought $1000 worth of Xerox and Kodak stock back in 1978, you would have less than $1000 left, even without considering inflation. You would have been much better off investing in a Dow Index fund, where they distribute their investments in a wide variety of companies to roughly track the Dow Index.

My first reaction was, “How can a company fawk up so much?”. At least they survived for 100 years, so they are better than the bunch of companies that went bust during that long time period. But Xerox and Kodak were not just “some company”. They had highly superior technologies compared to their competitors, was a market leader and had a bunch of cash to invest in their futures. Heck, “xerox” became a common noun replacing “photocopy”. What did they do with all that money? Across those 30 long years, how come there was no CEO who had the guts to use the cash to turn around the company and expand into different areas? I heard that Xerox has been trying to transform into a document services company, whatever that means. Getting rid of hardware and just including “services” does not guarantee high margins. Not everyone can pull off an IBM (wonder if HP can do it).

Even worse, there are news floating around that Kodak is going to have an auction for its huge pile of patents. Analysts are saying Kodak is sitting on a gold mine. This makes me wonder even more “How can they fawk up so much when sitting on a gold mine?”. Basically they are admitting they are too stupid to monetize superior technology, so they are letting other companies do that with their patents. Actually, most companies that are interested in Kodak’s patents already have the technology developed. It’s not like they would study the patents and build upon them to develop new technologies. They just want to buy the patents to protect themselves from future infringement.

One could argue that a successful patent auction would foster technology innovation because it rewards inventors. Basically, the auction would show that inventors can get financially rewarded without finding a way to develop a business with their technology. This could motivate people to concentrate on technology innovation without worrying too much about creating a business out of it.

I think this argument is flawed. I believe inventors and technology innovators can be two separate groups. Rewarding inventors might motivate people to write patents, but not lead to technology innovation. Since you can write a patent just with an idea without really demonstrating anything, one could just jot down ideas while others are putting in days, weeks and years into actually developing that idea into a valuable technology. When the hard-working guy finally get something working and starts to build a huge business around the technology, the guy jotting down ideas can come with a bunch of black-suited guys and say “I would hate to see this company burn down…”. Okay it won’t be exactly like that, but they could sue the company or ask for licensing fees. Basically, the patent system could be rewarding the wrong people. I wonder if it is possible to give patents only to ideas that have some amount of demonstration. It might be very hard to define “demonstartion” and how much demonstration you need.

I should stop rambling about patents and start working on documents for my new patent haha. Before I do, here’s a stock chart of Apple across 1980 – present. The Dow Index looks like a midget compared to Apple (almost 10,000% growth over 30 years). Note that the red line here is the same red line in the chart above.

(Update) My wife, an expert in OLED, says that Kodak first invented OLED, before all the academics and Samsung jumped in. If this is the case, I agree that they should be rewarded for their discoveries. It wasn’t like they merely scribbled some ideas (as in certain software and UI patents). Kodak created an entire field through extensive R&D efforts across many years. Academics built upon their initial works and Samsung invested heavily to make OLED manufacturing possible in large volumes. How to distinguish this kind of case from merely jotting down ideas without demonstrating might be one of the key elements of  patent reform.

Another question is why patents need to be written in a way that’s so hard to understand. I heard that the US government created patents to have inventors disclose their inventions in exchange for exclusive rights. The government wanted to encourage public disclosure of patents thinking it would allow other people to build upon inventions and stur innovation. I think the intention was good, but the problem is that no one (except for lawyers) nowadays reads patents. That’s because it’s almost impossible to get any valuable information out of patents. Had Kodak merely patented their OLED technologies, innovation in that field might have been much slower. Because they published research papers with significant details on the technology, academics and other companies were able to build upon their findings. I think patents can serve their initial purpose much better if they are written in a way that conveys more information in a more effective way. I wonder if the government could require people to include details in patents as in research papers and use the claims sections for all the incomprehensible legal phrases.

Here’s a fantastic article on the Washington Post about “Five myths on the debt ceiling”. Here’s the part I loved (or hated) the most.

On March 16, 2006, one Democratic senator in particular denounced George W. Bush’s request to raise the debt limit. “The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure,” the senator thundered. “Increasing America’s debt weakens us domestically and internationally. . . . Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren.”

That senator was Barack Obama, and he, along with most Democrats, voted against a higher limit that day. It passed only because almost every Republican voted for it, including many who are now among the strongest opponents of a debt-limit increase.

Even Obama couldn’t help become one of the foolish politicians. I wonder how every single politician, even those who used to be very bright people, can become so stupid once they win a seat in the Capitol.

I recently watched “The Contender”, a great movie about American politics. I strongly recommend it to everyone who is interested in how politicians operate behind the walls. The movie is about a vice president nominee who fights through hearings to prove that she is well-qualified. Instead of asking questions about her thoughts on various issues crucial to running the country, a number of Congressmen on the hearing committee use the opportunity to dig into her private life, trying to find any scandal that can stir the media and prevent any kind of productive debate on important issues.

I feel like this endless routine goes on and on in all democracies. Politicians fight not for a policy or ideology that can save the country, but merely to take their opponents down. Since their main goal is to get elected by winning over their opponents, the debates do not focus on the important issues, but instead on scandals related to their opponents’ private life that has nothing to do with how this country should go forward. Media also focuses on those scandals since they are easier to understand for the general public compared to complicated nation-wide issues. I wonder how many people will choose to click an article about a sex scandal versus an analysis on national debt. Moreover, media nitpick on minor wording mistakes that politicians make during a public speeches instead of focusing on the general theme. Do people really think giving good speeches with polished words is the most essential skill of a politician? It might seriously be better to give good-looking Hollywood actors some scripts and let them do the interviews and speeches, while the politicians focus on getting real work done.

I’m not saying we should ditch democracy, but I am confident there should be ways to improve it by changing the system. We can’t rely on the politicians to change by themselves because they are just like all of us; humans who try to maximize their gains while abiding by the rules of the whole system. They won’t change unless they are forced to do so under a new system. I am pretty sure there are quite a lot of interesting research from political science people on this topic. Trying to think of any political science person I know…

Which brings me to this question. Totally unrelated to political science, but I wonder if there’s any online service where you can type in a question like “political science research on fixing democracy” and gives you the list of people in town who can help you answer the question. I sometimes have these random questions spanning history, social sciences, technology etc that I can’t find much information on the web. It would be great if this kind of service is connected with LinkedIn.

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