I’ve been curious about non-publicly-traded investments for a very long time. My interest stems primarily from starting out with the oil and gas tax shelters sold by small- medium-sized oil and gas companies that were around when I became a securities analyst, specializing in natural resources, in 1978. But I was also aware that Yale, where I had been a grad student for six (!) years, was beginning to shift to private equity as a way of maximizing its endowment funds.
The owner of Value Line, where I got my start, was deluged with prospectuses for oil and gas partnerships, so I became deeply acquainted with the format very quickly as he plopped prospectus after prospectus on my desk to evaluate. During this period, I also covered companies that prominently featured such partnerships, acting as the “master partner” who actually ran the operations and collected a hefty fee for doing so.
What I learned:
–a driller operating for himself would only start a well if he expected at least $3 in revenue for every dollar spent on finding oil or gas and getting it to market. With acreage drilled for limited partnerships, however, the rule of thumb was $2 in revenue. Put a different way, the partnership acreage was, in effect, reject acreage, undrillable without the limited partnerships footing most of the bill.
–very thick prospectuses spelled out who got what share of the oil and gas sales revenue generated by the partnership efforts. To my way of looking at them, after drilling costs and revenue distribution to entities higher up the food chain, the there was almost no way limited partners would ever make money. One day, I was chatting on the phone with an officer of one of my coverage companies and danced this thought by him. His response was that I was correct–that the biggest (only?) value in the partnerships was that the limited partner could mention at cocktail parties that he/she was involved in the oil and gas drilling business.
What triggered my mind to pull this experience out of deep storage?
I was reading about private equity involvement in a US chain of jewelry stores specializing in diamonds that just declared bankruptcy. I thought, “Who would invest in a retail outlet for diamonds? A half-century ago, maybe, …but now?”
The issues I see:
–in the old days the wholesale price of diamonds was controlled by the De Beers cartel. But starting just as I was entering the stock market, large diamond discoveries outside the De Beers orbit were being made. Those owners declined to participate in the De Beers cartel, creating secular downward pressure on the diamond price
–at the same time, synthetic diamonds, initially ugly and used in oil and gas drill bits, were being perfected. For decades since, they have been very cheap and hard to distinguish from the mined variety. And it also appears that tastes have changed to the point that younger consumers favor synthetic. The result of all this is that diamonds have long since become a commodity business
–it also appears that tastes have changed to the point that younger consumers favor synthetic, creating further price pressure
–there’s the question of conflict diamonds, as well.
Of course, I’m not on the inside and have no access to the actual investment rationale in this case. Still, it seems to me to be a case of swimming upstream against a very strong current.
The virtue (if that’s the right word–would “characteristic” be better?) of private equity, and of private credit as well, is that the holder doesn’t have to mark the position to market every day, as is the case with publicly traded stocks and bonds…another plus, avoiding the bad optics of an at least temporarily underfunded pension plan. Arguably, too, the relative illiquidity of these investments is simply the no-free-lunch price to be paid for the possibility/expectations of extra-high returns.
My guess is that we’ll ultimately find that the same set of political factors affecting the overall domestic economy and the currency are also at work in the private arena. That is, the combination of $US costs and foreign currency revenues is an unusually strong winner, and that the opposite is a worse-than-expected loser.
The biggest issue I see for the private arena is that it may be difficult to change structural elements like this quickly and at low cost. In addition, it’s possible/likely the dollar will take another beating if Trump is successful in recreating the pre-Volcker Federal Reserve that was so destructive in the 1970s.