On Wednesday, John Gittelsohn of Bloomberg wrote that CalPERS acknowledged that it has been in ongoing discussions with two former partners from the tech-focused private equity firm Silver Lake. Each is a candidate to run one of CalPERS two new private equity schemes, even though the board hasn’t agreed to commit the needed funds. In no functioning organization do you start recruiting before an initiative has been approved, but this speaks again to poor governance and lack of professionalism at CalPERS.
Dan Primack, the influential private equity columnist now at Axios, took a swipe at this CalPERS news Thursday morning. Primack pointed to the fact, as we have, that Silver Lake already took CalPERS for a big, costly ride and that the histories of the two Silver Lake executives don’t look compelling. As we’ll discuss, the picture is even worse than Primack indicates.
A refresher: the centerpiece of CalPERS’ “highly questionable plans,” as Primack put it, is creating two new large fims, each of which would invest roughly $10 billion of CalPERS monies. One would focus on “core economy,” whatever that means, and hold investments for a very long time, which is a prescription for valuation fraud and which, CalPERS now admits, is expected to generate lower returns than traditional, shorter holding periods. The other would invest in yet another fad, “late stage venture capital,” with focuses on life sciences and clean energy.
CalPERS has admitted these vehicles won’t be accountable to CalPERS; CalPERS won’t even appoint its toothless advisory board. CalPERS has also ‘fessed up that these funds may, which means will, raise money from other investors. At that point, CalPERS will have succeeded in re-creating the traditional private equity fund structure that it originally set out to escape with the initiative, only at much greater risk by making super-large commitments to start-ups with no track record and by making concentrated investments.
CalPERS’ “Fire, Aim, Ready” is a too-obvious effort to muscle the board. CalPERS staff is operating in an astonishingly high-handed and incompetent manner. The only rationale for trying to recruit candidates before staff has finalized the private equity scheme and the board has approved it is to strong-arm the board, by trying to argue that these great picks won’t wait much longer. It also serves to condition board to see the venture as a given by getting them to focus on implementation issues and divert their attention and energy from fundamental “Why are we doing this at all?” questions.
CalPERS’ staff is simply trying to get these schemes across the finish line rather than making sure they get done well. The way to get the most candidates for any sort of hiring process is to be public about the opportunity and invite proposals. This is particularly true if the role is attractive and the best candidates are currently employed. In this instance, there was definitely no public solicitation.
CalPERS almost certainly approached only the personal contacts of its executives and key advisers, particularly the uber-conflicted Silicon Valley lawyer Larry Sonsini, who has an extensive paper trail of business dealings with Silver Lake. The fact that CalPERS has kept its private equity staff frozen out of this process means this effort has to have been superficial since the CalPERS PE staff possesses most of the organization’s connections to the industry.
When CalPERS has repeatedly emphasized the importance of attracting “talent,” why would it so flagrantly undermine that objective via a severely constrained search process? The only plausible answer, as former board member JJ Jelincic intimated in his What’s the Payoff? article, is that staff is pushing this scheme so hard to advance their personal aims, as opposed to those of beneficiaries.
CalPERS yet again wants to enrich its victimizers. CalPERS acts like the battered girlfriend who keeps going back to the tattooed bikers who beat her.1 Remember that CalPERS took a highly embarrassing and visible hit via investing at BlackRock’s instigation in the Stuyvesant Town deal, in which the giant pension fund lost over $500 million. Moreover, that investment was made by senior management, over the objection of the apartment portfolio manager.
Yet despite BlackRock doing squat to make that up to CalPERS, CalPERS was falling all over itself to hand a large chunk of its private equity business to BlackRock, via a “what could they be thinking” fund of funds scheme which was guaranteed to increase costs and lower returns.
As we described in an earlier post, Silver Lake managed to do BlackRock one better, delivering big losses to CalPERS on what should have been a sure-fire deal. BlackRock’s StuyTown deal, like any real estate investment, could always lose money. By contrast, CalPERS took a stake not in a Silver Lake fund or deal but a 9.9% interest in the firm itself. Investing in an established private equity general partner ought to be as close as you can get to a guaranteed win: only vanishingly small odds of loss with handsome potential upside. Recall that, as Eileen Appelbaum and Rosemary Batt pointed out in their landmark book Private Equity at Work, over 60% of the income that private equity firms earn is from fees that the firm collects regardless of how it performs, like management and monitoring fees.
But Silver Lake got CalPERS to remove a critical investor protection, an anti-dilution provision, from the draft contract. No competent investor should have agreed to that. And Silver Lake then massively diluted CalPERS, effectively stealing the money CalPERS had invested. Nice work if you can get it.
One of the two candidates mentioned in the Bloomberg article, David Roux, was a co-founder of Silver Lake and a longtime member of the firm’s senior management. So neither CalPERS nor he can pretend he had nothing to do with
screwing CalPERS this loss.
These candidates aren’t such hot picks. CalPERS cooperated with the Bloomberg story, to the extent of having a senior staffer sit for an interview. CalPERS must have thought showcasing these supposedly hot-shot names would improve the not-very-good image of its private equity plans. As Primack’s hot take shows, that was a bad assumption. A fancy brand is no guarantee of fitness to task.
One prospect, as mentioned, is David Roux, a co-founder and recent CEO of Silver Lake who is now a “senior director.” Bizarrely, CalPERS is considering him to head the “core economy” buy and hold-too-long strategy, even though Roux’s entire professional career has been in and around tech. The consideration of Roux makes a mockery of CalPERS’ claim that it wants “deep expertise” in these roles. At best, it’s like taking a formerly great basketball player and trying to turn him into a golf pro. It means that Roux’s reflexes and his Rolodex are largely irrelevant to what CalPERS wants him to do.2
But even that assumes that Roux has kept his contacts active. Despite keeping a formal role with Silver Lake, it’s not clear what if anything Roux is doing for the firm. Roux lives in Virginia, when Silver Lake’s only East Coast office is in New York. It’s not uncommon for private equity firm founders to stay in the saddle well past normal retirement age; KKR’s Henry Kravis is 74; David Bonderman of TPG is 76; Steve Schwarzman of Blackstone is 71. Roux is a comparatively youthful 61. His distance from the firm suggests he doesn’t have the passion for deal-making that other successful firm founders had, raising questions as to his motives and view of his role with the CalPERS vehicle.
The red flags with the other Silver Lake candidate, Adam Grosser, are even more apparent. Roux is at least has unquestioned expertise, even if he is being asked to operate outside that realm. Adam Grosser is now a former partner of Silver Lake because Silver Lake is exiting the strategy with which Grosser was involved, that of “Kraftwerk,” which the website describes as “providing growth capital to technology and tech-enabled businesses driving efficiency across the operations, energy, and resources industries.”
To put it bluntly, Silver Lake would not be jettisoning this approach if it had been a success. And Silver Lake apparently didn’t think enough of Grosser to deploy him elsewhere in the firm. Note that Grosser came to Silver Lake in 2011 from Foundation Capital, where he had also been a partner. Partners in private equity firms seldom leave other than to start their own firms. Grosser’s exit from Foundation suggests either his deals didn’t do well or he had serious disputes with his former partners. The question of why Grosser left Foundation and what his track record was there bears investigating, particularly in light of presumed weak results at Silver Lake.
Are these really CalPERS deals or Larry Sonsini’s deals? As we indicated, it’s hard to fathom how CalPERS can possibly come out ahead by investing in risky new funds in a massive way. CalPERS claim that it needs these vehicles to invest “at scale” are barmy, since even bigger private investors aren’t going this route. Indeed, CalPERS is responsible for any difficulties it is having in private equity investing, first by having reduced its number of private equity managers, which its private equity consultant Meketa deemed to have been a bad idea. As noted above, CalPERS has also had no head of private equity for months, and the very real possibility that CalPERS would cut the size of its private equity staff would hurt morale and lead the best employees to leave. Thus CalPERS whinging about how hard it is to put all that money to work sounds an awful lot like a kid who has shot his parents asking for sympathy for being an orphan.
However, it sure looks like Friends of Larry are being positioned to do well. David Roux is a very long-standing buddy. For instance, when Sonsini was implicated in several options backdating scandals as a board member as well as the Hewlett Packard illegal wiretapping affair, it was Roux in 2006 who sang Sonsini’s praises for a full four paragraphs at the top of a Fortune article. And as we’ve pointed out, the rising tide of CalPERS funds going to Silicon Valley would raise a quite a few boats, some of which are sure to be Sonsini’s. We quoted Bill Lerach, the disbarred but still formidable one-time plaintiff’s attorney in our New York Magazine article on CalPERS. Recall that Lerach has tangled with Sonsini and is now a consultant on the pathbreaking fiduciary duty lawsuit against KKR, Blackstone, and PAAMCO over over-hyped and underperforming hedge fund investments by the Kentucky state pension system. His words bear repeating:
Are you kidding me? That guy’s not a fox in the henhouse. He’s an alpha wolf, whose law firm has been involved in more dubious financial companies and their practices and transactions in Silicon Valley than any other firm. Of course he’ll be great for his financial clients while he works inside CalPERS to direct billions of dollars to them. Will someone please call the cops?
Unfortunately, the only parties that might prevent this train wreck are the press and beneficiaries getting the attention of key politicians, first and foremost the state Controller and Treasurer, who sit on the CalPERS board, new governor Gavin Newsom, who I am told already has some insiders warning hime that he needs to get on top of the mess at CalPERS, and state legislators, particularly members of the Senate and Assembly pension committees. It’s hard to protect CalPERS from its own terrible reflexes, but the costs of not intervening are sure to be very high.
1 And we don’t see the usual inducement of great sex, which again raises the question of what the inducement is.
2 Roux’s experience as senior partner at a firm could arguably be very helpful but this firm would have vastly fewer employees than Silver Lake and would thus not need as much in the way of “adults in the room” to keep everyone playing nicely together. Roux would also likely be very good in raising new money, something which is of no value to CalPERS.