I am going to share a real case with you.  A founder hired a CFO as his business began to grow significantly.  He told the incoming CFO he had negotiated a lease line that had an 8% interest rate just prior to the CFO joining.  The CFO called us and asked if we wanted to lease at 8%.  I said “if 8% is good, how does 0% sound?” and immediately explained that the question is really “What is really important to you?  What are you solving for?”  I went on to ask, “Is it to say that you are paying the lowest interest rate?  Is it the lowest monthly payment?  Is it to have the most total cash available?  Is it to have the fewest financial restrictions or is it to know with certainty what the total cost of financing will be for the use of the equipment over the useful life of the asset?”

He was honest enough to say he had not considered these dimensions of the business decision and admitted that his company would be selling equity in a month or two.  The CFO then took time to prioritize.  What do you think he decided to do – minimize his total cost of financing or maximize his cash runway?

The second factor is the future supply of credit.  The suppliers of credit extend beyond banks and include private and independent firms, some with diversified lending products some specialized lenders and lessors like Fountain Partners.  What is the prospect for banks to increase loan production?  The Fed has certainly invited them to lend and some firms like JP Morgan (JPM) started to expand loan production in 2010.  What is the prospect that private market sources like endowments and foundations, family offices and individuals will increase their allocation to debt funds relative to historical averages?

We believe the stage is set for an over allocation to income strategies over the next 5 years.  Psychologically, people continue to carry aversion to instruments and issues that price every trading day.  Madoff, the flash crash, Galleon among other revelations leave the investing public with the impression that key elements of our economy can be high jacked or mismanaged by our best and brightest management teams, boards and elected officials.  Why shouldn’t we expect market participants to demand a greater premium to hold issues that are subject not just to everyday broad economic risk but to internal and external managerial exploitation and/or price manipulation?   The simple point is that we see people gravitating toward fixed income – any fixed income – any promise of returns from a negotiated instrument.  Much of the interest in debt and credit products makes great sense in the context that I just laid out.  The problem is that we (collectively as market participants) are likely to get it wrong again.  We tend to over shoot nearly everything and here we are likely to over allocate capital to debt and credit strategies.

People cannot help but relate the promise of fixed return to their experience in equities or commodities and most will have a positive bias toward debt.  One problem however is that credit products, even if there is not a daily market for them to trade in, do carry underlying volatility.  We may not see it or think about it, particularly when we cash our coupon every period, but underlying risk remains.  We worry that market participants fail to require the pricing required to match up with real underlying volatility and the potential for default.  We worry that market participants are about to over allocate to fixed income strategies and that debt and credit products are poised to be mis-priced.  Originators of and investors in debt and credit do not need to necessarily take as much risk as they did between 2004 and 2009 to mis-price debt.  They do not need to invent exotic varieties or to confuse borrowers, insurance companies or well intentioned government employees.  All they need to do is over bid the plain vanilla opportunities that are before them.  We think that the oversupply of credit is going to overwhelm an otherwise cyclical move to have tightened credit standards.  The pain of 2009 has already been or will soon be forgotten and greed will trump fear over the next 5 years.

Think about the historical failure and recent success of certain specialty e-tailers, the trajectory and success of others including Amazon since its founding, the evolution of Wal-Mart and other offline retailers and the entire future of e-commerce.  In the late 1990s I used to think about a point in time when the majority for consumer purchase activity was done through the internet directly sold by manufacturers or value added resellers.  I still wonder how far away that is.  Enjoy the article and let us know your thoughts:  http://www.businessweek.com/magazine/content/10_42/b4199062749187.htm

-Tom

Hosting executives and industry leaders are converging on Las Vegas over the next couple of days for the Hosting Transformation Summit 2009. It will be out in the desert and under the neon where challenges of the industry will be discussed and how hosting and related application providers can position themselves to succeed in the future.

So why is Fountain Partners attending? It’s simple. For hosting providers, CAPEX costs are a significant part of their business. Rather than to simply buy more and more infrastructure to keep up with client demand, businesses are turning to equipment leasing solutions that Fountain Partners provide. Moreover, hosting companies have held up very well overall in the recent economic downturn. While some application service providers have put off capex upgrades, hosting companies have continued to replace the old and sell the latest, fastest and most energy efficient processors available.

The summit will be a great way to catch up with these hosting providers as well as other financial professionals to let them know that equipment leasing is an excellent financing alternative for these CAPEX-intensive businesses, particularly with some banks and other forms of capital slow or unable to react to all but the largest operators in the space. Fountain Partners remains a trusted financial partner to hosting, colocation, cloud storage and managed services businesses and has continued to invest fresh money in to the industry throughout meltdown in the financial services industry.

Stay tuned in the next couple days for Tom Carter’s observations from the Summit by following him on Twitter @tom__carter.
www.twitter.com/tom__carter