Saturday, October 2, 2010

The Wonders of Private Equity

No comment needed

Creswell, Julie and Peter Lattman. 2010. “Private Equity Thrives Again, but Dark Shadows Loom.” New York Times (29 September) Dealbook Special Section: p. 1.

“This summer, executives from the New York-based private equity firm SK Capital traveled to Houston to celebrate the first anniversary of their acquisition of a nylon manufacturing business. Soon they will have a bigger reason to uncork the Champagne. The nylon manufacturer has announced plans to issue about $1 billion in debt, of which $922 million will be used to pay a dividend to SK. For SK, which paid $50 million in cash for the business, that is an astonishing almost 18-fold return in a little more than a year.”


Jack said...

A question from one of the uninitiated. If SK bought the company for $50M last year, why would anyone take part in the purchasing of debt that is 20 times greater than the perceived value of the business? If the company has sufficient collateral to warrant a $1B debt offering, why would it have been sold for only $50M one year ago?

michael perelman said...

I can only guess at the answer. Interest rates are low, perhaps low enough that people will jump at the opportunity to earn a high yield.

The problem is that these yields will become a reality only if the company survives. With the heavy debt burden, they very well may now.

If the nylon business goes belly up, the private equity company need not cry since they have already, no doubt, extracted great fees from the company, over and above the enormous dividend.

Myrtle Blackwood said...

"...{The] ownership [of a private company] residing in a small group of financiers. The company would end up saddled with an immense amount of new debt, often in the form of high-yield, high-risk subordinated debt certificates called junk bonds. The risk on these was high since, if the company were to go bankrupt and be auctioned off, the holders of the junk bonds would be the last to get any compensation....An important enticement to transform stocks and equity into bonded and other debt was provided by the insanity of the US tax code, which taxed profits distributed to shareholders, but not the debt paid on junk bonds. The ascendancy of the leveraged buyout therefore proceeded pari passu with the demolition of the US corporate tax base, contributing in no small way to the growth of federal deficits. Plutocrats are always adept in finding loopholes to avoid paying their taxes. Ultimately, the big profits were expected when the companies acquired, after having been downsized to "lean and mean" dimensions, had their stock sold back to the public.... "

George Bush, the Unauthorised Biography.
By Webster Griffin Tarpley and Anton Chaitkin
Chapter 19 – The Leveraged Buyout Mob

Myrtle Blackwood said...

2009 – December 14th. The CVC private equity firm is to avoid scrutiny after change in Luxembourg law. Details of its turnover and profit or loss are now no longer open to public scrutiny. Because it is a ‘specialized investment fund’ it is exempt from corporate income tax, business tax and net wealth tax.

CVC to avoid scrutiny after change in Luxembourg law
By Christian Sylt and Caroline Reid
Published: 6:48PM GMT 13 Dec 2009

CrocodileChuck said...

@Jack @ 6:33pm

I have no idea as to the structure of this deal. But, as far as PE deals usually work, probably something like this:

the PE co. organises financing for 90% of the purchase price; they themselves kick in 10%. The target co. is taken private, and costs are cut, the business restructured, etc. Typically after some point, the co. is either refloated, or sold to a third party. The proceeds of this sale are used to repay the bank or syndicate of lenders of the 90% which is borrowed. The remainder is the return for the original 10% so called 'equity'; if the PE co. is lucky, it is several times the value of this amount.

Jack said...

"The problem is that these yields will become a reality only if the company survives. With the heavy debt burden, they very well may now." Is that supposed to be "now"
or "not"?

And if the company defaults on that huge debt, relative to the last buy out price, what, if any, liability does SK bear for floating junk? Of interest will be to see what institutions buy the debt. Who at such institutions will be held accountable for buying junk for the sole purpose of greatly enriching SK principals? Will AIG be writing CDS contracts inorder for the buyers of the debt to hedge their risky bets? And what quantity of "naked" CDS positions will then be sold as profitable until such time that the original company chokkes on the debt?

This process has familiar scent. I'm becomiing even more curious as to the extent of similar "deals" that will put the debt market at risk. How do I find out if my
401K funds are being used to purchase such sterling investments?

john c. halasz said...

Likely, the LBO debt was stuffed into various CDOs and mixed in with other credits, so that the actual buyers didn't quite know what they were getting and missed the stench.

Kaleberg said...

I've actually been surprised that there is so little liquidation activity. Interest rates are incredibly low. Stock prices are moderate. It should be easy to score a short term loan based on the value of the acquisition target's existing cash reserves and cash flow. Use the money to buy control of the company, have it take on a pile of debt, issue you a dividend or whatever, and leave the operating firm screwed. It worked very well in the 1980s, even when interest rates were higher.

Hell, I've been looking for companies with big cash reserves selling at a discount. Watch, we'll probably start seeing companies taking out big loans as anti-takeover mechanisms. When incomes are flat, and there is nothing to invest in, this is a sure fire way to make money.

I think the real problem is that of corporate governance. I'm with Berle and Means: we need much higher corporate tax rates, or the real money will be in crap like this, rather than in producing goods and providing services.