Tuesday, October 6, 2009

Private Equity Skewered in New York Times

Quite a comprehensive piece in this weekend's New York Times on the world of private equity - using as a proxy the story of Simmons Bedding Company. This is a great topic and something that speaks to our system - the heads we win, tails we win culture in the upper echelons of finance (and one could argue the entire corporate system) and the costs that are born. I have seen locally for years many cases of private equity's "work" in the auto industry, and the most infamous example is the disastrous foray by Cerberus into Chrysler. But there are a litany of smaller examples both in manufacturing and outside of it. One piece that really woke me up on how the game works was a BusinessWeek article in 2006 on Burger King [BusinessWeek - April 10: Where's the Beef?]; I wrote about this piece about a year ago [Nov 8, 2008: NYT - Debt Linked to Buyouts Tighten the Economic Vise]

...the main story I want to focus on is private equity which were about 18 months ago the new golden children - masters of the universe; the best, the brightest, the new power brokers in our era of cheap credit and looking the other way while they load the companies they buy in debt while running off with huge paydays. So for their self interest they are effectively bogging down company after company and threatening the jobs of many in this country. The fallout will be even more apparent in the current credit situation.

I still to this day, on principle alone, won't buy Burger King (BKC) stock based on this story I read in BusinessWeek a few years ago [BusinessWeek - April 10: Where's the Beef?] I'm not the only one [Nov 19: Cramer Goes off on Private Equity] The irony is the IPO of Blackstone (BX) effectively put in the "top" in private equity.

Private equity firms embarked on one of the biggest spending sprees in corporate history for nearly three years, using borrowed money to gobble up huge swaths of industries and some of the biggest names — Neiman Marcus, Metro-Goldwyn-Mayer and Toys “R” Us.

The new owners then saddled the companies with the billions of dollars of debt used to buy them. But now many of the loans and bonds sold to finance the deals are about to come due at the worst possible time. So, like homeowners with an adjustable rate mortgage that just went up, some of private equity’s titans are facing a huge squeeze.

So here is the story in simple terms and yes I am simplifying for the hard core capitalists out there who defend our beautiful system. Private Equity firms soar in to take over company A (with cheap money handed out by the Fed). In return for providing management expertise (which come at a high cost) the private equity firm usually saddles the company with huge amounts of debt (to pay for said fees), while usually "streamlining" the company (read: cutting many jobs) which helps make the company more profitable in the very near term. With that "value add" to the bottom line the company can then be flipped to the next sucker down the line for a profit. Of course even if they cannot sell for profit they still get their fees for their expertise. Heads they win, tails they win.

So what happens if the acquired company suffers in the long run due to lack of investment in the near term (which helped turbo charge profits)? Who cares. The fees were paid to the PE guys - they've moved on to the next carcass. What happens if (even worse) the company goes bankrupt from the new debts thrown onto the balance sheet. Again - who cares. The fees were paid to the PE guys - next host body to feed on. And what happens when this builds up for a number of years across an entire economic system, with debt levels skyrocketing, posing threats to company after company laden with debt? That's where your Federal Reserve comes in to the rescue making sure a system that was created due to nearly free money is bailed out by... well, more nearly free money. Do you see why the Federal Reserve is so important to our financial oligarchy? Heads they win, tails they win.

"The mind-set was, since the money was practically free, why not leverage the company to the maximum?"

Notice how we keep coming back to the same source of so many of our problems? The vaunted Federal Reserve who simply fixes everything with easy money - and then pats themselves on the back that they "fixed" the problems of their own creation. They do not take responsibility for all the damage they have caused across our financial system ... so many ill effects, too many to measure or count that happen each day because "free market" rates for loans to debtors don't apply to anything.

This also speaks to a far larger conversation about the "system" of short termism - [Sep 9, 2009: WSJ - Vanguard's John Bogle, Warren Buffet Speak Out Against Short Term Nature of Markets] for the benefit of massive profits to a tiny group of people in the country, countless companies are raided, stripped, flipped, and ripped. Great if you are a leech - not so great if you are the host body. Even the Germans (socialists mind you ;)) call private equity firms nothing more than locusts. Meanwhile the unfettered actions of the PE firms are worshiped in the Anglo-Saxon model of the UK and US (how are those 2 economies doing again?). Just since I've started the blog we've pointed out a few examples; I don't really follow this closely day to day - I am sure I missed countless others.
  1. [Apr 11, 2008: This Day in Bankruptcies - Another Airline and our First Major Retailer] Two months before Linens ’n Things was acquired, it reported $2.1 million in long-term debt; by Dec. 31, 2007, that amount had exploded to $855 million.
  2. [Jul 21, 2008: Add Mervyn's to Our Growing Litany of Retailers Headed to the Great Sunset] It would also be an embarrassment to Mervyn's owners. Private-equity firms Cerberus Capital Management and Sun Capital Partners, along with three other partners -- including real-estate investor Lubert-Adler -- acquired the chain from Target Corp. in 2004 for $1.2 billion. The group put up about $400 million in equity and financed the rest. But while thousands of employees would lose their jobs and their vendors would get hurt in a Mervyn's liquidation, the private-equity buyers wouldn't stand to take much of a financial hit. That is because when they bought the company they structured the $1.2 billion deal as two separate transactions -- one for the retailer and a second one for the retailer's real estate.
  3. Sam Zell had a run in with Tribune [Dec 8, 2008: Tribune Files for Bankruptcy] Let’s say that a group of corporate executives uses scads of debt to take over a struggling company, sells off some profitable assets, lays off thousands of employees while achieving miserable results. And then, less than a year after saddling the company with $8 billion in debt, they opt for bankruptcy. You’d expect them to walk the plank, or at the very least, spend a good stretch of time in the naughty corner. But you wouldn’t expect the top 700 managers to collect $66 million in bonuses. ... both the company’s union and the trustee appointed to oversee the bankruptcy raised objections, arguing that the bonuses would be the highest ever paid — even as the company has its lowest cash flow in 10 years.

So this situation of asymmetric outcomes is one we should be asking as a country if we continue to want. But any time you raise some questions you get yelled at (unpatriotic! socialist! best system there is! let the free market live!) Which free market again? The one where the Federal Reserve constantly throws savers of the country under a bus to support the financial oligarchy with easy money? That is not exactly letting the free market work. But who am I to ask these questions - I just provide stories and stare blankly at walls seeing what I see, and shrugging my shoulders since very few care to ask questions. The way I see it, the dogma will rule the land and until the country runs out of hosts for the locusts to feed on, this will continue... all the while many of the hosts repeating the dogma themselves. Ironic.

If you are new to private equity (and let me be clear that some subset of the players involved actually are trying to make sensible deals and think out more than a few quarters or years) I encourage you to read that Burger King piece I listed above, and read / watch this New York Times story.

---> There is a fantastic set of mini 1-2 minute videos the New York Times - wish I could embed them but go here. It takes about 15-20 minutes to flip through them all. This should be a one time "special report" TV show on all the major networks at 8 PM Thursday night so those who only get their news from the Boob Tube could figure out part of what is going on in the country. The series is called: Flipped - How Private Equity Investors Can Win While their Companies Lose.

Again, the New York Times uses as a proxy Simmons Bedding Company for the associated story, and anyone who defends this system of leeches feeding on hosts will obviously find some strategic mistake found at Simmons itself - that's really beside the point. This is but one company in a long line of examples - the question should be about the system, not company ABC or XYZ.
  • For most of the 133 years since its founding in a small city in Wisconsin, the Simmons Bedding Company enjoyed an illustrious history.
  • Simmons says it will soon file for bankruptcy protection, as part of an agreement by its current owners to sell the company — the seventh time it has been sold in a little more than two decades — all after being owned for short periods by a parade of different investment groups, known as private equity firms, which try to buy undervalued companies, mostly with borrowed money.
  • For many of the company’s investors, the sale will be a disaster. Its bondholders alone stand to lose more than $575 million. The company’s downfall has also devastated employees like Noble Rogers, who worked for 22 years at Simmons, most of that time at a factory outside Atlanta. He is one of 1,000 employees — more than one-quarter of the work force — laid off last year.
  • But Thomas H. Lee Partners of Boston has not only escaped unscathed, it has made a profit. The investment firm, which bought Simmons in 2003, has pocketed around $77 million in profit, even as the company’s fortunes have declined. THL collected hundreds of millions of dollars from the company in the form of special dividends. It also paid itself millions more in fees, first for buying the company, then for helping run it. Last year, the firm even gave itself a small raise.
  • Wall Street investment banks also cashed in. They collected millions for helping to arrange the takeovers and for selling the bonds that made those deals possible. All told, the various private equity owners have made around $750 million in profits from Simmons over the years.
  • How so many people could make so much money on a company that has been driven into bankruptcy is a tale of these financial times and an example of a growing phenomenon in corporate America.
Financial Oligarchs always seem to win in our system.


Of course our CEO's are also part of the "heads we win, tails we win" culture - in a smaller separate piece the tale of Simmons CEO for much of the latter part of its non bankrupt life. Again, when you pay people at a level that it does not matter how they perform; they have secured generational wealth no matter the outcome of their decisions... well you have American 'free market capitalism'. The association between wages and performance have completely broken down in the top tranches of our society.
  • Mr. Eitel, former colleagues said, really wanted to bring some sizzle to the ho-hum mattress business. He was paid millions of dollars to run Simmons for several private equity investment companies, first Fenway, then Thomas H. Lee Partners. Like those firms, he fared well, even though Simmons plans to file for bankruptcy.
  • ... while Simmons now faces an uncertain future, Mr. Eitel was a winner in The Great Game of Life. As chief executive, he enjoyed country club memberships, personal use of the corporate jet and thousands of dollars a year in free mattresses. Before stepping down last fall, he earned more than $40 million in compensation, bonuses and perks, according to an analysis by Brian Foley, an independent compensation consultant in White Plains. He earned the bulk of his money when Simmons was sold to Thomas H. Lee Partners. (heads he wins, tails he wins - $40M to help run a company into the ground; boo yah)
  • Mr. Eitel ran Simmons as if it were his fief, several former executives said. His son joined Simmons’s sales force and a son-in-law landed in the company’s marketing department. A daughter often sang at corporate functions and even wrote and recorded a series of songs that were pressed into CDs and distributed at a sales meeting in Las Vegas.
  • ... many former Simmons executives said that he ruled from afar — that he rarely appeared at the Atlanta headquarters. Instead, he spent much of his time in Naples, Fla., where he and his wife built an opulent home with a 1,000-bottle wine room and a multitier cascading pool featuring glass mosaic tiles. The home was listed this spring for $16 million.
  • Mr. Eitel also spent a great deal of time wooing clients from his 80-foot yacht, Eitel Time. With his boat, which had 11 televisions, a hot tub on the flybridge and a sunken granite-topped bar in the salon, Mr. Eitel took customers out for cocktail cruises and junkets to Martha’s Vineyard. The private equity firms that owned Simmons during Mr. Eitel’s tenure appeared to embrace Mr. Eitel’s lifestyle. The first year that Thomas H. Lee Partners owned Simmons, the mattress company even paid the $92,000 salary and benefits for the captain of his yacht.
Did he do a good job? Bad job? I don't know - his company is in bankruptcy - he can blame the PE firm I suppose. But does it matter? Not in Cramerica. Just reach the C level suite - and then keep the seat warm for a few years. Then crow about how few people in the entire world could do this work, and if you are not paid for your acumen you will (a) be unmotivated as opposed to the common peon lower in the company ranks and (b) move to another country. ;) Again, this brainwashing that only a few people on the planet have this skill set (wining and dining on a yacht cannot be too hard?) is what the defenders of the system cry out each time it's challenged. Or they say it's a one in a million anomoly - even though I could post a new example each day if I tried.

It is nice to see the stirring of emotion and understanding in the "comments" section of the story (546 comments!) - many things stay hidden in dark corners until a mainstream newspaper actually tells the tale to the unwashed masses. Perhaps only when a critical mass decide some changes need to happen will there be any real push to reconstruct the system. Hopefully we won't have to wait until it reaches "pitchfork" stage; but until them let the transfer of wealth from the many to the few continues (reverse Robin Hood) while we hear how just 0.2% of America truly has the brains to hold these exalted roles in C-level suite, investment banks, and private equity. Everyone else in the country (or globe)? Just not talented or smart enough.


Yves over at Naked Capitalism also calls out the pirates of capitalism... her well titled piece is: New York Times Fails to Call Private Equity Looting by its Proper Name

The New York Times tonight features a generally very good piece, “Buyout Firms Profited as a Company’s Debt Soared,” by Julie Creswell that falls short in one important respect: it fails to call a prevalent and destructive practice of private equity firms by its proper name.

PE firms in the risk-blind environment preceding the credit crunch got into the habit of producing good to stellar returns by modifying their usual formula. The traditional model was to buy companies with a ton of debt, then improving their bottom line by a combination of partial asset stripping (selling off ancillary operations), cost cutting, and once a blue moon, actually doing something to improve operational performance. Then the company would be sold, either privately, usually to a corporation, or taken public.

But the PE firms found a much easier approach: just pile on more and more debt, and pay themselves a special dividend. No need to do any work, just keep borrowing until you had recouped your investment and then some. And that way you did not need to care how the company fared. If you destroyed the business, it was of no mind to you and your investors. Other saps were left holding the carcass.

Boo Yah! American "free market" capitalism; working like a charm at concentrating wealth in fewer and fewer hands under the guise that just 0.2% of our nation has the brains, hence deserve all the loot. Source? Dogma.

More than half the roughly 220 companies that have defaulted on their debt in some form this year were either owned at one time or are still controlled by private equity firms, according to analysts at Standard & Poor’s.

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