BrainTrust Query: Has the risk been taken out of corporate buyouts?

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Jul 26, 2006
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By Bill Bittner, President, BWH Consulting

(www.bwhconsulting.com)


In the first of a series, Tuesday’s front-page article in The Wall Street Journal described how the new corporate buyouts funded by hedge funds and investment bankers no longer involve much risk for the investor. The retail industry is no stranger to corporate buyouts. And although you have to ask yourself, “Where were the Board of Directors if another group of people feel the company is ready for a turnaround?” – there are legitimate situations where a firm needs help from outsiders to make the tough decisions that will allow it to survive.


The problem with today’s buyouts is that the buyers want their money back right away. Instead of sticking with the company and waiting for the turnaround to fund their payment, the investment bankers are loading the firm up with debt and paying themselves special dividends. This creates an ongoing interest payment for the firm and can make an already bad situation worse.


In order to make the debt payments, the firm begins cutting back on employees and reducing benefits to retirees. If things get really bad, the firm goes into bankruptcy. Of course, the investment bankers who have already taken out their money are there to provide bankruptcy services.


If things go well, the investment bankers take the firm public again in few years and retain a large holding in the newly floated securities.


Discussion Question: Does it make sense that firms conducting buyouts are able to saddle the acquired firm with debt just so the acquirer can get their
money back?

Yes, we’ve known that this goes on, but the Wall Street Journal article gives us a clearer idea of the magnitude of this new way of doing business.
I am all for “risk and reward” and I believe those willing to put up their resources to create companies or restore them should benefit. I don’t believe individuals should be
able to profit merely because they have a lot of cash and clever lawyers on their staff.


It seems that by buying out a company, loading it with debt, taking back your money, and receiving further profit – whether the company succeeds or fails
– you’re doing nothing but keeping a lot of pencil pushers employed.

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9 Comments on "BrainTrust Query: Has the risk been taken out of corporate buyouts?"


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David Livingston
Guest
14 years 7 months ago

It is very common to see the buyers of an acquired company immediately borrow money and give the investors their money back. Maybe not the next day but over the next couple of years. After that, it’s all profit if they are able to continue to generate cash flow and pay more dividends. If things turn sour, who cares as long as the investors are made whole? It’s all about the dollars and investors have to separate themselves from the emotional aspects such as job losses and loan defaults. It’s like slaughtering animals for food. As long as the cow is not our pet, we don’t mind.

Craig Sundstrom
Guest
14 years 7 months ago

LBOs often (usually?) have little theoretical justification: why should the firm itself be saddled with mountains of debt that have nothing to do w/ the actual operations? Why shouldn’t the debt be treated as exactly what it is, the personal obligation of the owners? Of course, even this treatment would do nothing to prevent destructive (management) behavior… and that, ultimately, is the real problem. Too many buyouts are by people who either can’t or won’t put the interests of the company before their own. If the havoc of their folly was just restricted to themselves – and those foolish enough to lend to them – it would be a private matter. Unfortunately, it also carries over to employees, suppliers and landlords… all of whom bear much of the burden, but reap few benefits.

Bill Bishop
Guest
Bill Bishop
14 years 7 months ago

Bill has highlighted a real problem that goes well beyond our sector of the business. The problem is that it’s still very easy to take on debt and, as a result, many companies are over-leveraged from a debt point of view.

This, of course, limits what management can do and frequently leads to a very short-term focus.

Strikes me that Bill’s thinking is clear and spot-on, but we do have an opportunity to change the headline to read something like, “Think twice about corporate buy-outs; they’re a lot riskier than they look.”

Ed Dennis
Guest
Ed Dennis
14 years 7 months ago

This is a hateful means of making money, nothing is created, nothing is built, all but the investors are done a disservice and employees conditions are generally worsened. It is a shame that this callous disregard for humanity is only dealt with after the damage has been done. I generally feel that the government should stay out of our lives but I do believe that any receipts (not income) that a buyout group receives should be taxed at 98% the first year, 89% the second year, 85% the third year and scaled down to 50% after the tenth year. I believe this would eliminate the excessive charges, stock pumping tactics and generally discourage predatory purchasing in the USA. Let the buzzards do their dirty work in Europe or China!

Eliott Olson
Guest
Eliott Olson
14 years 7 months ago

Buyouts occur because capital is not being used efficiently. If a public company is bought out by an investment banker, it means that management and the directors have gone ROAD, retired on active duty. If you remember, the investment bankers were circling Kroger a while ago and Kroger juggled their capital, payed a dividend and took on debt to remain a virgin.

It used to be that many companies owned their own real estate. Since the book value of the real estate rarely keeps pace with the real value, a buyer has something to leverage. Even without ownership, the leases can have value. It will be interesting to see what the spread in value will be at Sears.

Kai Clarke
Guest
14 years 7 months ago

Firms which are ripe for purchase have many assets that the purchaser can use. How they use them (as a basis for paying off shareholder debt) is only a balance sheet issue. Debt is debt. Outstanding liability is still just that, a liability. Many times this has a short term effect on earnings, but so does the sudden influx of cash (the other side of this equation) during a buyout. The important key here is that there is still much risk in a buyout, and only a healthy company can survive in today’s market. The important point here is that a company must be robust and profitable to pay off these debts for the sharholders to receive their money. Otherwise everyone loses (and the stock goes down).

Mark Lilien
Guest
14 years 7 months ago

Leveraged buyouts aren’t new. But they are more popular when interest rates are relatively low, since lenders only make money when they’re paid back. Many investors are attracted to retailing’s high cash flow, generated by depreciation. The cash flow can pay back the loans. The problem: is depreciation a real cost or can it be ignored? Most retail assets need replacement and refurbishment. In the long run, depreciation is a real cost. If the retailer uses the cash flow to pay back the big loans, there’s less money to refurbish the stores and their technology.

However, recently failed retailers (and those who are still struggling) are largely not victims of investor buyouts. They’re usually mediocrities with no unique market positioning and below-average managements.

Robert Antall
Guest
Robert Antall
14 years 7 months ago

Remember “Bonfire of the Vanities?” We are going through another cycle of “leveraged buyouts,” only spun differently, where the investors make lots of money; dress up the company and sell it to the public saddled with unservicable debt. The problem with these deals is that no one cares about the long-term health of the company, its employees, customers or retirees. It’s all about making money for the investors. Look at Sears. Lampert is bleeding the company of all its cash by cutting marketing, store remodels, etc. How can they hope to compete in the long run with Target, Wal-Mart, Home Depot, Kohl’s, JC Penney, et. al.? In general, these deals are not good for retail. In many cases, the companies that were once healthy are sold off to a competitor or fold.

Bill Robinson
Guest
Bill Robinson
14 years 7 months ago

Why are so many fine firms selling out to investments houses? To the buyer, retailers are attractive because of positive cash flows and the prospect of a quick turn. Sellers are motivated to sell because it is difficult to run a publicly traded company with the quarterly filings and the analyst scrutiny, Sarbane-Oxley, etc.

I worry that all of these going-private transactions will add even more volatility to the retail industry at a time when customer loyalty is low. We want our trusted retail brands to be providing excellent service season after season. We don’t want our retailers to be changing hands every couple of years, disrupted by management changes, and paying huge fees and dividends to the investors.

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