“Debt is the lifeblood of private equity...”
April 6, 2018 9:55 AM   Subscribe

“If you have seen the movie Goodfellas, you may recall the scene where the mob takes over a bar: they run up bills on the company’s credit, rob the place blind, and then, when they’ve gotten as much as they can, burn the place down and walk away. That is only a very slight exaggeration of the real business model of private equity. “ The Working Person’s Guide To The Industry That Might Kill Your Company. (Splinter) “Private equity is remaking the retail environment, causing even successful companies like Toys ‘R’ Us to go out of business. And they’re fundamentally remaking American commerce in the process, with Amazon, Target, Walmart, and Dollar General set to benefit. Meanwhile, private equity is more or less getting off scot-free.” The Real Retail Killer. (New Republic)
posted by The Whelk (66 comments total) 68 users marked this as a favorite
 
Does private equity explain what happened to newspapers?
posted by ZeusHumms at 10:00 AM on April 6, 2018 [1 favorite]


Depends on the newspaper. The Denver Post is a vulture-capitalist victim, and it's not alone.
posted by Holy Zarquon's Singing Fish at 10:02 AM on April 6, 2018 [9 favorites]


Previously, by The Whelk
posted by ZeusHumms at 10:04 AM on April 6, 2018 [1 favorite]


Oakland and San Jose, California, too: East Bay Express: Feeding on Local Newspapers
posted by purpleclover at 10:09 AM on April 6, 2018 [6 favorites]


In that previously, mandolin conspiracy's comment hit my take on it.

Where does the money come from ? The private equity folks take over, and banks (?) lend the new company tons of money ? Or pension funds/endowments/"investors" in a hedge fund ? I'm trying to figure out who is taking the haircut when the company goes under (because it was so saddled with debt that private equity used to pay themselves).

(I mean, I know deep down it's the little people that pay for it, because capitalism, but.. )
posted by k5.user at 10:09 AM on April 6, 2018 [2 favorites]


I don't understand why leveraged buyouts are legal. How are they functionally different than a bust-out?
posted by ishmael at 10:14 AM on April 6, 2018 [5 favorites]


The private equity folks take over, and banks (?) lend the new company tons of money ?

Yeah, I can never figure out how private equity firms can ever get a loan after doing a bust-out like this ever again.
posted by Pope Guilty at 10:18 AM on April 6, 2018 [4 favorites]


Everybody still gets paid back in a leveraged buyout. It's more like taking out a loan to buy a Maserati, and then paying it back by selling the car for parts and scrap. If there were hundreds of thousands of people who depended on that Maserati for their income and health insurance.
posted by Holy Zarquon's Singing Fish at 10:19 AM on April 6, 2018 [35 favorites]


Where does the money come from ?

I mean the accounting can look a bunch of different ways but it's almost always an extraction of value bound up in implicit (or explicit) commitments to employees.
posted by PMdixon at 10:24 AM on April 6, 2018 [6 favorites]


Not to derail too hard, but since someone mentioned the Denver Post: it's been three weeks since they laid off a third of the newsroom, and today they committed a rather egregious editorial error.

Which, like, lol.
posted by 7segment at 10:27 AM on April 6, 2018 [10 favorites]


Pope Guilty: Private Equity doesn't need loans. It has investors lining up, chomping at the bit, to give them money. The PE firm owns the company, but the company owns the debt because of all the legal machinations around incorporation and so on and so forth. Essentially, Jeff Bezos may own (a majority stake of) Amazon, but if Amazon takes out a loan, it's not Jeff Bezos on the hook for it.

Edit: The article makes the point better: “It’s as if you buy your neighbor’s house. You put down the down payment. You own the house. But your neighbor has to pay off the mortgage. And if the neighbor can’t pay the mortgage, they go bankrupt, not you. That’s a sweet deal.”
posted by SansPoint at 10:45 AM on April 6, 2018 [10 favorites]


When Remington declared bankruptcy recently all the coverage was about falling gun sales under Trump without a democratic gun-grabber boogeyman. Nobody asked why a 200 year old company selling a products that are virtually unchanged for the past 50 years was a billion dollars in debt.

I know a guy who owns a pretty nice sailboat made by the British firm Oyster; they just declared bankruptcy in February after having their best quarter ever. It was a 45 year old company that was bought by private equity 10 years ago.

One commonality between these companies is a drastic reduction in product quality. Remington was forced to issue a number of product recalls and class action lawsuits due to production and design issues. Oyster had a brand new ten million dollar yacht lose its keel and scared away its profitable superyacht buyers. A big part of the PE method of value extraction is to slap a valuable brand name on crappier and crappier products until the customer base gets wise to the game and moves on.
posted by peeedro at 10:45 AM on April 6, 2018 [43 favorites]


peeedro: It's the same principle that leads to the Grocery Shrink-Ray. Cut the amount of product, put it in the same box, sell it at the same price as the original amount of product, and now you're making more money selling less to people who will never notice unless they bother looking at the per-unit price. And if you do it slowly enough, they won't even notice then, either.
posted by SansPoint at 10:52 AM on April 6, 2018 [4 favorites]


To an extent yes, but I think the economics of lifestyle goods like rifles and superyachts might be a little different than necessities like sugar and toilet paper.
posted by peeedro at 10:57 AM on April 6, 2018


peeedro: It just goes to show that the pursuit of extra short-term profits knows no limit, no matter what kind of customer you are.
posted by SansPoint at 11:00 AM on April 6, 2018 [1 favorite]


But your neighbor has to pay off the mortgage

The point is, the debt (mortgage) is ISSUED AFTER the purchase, not before. Why would anyone lend the now-private-equity-owned organization any money, knowing that the entity is worthless based on track record?

i.e. what's the "credit score" for any entity owned by a fucking private equity firm?
posted by lalochezia at 11:01 AM on April 6, 2018 [2 favorites]


I have the same question about how, exactly, the company takes out a loan which is used by the private equity firm to buy the company. Are we talking about a leveraged buyout? In that case,
a company is purchased with a combination of equity and debt, such that the company's cash flow is the collateral used to secure and repay the borrowed money.
That sounds very similar to a mortgage on a house. In that scenario, I can imagine the purchaser dismantling the house piece by piece and selling the wood and siding and roof for extra profits, trying to keep just enough of the house intact that they can sell it along to the next sucker before it collapses.

But: The way that it's described in the article, that's not what's going on here. They aren't saying that the company's cashflow is used as collateral for the private equity firm's loan as in the case of a leveraged buyout, they're saying that the loan is to the company itself but nonetheless gives the private equity firm its ownership of the company.

I don't see how that would work legally. I think I need "private equity for dummies".
posted by clawsoon at 11:02 AM on April 6, 2018 [1 favorite]


clawsoon: The Private Equity company will typically own the company in the same way a CEO owns the company, by holding the majority of the shares/equity.
posted by SansPoint at 11:10 AM on April 6, 2018


The PE firm owns the company, but the company owns the debt because of all the legal machinations around incorporation

Right, but why is any bank or other credit-provider dumb enough to extend a loan to a company that Bain just bought?
posted by GCU Sweet and Full of Grace at 11:11 AM on April 6, 2018 [6 favorites]


SansPoint: The Private Equity company will typically own the company in the same way a CEO owns the company, by holding the majority of the shares/equity.

Yes, but in order to buy enough shares to own the company, didn't the private equity firm have to take out a loan? How does the borrower on that loan become the company instead of the private equity firm?
posted by clawsoon at 11:20 AM on April 6, 2018 [1 favorite]


Right, but why is any bank or other credit-provider dumb enough to extend a loan to a company that Bain just bought?

Exactly. Where's the money coming from ?

That's why my guess was pensions/endowments/hedge funds -- folks chasing magical pony returns. Because you'd think anyone else with any sanity who has looked at the numbers and done the research would walk away from such a toxic deal. They should be sophisticated enough to know better.

(Though we still have junk bonds, penny stocks and other ways to part a fool from their money.. )
posted by k5.user at 11:24 AM on April 6, 2018 [3 favorites]


If I had to guess, it's because there is enough profit just in loan fees, the amount of time the loan is actually serviced, etc., etc. to cover the lost amount.
posted by maxwelton at 11:25 AM on April 6, 2018


From what I've quickly read about Toys R Us, whoever made the initial loan almost made their principal back, having been paid $400 million/year for ten years on a $5 billion loan. For ten years, it appeared to be a good deal for all the financiers involved. The parasites on the host were getting fat, and that was great encouragement for other parasites. They were sucking a little bit more out of the host every year than it could replenish, though, and it finally weakened, stumbled, and laid down to die.
posted by clawsoon at 11:38 AM on April 6, 2018 [3 favorites]


Right, but why is any bank or other credit-provider dumb enough to extend a loan to a company that Bain just bought?

It's basically against the law to make lending decisions based on the specific person or company. They are essentially exploiting laws designed to prevent racist and ageist lending decisions in their own favor. When you are taking out a loan, you are credit score, a recent history, and an income. They can (if necessary) start new firms (shell corporations) to hide any recent past liquidity issues.
posted by The_Vegetables at 11:40 AM on April 6, 2018 [3 favorites]


DISCLAIMER: I don't know anything about this stuff, I just did a little digging because I'm curious.

I think the article gets it wrong, and what private equity firms do is equivalent to a leveraged buyout (these professors equate the two, describing the evolution of leveraged buyout investment firms to private equity firms).

I think the PE firm's debt (which it used to buy the company) FUNCTIONALLY becomes the company's debt, because the PE firm controls the management of the company.

As to where the money comes from, it seems to be a combination of the PE fund and loans. Banks used to be the primary investors in these loans, but it looks like they may have wised up since the 90s after leveraged buyouts crashed and burned (from the article linked above):

In a typical private equity transaction, the private equity firm agrees to buy a company . . . the buyout is typically financed with 60 to 90 percent debt—hence the term, leveraged buyout. The debt almost always includes a loan portion that is senior and secured, and is arranged by a bank or an investment bank. In the 1980s and 1990s, banks were also the primary investors in these loans. More recently, however, institutional investors purchased a large fraction of the senior and secured loans. Those investors include hedge fund investors and “collateralized loan obligation” managers, who combine a number of term loans into a pool and then carve the pool into different pieces (with different seniority) to sell to institutional investors.
. . .
The private equity firm invests funds from its investors as equity to cover the remaining 10 to 40 percent of the purchase price. The new management team of the purchased company (which may or may not be identical to the pre-buyout management team) typically also contributes to the new equity, although the amount is usually a small fraction of the equity dollars contributed.

posted by materialgirl at 11:41 AM on April 6, 2018 [4 favorites]


I'm not a PE person, but here's my rough understanding on how these transactions work:
  1. The PE firm gets a bank loan or uses available funds from limited partners to buy a company from the existing shareholders.
  2. The company is now private and the PE firm owns it outright (although sometimes there are still minority shareholders).
  3. If the bought company has spare cash (and many of these PE targets do), this cash is paid out to the PE firm as a one-time dividend. The PE firm then uses this to pay back part or all of the loan.
  4. As the owner of the company, the PE firm authorizes the bought company to take a large loan. This is called adding leverage, and it has the mathematical effect of increasing the company's return on equity.
  5. The PE firm uses the cash from the loan to pay itself another one-time dividend, which it uses to pay back the rest of the loans it took to buy the company in the first place.
Now the PE firm owns a debt-laden business which they can theoretically grow and improve. If things go well, they IPO or sell at a later date and make lots of money. If things go badly, the company goes bankrupt. If enough of these companies are successful, the PE firm wins over time.

As pointed out above, the banks generally make back the principle from the successful companies and most of the principle from unsuccessful companies. If enough companies win, and the interest rates on the loans are set correctly, the banks can make money in the long run on loans to PE backed companies from PE firms with good track records.

The right question to ask here is how many PE firms have good track records? Toys R Us didn't work out, but without looking at the rest of the portfolio it's hard to tell if anyone actually lost money here.
posted by fremen at 11:44 AM on April 6, 2018 [28 favorites]


It's basically against the law to make lending decisions based on the specific person or company. They are essentially exploiting laws designed to prevent racist and ageist lending decisions in their own favor. When you are taking out a loan, you are credit score, a recent history, and an income. They can (if necessary) start new firms (shell corporations) to hide any recent past liquidity issues.

No, no, no, this is not how commercial lending works. Not even vaguely. I don't have time to type up a long comment right now, but those of you who want further reading may want to consult When Wall Street Met Main Street, which is a fairly readable explanation of the PE model and how things can (and often do) go wrong.
posted by praemunire at 11:47 AM on April 6, 2018 [13 favorites]


Thanks, fremen! I think step 4 was the point of confusion. So, to clarify: PE firms buy the companies on debt, then direct companies to take on their own debt to (in theory) make whatever operational changes?
posted by materialgirl at 11:48 AM on April 6, 2018


PE firms buy the companies on debt, then direct companies to take on their own debt to (in theory) make whatever operational changes?

Yes, I believe this is the approach. The practicalities may vary, and I'm not a practitioner so I could be wrong.

As I said, adding leverage has the effect of increasing the return on equity. This also increases the risk to the owner of the equity (more return = more risk), so the chance of things going wrong increases.

For a PE firm, their goal is to balance the amount of risk they can handle with the returns they want. The banks have the same goal, and both groups are aware of what the other wants and needs. If enough companies in a portfolio succeed, then a few high profile failures are not a problem (and in fact could be expected).
posted by fremen at 11:54 AM on April 6, 2018 [2 favorites]


With Sears, didn't the PE owner set up a real estate company, whose sole function was to receive the transfer of all the properties occupied by the Sears stores, and then charge Sears rent for the stores that sat on the properties they used to own? Thus setting up a straight flow of cash out of Sears and into the pocket of the PE firm. Like others, I simply don't understand how all this is legal.
posted by lagomorphius at 12:00 PM on April 6, 2018 [11 favorites]


Thanks for the explanations! The extraction of multiple one-time dividends in order to pay off the PE firm's loans is the key part that I was missing.

Looking further into the Toys R Us case, it sounds like the original justification for the $5 billion loan in 2006 was all of the real estate the company owned. Presumably, the logic of the lenders was that even if the company failed they'd still be sitting on lots of valuable real estate. Ditto with Eddie Lampert and Sears. I assume that the sale price of the company was much higher in 2006 than it would've been after the real estate crash, and thus the loan needed to buy it was much larger.

Then real estate prices crashed in 2008 and the genius plan fell apart.

If real estate prices hadn't crashed, I wonder if the PE firm would've wound down Toys R Us much earlier and extracted its money by selling off the real estate.
posted by clawsoon at 12:01 PM on April 6, 2018 [1 favorite]


lagomorphius: Well, if the owner owns the company and all its assets, then they can legally sell off those assets as they wish, including transferring ownership of them another company run by the same owner, which can then use those assets as it wishes. So, it's perfectly legal, it's just scummy as fuck.
posted by SansPoint at 12:02 PM on April 6, 2018 [1 favorite]


4. As the owner of the company, the PE firm authorizes the bought company to take a large loan. This is called adding leverage, and it has the mathematical effect of increasing the company's return on equity.
5. The PE firm uses the cash from the loan to pay itself another one-time dividend, which it uses to pay back the rest of the loans it took to buy the company in the first place.
There's one problem here: If the cash from the loan is being used to pay a dividend instead of invest in operations or expansion, it won't increase the company's return on equity, will it? Or... I guess it's increasing the return on equity for the owners, but it's the point at which my lender's eyebrows would go up. If a business came into my (hypothetical) bank and said that it wanted to take out a large loan in order to give the owner a big one-time bonus, I'd reject the loan because it's not creating more cashflow that'll help pay the loan back.

I assume that private equity firms must be good at making payouts to themselves sound like rock-solid business cases.
posted by clawsoon at 12:13 PM on April 6, 2018


Friendly reminder that doing all of this is exactly how Mitt Romney made all of his money, and it is in fact his firm, Bain Capital, that is doing this to Toys R Us.
posted by kafziel at 12:16 PM on April 6, 2018 [20 favorites]


One commonality between these companies is a drastic reduction in product quality. Remington was forced to issue a number of product recalls and class action lawsuits due to production and design issues. Oyster had a brand new ten million dollar yacht lose its keel and scared away its profitable superyacht buyers. A big part of the PE method of value extraction is to slap a valuable brand name on crappier and crappier products until the customer base gets wise to the game and moves on.

It's called reputation mining and it is everywhere for everything now. You simply cannot trust a brand to actually deliver the same product from one moment to the next anymore. Quality, sizing and materials, it can all be off from one version to another.
posted by srboisvert at 12:26 PM on April 6, 2018 [22 favorites]


From materialgirl's link:
The Private Equity Analyst (2008) lists 33 global private equity firms (22 U.S.-based) with more than $10 billion of assets under management at the end of 2007. The same publication lists the top 25 investors in private equity. Those investors are dominated by public pension funds, with CalPERS (California Public Employees’ Retirement System), CasSTERS (California State Teachers’ Retirement System), PSERS (Public School Employees’ Retirement System), and the Washington State Investment Board occupying the top four slots.
So pension funds are where the equity comes from. I haven't gotten to the part which explains where the loans come from.
posted by clawsoon at 12:28 PM on April 6, 2018 [2 favorites]


adding leverage has the effect of increasing the return on equityy

Return on equity is just one of many financial variables. I'm not sure why the focus on this particular one. Fine if you are fleecing individual investors, but pension funds and university endowments are run by professional money managers too.
posted by The_Vegetables at 12:29 PM on April 6, 2018 [1 favorite]


So pension funds are where the equity comes from. I haven't gotten to the part which explains where the loans come from.

Major banks, mostly. In Toys R Us's case, it looks like it was JPMorgan and Goldman Sachs kicking in the most money and negotiating the terms for the whole group of lenders.
posted by Copronymus at 12:32 PM on April 6, 2018 [1 favorite]


If a business came into my (hypothetical) bank and said that it wanted to take out a large loan in order to give the owner a big one-time bonus, I'd reject the loan because it's not creating more cashflow that'll help pay the loan back.

...unless the owner had a big loan at my bank and I knew that the owner was going to use their bonus to pay off that loan. Hmmmmm. In that case, making a loan to pay a bonus/dividend might make sense, especially if I expected the company to be around longer than the owner. In the paper that materialgirl linked, it says that private equity funds are typically time-limited to ten or thirteen years, so as a bank I might think that moving the loan from the PE firm to the company is a good idea.

But I'm not a banker, so I'm not sure.
posted by clawsoon at 12:36 PM on April 6, 2018


Return on equity is just one of many financial variables. I'm not sure why the focus on this particular one. Fine if you are fleecing individual investors, but pension funds and university endowments are run by professional money managers too.

At the place I work, last time I checked my guess would be about 2/3s of the people on the board of trustees were PE owners/CEOs/managers. They don't directly control how the endowment is managed, but still...
posted by lagomorphius at 12:38 PM on April 6, 2018 [2 favorites]


Like others, I simply don't understand how all this is legal.

A bit earlier we read:

A big part of the PE method of value extraction is to slap a valuable brand name on crappier and crappier products until the customer base gets wise to the game and moves on.

Seems to me John Ruskin once wrote, "There is hardly anything in the world that some man cannot make a little worse and sell a little cheaper, and the people who consider price only are this man's lawful prey."
posted by ricochet biscuit at 12:41 PM on April 6, 2018 [9 favorites]


Thanks Fremen!

I get the general gist of how all of this is legal. What I don't understand is how banks lend all this money for the leverage ? Don't they have incentives in place to not lend in the first place if this circuitous profit making scheme of leeches fails enough times?
posted by savitarka at 12:46 PM on April 6, 2018


I assume that private equity firms must be good at making payouts to themselves sound like rock-solid business cases.

Because this:

The right question to ask here is how many PE firms have good track records? Toys R Us didn't work out, but without looking at the rest of the portfolio it's hard to tell if anyone actually lost money here.

Ideally, the PE firm borrows and invests in the purchased company, materially improving its performance, while the PE firm draws management fees. If they do a good enough job of it, they'll pull out earnings to repay original investors/lenders, and then borrow more against the purchased company's performance, or continue to pull management fees and dividends, or sell and move on to the next deal.

My wife's first executive level job was at a firm that had recently been purchased by PE. They sank a lot of resources into their purchase (including hiring my wife, but also a lot of capital and product R&D expenditure) and saw it grow from $170M to $800M in just three years. They cycled through the process above (management fees, repaying the first round of investors/lenders, repaying the second round of investors/lenders) all the while taking fees and dividends. Then events in the wider economy shifted (mid-to-late-oughts) (money wasn't as easy to get any more) and performance of the company slipped, setting off some covenants in the bank loans (borrowing costs went up, somehow), which hurt the ability of the company to continue to invest in itself, until finally they entered BK for a restructure, swapping debt for equity and the PE firm walked away.

GE Capital was one of the lenders, iirc, but there were several, and they were all large and sophisticated. It wasn't obviously a bust-out -- there was a solid track record of performance -- but that's what happened anyway. We heard a lot of "in hindsight, maybe PE firm shouldn't have taken that last round of debt, but honestly, in those circumstances, that's the decision you would make every time. Sometimes deals go bad."
posted by notyou at 12:52 PM on April 6, 2018 [4 favorites]


savitarka: What I don't understand is how banks lend all this money for the leverage ? Don't they have incentives in place to not lend in the first place if this circuitous profit making scheme of leeches fails enough times?

Perhaps banks, too, not only investors, are subject to periods of irrational exuberance. Didn't they make lots of exuberant loans in the 1970s to Third World countries with oil that went bad in the '80s? And then in the 2000s they went nuts for residential real estate? (And I'm sure I'm missing a bunch before, after, and in between.)
posted by clawsoon at 12:58 PM on April 6, 2018


notyou: They sank a lot of resources into their purchase (including hiring my wife, but also a lot of capital and product R&D expenditure) and saw it grow from $170M to $800M in just three years. They cycled through the process above (management fees, repaying the first round of investors/lenders, repaying the second round of investors/lenders) all the while taking fees and dividends. Then events in the wider economy shifted (mid-to-late-oughts) (money wasn't as easy to get any more) and performance of the company slipped.

It sounds like the strategy was to trade resilience (provided by low debt) for growth (provided by high debt). It would be interesting to see how companies fare, on average, after they're transformed and then sold by private equity firms, especially when the private equity firm sees the whole thing as a success. Is the company that they leave behind bigger and better and stronger and more resilient, or do they on average suck so much out in management fees and dividends that it's bigger and better but has a fatal debt weakness?
posted by clawsoon at 1:09 PM on April 6, 2018 [1 favorite]


Am starting with this Wikipedia entry: History of private equity and venture capital, and seeing where it takes me.
posted by ZeusHumms at 1:47 PM on April 6, 2018 [1 favorite]


Robert Reich has a nice 3 minute explainer that I think first saw in one of the 2012 election threads.
posted by klarck at 2:37 PM on April 6, 2018 [5 favorites]


The company is just a vehicle for cash payouts to the owners in this scenario, nothing more. The bank muscles the company up with artificial growth hormones (debt at the request of the PE owner, used for whatever quick growth schemes the PE managers can think up), the managers cut out any of the fat they can find (pensions, jobs, quality suppliers), then the company is slaughtered for any value that is left, to make an exit for the lender and owner.
posted by hexaflexagon at 2:40 PM on April 6, 2018 [3 favorites]


The companies are held by PE funds, which usually have terms of 3-7 years (with options to extend the tenor), so the firms buy the company hoping they will be able to sell it for a profit or list it on the stock exchange during the fund term.
The loans are generally funded by a syndicate of large banks. The loans are to the company, or an SPV holding the company owned by the fund, rather than the fund itself and would be assessed based on the company.
posted by Kris10_b at 3:17 PM on April 6, 2018 [1 favorite]


Meanwhile in New Zealand we have a debt issue in the dairy farm sector. Debt is currently north of nz$40 billion. Farmers are getting blamed but on closer look, almost every farm has at least on private equity partner - few of whom have any real idea of either farming or milk supply chain.

PE has become essential to the farm as - often - the farmers' primary lending banks are increasingly pushing for earlier returs; the banks are tightening up - it's a vicious circle (I'm not a banker but am a farm environment consultant).
posted by unearthed at 3:21 PM on April 6, 2018 [3 favorites]


unearthed - the problem with getting lending from NZ banks for the dairy industry is probably concentration risk. The PE funds have access to offshore banks who don't have that kind of large exposure to the sector. They need a 3rd option for funding the farms that can't currently access offshore funding. Australian banks can't help because they own most of the NZ banks anyway.
posted by Kris10_b at 3:40 PM on April 6, 2018 [2 favorites]


Right, but why is any bank or other credit-provider dumb enough to extend a loan to a company that Bain just bought?

The vast majority pay off. The stories about companies that go bust are the financial journalism equivalent of "if it bleeds, it leads." And a lot of comments here are like Trump after watching Fox, assuming the selective reporting means the country is in the throes of the worst crime rates ever.
posted by jpe at 4:12 PM on April 6, 2018 [7 favorites]


Yeah the banks come out just fine out of these situations - it's the company that's purchased where the money comes from.

I think of it as resiliency mining. A company that's survived any length of time has redundancy and capacity to survive changes in the market. That's worth something, that's where the profit comes from, but it leaves the

Dick Smith in AU/NZ got wrecked this way primarily by short-term inventory decisions - costs were cut to service debt, leading to no stock on shelves, leading to lower sales, leading to a death spiral. See Dick Smith is the Greatest Private Equity Heist of All Time
posted by xiw at 4:44 PM on April 6, 2018 [5 favorites]


I kind of admire a good scam, but scams are supposed to be on the order of selling musical instruments to small towns in Iowa, not destroying the retail sector.

When capitalism can't run a frigging toy store or book store without destroying it, it's probably time for some socialism.
posted by zompist at 8:14 PM on April 6, 2018 [7 favorites]


> k5.user:
"(Though we still have junk bonds, penny stocks and other ways to part a fool from their money.. )"

And ICOs. Please do your research. chuckling
posted by Samizdata at 10:30 PM on April 6, 2018 [1 favorite]


Ahhh yes the wonders of interest tax shields. Did you know you don’t have to pay taxes on debt payments? So if you’re an investor, you have two choices:

- give away a bunch of money now and return a set amount of money every year for a while (debt)

- give away a bunch of money now and return a changing amount of money forever (equity)

Under the second you have to pay taxes on the changing amount of money (I.e. corporate taxes) The first you don’t. So if you’re a team of investors you want to use a lot of the first type of funding and less of the second. This is LBOs help investors do. It’s really about tax avoidance.

If you are able to flip the company through cutting costs, gaining market power, or increasing sales, that’s kind of gravy.

On the other hand, if you have a 20-year old family business and no heirs, what are you going to do? Who are you going to sell your business to if you want to retire? This is a classic PE situation and if you look at PE returns investors focused on making these small companies operate better do better then the ones doing Toys R Us type stuff.
posted by The Ted at 10:47 PM on April 6, 2018 [8 favorites]


> zompist:
"I kind of admire a good scam, but scams are supposed to be on the order of selling musical instruments to small towns in Iowa, not destroying the retail sector.

When capitalism can't run a frigging toy store or book store without destroying it, it's probably time for some socialism."


Monorail?

Also, not so interested in socialist toy stores. All they have are mustachoed action figures and stuffed bears...
posted by Samizdata at 1:07 AM on April 7, 2018


Nobody asked why a 200 year old company selling a products that are virtually unchanged for the past 50 years was a billion dollars in debt

See also Gibson.
posted by aspersioncast at 12:33 PM on April 7, 2018


seems to me the PE investor and the banks that lend them money all profit, even when the company eventually fails, because the whole operation is designed to make the company look as lean and mean as possible in the short term in exchange for ending any hope of long term success, i.e., by gutting its workforce and degrading its products. even struggling companies can be squeezed until they look good if you dont care what effect this has in the long term.

it's like if you could bet money on a student doing great on a test by forcing her to take speed; you'd probably win that bet, even though you're obviously hurting her long term success, at which time you'll be long gone.
posted by wibari at 12:36 PM on April 7, 2018


Aren't PE's how gangsters, mobsters, drug lords, warlords, & corrupt governments launder their money exchanges?
posted by Mesaverdian at 5:47 PM on April 7, 2018


Now the PE firm owns a debt-laden business which they can theoretically grow and improve. If things go well, they IPO or sell at a later date and make lots of money. If things go badly, the company goes bankrupt. If enough of these companies are successful, the PE firm wins over time.

The PE firm basically never loses cash money on a deal unless they are grossly incompetent. They typically extract as much money in management fees as the loan covenants will allow, so after the dividends "pay off" (offset, really) most of the debt that was on the PE firm's books it doesn't take long to make a deal cash positive even if they end up taking a gigantic paper loss, which they do intentionally sometimes to hold down their tax bill. And oftentimes the ultimate source of the funds ends up being a retirement plan or other pot of money intended to fund future obligations.

For an example not involving a PE firm, look at the original Iridium. Despite funding the company from the beginning and it going bankrupt with $4 billion in debt so quickly after going to market, Motorola made a huge cash profit on the deal even before the accounting losses saved them a bunch of tax. Essentially, Motorola provided them with a turnkey operation in exchange for debt and ongoing fees for managing the constellation, a couple of Earth stations, and the backend systems. Iridium then raised money for working capital and initial debt payments from the licensees running the ground stations in various other parts of the world (whose other money also mostly flowed toward Motorola for equipment and installation and software, etc.) and bank loans once it got close to starting commercial service.

Essentially, all that money went straight in Motorola's pocket through required payments on the satellites and other equipment and excessive management fees, subscribers didn't materialize quickly enough, bankruptcy was declared with Motorola providing a bit of DIP financing that they more than made back through continued management fees before the operation got sold to some people on a shoestring budget that only got their financing thanks to a DoD contract. And, of course, Motorola continues their fuckery to the point of coming within minutes of deorbiting the satellites so as to extort another $70 million.

It's the classic LBO scam, only instead of stripping the target's assets to return the cash new management put in, they used the excessive margin on the equipment and services that were to be paid shortly after launching service to return their own cash investment plus some. Once the large initial payments were over Motorola was better off with the tax losses than they were with the NPV of the remainder of the debt they were owed as soon as it became clear the high margin on the management fees for operating the constellation wasn't going to last.

On preview: Mesaverdian, the answer you're looking for is luxury condos, which outside of Miami can be bought with cash by a shell corporation with zero oversight. Don't need to do any of that pesky proving the origin of funds or much in the way of tax paperwork if it's a foreign corporation. Then they can flip it or use it as collateral for a legit loan from a bank or whatever to get clean cash back out.

Any sort of investment will work, it's just that real estate involves less oversight than anything the SEC or FINRA might look at so it's less likely to go sideways. And it's harder for them to tie back to you and your illegitimate funds.
posted by wierdo at 6:02 PM on April 7, 2018 [2 favorites]


for me, one of the biggest but least-covered news stories of the past decade has been Argentina's debt. Remember when they agreed with all but a few lendors to repay them, but a few vulture capitalists took Argentina to court in USA to block it? and won? And because USA controls the world banking system, Argentina wasn't able to repay the debtors (over 90%) whom it had reached agreement with? So they had to hold elections and vote in a pro-american-capitalism party and repay the debt to the vulture capitalists first? That interested me, as i assumed it was possible for a nation state to repay its lendors without going through the USA banking system, i didn't realise USA had a chokehold on it. I assume it's a way of maintaining world hegemony with the prospect of receeding military dominance (a) China b) over-reach in too many war arenas).
posted by maiamaia at 3:23 AM on April 8, 2018


That interested me, as i assumed it was possible for a nation state to repay its lendors without going through the USA banking system, i didn't realise USA had a chokehold on it.

Argentina is kinda a special case. While it's not abnormal for states to issue debt under either New York or London law in the aim of getting a lower interest rate (and if the debt is issued under the laws of a particular jurisdiction that jurisdiction obviously controls the terms of the repayment), Argentina's debt is basically a law school final exam.
posted by PMdixon at 8:30 AM on April 8, 2018 [1 favorite]


Something always hovering just outside my view is the intense buy in by PE firms in public water supply systems Private Profits From Phnlic Works (NYT) and this Arsenal For Democracy episode where they talk about towns that had thier water supply system bought by PE firms wherein all the prices go up and none of the proposed infrastructure gets built. (Works cited PDF)
posted by The Whelk at 9:50 AM on April 8, 2018 [2 favorites]


One commonality between these companies is a drastic reduction in product quality. Remington was forced to issue a number of product recalls and class action lawsuits due to production and design issues.

Right, but Remington isn't actually filing for bankruptcy because they are bankrupt. They are doing it in an attempt to shut down the Sandy Hook lawsuit that might hold them liable for one of their guns being used to murder a bunch of kids.

See also.
posted by a fiendish thingy at 9:34 AM on April 9, 2018 [1 favorite]




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