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Thursday, October 19, 2006
BusinessWeek Article:Private-Equity firms Bringing the Next Bubble Crisis?
After listening to this podcastof this weeks front cover BusinessWeek article, I was quite upset. Alarms went off in my head about how this could be a catalyst for another bubble crisis or the entering into a U.S. depression with thousands of jobs lost.
I'll just summarize the main point of this article. There are hundreds of private-equity transactions that have occured over the last few years where businesses are bought by private-equity firms. The same private-equity firms pays themself a dividend or fee for the purchase which is reasonable to some extent, but has beeen taking on horendously unethical levels. Case in point.... the p-e company that recently bought Hertz from Ford for roughly 3.5 Billion paid themself a 1 Billion dollar dividend. Crazy!!!!! Normally, much of the money comes from cash on hand or additional loans that is essentially a levy on the value of the company. How is this legal? I don't know who is more stupid here....the Bank that gives the loan, the private-equity firm that really thinks this won't have repercussions on our economy or our government for not having laws yet in this area. According to the B-Week article, they reviewed a little over a 100 transactions and found about 15% of them to have crossed the line on ethical financial management practices.
I wish I had the time to research the people who head up these private-equity firms. Many of the leaders of these firms are sure to be B-School grads. The actions of some of these private-equity firms need national attention. I'm so happy that BusinessWeek put out this article. Bravo BusinessWeek!
If I had the time, I'd make a list of the top 6-15 managers in each company that clearly show questionnable actions based on this article and then trace back which Business Schools they graduated from. I'd check on their donations back to the schools and make each Dean, Admissions Director, Career Center Director and Finance Chair aware of this article and that John XXX or Jane XXX from their school was part of the companies in question. This is a real ethics crisis issue. I hope you will take the time to read the article and/or listen to the audio of the podcast below. More importantly, I hope some of the readers of this Blog entry who have more time will do something about this.
Gluttons At The Gate
Private equity are using slick new tricks to gorge on corporate assets. A story of excess.
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BusinessWeek:Gluttons at the Gate Podcast
Three weeks after giant private-equity firm Thomas H. Lee Partners agreed to buy an 80% stake of Iowa Falls ethanol producer Hawkeye Holdings in May, Hawkeye filed registration papers with the Securities & Exchange Commission to go public. The buyout deal hadn't even closed yet, but Thomas H. Lee was already looking forward to an initial public offering expected to generate a huge profit on its $312 million investment. The firm didn't just cross its fingers and wait, however: It took $20 million from Hawkeye as an advisory fee for negotiating the buyout and a $1 million "management fee"--and will soon take about $6 million to meet its own tax obligations. All told, Thomas H. Lee will collect payments of around $27 million by yearend--despite Hawkeye's having earned just $1.5 million in the six months through June.
These are crazy times in the private-equity business. It used to be that buyout firms would spend 5 to 10 years reorganizing, rationalizing, and polishing companies they owned before filing to take them public. Thomas H. Lee couldn't have created much lasting economic value in the three weeks before the filing, but that didn't stop it from writing itself huge checks from Hawkeye's ledger. Thomas H. Lee and Hawkeye declined to comment.
Buyout firms have always been aggressive. But an ethos of instant gratification has started to spread through the business in ways that are only now coming into view. Firms are extracting record dividends within months of buying companies, often financed by loading them up with huge amounts of debt. Some are quietly going back to the till over and over to collect an array of dubious fees. Some are trying to flip their holdings back onto the public markets faster than they've ever dared before. A few are using financial engineering and bankruptcy proceedings to wrest control of companies. At the extremes, the quick-money mindset is manifesting itself in possibly illegal activity: Some private equity executives are being investigated for outright fraud.
Taken together, these trends serve as a warning that the private-equity business has entered a historic period of excess. "It feels a lot like 1999 in venture capital," says Steven N. Kaplan, finance professor at the University of Chicago. Indeed, it shares elements of both the late-1990s VC craze, in which too much money flooded into investment managers' hands, as well as the 1980s buyout binge, in which swaggering dealmakers hunted bigger and bigger prey. But the fast money--and the increasingly creative ways of getting it--set this era apart. "The deal environment is as frothy as I've ever seen it," says Michael Madden, managing partner of private equity firm BlackEagle Partners Inc. "There are still opportunities to make good returns, but you have to have a special angle to achieve them."
Like any feeding frenzy, this one began with just a few nibbles. The stock market crash of 2000-02 sent corporate valuations plummeting. Interest rates touched 40-year lows. With stocks in disarray and little yield to be gleaned from bonds, big investors such as pension funds and university endowments began putting more money in private equity. The buyout firms, benefiting from the most generous borrowing terms in memory, cranked up their dealmaking machines. They also helped resuscitate the IPO market, bringing public companies that were actually making money--a welcome change from the sketchy offerings of the dot-com days. As the market recovered, those stocks bolted out of the gate. And because buyout firms retain controlling stakes even after an IPO, their results zoomed, too, as the stocks rose. Annual returns of 20% or more have been commonplace.
The success has lured more money into private equity than ever before--a record $159 billion so far this year, compared with $41 billion in all of 2003, estimates researcher Private Equity Intelligence. The first $5 billion fund popped up in 1996; now, Kohlberg Kravis Roberts, Blackstone Group, and Texas Pacific Group are each raising $15 billion funds.
And that's the main problem: There's so much money sloshing around that everyone wants a quick cut. "For the management of the company, [a buyout is] usually a windfall," says Wall Street veteran Felix G. Rohatyn, now a senior adviser at Lehman Brothers Inc. (LEH ) "For the private equity firms with cheap money and a very well structured fee schedule, it's a wonderful business. The risk is ultimately in the margins they leave themselves to deal with bad times."
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