This book is an indictment of the destruction PE Funds have wrought on American businesses. The author explores the epidemic of Leveraged buy-outs (LBOs) through the lens of the people who worked at the companies that got bought out.
I was quite curious about the LBO structure itself, which was the reason I picked up the book. In a leveraged buyout, the PE fund (buyer) buys shares of a company by making the company take out a huge loan.
If you have taken a class in accounting, you would know that
Assets = Debt + Shareholder Equity
and
Shareholder Equity = Share capital + Share premium + Retained Earnings
Retained Earnings = Revenue - Expenses - Dividends
Retained earnings are the part of the profit that the company has kept for reinvestment, or as reserves for black swan events.
The share capital + share premium reflects the share price, which is a proxy for the assets that the company has, including cash and property.
If you were to invest in a company, of course, you would like the company to have more assets than debt. Or in other words, you would like it if the company has a lot more equity than debt.
Typically, if you look at a publicly traded company, the debt to equity ratio would be in favour of the equity, say, 1:3. In other words, the debt that the company has is one-third of the equity. An LBO reverses this and makes the debt-to-equity ratio 3:1.
Toys R Us, for instance, took $ 5 billion in loans to fund its acquisition by PE funds. This came with a $400 million interest payout every year.
PE Funds like to project themselves as knights in shining armour who are helping dying businesses rejuvenate themselves. Most of these companies eventually are run into the ground, and the collateral damage is the employees. So, how does it make sense for the PE funds, and how does it make sense for the banks? Why do they even do this?
This is where I found the book really illuminating. The author follows 4 individuals and what happened to them before the PE fund took over, during the takeover and after it. The story is very common: a PE fund comes in, talks about efficiencies and productivity, and fires a lot of people. Makes one person do the job of 5 while reducing that person’s salary. Pays 1000 times that person’s salary to the CEO. Runs the business into the ground, or continues to amalgamate and make sure more such businesses roll into the holding company, reduces choice and gouges the customer while providing shitty service.
It makes sense because, the PE fund has itself raised most of its money from pension funds and the likes. The partners are on the hook for just 10%. Those very partners charge 2% per annum in management fee. That 2% is on the entire capital deployed. Say a PE fund is managing $1 billion, the partners kick in $100 million but charge management fee on $1 billion. They are netting $20 million each year even if they are doing a lousy job.
What caught my attention was the industries that were covered. Housing, Newspapers, Retail, and Hospitals.
The common thread is that almost all of the businesses are ones that started 30+ years ago. They are barely profitable or loss-making with an inability to make more investments. But most importantly, they all own land, sometimes in prime locations of the city, which have accumulated huge capital gains over the years.
The PE business in America is an elaborate scheme to transfer capital gains without incurring taxes.
No sooner have the PE funds moved in, their first order of business seems to be to sell the asset and lease it back to the business. The one thing that made the business operation financially efficient is removed. This is billed as a way of creating capital pools that can be reinvested in the business. The proceeds are rarely used to invest in the business; they go partly towards the debt and partly towards paying the management fees that the PE funds charge their target businesses for the disastrous job that they do.
They manage to project it as a service that they are doing for the retirees by making larger returns for them.
When the company eventually fails, the banks that lent money move in to sell whatever assets remain within the company to the next highest bidder and make good their investments.
PE Funds are just another way the boomers are screwing over their kids and their grandkids.
where did the boomers come into play at the end of your narrative? What makes you think they are messing with their kids and grand kids....elaborate please