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3 The highs and lows of
buyouts By Julian Delasantellis
Your 70-inch flat-panel plasma TV is the
pride and joy of your life, but it's not working.
The repairman says it has to go back to the shop.
That's the last you hear from him. You go down to
the shop, lo and behold, your TV is on sale in the
window, for a lot more than what you paid for it.
You don't think this is very fair, so you
call the police, who, in this case, happen to be
the US Securities and Exchange Commission. You
describe your situation, but the officer is
unsympathetic.
"Son,"
he says. "You just don't understand how private
equity buyouts work, do you?"
During the
long twilight struggle of the Cold War, the United
States had a one-word answer to the ideological
challenge posed by the communist world, and that
word was democracy. In the political realm,
citizen democracy was the stated counter to the
top-down rule by the unelected commissars on the
other side.
In the economic realm, the
counter to rule by the central planning
apparatchiks was said to be shareholder
democracy, the fact that, in the US, the great
commercial and industrial combines were owned not
by the state, but by millions of individual
shareholders, each of which had, according to the
size of their holdings, a voting and proprietary
right to a share of entity's earnings, and the
right to question corporate management as to the
operations and future of the enterprise.
But no elite Gulliver really wants or
appreciates being restrained by the Lilliputians
of the common voting masses. With the end of the
ideological threat posed by communism, (which
happened long before the actual fall of the Berlin
Wall) America's governing classes realized that
now they were the ones that had nothing to lose
but the chains of democracy's facade.
In
the political realm, it is the operation of the
campaign finance system that has essentially
eliminated the threat to the plutocratic elite
inherent in voter democracy. In the corporate
realm, the same function is being accomplished
through the rise of the phenomenon of the private
equity buyout.
Many people might think
that the era of the private equity buyout ended
with the "Barbarians at the Gate" buyout of RJR
Nabisco in 1988. This was the deal that the chief
executive officer of RJR Nabisco, F Ross Johnson,
initiated when he realized that his stockholders
might not be happy that the company's next major
product, the Premiere smokeless cigarette, was
returning focus group test results that reported
that it "tastes like" (scatological expletive )
"and smells like a fart".
The $25 billion
leveraged buyout of the company, in which a group
of investors led by the takeover firm Kohlberg
Kravis Roberts bought all the publicly traded
stock shares of the company, turning it into a
private entity, might have solved the delicate
issues surrounding Premiere, but the massive
amounts of debt that was saddled on the company
(in order to fund the purchases from the public
shareholders) inhibited the company’s operations
and growth for many years, and this put the
private equity buyout phenomenon into an
unfavorable light well into the 90s.
The
layoffs that followed the buyout (for the new
company, weighed down by its massive debt load,
just could not support the levels of corporate
operation and employment it had previously) did
not particularly endear this process to the
public. Back then, this was a factor that mattered
more than it seems to now.
These days
private equity is back with a vengeance. The year
2007 has already seen the biggest private equity
deal in history, the $39 billion buyout of Equity
Office Properties by the Blackstone Group. This
follows close on the heels of a number of big
deals from 2006, notable among them the $21.2
billion buyout of Hospital Corporation of America
(controlled by the family of ex-US Senate Majority
leader Bill Frist), and the $19 billion buyout of
radio and media giant Clear Channel.
Even
The Carlyle Group, that super-secret international
defense private equity conglomerate so chock full
of former world leaders (former US presidents
George H W Bush and Bill Clinton and former
British prime minister John Major) as current and
former principals that it is sometimes seen more
as a villain in a James Bond film than as an
investment vehicle, is getting into the act.
Carlyle recently eschewed its normal investments
in death and destruction to buy out Philosophy,
Inc, a purveyor of soaps, shampoos and other
personal and skincare products.
At its
core, private equity is really easy to understand.
To calculate the value of any publicly traded
corporation, all you have to do is take the stock
price and multiply it by the number of shares
outstanding. Thus, a $40 stock that has one
million shares outstanding has a total worth (its
"book value", in stock lingo) of $40 million. That
supposedly includes everything that the company
possesses, from the real estate value of the
spaces in its parking lots to the brand loyalty of
its customers to its products. Where private
equity enters the scene, and where it
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