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3 The highs and lows of
buyouts By Julian Delasantellis
gets complicated, is when somebody
thinks a company is worth more than the book
value.
If the public shareholders are the
sellers in a private equity transaction, it is
probably one of a small number of large private
equity partnerships (KKR, Bain Capital, Thomas H
Lee Partners, Blackstone) that are the buyers.
Standard procedure is for one of these concerns,
with huge pools of borrowed and partner money
at
their disposal, to offer the stockholders a small
premium (usually around an extra 10% or so of the
pre-offer selling price) in order for the
stockholders to find it worth their while to sell,
to "tender" their shares to the buyers. Once 50%+1
of the shareholders do so, the buyout is
successful, and the target company goes private.
But why would the buyout companies do
this, pay more than the market price for these
companies? Statist, central planning economics
fell out of favor in business and management
theory in the late 1960s, when it became clear
that the capitalist, market-centered model
provided higher levels of growth and affluence
than those of the planned economies of the East.
In its place, the dominant paradigm taught
in the West's business and economics schools
became something called the Efficient Markets
Hypothesis. This theory, first propagated by
Eugene Fama of the University of Chicago's
business school, stated that the collective wisdom
of the market, continuously reflected in the
current market price of any stock, bond, or traded
commodity, best reflected the future price
prospects of these instruments.
Therefore,
no one could "beat" (for example, generate
investment returns in excess of broad market
averages) the market regularly, since the
information you were using to judge the
desirability of any traded instrument, be it
economic growth prospects, the desirability of a
company's new product, weather patterns, or an
unlimited number of other factors had previously
been considered by other investors and was already
reflected in the stock price. If all investors had
the same access to the same information, the
market was said to be "efficient", modern
econospeak for "fair".
But that raises the
question, what if some investors in the market
have secret, superior information that the general
market lacks? Isn't that an unfair advantage?
Much in contrast to the generally bleak
fates of rank-and-file line workers of companies
taken private in private equity buyouts,
generally, the existent senior corporate
management of these companies doesn't usually fare
that bad. Sometimes they make out like bandits.
You might get a few heads lopped off at the very
top just for appearance's sake, but that's usually
it. This is rather surprising, since one of the
stated justifications of the whole private equity
industry is to bring efficiency, discipline and
focus to corporate entities said to be previously
inefficient, wasteful and slothful.
What
is it that these underachieving managements have
that so tempts these rapacious private equity
buyout companies?
If you're down on the
factory or call-center floor looking up at the big
shots of a corporation far above you, they all
must seem pretty similar-rich, privileged, usually
white and male, and really far away from you. In
reality, the two institutions at the top of the
corporate pyramid have widely divergent functions.
The board of directors are the elected
representatives of the stockholders, the real
owners of the corporation.
Corporate
management are the executives hired by the board
to run the corporation. They are usually very well
rewarded for this employment, but, in the end,
their status is that of employees not all that
different from those on the factory floor. The
real riches of the American corporate sector,
reflected in those multi-billion dollar corporate
book values that are supposed to be the sole
property of the stockholders, is, for the most
part, out of the reach of most corporate
management.
A private equity buyout goes
through. This tune will soon change.
Over
at the private equity buyout firm, they're in a
big hurry. The buyout has gone through, so they're
stuck owning billions of dollars worth of a
company that the market believes it paid too much
for. Worse still, since most of the funding used
to take the company private was borrowed, they
immediately have to pay interest and principal
back on this company they bought. The new owners
must start generating a positive cash flow, and
they have to do it fast, before the interest
charges bury them. They have to cut away and sell
off the parts of the company that are valuable but
inefficient, and concentrate on the core
activities of the company that are generating
money.
But the buyout team are corporate
outsiders. If only they can get the expertise of a
group of executives who intrinsically know and can
differentiate the company's fat from its lean.
Somebody like ... the existing corporate
management.
Thus is the devil's bargain
that is at the root of most of the current crop of
private equity deals. Even though the stated
purpose of
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