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Private equity: scouring the world for deals « Previous | |Next »
May 7, 2007

The international capital flows of the global economy currently appear in the form of hedge funds and consortium's of off-shore private equity firms engaged in buyouts or takeovers of well established public corporations. We have seen their play with the Seven and Network, these (involved the two leading US private equity firms, CVC and Kohlberg Kravis Roberts) with Qantas by Airline Partners Australia (which had been put together by Macquarie Bank). We may yet see a play with respect to Telstra.

A private equity firm will control the management of a company they’ve invested in, and will often bring in new management whose job is to make the company more valuable for a three-to-five year exit, usually a tradesale (a flip) or a re-listing. In many cases these private equity deals work by loading up the acquired company with debt, splitting the parts up, reducing costs and acquiring the cash flow to repay the debt, then repackaging the company, and selling if off for a higher price. Up to 90 percent of the cost of takeovers (also referred to as "leveraged buyouts") is funded by debt.

You get the distinct impression that the banks are falling over themselves to provide the debt finance for the deal, whilst the private equity firms are very cashed up and are scouring the world looking for deals. This kind of freewheeling market capitalism is where the excitement is, and we should not underestimate its significance.

In an essay for the Harvard Business Review (October 1989) Michael Jensen wrote that:

“The publicly held corporation, the main engine of economic progress in the United States for a century, has outlived its usefulness in many sectors of the economy and is being eclipsed. Takeovers, corporate breakups, divisional spin-offs, leveraged buyouts and going-private transactions are the most visible manifestations of a massive organizational change in the economy. Despite the protests, this organizational innovation should be encouraged. By resolving the central weakness of the large public corporation – the conflict between owners and managers over the control and use of corporate resources – these new organizations are making remarkable gains in operating efficiency, employee productivity, and shareholder value.”

Presumably, the regulatory governance regime needs to be lightened to allow the private equity firms to make their play, as they don't have to give out very much information about their activities. After all this is capitalism, and the people that the private equity firms should be accountable to are just the people who have invested.The private equity firms should be able make a great deal of their money from the fees they're charging from the 'deal flow' (the various deals turned over).

What holds up the PE deal making are low interest rates, creative financial engineering, affordable capital and a leveraged bet on rising stock markets – temporary market conditions? The possibilities of debt, distress and default associated with excessive gearing loom with a change in market conditions. If the market changes, you get caught.

| Posted by Gary Sauer-Thompson at 1:54 PM | | Comments (4)
Comments

Comments

Just a few questions.
When you say that the target company is loaded up with debt, are you meaning that the new owners are transferring their own debts incurrred as to leverage for the takeover, into the books of the taken over company?
Then new management cuts back on debts by cutting workforce, maintainence etc?

If such a company is laden with debt, how does it become an attractive target for sale later down the line, or is the debt-laden component separated from the rest allowed to go bankrupt, with those responsible somehow able to avoid responsibility for the debts ( Tax write-offs, government bailouts, offshore ownership out of reach of local law enforcement as happened with Ansett?

I suppose also it is all to do with anticipations of how the market will be operating in say five years time, as the Qantas adventure indicates vis-a-vis the emergence of Emirates and Singapore airlines, whose emergence destroys the rationale upon which Qantas'survival and prosperity was previously predicated. It becomes a firesale, with the kind equity managers humanely salvaging what's of benefit from a hopeless case?

One supposes it's all good fun for billionaire equivalents to auto wreckers and metal salvagers; for them and future purchasers, a more creative use is found for an acquired property.
Goodbye use value; hullo symbolism-laden exchange value.
But Christ help the poor putzes who work for these companies and nations like Australia who are ripe for the ransacking. And what can you say of the people running Qantas just now, a handful of people paid hundreds of $millions to sell out workers, (later cared for by Australian taxpayers via welfare)and small investors who had a going concern shafted through the complicty of those meant to represent their investment, who sold out to the enemy.
BTW, what role has the AUSFTA had in increasing the posibilities for private equity buy-outs?

Paul,

The leveraged buyout is done through debt. If you own Qantas then Qantas own the debt and has to repay it.

That is done through cash flow and selling off parts (Qantas Club, Frequent flyers, Catering etc)

A more efficient and focused Qantas is worth more and so it can be sold for a greater prrice than it was bought for.

The whole thing is done in 5 years as the deals need to keep turning over.

The other attractive thing for the off shore players is that the capital gain will be tax free, which on top of the interest bill from high degrees of leveraging reducing tax on profits, make these deals very attractive.

Thanks big bob.
Am not familiar enough with all the esoterics of bean counting, commerce and economics, but your comments make eminent sense.
They are actually sort of paradigmatic of the whole keynesianism under seige from neo lib paradigm.
All looks like a long- dead sheep in a paddock. You sense where all the movement is coming from and you see the action when you have a closer look.
Not that the sheep knows. Although, life is probably not all that good for a sheep that's flyblown if its still alive ( mayhap, doesn't feel like talking about the wether, and neither would ewe, lamb! ).