Wednesday, December 24, 2008

No More Leveraged Buyouts


Stop speculators from ruining strong companies

JAMAICA, VERMONT—The Crash of '08 offers the incoming Obama administration a rare chance to rein in the excesses of our economic system. I can think of few better places to start than banning leveraged buyouts.

Leveraged buyouts are Wall Street's solution to American capitalism's dirtiest secret and biggest problem: No one has any money. Really. Working as an investment banker during the 1980s, I was repeatedly astonished when deals would fall apart because would-be buyers of major corporations didn't have enough cash on hand to buy a house in the Hamptons. Many of the wealthiest people in the world, it turned out, have zero or negative net worth. According to The New York Times, for example, one of Donald Trump's biggest sources of income was his job hosting the TV show The Apprentice. Those buildings with his name on them? He leased his name to developers who liked his brand.

It's true: The rich are different from you and me. But not because they're rich. If most "wealthy" people ever had to settle up with their creditors, they'd be worth less than the average homeless Iraq War vet. What they do have—or, until recently, had—are big lines of credit.

LBOs are a way for cash-poor "rich" people and corporations to buy companies they can't really afford. First the would-be acquirer buys enough stock to get controlling interest in the targeted company. A bank lends him the rest of the purchase price, using the purchased company's own assets as collateral. Overnight, a profitable company with a healthy balance sheet can find itself burdened with staggering debt—its own purchase price.

Now the corporate raider owns the company. But the company owes big payments to the bank. The raider has two options. He can use his management skills to make it more efficient and profitable. Or he can sell off pieces of the company. More often than not, "turnaround" experts find that they're not much smarter than the management they replaced and end up selling assets and cutting costs. For other acquirers, turnarounds aren't the point. They're out to gut the joint from the start.

The results are the same in both scenarios. Each sale of a division and each round of layoffs reduces the already cash-starved acquired company's chances of survival. The formerly profitable company is forced to file bankruptcy. Its employees lose their jobs. Because the law inexplicably lets corporations use retirement plans as collateral for loans, they often lose their pensions, too. Suppliers are stiffed. Customers suffer higher costs due to less competition.

It's bad news for most people—but not for everyone. The corporate raider sells off his equity stake in the company before the fiscal excrement encounters the fan, then pays himself and his friends millions in golden parachutes. The bank, which collected high interest payments as the company began its post-LBO decline, seizes and sells off what remains of the company's assets.

Here's another way to look at it: Let's say you want to buy a car you can't afford, like a Rolls Royce. You "buy" the fancy handcrafted auto using the car itself as collateral. When the payments come due, you sell the engine, tires, carburetor, CD player and other parts to a chop shop. You pocket the cash and default on your loan. This, of course, is illegal—yet in this scenario, all that's been lost is a nice car.

LBOs inflict much greater damage. They transform profitable companies into bankrupt ones, throw thousands of people out of work, stifle competition and deprive government of the tax revenues it needs in order to build schools, maintain roads and drop bombs on Muslims. Yet LBOs are legal.

Generally speaking, LBOs succeed under two conditions: an expanding economy and a management team able to radically increase profits in a short time. These conditions are rarely present at the same time, and almost never for very long.

Signs that the LBO model was untenable began appearing 20 years ago, when two of corporate raider Robert Campeau's victims, the Revco drugstore chain and Federated Department Stores, went bankrupt. Federated, which employed thousands of American workers before Campeau came along, had been saddled with LBO debt equal to 97 percent of its net assets.

LBO transactions have since led to scores of bankruptcies and hundreds of thousands of Americans losing their jobs—all to line the pockets of a tiny cabal of greedy speculators. The LBO goons' latest victims, ironically enough, are the media giants lionized by their own business reporters in breathless puff pieces.

In 2007 Sam Zell, described as "a 65-year-old billionaire and president of Chicago-based Equity Group Investments," bought the Tribune Company for $8.23 billion. Tribune was one of the largest media chains in the United States, owning the Chicago Tribune, the Los Angeles Times, The Baltimore Sun, 20 television stations, and other properties—as well as the Chicago Cubs baseball team. Like most "billionaires," Zell didn't have any money. Like most takeover artists, he didn't know anything about the multibillion-dollar business he wanted to run.

Zell invested a mere $315 million (3.6 percent of the purchase price) and stuck Tribune with $8.4 billion of debt, promising to make early debt payments by selling the Cubs and turning around the company's flagging newspapers.

Everyone saw trouble ahead. "The leveraged buyout is making Tribune one of the riskiest newspaper companies, according to John Puchalla, a media analyst at Moody's Investors Service in New York," reported the Bloomberg business wire service at the time. Now, a year later, Tribune has filed for Chapter 11. Layoffs are coming fast and furious. After just 18 months under Zell's careful stewardship, Tribune—formerly a profitable company—reports assets of $7.6 billion and debt of $13 billion.

"Factors beyond our control have created a perfect storm—a precipitous decline in revenue and a tough economy coupled with a credit crisis that makes it extremely difficult to support our debt," Zell said, acknowledging the disaster.

Zell is right about the credit crisis. But it would have been a lot easier for Tribune to weather the storm if he'd never come along.

Ted Rall is the author of the seminal Generation X manifesto "Revenge of the Latchkey Kids" and a former loan officer for The Industrial Bank of Japan. He draws cartoons and writes columns for Universal Press Syndicate.

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