" /> The IUF's Private Equity Buyout Watch: December 2007 Archives

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December 19, 2007

Behind the Credit Crunch

Ever wonder about the meaning of 'High Grade Structured Credit Enhanced Leverage Fund'? Two British satirists explain it all in one of the more trenchant analyses we've seen…


December 18, 2007

Private Equity's Growing Reach in Food Testing

As food safety issues involving pathogens widen in scope and frequency, food safety testing services are increasingly coming under private equity ownership.

3i Group, rated 13 in the global private equity league, has agreed to buy the UK's largest food testing company Inspicio PlC for USD 467 million. The buyout will be financed with slightly over 50% in equity, a group of banks providing the balance in loans for as yet undisclosed terms.

Inspicio was founded in 2005 to aggressively buy up food and other testing service companies. It now operates in 130 countries with ca. 5,000 employees, thanks largely to the 2005 buyout of the UK-based global testing company Inspectorate. The company can test at every stage of the food chain from seeds, soils, fertilizers and crops to processed foods. Recent Inspicio acquisitions have included the Finnish multi-service testing company Inspecta in 2002 and the French food testing company Carso).

As governments have scaled back and even abandoned their own food testing services (the state-owned Inspecta, for example, was privatized by the Finnish government in 2002) and certification of all sorts has expanded exponentially, the global testing/certification business is estimated to total some USD 71 billion annually. 3i, with a substantial food company portfolio of its own, has actively promoted food testing and certification as an engine for driving sales and consolidation, trumpeting its ability to deliver better results in detecting E-coli in meat than government testing services like the US Department of Agriculture. With Inspectorate, Inspicio's biggest division, focused on oil-based products, Inspicio is now ideally positioned to cash in the biofuels boom.

In a 2003 report on food safety (including a timely reminder of the risks to the food system of terrorist attacks), 3i stated that "Safety scares are driving demand for better food testing and traceability technologies. Global venture capitalists are specialists at matching innovative businesses with networks of suppliers, partners and the food and drinks industry is a good place for us to demonstrate these skills." 3I's current portfolio of food companies includes UK distributors Fosters Traditional Foods, Mionetto (wines, Italy), Monviso (Italy, baked goods), Gestion (France, retail), Refresco (Netherlands, drinks), and Senoble (France, private label dairy desserts).

December 12, 2007

Penny a Basket for Tomato Pickers Too Much for PE-Owned Burger King

Private-equity owned Burger King, the world's second largest restaurant chain (over 11,200 units in 65 countries), adamantly opposes an agreement which would see Florida farm workers receive one extra US cent for every pound of tomatoes purchased by the fast food giant.

Moreover, the company has pressed the Florida Tomato Growers Exchange to instruct its members to cease honoring the purchase agreements with rival chains Yum Brands and McDonald's.

In March 2005, after a four year campaign by the Coalition of Immokalee Workers (CIW), a farmworkers organization which has been supported by the IUF and US unions, Yum Brands (owners of Taco Bell) agreed to pay the extra penny per pound. The extra cent is estimated to have added 40% to the largely immigrant farmworkers' wages (which still fall under the poverty line). Earlier this year, McDonald's likewise agreed. Fast food restaurants are the largest purchasers of Florida tomatoes.

Burger King and the growers now contend that these agreements violate (without explaining how) federal law .The head of the FTGE comented that they are "un-American", while Burger King announced that they "fail to provide any solutions for the real issues facing farmworkers." The growers association has threatened any member honoring the agreement with a USD 100,000 fine. McDonald's and Yum Brands have stated that they wish to continue honoring the agreement, but that for now they are… "on hold." So Florida's tomato pickers began December with a 40% wage cut.

Three private equity funds - Bain Capital, Goldman Sachs Capital Partners and Texas Pacific Group scooped up Burger King for USD 1.5 billion in a heavily leveraged deal into which they put only USD 325 million of equity. In addition to collecting multi-million dollar annual management fees, they cashed in (USD 30 million) on cancelling their management contract when a quarter of the company's shares were taken public through an IPO last year which netted USD 425 million. Prior to the IPO, Burger King borrowed USD 350 million (underwritten by J.P. Morgan and Citigroup) to fund a USD 367 million dividend which pushed their debt to earnings ratio past 6 to 1. Goldman Sachs, Bain and Texas Pacific Group still control 75% of Burger King shares.

Annual bonuses in 2006 for the top 12 Goldman Sachs executives were double the annual wage bill for the 10,000 Florida tomato pickers.

On November 30, over 1,500 farmworkers and supporters marched through Miami to Burger King's corporate headquarters to protest the company's role in sinking the agreement with the fast food chains. Workers who couldn't come to Miami sent their shoes, which were collected under a sign reading "Doubt our poverty. Walk in our shoes."

December 04, 2007

Casino Business Wobbles at High Stakes Debt Table

The gaming industry (casinos), a major employer in the IUF sectors generally thought of as relatively immune to cyclical developments, is showing signs of being hit by the credit crunch afflicting LBOs. Beginning with the 1998 Colony Capital buyout of Harvey's Casino Resorts, buyout funds have moved into the sector in a big way, attracted by the industry's tempting real estate portfolios and stable cash flows.

Colony went on to form Resorts International, a gaming subsidiary which operates the Las Vegas and Atlantic City Hiltons, Resorts Atlantic City, Resorts Tunica and Resorts East Chicago. The buyout rush culminated in last year's $27.8 billion leveraged buyout of Harrah’s Entertainment by Texas Pacific Group and Apollo Advisors.

In February 2007 - the height of the buyout binge - an industry publication touted the virtues of "alternative" financing for the gaming industry in the following terms: "Today, the massive liquidity of the capital markets has embraced the gaming industry, and that love affair has driven an unprecedented level of deal activity in the industry, including: leveraged buyouts (LBOs), mergers and acquisitions, recapitalizations, new builds and expansions. If a hedge fund or private equity investor is comfortable with the credit (i.e., the borrower), that investor is capable of pricing each security in the capital structure based on risk/return profile of that security. This mode of thinking is highly typical of today’s competitive marketplace and is a far cry from the manner in which federally regulated commercial banking institutions have operated in the past. In the end, it is this aggressiveness of capital market investors that has benefited companies in the gaming industry (http://www.theinnovationgroup.net/maint/docs/AlternativeFinancing.pdf).

In January 2006, Aztar Corporation was acquired in a USD 2.75 billion LBO by Columbia Sussex in a tough bidding war which pushed up the price and saw it taking on Aztar's 676 million in debt. Aztar owns the Tropicana casino-resort properties in Las Vegas and Atlantic City, NJ and other casinos.

Following its assumption of ownership, Columbia Sussex laid off 1,000 union workers at the Atlantic City Tropicana- a quarter of the workforce. The establishment is now understaffed and filthy, according to the official investigative report undertaken as part of the casino's relicensing procedure. "Numerous patron complaints from Tropicana Atlantic City's own files evidence the impact that the layoffs have had on the condition of the property and shown that there is true concern about Tropicana's ability to create and maintain a successful, efficient casino operation," said Yvonne G. Maher, acting director of the Division of Gaming Enforcement.

Revenues have declined sharply, and Columbia Sussex 17% yield debt issues are currently trading at 68 cents on the dollar.

Falling real estate values, continuing credit contraction and weakening consumer demand are all reflected in the falling value of buyout debt generally as the spectre of default and possible bankruptcy looms over the most vulnerable leveraged buyout deals. A November 7 article in the US Business Week notes that "Half of the dozen US companies that defaulted on their debt this year were owned by private equity firms", citing Standard & Poors.

"Leverage", observes Barron's in a December 3 article, "unfortunately cuts both ways. When markets get rocky and financial results suffer, private equity investments can generate big losses. Looking ahead to 2008 and '09, private equity firms could be in the uncomfortable position of telling their investors about impaired equity investments or complete wipe-outs."

Barron's cites the case of the real estate brokers Realogy, bought by Apollo Management for USD 2 billion in April this year. Annual cash flow this year is predicted to barely exceed the 650 million in annual interest charges. Staggering under its burden of debt, and with no real estate upturn in sight, the company's senior unsecured loans are trading at 75 cents on the dollar, while the riskier, higher yielding notes due in 2015 are trading at 62 cents on the dollar. At current trading, Realogy has USD 4 billion in bank debt and 1.7 billion in senior notes outstanding.

Another Apollo buyout, the retailer Linens 'n Things, lost 79 million last quarter, with its debt now trading at just over 50 cents on the dollar. "Unless the retailing environment improves", notes Barrons, "Apollo and its partners could lose all of the $600 million equity investment. Apollo paid USD 1.3 billion for the chain in November 2005, when credit was abundantly cheap.

That the market has turned should come as no surprise - for those whose memories are sufficient to recall that the LBO business is by nature cyclical, and that collapsing junk bond prices in the wake of an LBO bubble are predictable and inevitable. We've been there before, and workers pay the price.

Private Equity Workshop Advances Union Bargaining Agenda

While unions internationally continue to push for regulatory measures to curb the funds, and while they explore discussions with the funds and management of their portfolio companies to secure trade union rights, buyout funds are now major national and transnational employers. Unions need to adapt their collective bargaining practices to the changed financial and management imperatives that a leveraged buyout imposes.

Following on the successful international conference held in November 2006, IUF, IMF and UNI organized a workshop in Nyon, Switzerland on November 14 focusing on concrete organizing, bargaining and negotiating tools for unions.

In the first of two presentations, the IUF's Peter Rossman reported on new trends in the buyout business following on the global credit crisis set in motion this summer with the collapse of the US subprime loan market. Despite the credit crunch, investors, including employee pension funds, continued to invest in private equity. Buyout funds had already raised over USD 263 billion in the first 10 months of 2007, more than for the whole of 2006, and there was no indication that pension fund money was retreating significantly. While the big leveraged buyouts were temporarily off the agenda, the funds continued their activity in the food sector with buyouts of small and medium size companies, often consolidating them into substantial companies with manufacturing and distribution on a wide scale and big payrolls. The danger for employees was the vulnerability that comes with the heavy leverage taken on with each successive buyout.

Buyout funds, while waiting for the credit pipeline to free up, would also be acquiring significant shares in listed companies. Unions had to be aware that in such cases the funds were not simply another activist investor in search of "shareholder value" but a structurally aggressive investor. To take their large profit on the deals as "carried interest", they had to beat the "hurdle rate", or profit threshold, agreed with investors in the funds. The IUF presentation gave examples to illustrate the shift in focus of buyout activity from the credit-strapped North American and European markets to the Asia/Pacific region.

Elaborating on the implications of the credit crisis for unions and collective bargaining, Rossman pointed out that credit markets were now incapable of financing big secondary buyouts and the large-scale debt refinancing which had permitted many private equity-owned companies to be pushed to the point of insolvency while still serving as cash cows for the funds. Exiting investments through a return to public stock markets was also problematic in the current situation. Private equity funds would therefore be managing their portfolio companies under even tighter cash flow constraints than originally anticipated. Unions would have to develop appropriate bargaining strategies to withstand these additional pressures.

In a second afternoon session, the IUF elaborated on the ways in which private equity ownership - and in particular the weight of massive debt (leverage) on the portfolio companies' balance sheets - fundamentally altered the context of collective bargaining. Unions engaged in collective bargaining with private equity-owned companies were essentially negotiating with a bundle of debt; understanding and unpacking that debt was fundamental to the bargaining process. Unions would have to press for full disclosure of the total amount of debt incurred in the buyout process (including fees etc.) as well as the types and maturity of the bonds and debt securities, the rates, the loan covenants etc. Negotiating a collective agreement, however, was only the first step. In order to detect cash being pumped out and new debts being assumed, unions would have to press for ongoing access to verifiable financial accounts in order to continuously monitor debt- and dividends-to-earnings ratios. Unions would also have to monitor asset management, including the selloff of real estate and "intellectual property" (trade marks, brands etc.) and understand their implications for cash flow management in order to secure ongoing investment as a bulwark against asset stripping. Defending company pension commitments was also a strategic imperative, and could be used in some cases to block a buyout.

The IUF presentation was complemented by a presentation from the IMF's Ron Blum, who explained the ways in which degrees of leverage led to changes in management cash flow strategy with immediate implications for workers. Learning to Identify these management techniques was an essential task for collective bargaining under private equity ownership, and crucial for securing employment and investment commitments. The presentation included concrete examples drawn from the metal industry in Europe and North America.

Stephen Lerner and Michael Laslett of the North American SEIU stressed the importance of union pressure on pension fund trustees. Despite their legal obligation to deliver maximum returns, pension fund trustees were in fact susceptible to various forms of pressure. Unions had not yet learned to exercise this pressure strategically, and many unions were in fact not even informed of the extent or the details of their own pension funds' investments in private equity. The SEIU had been able to turn up political pressure on the funds by campaigning for them to disclose the fiscal impact of their acquisitions - another useful campaign tool.

One of the main conclusions of the presentations and discussions was the need for more educational material to assist unions in campaigning against the funds and their buyouts and to prepare unions to negotiate with them more effectively. The IUF will be producing new educational material to supplement the Workers' Guide to Private Equity Buyouts.