" /> The IUF's Private Equity Buyout Watch: June 2008 Archives

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June 26, 2008

IUF at ILO Highlights Role of Financial Speculation in Food Price Crisis

As part of this year's International Labour Conference, which included the first discussion in 20 years on rural employment issues, the ILO on June 11 convened a “High-Level Panel on the Food Crisis, Production, Investment and Decent Work”. Speaking on the panel, IUF general secretary highlighted the impact of recent investment flows into commodity markets in helping fuel the hyperinflation in the price of basic food staples which has provoked global hunger riots. "While international agencies have suddenly discovered underinvestment, investment in commodity indexes has climbed from US$13-billion in 2003 to $260-billion in March 2008 - and according to some analysts may soon hit a trillion US dollars. Yet the FAO briefing paper for the Rome summit devoted a dismissive two paragraphs to the phenomenon in its 'assessment of recent developments', and nothing in its concluding 'policy options'. Private equity and hedge funds - investors focused on short-term, high-yield gains - have been expanding beyond futures markets and are now pouring billions into acquiring farmland, inputs and infrastructure. The real world has been left behind - and with it production, investment and decent work. The real issue is what kind of investment, what kind of production, and who benefits."

For the full IUF presentation (also available French, German, Japanese, Spanish and Swedish) click here.

Slash and Burn Sun Capital Extends Reach in Produce, Coffee, Restaurants

Private equity fund Sun Capital Partners on June 24 acquired Sunrise Growers-Frozsun Foods, the largest US producer of frozen strawberries and a leading distributor of fresh strawberries and other produce.

Sunrise produces, distributes and sells under its own brands as well as through retail and foodservice private labels, producing 130 million pounds of frozen strawberries and other processed fruit products and distributing over 7 million trays of fresh strawberries annually.

In 2006 Sun Capital together with pe fund EG Capital Group, picked up five of Kraft's Canadian brands and manufacturing sites, now operated as CanGro Foods. CanGro immediately began selling off the brands and closing sites. In two years of private equity ownership, over half of the former union jobs at Kraft were eliminated. Outsourcing the supply of fruit for canning has also had a catastrophic impact on rural and agricultural income.

Earlier this year, Sun Capital acquired Canadian-based Timothy's World Coffee's parent company. Timothy's directly owns or franchises 166 coffeehouses and retail units, of which 77 are in Canada and 50 in the US. Timothy's also distributes single serve coffees and teas, and in September 2007 teamed up with Canadian Monogram Food Solutions Emeril's K-Cups line of high-end single-serve coffees. In April 2008, Timothy's signed a deal with Six Continents Hotels to supply these coffees to the parent company's Crowne Plaza, Hotel Indigo and Intercontinental brands. The deal was described by Timothy's head Leslie Chase as "Elevating the in-room coffee experience to an unprecedented level of ease, sophistication and luxury. Making the in-room experience on par with the other luxury appointments Six Continent's clientele have come to expect."

Sun Capital owns wholly or in part restaurant companies with over 2,200 locations and USD 3.4 billion in aggregate revenues, including Boston Market Corp., Bruegger's Enterprises, Fazoli's Restaurants, Friendly Ice Cream Corp., Garden Fresh Restaurant Corp., Real Mex Restaurants, Restaurants Unlimited and Souper Salad. In January 2008 it completed the USD 80 million acquisition of the 73-unit Smokey Bones chain from parent group Darden Restaurants, which had closed 53 units prior to the sale.

June 07, 2008

No Deleveraging in PE Buyouts: New Study Points to Rising Debt, Rising Risk of Default

According to a new report by Standard & Poor's, the "deleveraging" expected in the wake of the credit crunch has not only failed to materialize, but debt levels in private equity buyouts in Europe have actually risen, heightening the risk of default. The head of research at Standard & Poor's, who have released a new study, told the Financial Times on June 5: "In the current market where the availability of debt has declined and business prospects are deteriorating, you would expect deals would get more conservative."

According to the study, however, in private equity buyouts between €250-500 million, leverage has actually substantially risen. In the first quarter of 2008, debt to cash flow multiples rose to 6.8, as against an average of 5.8 for 2007. Purchase prices multiples also increased to 10.4 times EBIDTA compared with an average 8.7 last year. Cash available to companies taken private through leveraged buyouts for paying off their debt has fallen to 2.2 times their debt levels, compared with 2.5 in 2007 and 4 in 2003.

The conclusion? "Record levels of leverage in deals, rising purchase price multiples and the falling ratio of cash that companies have available to cover debt will make it harder for them to repay their loans and put pressure on default rates."

A convenient survey of recent US pe-banked bankruptcies can be found here. Among the pe-owned companies in the IUF sectors in the US which have recently filed for bankruptcy are the restaurant chains Vicorp Restaurants Inc., which will be closing 56 Village Inn and Bakers Square Restaurants, and Buffets Inc., the largest national steak restaurant chain. According to the report, the cookie maker Mrs. Fields Famous Brands is preparing to file for bankruptcy soon.

Financializing Food: Deregulation, Commodity Markets and the Rising Cost of Food

Deregulation and the systematic exploitation of US regulatory loopholes have facilitated a recent surge in speculative investment in commodity markets, much of it by institutional investors including pension funds. The influx is one of the driving forces behind the hyperinflation of basic food staples.

Financializing Food: Deregulation, Commodity Markets and the Rising Cost of Food

A May 31 article by Sinclair Stewart And Paul Waldie in the Toronto Globe and Mail (Feeding frenzy) describes how deregulation and the systematic exploitation of US regulatory loopholes have facilitated a recent surge in speculative investment in commodity markets, much of it by institutional investors including pension funds. The influx is one of the driving forces behind the hyperinflation of basic food staples.

"These funds", write the authors, "Have plowed tens of billions of dollars into agricultural commodities as a way to diversify their assets and improve returns for their investors. The amount of fund money invested in commodity indexes has climbed from just $13-billion (U.S.) in 2003 to a staggering $260-billion in March 2008, according to calculations based on regulatory filings. Michael Masters, a veteran U.S. hedge fund manager, warned a Senate hearing this month that this number could easily quadruple to $1-trillion, if pension funds allocate a greater portion of their portfolio to commodities, as some consultants suggest they are poised to do. Because agricultural markets are small - relative to stock markets - the amount of cash pouring in gives these funds substantial clout. Mr. Masters estimated that that these big institutional investors control enough wheat futures to supply the needs of American consumers for the next two years, and blamed the "demand shock" from these recent entrants to the commodities markets as arguably the primary factor behind the sudden take-off in food prices.

"If immediate action is not taken, food and energy prices will rise higher still," he told the hearing. "This could have catastrophic economic effects on millions of already stressed U.S. consumers. It literally could mean starvation for millions of the world's poor."

The authors trace the progressive loosening of regulatory requirements which has made possible the enormous influx of money, much of it fleeing the meltdown in the market for mortgage-backed securities and the wider fallout, including big leveraged buyouts.

"Beginning with the energy market, regulators made a series of far-reaching decisions that gradually loosened oversight of complex commodity derivatives and created loopholes for large speculators, allowing them to trade virtually unlimited amounts of corn, wheat and other food futures."

The key breakthroughs for investors came in the energy futures market, establishing general precedents for all commodity trades (including food). In 1989, the US Commodity Futures Trading Commission (CFTC) issued a policy paper declaring that it would not regulate "swap deals" - commodity purchases involved financial intermediaries (typically banks) and the dealers. This was followed by a 1990 declaration by the CFTC that it would consider oil trading on the Brent Market as "forward contracts" (a contract in which the buyer ultimately takes delivery of the commodity) rather than "futures contracts" (in which the buyer rarely takes delivery, but uses the contract for purely speculative purposes). Futures contracts had traditionally been regulated, in order to curb speculation and volatility in key markets; forward contracts are not regulated. The ruling meant that oil futures trading was to be treated as outside the scope of CFTC regulation.

"The CFTC's embrace of a narrow definition of a futures contract built on the regulator's earlier promise that it would not police swap transactions. Together, these moves opened up a new frontier of commodity trading, enabling financial speculators to buy and sell complex derivatives away from the prying eyes of regulators and exchanges."

Expanding beyond the energy market into other commodities, institutional investors began diversifying into food. As the authors describe the chronology of deregulation, "It wasn't long before this infusion of money hit another regulatory snag. For almost 75 years, the CFTC has imposed limits on how much of certain agricultural commodities, including wheat, cotton, soybean, soybean meal, corn, and oats, can be traded by non-commercial players - that is, investors who are not part of the food industry. So-called "commercial hedgers," like farmers or food processors, can trade unlimited amounts in order to manage their risk."

"The limits were designed to prevent manipulation and distortion in what are relatively small markets, and at the same time to allow for a small amount of speculative activity, in order to provide liquidity for trading.

"For decades, the restrictions didn't pose much of a problem. And then, in 1991, as new money began pouring in, the playing field suddenly shifted.

"Emboldened by the CFTC's laissez-faire approach, a bank approached the regulator and, for the first time, requested an exemption from speculative trading limits in an agricultural commodity.

"The unnamed bank was acting as a "swap dealer" for a pension fund: Essentially, it was a middleman who helped the pension fund get exposure to commodities. A spokesman for the regulator declined to identify the bank or the pension plan, citing confidentiality requirements."

The CFTC granted an exemption, ruling through a particularly tortuous logic that the swap dealer was for practical purposes no different than a food industry "commercial hedger", and therefore exempt from regulation - and regulatory limits on the size of the investment. The decision, however, was a one-time affair rather than a change in the rules. Investors need assurance that the exemption would become precedent, so in 1992 Congress passed legislation empowering the CFTC to determine what kinds of derivatives could be treated as forward contracts. Regulation was further loosed through new legislation in 2000 which established new exemptions, including virtual trading in energy futures contracts - the "Enron loophole".

Freed of regulatory limits and requirements, pension funds increasingly turned to food commodity markets, The Ontario Teachers' Pension fund, which began with a modest investment in 1997, now has some USD 3 billion invested. With rising investor activity and increasing demand, prices became to rise: "Between 2000 and 2007, the price of wheat increased 147 per cent on the Chicago Board of Trade. Over the same period, corn increased 79 per cent and soybeans 72 per cent. In the past year, in particular, the price moves have been dramatic. The CFTC's moves to deregulate the sector, meanwhile, only inspired calls for more deregulation. As more funds piled in, stoking demand for agricultural futures contracts, speculators began clamouring for more flexibility with trading limits."

Always eager to abandon its mandate of regulating in the public interest, the CFTC in 2005 expanded trading limits on the amount of wheat, corn, oats and soybeans that traders could buy or sell at any one time on the futures markets.

In 2006, Deutsche Bank and an (undisclosed) fund asked to be exempted from all trading limits. The regulatory authorities assured them that there would be no penalties for exceeding the limits.

More recently, the CFTC has proposed full regulatory exemption for index and pension funds, which would allow them to invest directly In the face of rising criticism, the same arguments produced in defense of the buyout binge are being adduced: the funds are "bringing liquidity" to the market, and generalizing risk.

From another point of view, it has been estimated that every percent point increase in the price of food pushes an additional 16 million people into hunger.

In its briefing paper for the World Food Summit held June 3-5 in Rome, the FAO devoted two perfunctory paragraphs to the influence of financial markets in pushing upwards the cost of staple food commodities in its "assessment of recent developments", and had nothing to say on the matter in its concluding "policy options". Regulating financial markets, it seems, is not a policy option in the face of mass starvation.