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Debt matters: what is at stake in the struggle to refinance portfolio companies

It should come as no surprise that private equity-owned companies make up over half of the 293 entries on Standard & Poor's recent "weakest links" list of corporations facing credit downgrades (reported in the June 2 Financial Times) or that private equity funds were involved in 78 of the last 140 corporate defaults The suffocating weight of high leverage on company balance sheets has been regularly documented on this site. Nor is it exactly news that, according to S&P, exiting a leveraged buyout through a return to the stock market "is less feasible in the current environment, perhaps compelling sponsors to the engagement longer and deeper than they had originally planned”. Precisely this point - and its implications for unions engaged in collective bargaining with private equity owners who never intended to remain for long on the employer side of the bargaining table - was made by the IUF in August 2007 at the onset of the credit crisis (The Harsh World of Leveraged Buyouts Has Suddenly Gotten Harsher). What is new and significant, and will have a direct impact on employment and collective bargaining/union organizing is the intensifying fight over debt restructuring heating up inside the financial ruins of deeply scarred companies.

With over USD 1 trillion in buyout-related junk bonds coming due by 2014 and private equity-owned companies under severe cash strain, the battle is on in a war of position beyond bondholders and debt holders with claims on equity. The private equity funds - whose buyout strategy consisted of reducing their own equity stake to an absolute minimum in doing the deals - are now seeking to amass equity claims (which would leave them in control of what's left or could be extracted) in preference to those with a shot at cash in the event of company bankruptcy.

"Some debt exchanges are transferring wealth from bondholders, who are taking losses, to equity investors, who benefit when debt is extinguished", notes an April 17 Reuters article.

One way to measure the intensity of the combat is by the volume of "exchanged debt" changing hands in refinancing operations as the buyout funds trade old debt for new to position themselves for default/bankruptcy. According to Professor Edward Altman of New York University, quoted by Reuters in the April 17 article, distressed debt exchanges in 2008 totaled nearly USD 30 billion - or double the total value of the previous 24 years combined!

"The new twist", observes Reuters, "is that debt exchanges are becoming more coercive, meaning that bondholders participate not to receive benefits such as higher coupons but out of fear of harm if they hold out. In these kinds of exchanges, investors who swap their debt are often bumped higher in the capital structure, weakening the holdouts’ claim on a company’s assets if it goes bankrupt."

This is precisely what has been happening at Harrah's, the world's largest casino complex owned by TPG and Apollo. The funds have been buying up second-lien notes for 37 cents on the dollar, but have faced revolt on the part of bondholders anxious to secure the best possible deal when bankruptcy comes. (In addition to scooping up its own debt, Harrah's in late May issued USD 1.375 billion of notes paying 11.75% to pay down debt arising from the 2008 leveraged buyout. According to data from Bloomberg, "Speculative-grade companies, rated below Baa3 by Moody’s Investors Service and lower than BBB- by S&P, have sold $43 billion of junk bonds this year, 34 percent more than in the same period of 2008, according to Bloomberg data." So in the middle of an ongoing "credit crisis", junk bonds are flooding the market!)

Harrah's has also announced a USD 500 million cost-cutting program, which together with the refinancing pressure will translate into immediate pressure on workers and their contracts.

Bondholders at Freescale Semiconductor, the chipmaker taken private in December 2006 by a Blackstone-led private equity consortium including Carlyle, Permira and TPG, have recently sued the company, claiming its exchange program "unjustly enriched" noteholders who swapped "nearly worthless" notes for a loan backed by company assets as collateral. The lawsuit claims "The noteholders will have a substantially better chance of recovery if Freescale files for bankruptcy."

The consequences of the heavy leverage in the Freescale buyout were accurately identified by Business Week's April 3,2008 "When a Buyout Goes Bad", which called the deal "one of the ugliest buyouts in history.", noting that the debt burden would cripple capital expenditure and investment in R&D in the highly competitive and volatile technology sector.

"Freescale has no plans to lay off employees or sell or otherwise dispose of its facilities", according to the company's filing with the Securities and Exchange Commission which announced the buyout. By the end of last year the company had laid off some 2,500 employees - 10% of the global workforce. For workers, the ugly buyout gets even uglier.

Lenders are also pushing back at Clear Channel Communications, taken private in 2008 by Bain Capital and THL. According to the New York Post of May 22, "Only nine months after private-equity firms THL Partners and Bain Capital bought the radio and billboard giant in a $27 billion leveraged buyout, the two firms this week reached out to Clear Channel's largest senior lenders to propose a debt exchange and were roundly rejected by at least two lenders, who sources said had little interest in the proposal." The Post quotes one of the lenders who "said he might fare better forcing the company into bankruptcy than accepting a debt swap".

Clear Channel - whose private equity owners had to take legal action against the banks to force them to finance one of the last of the giant buyouts deal as the credit crisis deepened - has already had to lay off 1,850 employeees on its short march to bankruptcy. Now the battle over refinancing will determine how many workers are left in what remains of the company and how the debt holders dispose of its assets. The lesson for unions is that debt matters: how much debt and what kind of debt are on a company's books are crucial issues for unions defending workers' jobs and working conditions.