" /> The IUF's Private Equity Buyout Watch: February 2010 Archives

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February 03, 2010

Blackmailing the Taxman, from Davos to Sydney

Blackstone Chairman Stephen Schwarzman, speaking from Davos, Switzerland, has warned Australia of a foreign investment "chill" following that country's efforts to collect taxes on a windfall deal from private equity giant TPG.

He needn't have bothered; according to reports in the Australian media, the government has for some time been discretely polling private equity firms to ask if.. paying taxes would influence their feelings about doing deals there. They'll be reporting their scientific findings to the Treasury and Prime Minister

Schwarzman knows something about taxes, having earned over USD 702 million in 2008, making him the highest-paid US executive (Oracle's boss was a distant second, with 557 million). Blackstone and TPG have been serious rivals in bidding wars, but TPG's adventures with the Australian Taxation Office show that competitors know how to close ranks in the face of a joint threat.

In June 2006, TPG, together with management and another, smaller, private equity fund, led a buyout of Australia's Myer department store chain, for AUD 1.4 billion (1.04 billion USD), with 500 mlllon in equity. Beginning the next month, the new owners starting selling off property and leasing it back. Within a year, the private equity investors had recovered their initial stake with the cash from the property deals.

Inventory was reduced by more than half in a huge selloff at some one-third of value; depots were shut and distribution centralized; a former Australian Miss Universe, whose face adorned the 2009 share offer prospectus (urging investors to buy "A piece of my Myer"), was hired for a 4 million dollar, 4-year promotional stint. The company took on new debt, issuing 250 million in notes.

The fire sale, the property selloffs and a downsized distribution worked financial wonders: while sales remained stagnant, operating profits increased by 17%

As stock markets recovered in 2009, Meyer's private equity owners timed an IPO perfectly, returning the company to the public stock market in November 2009 with an initial share offering of 2.4 billion AUD which valued the company at AUD 2.8 billion.

TPG made a 400% return on its investment.

Those who bought the shares weren't so lucky.MYR.AX lost more than eight percent on it's first day of trading, removing AUD 200 million from the company's market capitalization. On January 31, 2009, the stock was trading at a little over 3 dollars a share, down from its initial offering at AUD 4.10.

Shortly after the IPO, the New York Times Dealbook noted: The Myer deal evokes shades of Debenhams , the British department store chain TPG took public in 2006 with Merrill Lynch and the private equity firm CVC Capital Partners. They, too, scored an almost fourfold return, while the value of Debenhams stock has since fallen by half… The sale of Myer’s flagship store raised 605 million Australian dollars, which helped the buyout firm repay itself in full after little over a year. The catch: selling property locks retailers into paying rent, exacerbating the effect of any sales decline. Debenhams has learned that the hard way.

Two weeks after the IPO closed, the Australian tax authorities determined that TPG owed AUD 620 million in taxes and penalties on the profits from the IPO. A freeze was ordered on the TPG account set up to handle the deal. The account held 48 dollars.

To justify its claim, the Australian tax authority has proposed that profits from the disposal of assets acquired through a leveraged buyout be treated for tax purposes as revenue rather than a capital gain, which is taxed at a lower rate. The debate on taxing buyout profits is not new (and is identified in the IUF Workers' Guide to Private Equity Buyouts as one of the key tax loopholes which makes the business so profitable). The argument is straightforward: private equity funds are in the business of buying and selling companies on a regular (if cyclical) basis, which provides them with a stream of revenue. Their profits should accordingly be taxed on that basis.

Second, the tax office claimed that TPG established its investment through a tax-avoidance scheme, exercised through a network of overseas and offshore structures in the Netherlands, Luxembourg and the Cayman Islands. Australia's private equity lobby has vociferously contended that this is a normal scheme used by overseas and even domestic "alternative asset" managers to avoid "double taxation" by headquartering the investment vehicle in a country with which Australia has a tax treaty.

The schemes exist, however, not to prevent double taxation, but to ensure little or no taxation.

Under the terms of a tax treaty, a foreign company operating in Australia can pay its income tax in the parent country. On paper, the Myer assets were (indirectly) held by a company in the Netherlands (which has a tax treaty with Australia) called NB Swanston BV. The parent of the Dutch company, NV Queen Sarl BV, is registered in Luxembourg. The mother of them all is (or was) something called TPG Newbridge Myer, registered in the Cayman Islands.. Under Dutch law, a subsidiary based in the Netherlands pays no taxes on dividends to a parent company registered in the European Union - which explains the function of the Netherlands- and Luxembourg-based shell companies interposed between Australia and the Caymans. Double taxation in this case equals no taxation. This explains the dire warnings coming out of Davos, but not the polling exercise of the Australian government, whose tax collectors have in fact issued a sound judgement.

The whole affair shows yet again the extent to which financial engineering and tax dodging constitute the foundation of the buyout business. Taxing these enormous profits could shave billions off public deficits and help finance public services and stimulate recovery at a time of massive unemployment. Foreign investors in Australia have already been exempt from capital gains tax for more than three years due to changes brought in under the previous right-wing government. For a Labour government to yield to blackmail at a time when governments including the United States and Korea are considering measures to increase taxation on private equity profits would be decidedly unhelpful. Australia in fact has no need to introduce changes to existing tax regulations to start collecting the money; the government only has to enforce what's already on the books.

February 01, 2010

Kraft and Cadbury, Victors and Spoils

Barring any last-minute surprises, Kraft, the world's second-largest food company, will swallow UK-based Cadbury in a deal which in its reliance on debt bears a family resemblance to...a leveraged buyout.

Barely a month after deriding Kraft as an "unfocused" conglomerate and declaring "There is no strategic, managerial operational or financial merit in combining with Kraft", Cadbury Chairman Roger Carr (an advisor to buyout giant KKR) announced that the price was right. He praised Kraft for its commitment to "our heritage, values and people throughout the world"…and acknowledged the inevitability of job cuts.

Prior to moving on Cadbury, Kraft's debt stood at nearly half the company's market capitalization. Despite the sale of its North American frozen pizza business to Nestlé for just under USD 4 billion, new debt taken on to fund the Cadbury takeover will push the debt ratio still higher.

Hedge funds played an active role in driving the deal forward. In the positioning over the sale price, hedge funds gobbled up as much as one third of Cadbury stock and will be insisting on their share of the expected windfall.

One of these funds, Pershing Square Capital, reportedly increased its stake in Cadbury to 2% in the final run up to the sale. Pershing Square is the hedge fund which, in April 2005, acquired a 5.6% stake in Wendy's International and in June hired Blackstone to advise on "unlocking value" from the company. Later in the same month, Wendy's announced plans to sell the real estate under more than 200 sites to franchisees and begin a partial selloff of its doughnut unit through an IPO. By noon on the day of the announcement, Wendy's shares jumped over 13%. The cash from the IPO and real estate deals was used to fund the buyback of 18% of Wendy's stock.

Two months after Wendy's finished unloading the rest of the doughnut business, Pershing Square dumped its shares in Wendy's. The Cadbury takeover has provided these "investors" with a lucrative target for the profits generated in the heady days before the financial meltdown and the stock market dive.

In finance, however, it is not always the swiftest who reap the spoils. Under growing pressure to meet investor "expectations", Kraft eliminated over 19,000 jobs in 2004-2008 and took on huge amounts of debt to fund share buybacks. Until last year, when momentum slowed due to the financial hangover from the acquisition of Danone's European biscuit business, the dividend was raised annually, even quarterly, while the company scrambled to meet earnings targets through progressive rounds of cost-cutting.

Cadbury moved more slowly to accommodate pressure for "shareholder value", only shifting into high gear with the 2008 "Vision into Action" program which coupled increased dividends with plans to eliminate 15% of the global workforce. Having started later, Cadbury's balance sheets were in better shape when Kraft and the dealmakers began to circle the company. So in December 2009, as the jockeying over the takeover price continued to heat up, Cadbury announced that it would deliver even more to shareholders by slashing investment and ramping up margins.

The UK's Unite, which fought to keep Cadbury independent and warned that a heavily leveraged takeover would inevitably encourage asset-stripping and job losses, now has to confront the weight of even more debt: over 7 billion borrowed UK pounds out of the purchase price of GBP 11.9 billion (USD 19.4 billion). That burden will weigh not only on Cadbury, but also on workers throughout Kraft's global operations, who will have to build a global defense.

Cadbury top management can enjoy their windfall, financial advisors on both ends of the deal will pocket millions and the hedge funds who loaded up on Cadbury shares) as the takeover war raged can cash in their chips and turn to short selling Kraft.

It is easy, but ultimately pointless, to accuse people like Roger Carr of treachery. He has a long history of presiding over company breakups. But it is hugely relevant to question the meaning of "investment" in a world where "investment banks" have no stake in the companies on the receiving end of the deals, when "investors" buy and sell shares with a perspective which has been compressed from years to days and even minutes, and when pension funds ostensibly acting on behalf of employees' long term interests are increasingly indistinguishable from traders motivated solely to increase their assets under management. The only group with a long-term investment in the future of their workplaces, it would appear, is the workers who build the businesses. The Cadbury deal shows just how few cards they hold - and what has to change.