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.

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.

Not long after the highly leveraged Hilton deal, markets crashed; occupancy rates and room revenues hit their lowest trough in decades and continue to fall. When Blackstone bought Hilton, the Bloomberg lodging index - which records the market capitalization of listed hotel companies - was up 38% on the previous year. It peaked at 300 in September 2007, and today stands at around 120.

At the time, however, financial markets saw it as yet another canny buyout. The money carousel, it seemed, would never stop spinning.

In March 2004, Blackstone bought the Extended Stay America chain for just under USD 2 billion, assuming at the same time USD 1.13 billion of the company's debt. Occupancy rates and net income had been falling over the previous two years, but markets were "frothing". Blackstone paid a 24% premium over the company's listed share price. At the time, Extended Stay, which primarily serviced business employees on longterm job assignments, had 475 hotels nationwide.

In April 2007, Blackstone sold Extended Stay to real estate investors Lightstone Group for USD 8 billion.

The deal was done with USD 1 billion in cash and 7 billion in debt. Lightstone had no experience in the hospitality sector, but markets were even frothier than in 2004. "This was a perfect opportunity for The Lightstone Group to expand its growing portfolio into the hotel industry and acquiring Extended Stay Hotels immediately puts us in a leadership position within the extended stay market," said the then CEO. "This transaction is consistent with our strategy of acquiring companies with outstanding brand identity and bringing the necessary resources to unlock long term value."

Two years later, in June 2009, Extended Stay filed for bankruptcy protection - with $7.1 billion in assets and $7.6 billion in debt at the end of last year. “Extended Stay is significantly over-leveraged and the projected cash flows cannot continue to service over $7 billion in debt,” according to the company's general counsel" - how they managed to make it this far would certainly make fascinating reading.

Who owns the debt? The bankruptcy proceedings will have to sort it out, but it's easier than with the earlier megabuyouts. Because the credit crisis hit soon after the deal was finalized, the banks had no chance to bundle the debt up into the kinds of securities which the LBO boom propelled into the furthest reaches of the financial universe. The banks still have most of it - but of course the banking landscape has also gone through some fundamental changes since then. The largest chunk of the secured debt (USD 984 million in mezzanine debt and 515 million in mortgage debt) is owned by Wachovia Bank NA, the bankrupt lender saved from collapse last year through a shotgun marriage with Wells Fargo. Citigroup had hoped to get it cheaper, with significant help from the US treasury, and sued when Wells Fargo topped their bid. But the federal government and US taxpayers aren't off the hook: the Federal Reserve has close to 900 million in Extended Stay debt.

Blackstone unloaded Extended Stay at the right moment, cashing in big time. Times have changed, as all but the financial amnesiacs know they must. They now have a significantly larger problem with Hilton - and so do Hilton workers.

Hilton, according to the Wall Street Journal, is seeking to restructure its debt - which still stands at... USD 20 billion, meaning there has been no net debt reduction since the buyout over two years ago. According to the WSJ, "In the Hilton negotiations, Blackstone is considering contributing $800 million of new equity to buy back debt at a discount. It also is seeking to extend debt maturing in 2013 to 2016, while converting some junior slices of debt into equity. The $800 million in additional equity would come from funds managed by Blackstone that already have invested in the deal", Blackston's largest single investment.

As with the collapse of the much smaller Extended Stay, the federal government is sitting on a sizeable pile of this dubious paper. As a result of the deal which saw US taxpayers paying for the "merger" of the collapsing Bear Stearns with JP Morgan Chase, the Federal Reserve owns USD 4 billion of the debt - and the terms of the deal limit Blackstone's ability to buy it back on the cheap.

So with the hospitality industry suffering from severe recession, the value of commercial real estate tumbling and taking with it the financial house of cards built on these fictitious assets, lenders in revolt against the refinancing schemes (see Debt matters: what is at stake in the struggle to refinance portfolio companies) which weaken their claims and the US Treasury as a wild card, that leaves Hilton workers to bear the brunt of the damage.

The WSJ cites Blackstone President Tony James on a recent earnings call claiming "You can effectively rewrite history by changing a company's capital structure and reducing its leverage." Debt can be restructured, history cannot - restructuring debt at Hilton will inevitably involve attacks on employment levels and on terms and conditions across a very wide front. Unions need to absorb the lessons of the past.

Private equity funds can raise money through issuing shares in their companies in part or in whole, but stock markets have not welcomed recent efforts to raise cash through share offerings, which in the US netted only USD 3.7 billion over the last 6 months, when stock markets were recovering. According to Bloomberg, recent share offerings show the worst performance since 1995.

"In commercial real estate and leveraged buyouts, the bloodletting is yet to come", according to hedge fund investor George Soros.

On October 29, Enron spinoff AEI International had to cancel its proposed USD 800 million public offering when prospective buyers refused to buy the stock even at a radically reduced share price. The offer was cut from a projected USD 800 million to 300 million, ultimately prompting the big investment banks underwriting the issue to withdraw the offer.

Bloomberg quoted analyst Timothy Monfort as saying “Investors are more focused than ever before on buying healthy balance sheets. They don’t want to see a stop-gap measure and they want to know that the equity investment offers a complete solution for the company.”

Healthy balance sheets however are in short supply. The October 25 public offering by Dole, the world's largest fresh fruit and vegetable company, likewise flopped due to the company's high debt level. Dole had hoped to pay down a piece of the enormous debt resulting from its 2003 leveraged buyout by offering shares giving 41% percent ownership at USD 15 per share. The IPO saw this reduced to USD 12.50; on November 5 Dole was trading at USD 11.40.

According to CNN, "Even after the IPO, Dole has debt nearly four times its earnings before interest, tax, depreciation, and amortization. That's more than 50% higher than the leverage levels at rivals like Del Monte and ConAgra Foods. Last year its interest expense ate up a third of its EBITDA. If sales of its branded produce don't rebound, there won't be much left for shareholders to harvest."

Guy Hands of the UK's Terra Firma told the October 14 Super Return Middle East Conference in Dubai “For certain sponsors [i.e. buyout funds], the reality is they’re unlikely to get any carry from these funds, so they want to get out and get on to the next one quickly.” (Carry is the industry term for the 20% share of overall profits captured by the fund bosses - see the IUF Workers' Guide to Private Equity Buyouts).

So where does that leave workers at a time when the funds which own the companies which employ them are anxious to unload but investors are less than enthusiastic about buying companies burdened with intolerable debt levels? Ambitious plans to IPO portfolio companies may have to be shelved in the light of current conditions.

The last things private equity "investors" do is invest in the companies they take over - a point highlighted in the most recent Moody's study of private equity defaults, which according to the New York Times "concludes that private equity firms invest virtually no capital in the companies they buy, especially those in distress."

The funds will be compelled to reduce costs and raise cash in a fierce drive to lower debt ratios. This will entail a mix of trying to force debtors spooked by the risk of losing everything to accept big losses through aggressive debt restructuring , scouring their companies for remaining assets to sell off (as Dole has been doing with large parcels of farmland), and aggressively attacking wages, benefits and pension plans. IPOs will bring no relief to unions representing workers in private equity-owned portfolio companies, who should be on alert and demand comprehensive access to all financial information.

In June, workers at Harvard University were told that 275 of them would be laid off and 40 would have their hours cut.

Weeks earlier in Texas, retired state employees and retired teachers learned that they wouldn't be receiving long overdue pension increases. Those still working for the state learned that they would be paying higher contributions to their pension fund and new state employees would have their pension benefits cut.

The layoffs at Harvard, the higher pension contributions and lower benefits, and the lack of pension increases are collateral damage from what Harvard President Drew Gilpin Faust called "a set of extraordinary financial challenges."

What were these "extraordinary financial challenges? There was really only one: the precipitous decline of investment assets that help pay Harvard's operating expenses and fund pensions for Texas teachers and state workers.

The value of Harvard's endowment fund, which pays more than one-third of the university's operating expenses, has dropped 30 percent since June 2008.

Texas' two main public pension funds, the Teachers Retirement System and the state workers' Employee Retirement System, in March reported losses of 32 percent and 28 percent respectively.

Harvard's financial losses and subsequent job cuts are largely due to its over commitment of funds to private equity investments and other alternative assets.

In Texas, returns on private equity investments have been disappointing, but TRS and ERS remain committed to increasing their investments in private equity and other alternative investments.

Harvard's Problems

Harvard was one of the first large institutional investors to jump into the alternative asset market. Private equity is one type of alternative asset; others include real estate, commodities, and hedge funds.

By 2008, 35 percent of Harvard's endowment investments were in alternative assets instead of stocks and bonds, the more traditional investments.

The strategy worked well. Over a ten-year period, Harvard's private equity holdings generated a 28 percent return on investment.

But in 2008, the bottom fell out of the private equity market, and Harvard suffered huge losses. Steve Davidoff, who teaches law at the University of Connecticut School of Law and contributes frequently to the New York Times Deal Book blog, estimates that the value of all of Harvard's private equity investments dropped by 40 percent between June 2008 and March 2009.

Layoffs and pay freezes for staff and faculty followed.

Why the sudden downturn in private equity investments?

Private equity investments work like this: A private equity company sets up an investment fund and solicits commitments of capital from big institutional investors like pension funds and endowments and from large private investors.

The company uses the committed capital to partially fund deals such as leveraged buyouts of publicly owned companies, the purchase of corporate bonds and securities selling for less than their face value, and venture capital investments.

Generally, private equity investments are speculative in nature. They rely heavily on borrowed money--according to Barron's private equity companies in the mid-2000s borrowed nearly $1 trillion just to finance leveraged buyouts--and are sold when the investment becomes worth more than the original price.

The profits from these deals are shared with investors as are the losses. During the mid-2000s some private equity funds were generating returns of 50 percent or more. The norm was 25 percent.

But these profits were unsustainable because they were fueled by huge amounts of debt. Leveraged buyouts, the main private equity deal of this decade, saddled companies acquired in these buyouts with heavy debt burdens.

As long as revenue remained constant or grew, most of these companies could pay their debts. If there was a problem, cheap and easy credit for refinancing debt was always available.

But when the recession hit, revenues dropped and cheap, easy credit dried up. As a result, many of these companies were unable to make debt payments forcing bankruptcies and near bankruptcies

One of the Teachers Retirement System's private equity investments is illustrative. Back in 2007, TRS decided to commit $300 million to Colony Investors VIII, an investment fund set up by Colony Capital, a Los Angeles private equity company that specializes in real estate deals.

At the time, one of the deals that Colony had in the works was the purchase of Station Casinos, a gaming company that owned about a dozen mid-level casinos in Las Vegas.

Despite some reluctance, TRS agreed to this commitment after a private consulting firm estimated that the commitment would generate an annual return on investment of nearly 19 percent.

Unlike many private equity ventures that are speculative in nature, this one was to be a long-term investment. Colony in partnership with Station's managing partners, the Frettita brothers, Frank and Lorenzo, bought out company stock holders, took the company private, and planned to use land already owned by the company to build new, high-end casinos.

Colony and the Frettita brothers borrowed about $3 billion to buy stock from shareholders at about $90 a share, increasing the company's debt load to more than $5 billion.

The deal was done in November 2007, but by December 2008, Station was in trouble. The recession caused revenue to drop sharply, and for the final quarter of 2008, Station reported a net loss of $3 billion.

By January 2009 it was unable to pay interest on bonds coming due, the first in a series of defaults.

In February, the company announced that it would file for bankruptcy and asked bondholders to accept payments of between ten and 50 cents on the dollar for their bonds.

Since then, the company has been in pre-bankruptcy limbo as it tries to negotiate a pre-packaged bankruptcy deal with bondholders who didn't like the original offer. (Update: Station filed for bankruptcy in July.)

Investors who committed capital to Colony have taken a beating. Whitehall Street Global Real Estate Limited Partnerships 2007, a Goldman Sachs investment vehicle, reported that its $139 million investment in the Station deal was now worth $31 million.

As for TRS, its investment in Colony Capital Investors VIII has dropped 77 percent in value since 2007.

Illiquidity: Another Problem for Investors

There is another problem with private equity investments that wasn't anticipated when returns were high. These investments are highly illiquid. That is, if something goes wrong and you want to get your money out of the investments, it's difficult to do so.

When an investor like Harvard, TRS, or ERS commit capital to a private equity fund, they do so for a certain period of time, usually ten years. The private equity company draws on these commitments as needed.

Investors pay the private equity company a management fee of on average 1.5 percent of committed capital. Investors become limited partners with little say in how the capital is invested.

When Harvard's private equity investments turned sour, their illiquidity amplified Harvard's problems. The university tried to get out of some of its commitments, but Harvard's private equity partners were hemorrhaging money themselves and wouldn't let the university do so.

Harvard tried to sell some of its private equity investments to other investors, but the offers it received, estimated to be about 20 cents on the dollar or less, were so low that it decided not to sell. Instead, it froze salaries and laid off staff.

Although not as hard hit as Harvard, Texas state workers' Employees Retirement System has run into problems caused by the illiquidity of its private equity holdings and other illiquid investments.

ERS staff recently told the system's Board of Trustees that its monthly cash flow excess of $10 million would shrink to $5 million by 2017 because of its private equity and real asset commitments and because the return on investment outlook for these investments was bleak.

It seems likely that this predicted decline in cash flow was partially responsible for the higher contributions that current state employees will be making to the pension fund, the cuts to the benefits of new employees, and the lack of a pension increase.

TRS and ERS Stay Committed to Private Equity

ERS's and TRS's private equity and other alternative assets have so far been disappointing. TRS's private equity one-year return on investment was -25 percent. TRS investment staff isn't expecting much improvement.

A recent report to the TRS Board of Trustees said that, "distributions (from private equity investments) will continue to be lower than normal levels over the next 12 to 18 months." Other alternative assets such as real estate had equally disheartening returns.

But unlike Harvard, which has begun to divest itself of some of its private equity holdings and will be less aggressive investing in alternative assets, both Texas public pension funds plan to increase their alternative investment holdings.

Under pressure from state leaders to increase investment returns so the state would not have to increase pension contributions, TRS in 2007 decided to increase its allocation of alternative asset investments from 5 percent to nearly 30 percent over a three to five year period.

TRS remains committed to making this transition.

ERS is also planning to increase its holdings of alternative assets. Today ERS's alternative asset holdings are less than 5 percent of its portfolio, but it plans to increase these holdings to 21 percent.

One reason that TRS gives for increasing its holdings is that alternative assets including private equity have performed better than its stock market investments.

In March, TRS issued a report saying that these results are proof that its alternative asset strategy is sound and that it will continue to increase its alternative asset holdings.

Time will tell whether this bet pays off. If it doesn't, 1.4 million Texas teachers, state workers, and retirees whose pension benefits are administered by TRS and ERS could be facing the further benefit cuts.

In response to an unfair labour practices complaint filed by the union at the National Labor Relations Board (NLRB) earlier this year, a judge on June 30 agreed with the union that Brynwood had committed an unfair labour practice by invoking economic difficulties to justify the contract slash-and-burn offer but then refusing to provide any information about the company's actual finances. The judge ordered the workers reinstated with back pay, instructing the company to furnish the requested information and engage in genuine bargaining.

The union has responded to the announced closure by filing new charges against Brynwood Partners at the NLRB denouncing the threat to relocate production and close the factory as illegal retaliation for the union's successful legal action in getting the workers back to their jobs.

According to BCTGM Local 50, which represents the Stella workers, "In an attempt to reopen negotiations, the union exercised its right to demand bargaining over both the renewal of the expired collective agreement and the company’s decision to close the plant and relocate production. In a July 13 letter to company attorney Mark Jacoby, the union asked to be given the information the federal judge had previously ordered the company to provide. Further, since the company indicated that it was relocating production because of allegedly high labor costs, the union is entitled to and demanded information regarding the identity of the facility production was being transferred to and the projected costs of production and distribution of Stella D’oro products from that facility."

The union has also highlighted the tax rebates and subsidies that Brynwood Partners have received from city and state governmen to support local manufacturingt.

The BCTGM has identified at least two employee pension funds invested with Brynwood: CalPERS of California, the largest US public pension fund, and the Pennsylvania State Retirement System. CalPERS - which at the end of 2008 had over USD 43 billion invested in private equity - has recently voted to increase its private equity investment allotment from 10 to 14%, securing its position as one of the world's largest investors in private equity.

Brynwood bought the Turtles and Flipz confectionery brands from Nestlé, merged them as Demet's, and in December 2008 added two more Nestlé USA brands, Trerasures and Stixx. Brynwood's food portfoliio includes as well private label food manufacturer Richelieu Foods.

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.

When the family sold the business to Nabisco in 1992, Stella D'Oro had 3 bakeries across the US with 575 employees and annual sales of 65 million dollars. But the 1990's were the decade which crystallized "shareholder value", the pressure to deliver constantly rising dividends and share prices. Fixed investment was increasingly viewed as a liability rather than an asset. Cash flow began to be diverted away from productive investment to finance dividends and share buybacks. Despite healthy earnings, companies began to borrow heavily to pay out even more cash to shareholders. From third quarter 2004 to third quarter 2008, the companies in the Standard & Poors 500 spent 2.6 trillion dollars on dividends and share buybacks - on $2.4 trillion in earnings. Whole or partial product lines - including profitable operations - were sold off and rotated through a succession of owners.

For many workers, the process ends with the sale of orphan brands, manufacturing sites and services to a private equity fund. From 2000 through 2007, some 3,000 US companies with a value of over one trillion dollars were acquired by private equity funds through leveraged buyouts relying on massive debt to finance the deals.

RJR-Nabisco was taken private by KKR for 31 billion dollars in the 1989 leveraged buyout memorialized in the book (and later movie) “Barbarians At The Gate." KKR couldn't build the Stella D'Oro brand or the company's other products: they were too busy scrambling to meet interest payments and get their cash out. The mega-LBO failed to yield the anticipated megaprofits, despite massive job cuts and plant closings. So RJR-Nabisco was dismembered; in 2002 Kraft bought Nabisco, and with it Stella D'Oro, originally with an eye on challenging other up-market bakery specialists.

With Nabisco reeling from the ongoing buyout damage, Kraft began by investing in new equipment and production lines in the Stella plant in Illinois. But Kraft succumbed to the pressure for "shareholder value". The company abandoned its investment, scrapped the newly updated plant, and sold on the remaining Stella operation.

The shrinking process under Kraft left Stella D’oro with one plant and annual sales of roughly $30 million. Shortly after the Stella sale, Kraft announced a 23% increase in quarterly earnings and the elimination of an unspecified 8,000 jobs worldwide. Financial analysts were pleased: Kraft was finally getting serious.

Kraft sold Stella D'Oro in 2006 to a private equity house, Brynwood Partners. No one outside of a narrow investor circle knows the sale price or the terms of the sale. Because private equity firms are exempted from disclosure requirements, the public - including the Stella D'Oro workers and their union, Local 50 of the BCTGM (the Bakery, Confectionery, Tobacco Workers & Grain Millers International Union) - know nothing about the financial situation at the company that was once their collective bargaining counterpart. They can't know how much debt went into the deal, though they can assume it was a healthy portion of the purchase price. They can't know the rates of interest or who holds the paper. They can't know who invested in the Brynwood fund that did the deal (like all private equity investors, Brynwood Partners' fundraising is staggered in cycles).

They can't know the business plan, but they have to assume that the company books, as with every leveraged buyout, are guided by a single imperative: cash in, interest out. And they can only assume that Brynwood Partners' motivation in buying the bakery that used to be their workplace was to pay down the debt, get their money out early and sell it off as soon as possible to another investor. Brynwood's investors would expect nothing less.

The first attack on working conditions at Stella D'Oro was indirect: management replaced the union distribution company with "independent contractors" working for inferior pay. Then when the production workers' union contract ran out in July 2008, Brynwood put its first and "final offer" on the bargaining table: wages for most workers would be cut by a dollar an hour over the next five years. That meant that workers earning $18 an hour today would be making $13 in 2013. The company's first and only negotiating proposal also included stiff additional health care premiums, the elimination of Saturday pay, the elimination of paid sick leave and reduced holidays and vacation time. Under the contract proposal, nearly every Stella D'Oro worker would be considerably worse off at the end of the contract.

When the company refused to budge, the union felt it had no choice but to go on strike - and the members have been walking the picket line every day since August 13 last year. Since then, the union has received three communications from management. Soon after the walkout, union members were informed that they were being replaced by "permanent replacements", with no right to reinstatement. A letter in December informed that nearly half the positions had been "permanently replaced." And management has come up with a modification to its contract proposals: replacing the company pension plan with a 401k stock ownership plan (hardly an enticing prospect these days).

The Stella D'Oro workers are determined to defend their wages, benefits and dignity, and they've continued to walk the line. No one has broken ranks, and they've received support from other unions, community activists, and borough and state political representatives. Union members recently turned out in force for a demo at Brynwood Partners's Greenwich, Connecticut headquarters, chanting "No contract - no cookies!" But they're up against a tough adversary, and the current legal framework for industrial relations and collective bargaining is not in their favour. It's been decades since workers saw anything resembling strong government sanctions for “surface bargaining”. While management has clearly shown less than good faith, there have been no consequences for delivering ultimatums rather than seeking joint solutions through the collective bargaining process.

The federal government’s National Labor Relations Board recently issued a complaint, validating the union’s charge that Brynwood had not bargained in good faith. But given the broken status of US labor law, justice from the legal system could take years to achieve, if ever.

“We have never had serious negotiations with Brynwood,” according to local union President Joyce Alston." The Stella D'Oro workers are at pains to emphasize that they're not asking for more. Given the dire state of the economy, most would be happy to keep what they have.

The dispute at Stella D'Oro is much more than a routine conflict over wages involving a union intent on defending members' living standards and a hard-nosed management struggling with a tough economic climate. At the heart of the conflict is the huge burden of debt weighing down the balance sheets of companies taken private through an LBO.

A leveraged buyout is at best a highly fragile construction. When a company's books are swamped with debt, a rise in interest rates, an increase in raw material prices or even a slight consumer downturn can sink it. It is now estimated that up to one-half of all the companies owned by private equity funds could soon be looking at bankruptcy. Default rates are on the rise, and a number of private-equity owned restaurants, retail chains and manufacturers have already had to close their doors.

Outstanding LBO debt is a ticking time bomb in the debt markets. Like the sub-prime debt, it has been sliced, diced, securitized and "warehoused" in obscure corners of the financial universe that are only now coming to light. Buyout debt the banks couldn't move off their books when the meltdown came is weighing down their balance sheets, further aggravating the crisis in the financial sector.

The Obama administration is now proposing that private equity fund bosses' earnings be taxed at a higher rate. Considering that KKR's owners took in 1.3 billion in profits in 2007, at the peak of the LBO bubble, and that they probably pay a lower rate on their earnings (taxed at the present low rate as capital gains) than the Stella D'Oro workers, it's a welcome proposal, and a timely one. But it doesn't address the tax break at the heart of the buyout model, which is the unlimited deductibility of interest for business tax, not the low rate of taxation on personal income for the buyout chiefs.

This massive regulatory subsidy, which encourages financial pillage while costing taxpayers billions of dollars in lost public revenue, is an open invitation to poison the books. As long as company balance sheets are forced to assume the burden of their own buyout and saddled with colossal debts, workers like those at Stella D'Oro will be forced to pay the price.

Stella D'Oro is a classic example of a profitable company which has been drained and shrunk in the quest for quick gains and then turned over to the financial markets to leverage out the last bit of cash.

There was talk about cleaning up the fallout from the 1980's LBO boom in the early days of the Clinton administration. It soon got sidelined by the savings and loan crisis - and financial markets were progressively deregulated to facilitate the use of increasing amounts of debt to drive profits to new heights. So when conditions were ripe - from roughly 2000 to mid 2007, when the credit crunch began to bite - we had LBO boom number 2. The funds had changed their name to the friendlier sounding "private equity", but the mechanisms were the same.

The acquisitions were now global, the buyouts were bigger, the leverage greater, and the damage will be far wider than anything seen in the 1980s, which for many workers were a disaster.

Politicians and ordinary citizens have finally woken up to the damage unleashed by highly leveraged financial instruments. Regulatory proposals are lagging behind. The Obama administration should take action now - because working Americans can’t stand many more Stella D’Oros.

The Wall Street Journal defines their role as performing "a variety of client services, such as crafting marketing materials and investor presentations -- or making introductions -- to help firms win coveted business that generates significant fees." As the buyout business has come under growing pressure to deliver the returns pension funds had been led to expect, the use of the agents has increased. "Use of placement agents has risen in recent years, as the hedge-fund and private-equity industries have grown. At the same time, declining profits and an exodus of investors amid the downturn has put pressure on firms to raise money, which can generate more business for placement agents. More than half of private-equity firms globally, or about 54%, used placement agents to close funds last year, compared to 40% in 2006, according to London-based research firm Preqin Ltd."

Carlyle Group is the largest and best know private equity fund to have been publicly named in the course of the investigation, which originally sought to determine whether some two dozen funds violated securities laws (in essence taking illegal kickbacks) in exchange for access to the New York City Employees Retirement System (NYCERS). NYCERS has investments with no less than 94 different buyout funeds – USD 1.9 billion of USD 30 billion in total investments.

According to its former executive director John Murphy, "NYCERS is in the dark as to what these investments are worth [today]." It goes without saying that they're worth a fraction of their notional value only a year ago.

New York State has now banned placement agents from access to state employees' pension funds. Meanwhile, the number of funds under investigation and the geographical scope are widening.