The IUF's Private Equity Buyout Watch tag:www.iufdocuments.org,2011:/buyoutwatch/32 2011-11-08T10:15:23Z Movable Type 3.2 MF Global - canary in the (financial) coalmine? tag:www.iufdocuments.org,2011:/buyoutwatch//32.2490 2011-11-07T09:32:27Z 2011-11-08T10:15:23Z The October 31 collapse into bankruptcy of MF Global, the US brokerage firm with investment bank appetites and ambition, was the eighth largest corporate bankruptcy in US history, behind Lehman Brothers, Enron and Washington Mutual but ahead of automaker Chrysler.... Peter Rossman, IUF The October 31 collapse into bankruptcy of MF Global, the US brokerage firm with investment bank appetites and ambition, was the eighth largest corporate bankruptcy in US history, behind Lehman Brothers, Enron and Washington Mutual but ahead of automaker Chrysler. As with any bankruptcy, clients are scrambling to recover their money, but large sums have gone missing.

]]> Brokers are supposed to segregate client money from the money they use to fund their own trading, but apparently the walls were breached. This has triggered investigations for regulatory and, just possibly, criminal misconduct, and a great deal of media interest.

It will take time to unravel the books, but that's not the compelling story The salient lesson of the MF Global collapse is how well it illustrates the extent to which nothing has fundamentally changed, despite all the talk about regulation since the great meltdown of 2008. All the essential features are there: enormous leverage, government subsidies for pure speculation, the revolving door between finance and government and the transformation of buyout houses into omnivorous financial conglomerates.

MF Global was originally the brokerage division of UK hedge fund Man Financial, and operated out of a tax haven - Bermuda - even after going public. In 2008, huge losses on commodity derivatives nearly sank them. Private equity house J.C. Flowers rescued the company with money raised, in part, from public employee pension funds.

J.C. Flowers had become a star financial player through a deal involving the Long-Term Credit Bank of Japan, a 'too big to fail' bank which was drowning in bad debt after Japan's property bubble burst. In 1989. LTCB was nationalized and delisted from the Tokyo stock exchange. In 2000, J.C. Flowers was part of an international consortium which bought the bank and relaunched it as Shinsei Bank of Japan. Goldman Sachs collected big fees for advising the Japanese government on the deal, which included a 3-year government guarantee to buy back bad loans.

The new owners used the guarantees to dump the bad debt back on the government, eventually leaving it on the hook for over USD 46 billion. In 2004, J.C. Flowers made a 600% return on its initial investment when the bank went public, and paid no Japanese taxes on the gain.

In March 2010, another Goldman Sachs alumnus, former CEO Jon Corzine, took over as MF Global boss after failing to win reelection as governor of New Jersey. In February this year, Corzine announced his intention to transform the company into an investment bank within five years. The vehicle for that transformation was to be leverage - debt.

At the end of September, MF Global's balance sheet showed equity of USD 1.23 billion and assets of USD 41.05 billion - a staggering leverage ratio, like the ones that sank Bear Stearns and then Lehman. They were betting on mortgages, Corzine on eurozone debt. Like the other failed institutions, MF Global was boosting leverage through derivatives and funding long-term bets with short-term borrowing.

Corzine had placed a huge wager of USD 6.3 billion earlier this year on debt from shaky European governments, betting that they would be bailed out and the bonds redeemed at face value. As the asset values sank, the company faced escalating calls for cash collateral, calls it couldn't make because the bailout failed to arrive in time. This was a replay of the scenario which sank insurance giant AIG. When AIG was bailed out, Goldman Sachs was repaid in full by the US government for the bets it had placed through AIG.

MF Global doesn't qualify for government support, because it is not a retail bank. But its biggest client, JP Morgan, does.

The more things change, the more things stay the same.

Global finance remains addicted to stratospheric leverage levels, while profiting from a revolving door in which elected officials and regulators are more or less indistinguishable from those they are supposed to be regulating. The current chairman of the US CFTC, one of the regulatory bodies responsible for companies like MF Global, has removed himself from involvement in the investigation into MF Global's missing funds on the grounds of conflict of interest. He worked together with Corzine at Goldman Sachs…

Does MF Global's collapse signal more and bigger failures to come? Undoubtedly. But to call it the canary in the financial coalmine does a disservice to the coalmine. For all its hazards, coal provides a source of energy. The same cannot be said of derivatives linked to sovereign debt.

The frantic effort to rescue European government bonds has never been about supporting livelihoods and services - it is about bailing out investors who are buying government debt at a fraction of its face value and collecting astronomical interest payments. While unemployment soars and public services are dismantled, unprecedented sums of money continue to flow into instruments designed for one purpose only: to guarantee income streams to financial investors. If MF Global had won its bet, not a single worker anywhere would be better off. But win or lose, we pay.

]]> Kraft and Private Equity Slash and Burn at UK’s Burton’s Biscuits tag:www.iufdocuments.org,2011:/buyoutwatch//32.2477 2011-03-24T17:31:25Z 2011-03-24T17:40:01Z Burton’s Biscuits, the UK’s second largest biscuit manufacturer (after private equity-owned United Biscuits), has announced it will close its factory in Moreton, Merseyside, with the loss of 342 jobs, despite commitments to the union at the site that production would... Peter Rossman, IUF Burton’s Biscuits, the UK’s second largest biscuit manufacturer (after private equity-owned United Biscuits), has announced it will close its factory in Moreton, Merseyside, with the loss of 342 jobs, despite commitments to the union at the site that production would continue through May 2012. Workers at the plant, represented by Unite the Union, are being squeezed by two converging financial forces: transnational food giant Kraft, for whom Burton’s manufactures Cadbury biscuits and chocolate products, and Burton’s private equity owners.

]]> Under license to Kraft, Burton’s manufactures all Cadbury chocolate products. The Moreton site produces the new range of Cadbury Crunchie biscuits, Cadbury Turkish Delight biscuits, Cadbury Caramel biscuits and Cadbury Dairy Milk biscuits.

Kraft took on substantial debt to fund its USD 7.2 billion cash purchase of Danone’s European biscuit business in 2007, and piled on more debt when it bought Cadbury in January 2010. As a result of the Cadbury deal, Kraft’s financial structure resembles a leveraged buyout, with a debt-to-equity ratio pushing 50%. That hasn’t stopped Kraft from regularly upping dividends, and it’s now blaming high input prices for an additional squeeze on the workforce.

British private equity investors Duke Street bought Burton’s in 2007 in a secondary buyout from its original private equity owner HM Capital. In the buyout frenzy of the period, Duke Street reportedly paid some GBP 210 million. HM had bought the company in 2000 for GBP 130 million (beating out Duke Street!); they invested nothing while loading it with debt and bleeding it of cash.

Two months after Duke Street took charge, as part of the plan for “unlocking value” from Burton’s the Moreton workers were told that the site would cease producing Cadbury’s chocolates. The company CEO described this as a necessary measure for “securing the long-term success of the company”.

Local Labour MP Angela Eagle supported the union campaign against Duke Street’s plan to shut the Moreton factory. She took part in a 2007 parliamentary enquiry which helped thrust private equity into the spotlight. Production at the Moreton site was saved, though with the loss of 500 jobs. The union secured a memorandum of understanding that there would be no major employment changes until May 2012.

Eagle, speaking again about Burton’s in Parliament on January 26, 2011, described what happened at the time and since:

In 2007, the company earmarked the factory for total closure, but that was just months after the expiry of legal obligations it had agreed to in 2001 to access £4 million-worth of regional selective assistance from the regional development agency and rates rebates from the local authority. After that closure announcement, the work force were escorted off the site by security guards who had been hired specifically for the purpose. After that rather difficult beginning, we, together with the work force and their representatives, and after a successful campaign in the local community and this House, persuaded the company to change its mind. On 15 August 2007, a memorandum of understanding between the management and the Unite union, on behalf of the employees, was signed, saving manufacturing at the site and safeguarding a total of 437 jobs. In exchange for an undertaking that there would be no major restructuring on the site before May 2012, the work force accepted the proposed changes, some of which were painful, including new working practices. More painfully, there were 500 job losses despite evidence that the company's productivity had been increasing consistently year on year.

The Moreton work force have more than delivered on their side of the deal in the MOU. They have increased their productivity still further, despite having had pay freezes in four of the past 10 years and very modest increases in the other years. They have delivered £12.7 million-worth of cost reduction to the business and have agreed major changes in working practices to achieve that transformation.

I note in passing that the directors' remuneration increased by a staggering 97.5%, with a 119.9% increase for the highest paid director. That makes a startling contrast to the years of wage freezes inflicted on the work force at Moreton.

Duke Street continued to run up the debt, breaching its covenant with the lenders who funded the buyout in October 2009. Majority ownership is now shared between buyout giant Apollo Management and the Canadian Imperial Bank of Commerce, who converted their junior debt into equity, with Duke Street retaining a piece. The deal this time was valued at GBP 331.9 million.

Burton’s top management is now staffed by former Kraft managers. When Duke Street ceded control, Ben Clarke took over as CEO. Clarke had held top positions at Kraft including area director and vice president of Australia/New Zealand and category director of coffee and confectionery.

In March 2010 Kraft’s vice president of international customer development Steve Newiss was appointed to the new job of chief commercial officer. According to an industry trade report at the time (Burton’s Foods hires ‘top sales operator in Europe’) , “The move comes as Burton's, the UK's second-biggest biscuit manufacturer, announced a "new era" of investment. Newiss is expected to help Burton's grow its portfolio and expand into new markets. He will be responsible for commercial sales activities including customer management, retailer brand, international, category management and sales and operations planning.”

Speaking to FoodManufacture.co.uk after making public the company’s proposal to close the Burton’s Moreton plant, CEO Clarke said: "We've seen sales growth of 3-5% over the past 12 months and within that very strong growth from Jammie Dodgers, Maryland cookies and Cadbury products.

In a March 22 video story from the UK daily Guardian (How do you save a biscuit factory when it's not even clear who owns it?), Unite regional industrial organizer Richie James explains how Kraft, citing high cocoa prices, is pushing for additional cost savings and job cuts even before the proposed closure. He shows a series of dramatic photos testifying to the financial pillage of the site by the successive private equity owners. The factory which once employed 5,000 workers, and which the buyout bosses had pledged to transform into a “center of excellence”, is now a scene of neglect and devastation

Unite has been contesting the closure, which was announced on January 12, from when it entered into a 90-day ‘consultation’ period. The union has set up an on-line petition as part of their campaign for an alternative to closure – click here to support the campaign.

]]> EU Regulation of Private Equity: Results and Prospects tag:www.iufdocuments.org,2011:/buyoutwatch//32.2458 2011-01-13T15:54:36Z 2011-01-14T10:18:07Z Following 18 months of negotiations, the first-ever legislative regulation of private equity through a binding Directive was adopted by the European Parliament at the close of last year and will come into effect in 2013. What’s in it for workers?... Peter Rossman, IUF Following 18 months of negotiations, the first-ever legislative regulation of private equity through a binding Directive was adopted by the European Parliament at the close of last year and will come into effect in 2013. What’s in it for workers?

]]> The Alternative Investment Fund Managers Directive (AIFM), imposes specific regulatory requirements on private equity and hedge funds, as well as real estate funds and speculative funds more generally.

The AIFM Directive is the outcome of a political initiative launched some four years ago - at the height of the buyout boom - to contain the debilitating impact of leveraged buyouts on companies, workers and unions together with the heightened risk injected into the wider financial system through the growing size and scale of the buyouts.

An ambitious political agenda incorporating key trade union concerns was formulated in a report prepared by the Party of European Socialists (PES, the umbrella group of EU social democratic and labour parties, presided by Poul Nyrup Rasmussen) to which unions, including the IUF, contributed both analysis, case studies and concrete proposals for regulatory changes (see e.g. IUF at the European Parliament Highlights Dangers, Risks of Private Equity Buyouts).

As concerns private equity, important elements of that agenda - limits on leverage, measures to defend against asset stripping of acquired companies through “dividend recaps” and other devices, concrete reporting requirements which would give workers and regulators a genuine view of the state of the company - managed to survive the severe amending inflicted by hostile MEPs when it was finally adopted in September 2008. Adopting the report was the first stage in the development of a directive.

Two years and 1,700 amendments later, what remains? There is no doubt that intense lobbying by the funds succeeded in stripping the directive of much of its intended content and consequences.

What remains is, first, the recognition in law that private equity poses a distinct challenge requiring specific regulation. That in itself is a significant victory over “light touch” and “efficient market” ideology. The directive, in the words of the PES, “Is the first piece of legislation to enter into force within the framework of European supervision and the first piece of comprehensive legislation on the direct supervision of alternative investment fund managers (and indirectly of their funds).”

Second, it does enumerate specific rules on transparency and disclosure which will, at a minimum, prove a useful starting point for both workers and regulators.

Third, while it will not ultimately prevent the weakening and even destruction of viable companies we saw in previous buyout booms, it does contain concrete language on what is specifically described as “asset stripping”. Private equity funds may not pay out dividends (the notorious "dividend recapitalizations", or "recaps") or engage in other means of “capital reduction” for their first two years of ownership. The measures are limited in scope and in time, and only apply to large companies, but the adoption of a specific article on asset stripping constitutes another legislative first and recognition in law that specific regulations are required to contain financial vandalism by speculative funds.

While it does not set limits to leverage per se –the key component of a leveraged buyout – managers of funds above a prescribed minimum are obliged to communicate their leverage levels to national authorities, who may respond if the level is deemed to pose a systemic risk.

The glass is considerably less than half full – in fact it’s barely above empty - but there is at least a glass still standing in the face of a well-funded international lobby. Beyond the fact that the directive simply exists as testimony to the recognized need for a specific response to a previously immune form of activity, there is also the inclusion of a review mechanism which kicks in in 2017. The last word has not necessarily been said. This is crucial, because with interest rates low and investors again flush with cash, the stage is set for a resurgence of LBOs..

A successful transfer to new private equity owners of the services provider ISS, a company which is now on the auction block together with its half million employees, would signal that buyout activity is poised to break loose from the small scale deals which the financial meltdown imposed. And workers will have to again confront the attacks this will bring on jobs and conditions at a time of huge unemployment and savage cuts in public spending.

]]> Blackstone surfs government Hilton subsidy to demand massive concessions from hotel workers tag:www.iufdocuments.org,2010:/buyoutwatch//32.2425 2010-11-09T17:22:00Z 2010-11-09T17:24:58Z In a move which gives new meaning to “troubled asset recovery”, the Federal Reserve Bank of New York has gifted private equity giant Blackstone with USD 178 million. In early October, the Federal Reserve Bank of New York announced it... Peter Rossman, IUF In a move which gives new meaning to “troubled asset recovery”, the Federal Reserve Bank of New York has gifted private equity giant Blackstone with USD 178 million. In early October, the Federal Reserve Bank of New York announced it had sold back to Blackstone USD 320 million in debt from the heavily leveraged 2007 Hilton buyout for just 142 million, booking a 56% loss. The difference between the face value of the debt – backed by Hilton properties – and the money taken in by the sale amounts to a USD 178 million public subsidy to the buyout house.

]]>
The Fed acquired 4 billion dollars worth of Hilton debt as a result of the forced merger of the collapsing Bear Stearns with JP Morgan (see Blackstone’s Hilton woes will weigh on workers), where it was parked in a vehicle called ‘Maiden Lane’. The Fed paid a premium for the paper on Bear’s books while underwriting the operations on generous terms to shareholders. Since 2009, Blackstone has been scrambling to avoid stratospheric interest payments on 20 billion dollars borrowed to finance the Hilton deal by buying back its own debt on the cheap and rescheduling maturity. So far this year, Blackstone has managed to lop off some USD 4 billion.

“We were in good shape before and we’re in exceptionally good shape now,” Hilton CEO Chris Nassetta recently told investors.

Hilton workers have yet to see the benefits of this bountiful public subsidy. On October 18, members of UNITE HERE at the San Francisco Hilton on Union Square struck for 6 days (Hilton workers in other cities also took action) to protest Hilton’s demands for major contract concessions at a time of healthy occupancy and rising rates.

The Hilton workers have been without a contract for some 16 months since the previous agreement expired. Hilton is insisting that workers assume over 200 dollars a month in medical contributions and accept a pension freeze while trying to reduce staffing and increase workloads. Hilton is now pushing for a “Refresh Program” which would require housekeepers to clean 20 rooms daily – a 40% increase over the current 14 won after hard struggle and established in the previous contract.

Guadalupe Chavez, a housekeeper quoted on the union’s website, says ““Blackstone is still an obstacle to our recovery, lining their pockets while taking advantage of taxpayers and preventing a strong recovery for working families.”
Working conditions at Hilton, however, are unlikely to figure in the next industry-financed study of how private equity “creates value” for investors while generating employment. And the Fed should be publicly challenged to explain the logic behind this extraordinary act of charity to an investment fund which already benefits from massive tax advantages at a time when “austerity” is the new mantra.

]]> UN Special Rapporteur on the Right to Food Calls for Measures to Limit Food Commodities Speculation tag:www.iufdocuments.org,2010:/buyoutwatch//32.2423 2010-10-20T17:21:07Z 2010-10-20T17:28:55Z Are we witnessing a replay of the 2008 hyperinflation in the price of basic foodstuffs which pushed hundreds of millions of people already living on the margins into the ranks of the acutely hungry? In the past three months, the... Peter Rossman, IUF Are we witnessing a replay of the 2008 hyperinflation in the price of basic foodstuffs which pushed hundreds of millions of people already living on the margins into the ranks of the acutely hungry? In the past three months, the price of corn futures on the Chicago Board of Trade has increased by 70%

]]> In July, hedge fund Armajor purchased in a single trade a quantity of cocoa beans equivalent to 7% of global production, helping push cocoa prices to their highest level in over three decades. Armajor had effectively cornered the world market in warehoused cocoa beans. In September, riot police opened fire on demonstrators in Maputo, Mozambique protesting the increased price of bread, killing at least 13. On October 12, the giant commodity trader and primary processor Cargill announced a 68% increase in quarterly earnings: "Our results were led by the food ingredients and the commodity trading and processing segments, both of which experienced resurgence in volatility across agricultural commodity markets." Commodity funds, reports the International Herald Tribune, "are scooping up money at a time when stocks have often been stumbling along and bonds are offering skimpy yields. This year through September, investors plowed $18.3 billion into commodity offerings, versus $11.9 billion for the first nine months of 2009." Global food prices, according to the FAO, are at their highest level since September 2008 - despite projections that this year's cereal output would be the third highest on record.

A new report from the UN Special Rapporteur on the Right to Food, Olivier De Schutter, examines the role of speculation in the accelerated volatility and hyperinflation of food commodity prices in the "food price crisis" of 2007/8. He concludes that the evidence shows that "a significant role was played by the entry into markets for derivatives based on food commodities of large, powerful institutional investors such as hedge funds, pension funds and investment banks." The massive entry of these new players into the markets, according to the report, "Was made possible because of deregulation in important commodity derivatives markets beginning in 2000. These factors have yet to be comprehensively addressed, and to that extent, are still capable of fuelling price rises beyond those levels which would be justified by movements in supply and demand fundamentals. Therefore, fundamental reform of the broader global financial sector is urgently required in order to avert another food price crisis."

The report provides a clear analysis of how financial market deregulation has created a world in which the price of virtual food, traded through exotic financial instruments, can drive movements in the price of real food - and with it drive up the number of hungry, which in 2008 surpassed one billion people. It offers concrete proposals for new regulation. It assess the potential impact of the Dodd-Frank legislative reform of futures markets in the US (which affords a grace period and has not yet come into effect), and warns that countries hosting other major financial trading centers have yet to even draft similar regulations.

The report serves as a strong reminder that states' obligations to contribute to reailizing their citizens' right to food necessarily entails action to ensure that financial markets do not undermine this right. The Special Rapporteur's report also stresses the importance of re-establishing global food reserves as a necessary tool for reducing the volatile market conditions which feed financial bubbles: "The policy solutions that are needed to avert another crisis must address both the problems affecting underlying financial market fundamentals, and the conditions under which speculation is allowed to take place in essential food commodities, thereby exacerbating the effects of those movements in market fundamentals."

In June 2008, IUF General Secretary Ron Oswald told a special session on the food crisis of the International Labour Conference at the ILO in Geneva that "The FAO sees speculation playing no significant role in pushing prices upwards, but meanwhile investment funds are betting hundreds of billions of dollars on higher prices, creating a bubble that drives prices upwards. It was speculation alone which drove up the price of rice futures by 31% in a few hours on March 31. Retail prices follow, and the consequences can be fatal. As Tom Giessel, a US wheat farmer said recently "We're commoditizing everything and losing sight that it's food, that it's something people need. We're trading lives". . 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 forces generating hunger don't simply happen", said Oswald – "they are made to happen. If world cereal stocks are low, it is because governments were systematically pressured, lobbied, blackmailed and seduced into selling them off, thereby privatizing an essential mechanism for managing supply. The corporations now manage the planet's food stocks. Publicly funded agricultural research did not simply "decline" – it was consciously dismantled under the watchful eye of the World Bank."

This analysis is supported by De Schutter's report, whose work during his mandate has given many practical guideposts for action - by states but also by unions - to ensure that governments actively fulfill their obligations under international human rights law to ensure the right to food.

Food Commodities Speculation and Food Price Crises is available on the website of the UN Special Rapporteur on the Right to Food in English (download), French and Spanish.

]]> Blackstone (& Friends) Buy Extended Stay Hotels - This Time at Half Price tag:www.iufdocuments.org,2010:/buyoutwatch//32.2368 2010-07-13T17:52:36Z 2010-07-13T18:48:10Z Three months before becoming the world's largest hotelier (by rooms) with the 2007 leveraged buyout of Hilton Hotels Corporation, the private equity Blackstone Group unloaded the Extended Stay chain for USD 8 billion. It was a hell of a deal... Peter Rossman, IUF Three months before becoming the world's largest hotelier (by rooms) with the 2007 leveraged buyout of Hilton Hotels Corporation, the private equity Blackstone Group unloaded the Extended Stay chain for USD 8 billion. It was a hell of a deal for Blackstone, who picked up the chain in 2004 for just under USD 2 billion.

]]> It was a less than brilliant deal for the buyer, the Lightstone Group, for whom the purchase proved the beginning of an extended stay in bankruptcy and a narrow escape from personal liability for Lightstone's boss.

Blackstone had loaded up Extended Stay with debt: the 8 billion purchase price consisted of a billion in cash and 7 billion in debt. Two years later, in June 2009, Extended Stay filed for bankruptcy after struggling for months on life support, unable to service over 7.6 billion dollars in debt

Fast forward to May 28, 2010 when a consortium of private equity investors assembled by Centerbridge Partners, including Blackstone and Paulson & Co, successfully bid USD 3.92 billion to take Extended Stay out of bankruptcy protection. Centerbridge narrowly beat out a rival investor consortium including TGP and Starwood Capital Group, the financial power behind Starwood hotels. Bankruptcy advisers had previously estimated the value of Extended Stay at somewhere between USD 2.8 and 3.6 billion - a far cry from the 2007 8 billion price tag.

Centerbridge had already been picking up some of the Extended Stay mortgage debt on the cheap, so they could beat out their rival bidders by offering more but putting up less cash. Paulson of course is famous for raking in USD 20 billion by betting against the mortgage bubble prior to the financial meltdown, and has recently come into the news again for allegedly hand-picking the assets in a Goldman Sachs fund and betting on its collapse (though only Goldman has been indicted).

According to the Wall Street Journal, the cash paid to get Extended Stay out of bankruptcy (should the court approve) is nearly enough to retire some 4 billion worth of mortgage debt, but holders of the mezzanine (junior) debt are unlikely to see any money. The largest single loser in all this is the US tax payer.

When the US financial system collapsed along with the mortgage and other debt markets, the US federal reserve was left holding some USD 744 million in Extended Stay mezzanine debt and an additional 153 million in mortgage debt taken on through the Fed's assumption of Maiden Lane, a vehicle set up to shift ostensible 'assets' to the US government to finance JP Morgan's bargain basement acquisition of the collapsed Bear Stearns. The vast bulk of these 'investment grade' assets - CDOs, mortgage debt and related structured products - have since been downgraded to 'junk'. JP Morgan and Deutsche Bank backed the Centerbridge bid.

That leaves the US taxpayer on the short end of the deal, for a second time. The Federal Reserve, according to the WSJ, has already written down the USD 744 million to zero.

Since Extended Stay will eventually most likely be parked in a Real Estate Investment Trust, paying no taxes provided it distributes the vast bulk of the profits to investors as dividends. That will free up cash for lobbying against financial regulation. This is what lobbyists like to refer to as a 'win-win situation'…

]]> Demerging Accor - Less Than the Sum of the Parts? tag:www.iufdocuments.org,2010:/buyoutwatch//32.2335 2010-05-18T10:30:35Z 2010-11-08T10:15:00Z How many surprises can still be in store at Accor, the French-based hotel and prepaid services transnational? In 2009, when private equity investors Eurazeo and Colony Capital boosted their stake to 30%, it was described as a "vote of confidence"... Peter Rossman, IUF How many surprises can still be in store at Accor, the French-based hotel and prepaid services transnational? In 2009, when private equity investors Eurazeo and Colony Capital boosted their stake to 30%, it was described as a "vote of confidence" in existing management.

]]> Six months after the initial investment, the CEO was forced out, followed by the resignation of the Chairman and 5 other board members last year. On May 11 this year, Accor announced the resignation from the board of Alain Quinet, a representative of the French state investment group Caisse des Depots - and the last critic of current Board strategy.

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The financial situation at the end of the day this year is still solid, with the net debt standing at EUR1.624m -- EUR1.624b, sorry. EUR2.5b…And debt net ratio 20%, therefore investment grade. The bad news of the year is the net income which is a loss, EUR282m.

Gilles Pélisson - Accor SA Chairman and CEO, Thomson Reuters StreetEvents Earnings Presentation, February 24, 2010

France-based global lodging and services group Accor S.A.'s lease-adjusted EBITDA fell 19% in 2009, and we anticipate that negative earnings growth is set to continue in 2010. We are lowering the corporate credit and senior unsecured debt ratings to 'BBB-' from 'BBB'. A demerger of Accor Services), due in July 2010, will weaken Accor's operating diversity and business risk profile, in our view.

Standard & Poors, February 24, 2010

Stars and dogs

The voucher services business, cash rich and capital light, is being "demerged" from hotels, spun off into a newly listed 'New Services SA', while the hotel business which put Accor in the CAC 40 with operations in nearly 100 countries is on a fast track to dispose of EUR 1.2 billion in properties by the end of 2011 in order to pay down debt. Corporate chief Pélisson has spoken of a "star" (the vouchers) and a "dog" (the hotels). Having ransacked the board and forced through an operational split, Colony and Eurazeo are now "committed" to the company until…January 2012 - long enough to reap the presumed benefits of the property disposals.

When Colony and Eurazeo are long gone, workers at the hotel "dog" will be dealing with the consequences of the disposal operation. Accor employees have repeatedly voiced their concerns about the impact of the split, most recently at an emergency meeting of the Accor European Works Council in January this year. The risks to employees are clear. Pélisson and Deputy Executive Director Jacques Stern like to speak of "dematerializing" the services business through a shift from paper vouchers to paperless, virtual transactions. But the voucher business has few employees; the real shift comes with dematerializing formal employment at Groupe Accor as the company exits ownership of the properties. As hotel properties are disposed of, then franchised or leased back under management contract, employees' paychecks are increasingly written by a REIT or similar investment vehicle.

Accor calls this "asset right", celebrating and accelerating the selloff process already underway for some years. As Accor the hotel employer increasingly gives way to Accor the licensed brand, terms and conditions of employment are cut loose from global Group policy. Collective agreements at national level are shrunk and restricted in scope, leaving workers struggling to define and negotiate a relationship with a restless cluster of shifting investors with no connection to the real world of hotels.

Demerging debt?

Accor's two main investors have not been alone in pushing to split the Accor business into two separate listed entities. The only surprise when Accor unveiled its demerger plan along with the 2009 results on February 24 was the surprising decision to load the bulk of the company's debt (EUR 1.6 billion, up from just over EUR 1 billion at the close of 2008) on to hotels.

Major analysts had cheered the potential hotels/services split on condition that services, with its abundant cash flow and low capex, would assume the bulk of the debt, for the simple reason that the voucher business doesn't need an investment grade rating to fund current operations or to expand. The "strength" of its model, if it can be called that, depends on lobbying governments for tax breaks. Apart from Sodexho, Accor's competitors are mostly small national companies with below-investment credit ratings. The ostensible need for an investment-grade rating for payment security is a red herring, as the use of escrow accounts to hold voucher funds has demonstrated in a number of Accor's key services markets.

In it's October 9, 2009 review of potential demerger ("We believe in the equity story"), Société Générale noted that "The group's current strategy is unfavorable to bondholders, while market conditions have taken a turn for the worse in the hotel sector…Management's recent decision to separate prepaid services from the rest of the group has increased uncertainty over the evolution of the group's credit profile at the worst possible time…" Reviewing various scenarios, SG concluded that "there is a strong probability of a decline in value for bonds, even if they remain investment grade. We therefore maintain a Negative credit opinion." On the other hand, according to SG, Accor’s prepaid voucher business “could very well ‘live’ without an investment grade rating”. Natixis, in a report dated November 3, based its "Buy" recommendation on a demerger that would put 60% of net debt (versus the 25% announced by Accor on February 24) on services as "the best distribution to obtain financially viable structures for each of the entities and enable them to continue to grow." Every major institutional French financial analyst recommended that Accor treat existing and future debt issues in the runup to the split in such a way that the bulk of it would fall on the services business.

Under pressure

The 2009 results showed declines and/ or growing pressure in all key indices - net profit (a loss of EUR 282 million compared with net profit in 2008 of EUR 575 million), income, margins, turnover, occupancy, and a 60% leap in net debt. Not to worry, explained Péllisson and Stern in their February 24 conference call with investors: we did less badly than the competition, and increased the dividend payout rate from 60 to 72%!

A fundamental question remained unasked and unanswered in the investor call. If, as the corporate chiefs ceaselessly repeat, Accor in the depressed environment of 2009 managed to outperform every benchmark competitor, why the rush to assimilate the competition's business model by accelerating the selloff process at the cost of massive debt and the loss of the cash support from services? The recent Q1 investor conference showed that these questions remain very much alive.

Private equity in the driver's seat

The logic behind a proposed demerger which creates new debt through a financial reshuffle in services and then throws 75% of the combined net debt onto hotels cannot be found in the 2009 results. Its source is the investors driving the process, Eurazeo and Colony Capital.

They have good reason to be impatient - indeed, in the compressed timescale of private equity, they've already exceeded the longest of "long term" investment horizons. Funds have closed, investors have to be paid and new funds raised. Accor shares are trading at EUR 40.35 - compared with the average of EUR 46 when the two funds' took their stake. Eurazeo announced its own 2009 results in March - a loss of EUR 199 million, nearly triple the red ink for 2008 (that didn't stop Eurazeo from maintaining the EUR 1.20 dividend - an indication of where their, and Accor's, priorities lie). Colyzeo II, the Eurazeo/Colony joint investment vehicle with a big piece sunk in Accor and Carrefour, saw its value reduced by 63% in 2008. Colyzeo also owns a joint stake with Accor in gaming group Lucien Barrière, which Accor has now announced will be unloaded in order to pay down debt, though it still can't decide on the disposal mechanism.

Accor's current equity valuation stands at some 80% of what the funds need to reap with a 2012 exit which could satisfy their own investors. This can only be achieved by a high valuation of the services business (hence the low debt) and a rapid selloff of hotel properties to meet short-term financial targets. In less than 2 years, Accor needs to unload 1.2 billion worth of property to keep its investment grade credit rating or deliver a shock to bondholders already jittery about new shocks to the market for corporate debt.

Evaluating the property portfolio: anyone's guess

Accor's current portfolio has been variously estimated at from EUR 4 to 6 billion, depending on how you slice the numbers and rate prospects for recovery. Pélisson and Stern radiate optimism about the disposal prospects. Price, Waterhouse Cooper are less sanguine. Here's the conclusion of their Key Highlights from Emerging Trends in Real Estate Europe 2010 from March this year: "In this year’s survey hotels dropped from second place last year to twelfth place in 2010, to sit firmly at the bottom of the table. Hotels have been one of the sectors most impacted by the credit crunch and values have fallen significantly… global hotel transaction volumes sunk to the lowest annual transaction level of the decade, slipping a further 64% from 2008,to $9.4 billion in global hotel sales in 2009."

On April 14, according to the Financial Times, April, Morgan Stanley told investors to brace for "the worst losses in real estate private equity history owing to the fall in value of investments made at the peak of the market" - including their investment in InterContinental hotels across Europe. Some of the properties, like the US homes taken out by the collapse of the mortgage market, were literally under water. According to the FT, "An $800m portfolio of European hotels has also been handed to its lender. Morgan Stanley has fully written down its exposure to the fund." Two days later, the FT reported that Goldman Sachs' international real estate investment vehicle Whitehall Street International had lost 98% of its equity value and the fund was handing over the keys to the properties.

This is the market on which Accor is counting on to raise a quick EUR 1.2 billion? Occupancy rates, as even Pélisson admits, are possibly stabilizing, yet hardly growing. According to Société Générale, "The experience of 2001 to 2003 shows that the hotel sector was amongst the last ones to recover - both in terms of margins and top line growth. Since the recession is deeper this time around, it may take several years before any meaningful recovery materialises." Investors like Colony aren't buying hotels - they're buying up securities linked to collapsed commercial property.

Prosperity, for the current Accor board, is just around the corner - or their entire construction is in trouble. Accor's 2010 Q1 results got rough treatment from analysts unconvinced of a rise in hotel revenues any time soon. The prospects for disposing of Lucien Barrière through a stock market offering are not brilliant: more planned IPOs have been cancelled this year than have been executed, and few companies launched in public equity markets earned anywhere near their anticipated price. Casinos have been among the most prominent casualties of the crisis - just ask the private equity and property investors who binged on gaming at the height of the bubble.

Selling off the brands - first on the auction block?

Pélisson and Stern in their February investor call claim that cost-cutting rescued margins from total catastrophe in 2009, but that room for further cost reductions are now more limited. Investors are jumping over the revenue per room figures, demanding higher margins. Continued stagnation in occupancies, a snag in the disposal process, a slight increase in the cost of borrowing could all induce pressure for more savings - at considerable risk to service, reputation and, obviously, jobs. Does Accor have a "Plan B"?

This leaves the "portfolio of powerful brands" with a position in every sector of the market as the potential target of choice for short-term financial vandalism. When the expected cash fails to materialize, which brands will be sold first? Sofitel? Motel 6? These are among the least attractive brands in the portfolio. Will investors heading for the exit push for a fire sale?

Accor's demerger package is a knife-edge construction built on a questionable model and a hothouse timetable intended to boost the short-term equity value of the two companies for investors who won't be around long enough to confront the consequences. Bondholders and investors with a horizon beyond 18 months should be taking a closer look.

Accor calls itself "an employee-focused company", "the hospitality industry's 'best place to work'", "the world's leading hotel school" etc. But employees, like long-term investors, are a vanishing species. In the course of the February investor call, Pélisson twice mentioned Accor employees. The first time, they numbered 145,000, the second, 135,000.Asset-right means payroll light, and declining enrollment at the hotel school. Increasing numbers of Accor employees who built the brands on which the future depends now have to contend with an uncertain future in which their employment depends on the rapid selloff of their workplaces.

Accor wants to exit the gaming business, but they've bet the house.

]]> Blackmailing the Taxman, from Davos to Sydney tag:www.iufdocuments.org,2010:/buyoutwatch//32.2267 2010-02-03T17:02:05Z 2010-02-05T08:52:12Z 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.... Peter Rossman, IUF 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.

]]> Kraft and Cadbury, Victors and Spoils tag:www.iufdocuments.org,2010:/buyoutwatch//32.2264 2010-02-01T16:29:53Z 2010-02-01T16:43:20Z 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.... Peter Rossman, IUF 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.


]]> Blackstone's Hilton Woes Will Weigh on Workers tag:www.iufdocuments.org,2010:/buyoutwatch//32.2244 2010-01-04T08:26:09Z 2010-01-04T08:28:19Z Private equity operator Blackstone, according to the Wall Street Journal of October 29, "has good reason to be nervous about Hilton." They're not alone; the enormous leverage taken on to finance the buyout at the height of the debt bubble... Peter Rossman, IUF Private equity operator Blackstone, according to the Wall Street Journal of October 29, "has good reason to be nervous about Hilton." They're not alone; the enormous leverage taken on to finance the buyout at the height of the debt bubble now weighs heavily on the more than one hundred thousand Hilton employees around the world, on the wider financial system, and on the US Treasury, and therefore US taxpayers. Here's why.

]]> In July 2007, Blackstone bought the Hilton Hotels Corporation (490,000 rooms worldwide) for USD 26 billion, paying a premium of one-third over the company's share price. Blackstone and associated investors put in USD 5.6 billion in equity - the rest was financed by debt. Ignoring the growing fragility of the credit and real estate bubbles, financial analysts praised the deal, which capped a 5-year hotel buying spree for Blackstone (see Private-equity buyouts in the hotel industry). With the Hilton buyout, Blackstone owns some 4,000 hotels in 80 countries with 620,000 rooms, making it the world's largest hotelier by number of rooms.

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.

]]> Recap Rerun: Short Memories, Missing Regulation tag:www.iufdocuments.org,2009:/buyoutwatch//32.2228 2009-12-03T14:43:45Z 2011-04-23T09:52:33Z While defaults rise and growing numbers of private-equity backed companies continue their march to bankruptcy (though not necessarily losses for the funds which marched them there), the "creative" financial devices which helped fuel the buyout boom appear poised for a... Peter Rossman, IUF While defaults rise and growing numbers of private-equity backed companies continue their march to bankruptcy (though not necessarily losses for the funds which marched them there), the "creative" financial devices which helped fuel the buyout boom appear poised for a comeback.

]]> "Dividend recapitalizations" (taking on new debt to return cash to the buyout fund), "covenant light" (credit without conditions) and PIK loans (payment in kind, or funding debt by issuing new debt), among the presumed victims of the financial meltdown, are again being actively encouraged by Wall Street.

According to Bloomberg, writing on December 1, "Private-equity firms are returning to the high-yield, high- risk, debt market for acquisitions and dividend payouts little more than a year after Lehman Brothers Holdings Inc. failed and the global default rate for speculative-grade companies rose to the highest since the Great Depression." The article quotes JPMorgan Chase's head of leveraged loan sales saying head “Investors are thirsty for new names and product. They’re tired of shopping in the same aisles in the secondary market.”

Not only has buyout activity rebounded, so has the size of the deals. In the IUF sectors, for example, these include: KKR's acquisition from AB InBev of Oriental Brewery Co (USD 1.8 billion) and InBev's amusement unit for USD 2.7 billion); CVC's acquisition of AB InBev's Eastern and Central European operations for USD 2.2 billion (and a possible additional 800 million.; and Blackstone-owned Pinnacle Foods' USD 1.3 billion purchase of US frozen food maker Birds with just 300 million in equity.

These are of course far from the megabuyouts thrown up at the height of the LBO bubble, like the highly leveraged 2007 USD 45 billion buyout of energy group TXU (now Energy Future Holdings) by KKR., TPG and Goldman Sachs. (The size of that deal, according to the company's chief financial officer, has been considerably underestimated. The record 45 billion price tag should be revised upwards to 48 billion to take account of the existing debt on the company's books. Since the buyout, according to the CFO in an interview with the internet news site The Deal, the company has put an additional 3 billion in debt on its books by "paying the interest on several billion dollars of pay-in-kind toggle bonds by issuing more bonds instead of paying cash.")

Toggle bonds gave the buyout houses the option of paying off debt in cash or through new debt (payment in kind, PIK). According to a Financial Times article of December 2, "The techniques fell into disrepute during the financial crisis because they were based to varying degrees on the same rosy expectations that encouraged companies and consumers to assume what proved to be crippling levels of debt." Another instrument was the "covenant light", or virtually condition-free, loan to grease the buyout and allow the funds to take out cash post buyout by borrowing more (dividend recapitalization).

The disrepute, if such it was, was short-lived: covenant light, recaps, and highly leveraged deals are all back. USD 900 million of the debt used to fund the Birds Eye acquisition was covenant light, and the price was at a high ratio relative to cash flow.

While that deal was being finalized, according to the same FT article, "Wall Street witnessed the first Pik toggle deal since the crisis - a $250m financing for JohnsonDiversey, a cleaning services company. Meanwhile, several dividend-recap attempts have been mounted, including one involving the Booz Allen Hamilton consultancy, which is arranging $350m in loans that is likely to help pay a $550m dividend to Carlyle, its private equity owner. Tops Friendly Markets, a grocery chain, was using about a third of a $300m bond to pay a dividend to its owners, Morgan Stanley Private Equity, a Morgan Stanley executive said. Goodman Global, a maker of heating and cooling systems, has approached lenders seeking permission to use older borrowings to pay its owners - including Hellman & Friedman - a $115m dividend, according to the Standard & Poor's leveraged commentary and data division."

Bloomberg data shows US banks putting together USD 38.3 billion in high-yield,.high risk debt since September for buyouts and dividend payments, "more than in each of the previous three quarters."

A Wall Street Journal blog of November 20 quoted Paul Salem of Providence Equity Partners saying they had "recently received an offer of five times leverage from banks to do a dividend recapitalization, adding, 'Boy, memories are short.'"

The return of the recap and PIK loans and the rebound in the junk bond market are being ascribed to record low interest rates leading to "overheated" credit markets. Cheap money, however, can express itself in a variety of ways, depending on the wider environment. If the buyout funds and their banks are starting to party like it's 2006, and financing for real investment is systematically shunned in favor of speculation, it is the result of post Lehman political failure. Nowhere has a even a single significant regulatory measure been introduced to reduce the scope of highly leveraged finance, including private equity buyouts.

The call for action in the IUF's 2007 Workers' Guide to Private Equity Buyouts, written at the height of the boom, remains as pressing as ever:

The leveraged buyout boom in the US in the 1980s crashed to a halt because of movements in interest rates and the stock market which were unfavorable to the buyout business. Some of the funds went bankrupt, others reduced their profile and their activity. Today they're back with a vengeance, and global in their attack. The damage of the 1980s, however, cannot be undone – companies were ravaged and thousands of unionized jobs were scrapped. While some junk bond dealers went to jail, nothing significant was done in the way of regulation to prevent a recurrence – and that is the essential lesson. Workers – and society as a whole – cannot simply wait for the current cycle to run its course, as financial authorities and private analysts are increasingly predicting it soon will.

The cycle ran its course, leaving in its wake far greater damage than the first round. If anything has been learned, it should be that we can't afford to go another round.

]]> IPO Blues tag:www.iufdocuments.org,2009:/buyoutwatch//32.2221 2009-11-05T17:06:29Z 2009-11-05T17:30:45Z Private equity funds hoping to cash in on the stock market to return money to hungry investors through IPOs (initial stock offerings) may have hit a brick wall. What does this mean for workers?... Peter Rossman, IUF Private equity funds hoping to cash in on the stock market to return money to hungry investors through IPOs (initial stock offerings) may have hit a brick wall. What does this mean for workers?

]]> Private equity funds globally shelled out over USD 2 trillion since 2004 to scoop up companies, but returned two-thirds less to their investors in 2008 compared with the previous year. With debt in short supply and hugely expensive where it can be tapped, sales to other buyout houses - the preferred means of exiting an acquisition during the boom years - are next to impossible for midsize companies on up.

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.

]]> Private Equity Pain for Education and Public Workers tag:www.iufdocuments.org,2009:/buyoutwatch//32.2189 2009-09-07T13:27:23Z 2009-09-07T13:33:03Z Peter Rossman, IUF The article below, by Will H. Rogers, originally appeared in the Fall 2009 Update of the Committee on Political Education of the Texas State Employee Union, Local 6186 of the Communication Workers of America, AFL-CIO.

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.

]]> The Next Debt Bubble? PE Fuels Subprime Microfinance in India tag:www.iufdocuments.org,2009:/buyoutwatch//32.2188 2009-08-31T18:01:37Z 2009-08-31T18:11:36Z Microfinance, small business loans to the urban and rural poor, was originally conceived as a tool for poverty alleviation. It has become big business - and private equity has rushed in. The Wall Street Journal of August 13 reports that... Peter Rossman, IUF Microfinance, small business loans to the urban and rural poor, was originally conceived as a tool for poverty alleviation. It has become big business - and private equity has rushed in. The Wall Street Journal of August 13 reports that in India, private equity funds among other investors have "poured billions of dollars over the past few years into microfinance world-wide", using methods reminiscent of the aggressive, predatory lending which spawned the subprime debt bubble in the US. In India today, the article reports, "Some poor neighborhoods are being 'carpet-bombed' with loans" bearing interest of 24% to 39%.

]]> India's urban and rural masses now find themselves caught in a pincer movement of indebtedness. While tens of thousands of Indian farmers now annually commit suicide because they are unable to pay off debts, the urban poor have become victims of loansharking on an expanded scale - and private equity is playing its part.

According to the WSJ, "Nationwide, average Indian household debt from microfinance lenders almost quintupled between 2004 and 2009, to about $135 from $27." The individual sums pale besides the trillions spent in the rich world's buyout spree, but the recipients of these loans frequently subsist on a dollar a day or less.

Access to greater funding for microloans has expanded exponentially as the big lenders of small loans have turned their backs on non-profit activity and registered as for profit financial service firms. Enter private equity: "Of the 54 private-equity deals (totaling $1.19 billion) in India's banking and finance sector in the past 18 months, microfinance accounted for 16 deals worth at least $245 million, according to Venture Intelligence, a Chennai-based private-equity research service.

"International private-equity funds started taking notice of Indian microfinance in March 2007. That's when Sequoia Capital, a venture-capital firm in Silicon Valley, participated in a $11.5 million share offering by SKS Microfinance Ltd. of Hyderabad, India, one of the world's largest microlenders.

"SKS showed the industry how to tap private equity to scale up," said Arun Natarajan of Venture Intelligence.

"Numerous deals followed with investors including Boston-based Sandstone Capital, San Francisco-based Valiant Capital, and SVB India Capital Partners, an affiliate of Silicon Valley Bank."

The World Bank-associated Consultative Group to Assist the Poor estimates global microfinance funds under management at over USD 6.5 billion - an estimate of how far it has travelled.

And as loan officers on commission rack up new loans, indebtedness has skyrocketed - from a few hundred million dollars in outstanding loans in 2004 to nearly USD 2.5 billion today, with the number of lenders increasing from 53 to 233.


]]> US Pension Funds' Private Equity Disaster: Lost on the Road to Alphaville tag:www.iufdocuments.org,2009:/buyoutwatch//32.2185 2009-08-31T14:51:06Z 2009-08-31T18:24:37Z New research from Bloomberg makes clear the magnitude of the private equity losses suffered by US employee pension funds in the period 2000-2008.... Peter Rossman, IUF New research from Bloomberg makes clear the magnitude of the private equity losses suffered by US employee pension funds in the period 2000-2008.

]]> Public and private employee pension funds contributed significantly to the over USD 1.2 trillion raised by buyout funds over this period. The California Public Employees' Retirement System (CALpers), the Washington State Investment Board and the Oregon Public Employees' Retirement Fund invested over USD 53.8 billion, but have recovered only just USD 22.1 billion - 41%. The ultimate fate of these investments over a longer time period hinges on the eventual returns on the companies snapped up by the funds in the peak boom years 2006-7 - and these companies are currently valued at a fraction of the prices paid. Some of the major buyout deals have already ended in bankruptcy with many more looming.

Bloomberg unsurprisingly that "Buyout managers, and some pension funds, downplay their cash returns so far." At present, the money remains locked into the funds, with stiff penalties for withdrawal and huge losses for investors seeking to sell their stakes on the secondary market.

CALpers, which this June actually increased its investment allotment to private equity, is the largest US pension investor in the buyout business, with the Washington and Oregon funds third and fourth, respectively, according to Bloomberg. The three funds collectively increased their private equity commitments from USD 3.1 billion in 2005 to 8 billion, and then more than doubled their commitments the following year to USD 18.7 billion.

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