Timmy elsewhereOctober 7, 2012 Tim WorstallTimmy Elsewhere9 CommentsAt the ASI. nef being silly billies. Hardly news I know….. previousThe Telegraph really does like Hugh Bonneville, doesn\’t it?nextTerra Nullius 9 thoughts on “Timmy elsewhere” Frances Coppola October 7, 2012 at 9:50 am How did you miss this: “admired by the unions who represent much of its 6,000 workforce”? Having said that, I have some sympathy for NEF’s point of view. Highly-leveraged private equity buyouts were popular in the run-up to the financial crisis and it was usual to load the debt on to the balance sheet of the target company rather than keeping it on the balance sheets of the private equity purchasers. The company then spends a large amount of its income servicing the debt that was used to purchase it. When a financial crisis happens, the company, unable to service the debt any more, goes down with all hands while the private equity firms that actually borrowed the money walk away unscathed. Highly profitable, but distinctly sharp practice, I would say. The Thought Gang October 7, 2012 at 3:45 pm Frances In that scenario, it is the lender who has made the error in accepting too much risk. PE deals are highly leveraged, but that debt finance would be the lowest risk (followed by debt issued by the PE fund itself, followed by the equity) so if the lender doesn’t get paid then nor will the investors who have put up the higher risk loan notes and the equity. The PE firm itself will, I’m sure, take out some lovely management fees… but even there, it is usual practice for the partners in a PE firm to have personal exposure to the funds/investments which they manage. There are sophisticated investors/lenders at all levels of the transaction (save, perhaps, for some of the managers/employees in the business itself) so they should all be capable of judging the appropriate risk profiles attached to funding they provide. I’ve got plenty of experience working inside a PE investment that’s not worked out. I don’t know how highly leveraged it was at the outset, but I do know that the bank, who put up the first tiers of the debt, had first call on everything until they were repaid in full. The fund itself will take whatever scraps are left for its loan note finance, and the equity (which was considerable) is worth less than the paper it’s printed on. So, yes… sharp practice.. but it’s big boys playing with other big boys, so all is fair. Frances Coppola October 8, 2012 at 12:41 am TTG Umm, not quite. Banks are bailed out by taxpayers, remember? In fact leveraged buyouts were one of the main reasons for HBOS’s collapse and were also implicated in RBS’s failure. If we could be satisfied that the lenders would suffer the full consequences of their folly, I would agree that it’s simply capitalists being capitalists. But it isn’t, is it? It’s capitalists playing with our money and loaded dice. Hardly fair. The Thought Gang October 8, 2012 at 6:56 am Indeed… but if we’re at that stage then we should ‘hope’ that we are adding the owners and management of the bank to the list of people who’ve lost all their money.. for they also played at capitalism and lost. So the problem we have is the same problem we have with any other part of this mess, and the moral hazard therein. I’d just say that the way PE deals were structured wasn’t/isn’t, in itself, the issue? PaulB October 8, 2012 at 11:00 am I suppose the 6,000 workers may lose their jobs, despite having no responsibility for any of this. Is that a problem? Frances Coppola October 8, 2012 at 11:21 am TTG As PE deals were structured the way they were in the expectation that the lender would be bailed out, then yes, I’d say it is the issue. The money wouldn’t have been lent at all if there wasn’t an implicit assumption that the taxpayer would cough up if it all went pear-shaped. PaulB Yes, it is a problem – not least because it encourages taxpayer bailout not only of the lender but of the target company too. 6,000 people losing their jobs is an awful hit which most governments would be anxious to avoid. I’m sorry, I don’t mean to sound callous but I was looking at this principally as an economic problem. However I look at this, the way PE deals were structured seems to have depended on the expectation of bailout. Capitalism “red in tooth and claw” it wasn’t. Rent-seeking is more like it. The Thought Gang October 8, 2012 at 1:17 pm PaulB As Tim says in the original article… someone else has bought the business. Those 6,000 jobs might be threatened by the underlying business not being viable, but they won’t be threatened by the failure of the funding model. (OK, in fairness, that’s the theory of it. In reality, when a business has cashflow problems… be they because of bad funding structures or good-old bad trading.. then the wageroll will always come under focus. PE investors, whilst wrongly characterised as ‘asset strippers’ *do* have a fairly ruthless approach and will always look to squeeze more productivity (profit) out of fewer resources (people) and, in that context, is a massive over-simplification to suggest that a failure of ‘the capitalists’ won’t blow-back on the ordinary workforce) Frances You undoubtedly know more about how these lending decisions would have been made by the banks than I do. If there was a widespread perception that a bank failure would not be allowed then, sure, we can throw in the PE lending with everything else that went on… and I do know that the PE industry was paying stupid money for companies during the ‘good times’, and banks were getting nice and fat off the fees and interest. I guess the point I wanted to make was that if the bank lost.. then.. so did the PE fund, who would almost certainly have been left holding worthess junior debt, plus chunky equity. PaulB October 8, 2012 at 5:30 pm TTG: no, someone else bid for the business, but the sale hasn’t so far gone through because the creditors haven’t been willing at accept the write-down involved. Of course, in theory if the underlying business is profitable the creditors should be willing to keep it going. But with all parties trying to get the best deal brinkmanship will provide, these things can go wrong. Or if the underlying business is marginal, then the debt load might be the factor that causes it to close. john77 October 8, 2012 at 7:32 pm Actually most PE schemes that I’ve seen weren’t assuming that the bank would go bust and be bailed out. They assumed that the bank’s profits would take a small hit if things went pear-shaped. No PE scheme in the UK ever has been big enough to require a bank bail-out. Most of HBOS’ losses were down to rash lending on property and to property developers. In most PE schemes the mezzanine lenders were the ones most exposed to risk and these were charging a high interest rate to compensate for the risk. I personally reckoned a lot of PE deals involved a greater or lesser degree of sharp practice, particularly in the financial structuring to minimise the corporation tax liability and making a lot of the partners’ profit subject to CGT instead of income tax and NI but also in their habit of selling it on at a multiple of exit EBITDA having stripped out R&D and other long-term investment for the last couple of years before sale. The management was often treated worse than the workers, being offered a slice of the equity in lieu of a decent salary “subject to performance” and anyone whose target got missed due to factors completely beyond their control (credit crunch impact on sales, eurozone crisis impact on exchange rates, earthquakes, whatever…) got sacked and lost their promised equity. Leave a Reply Cancel replyYour email address will not be published. Required fields are marked *Comment Name * Email * Website Save my name, email, and website in this browser for the next time I comment.