Common Sense Living

Private Equity Firms – Trail of Destruction

Toys “R” Us, which also owns Babies “R” Us, declared bankruptcy this morning.  The news quoted the cause as competition from Amazon, and a high debt burden.  It is the latest in a string of corporate bankruptcies unseen since the Great Depression.  Other recent high profile bankruptcies include Payless ShoeSource, Bebe stores, Sports Authority, Radio Shack, Gordmans, HHGregg, Gymboree, Wet Seal, Limited Stores, Gander Mountain, among others!

Most, if not all of these bankruptcies have a common theme of destruction behind them:  A private equity (PE) firm that indebted the company to the hilt, giving the company no chance to survive.  In the case of Toys “R” Us, it was the PE firms of KKR (Kohlberg, Kravis, Roberts), Bain Capital, and Vornado Realty Trust.  With Sports Authority, the PE firm was Leonard Green & Partners.

Regardless of the PE firm, the outcome is nearly always the same:  An historically well run company is indebted beyond its ability to properly operate, the company goes belly up, and 10s of thousands of employees doing a good job are dismissed.  The PE firm walks away richer.  It’s corporate raiding at its finest!

How Does Corporate Raiding Work?

A private equity firm is a Wall Street investment company.  As such, they can raise money to buy companies, and are financially savvy.  They can spin a very good story about how to squeeze every last dime from a company they buy, by improving operations, by merging, by splitting up, etc.  These ideas or stories allow them to also borrow heavily to support corporate purchases.

In a simple example, the PE firm may target a company with a lot of assets on its books, a company with low debt.  In other words, a very well run company.  The PE firm borrows billions of dollars to acquire the target.  Once acquired, they can do what they want with the company, the first act being to replace or take control of the senior leadership.

The PE firm, through a variety of techniques, then tells this well run company to pile on debt, and with the new funds, the company pays a 1-time dividend back to the owning PE firm.  The PE firm then pays off its own debt, perhaps with some money left over, and leaves the company saddled with debt which eventually strangles the company.  But the PE firm doesn’t care too much… they have already made their profit.  If the company can hang on a few years and make a small profit, that’s just further gravy to the corporate raiding PE firm.

What’s Wrong With This Picture?

There is something wrong when a small nearly unknown participant in society can destroy a company for profit.  Companies provide the goods and services our society uses to better everyone’s life.  It used to be that if you wanted to make a profit, you had to build a company.  Now it seems the fastest way to wealth is to tear apart the very thing that most benefits society.

And we wonder why groups like “Occupy Wall Street” exist!

I Pity Nordstrom

Nordstrom, the darling of Brick & Mortar retail, has recently been in talks with both KKR and Leonard Green & Partners.  I wonder if the Nordstrom family understands they are dealing with the devil that will tear the family company legacy to shreds, as the PE firm cuts costs and throws quality and service to the wind!

This is sad, and this is one place I think our government should get involved!  The destruction of companies for profit should be outlawed!



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