Wonders of private equity
Wonders of private equity at Econospeak by Michael Perelman points to another example of of the a type of ‘investment’ that adds up to a very different idea than many think.
No comment needed.
Creswell, Julie and Peter Lattman. 2010. “Private Equity Thrives Again, but Dark Shadows Loom.” New York Times (29 September) Dealbook Special Section: p. 1.
http://dealbook.blogs.nytimes.com/2010/09/29/private-equity-thrives-again-but-dark-shadows-loom/?ref=business
“This summer, executives from the New York-based private equity firm SK Capital traveled to Houston to celebrate the first anniversary of their acquisition of a nylon manufacturing business. Soon they will have a bigger reason to uncork the Champagne. The nylon manufacturer has announced plans to issue about $1 billion in debt, of which $922 million will be used to pay a dividend to SK. For SK, which paid $50 million in cash for the business, that is an astonishing almost 18-fold return in a little more than a year.”
Fantastic. Imagine how pleased SK’s clients must be.
Somebody please tell me what this has to do with capitalism.
WASF!
JzB
So the difference between private equity and the mafia is that the private equity group has limited liability right?
The mafia only gets 20-30%.
I’d also like to get a copy of the 500 page prospectis that will accompany the coming “high yield” bond offering. Should be fun to read, especially knowing the last valuation on the company was 50 million. I truly wonder how they will explain the company can afford 1 billion in high yield debt, especially since the company retains almost nothing to invest in the biz.
But at least the SEC will have there seal of approval on there noting that all things are properly disclosed, and a proper safe harbor statement is there warning us of dangers that may be of concern to us.
Also, a note to the employees of the company. QUIT NOW!!! I went thru one of these already (not quite this bad) AND YOU ARE SCREWED BIG TIME!!!
So who would loan $1 billion to a company that is worth 1/20 of that amount?
“At SK Capital, which invests primarily its own executives’ money, the decision to issue the dividend-paying debt was partly based on the expected jump in tax rates on dividends that go into effect next year, said the firm’s co-founder, Barry Siadat. He also says SK so improved the nylon manufacturer’s operations that it can easily handle its new low levels of debt.
Gee…and which economic Blog is consistantly telling us all that raising tax burdens is good for the childern? It couldn’t be this one could it?
“But critics of these so-called dividend recap deals say they only add strain, in terms of borrowed funds on the balance sheets of companies, at a time when the economic outlook remains cloudy.”
Companies to not invest thier flow, and to just hang on to it? Oh my God! That’s ridiclous, off with their heads.
“Dividend recaps are a concern and we definitely monitor them,” Mr. Dear of Calpers said. “If the economy sours from here, private equity firms could be looking at more distressed situations or possible bankruptcies.”
So what is the message here? Maybe we should raise taxes, because it’s good for the economy?
“St. Louis-based Solutia will receive $54 million in cash and a 2 percent stake in a new company that will be formed to include the new business. SK Capital also will assume almost all of the nylon unit’s liabilities, including employee and pension costs. Solutia will use proceeds from the sale to pay down debt.”
“The unit employs 2,000 and had sales of almost $1.8 billion in 2008, while posting a pretax loss of $135 million. Solutia’s nylon business “is a non-core division of a major public company with good assets, good customers and good technology that was caught up in tough economic times,” SK Capital co-founder and managing director Barry Siadat”
http://plasticsnews.com/headlines2.html?cat=1&id=1238591917
You might want to check with the IRS and get their definition of dividend-paying debt.
Stock or equity dividends got the bush tax cut. Anything from bonds, loans or even IOU instruments did not, even if the payout was described as a dividend. That always got taxed at the full income rate.
Also no word about the 900M+ that they pocketed. I bet the 57M they left the company with to pay down debt pays the dividend for 6-9 months. “Improving the operations” means they eliminated bonuses, cut pay and cut staff to the bone. Other than that, surely the company had no problems and outside no- nothing management fixed everything and we have a solid turnaround play. There is the employee pension plan and no doubt they will mod that or when they close up shop and the partners re-open under another name it gets absorbed by the government in the Pension Guaranty Fund.
Things smell a little fishy, but they didn’t throw Millikin in jail for nothing.
I suspect that the media description of the transaction is inaccurate. There were probably substantial liabilities that were paid off in the purchase transaction leaving the company debt free, and the distribution while called a “dividend” in the story, was probably mostly a tax free “return of capital” for tax purposes in the amount of the company’s basis (purchase price plus liabillites assumed) in the asset (if it was larger, capital gains taxes would have applied).
In the original deal structure, with qualified dividend treatment, they probably figured that entity level corporate tax (zero until pre-tax losses were absorbed by future earnings) plus dividend payments out of past or future earnings at the 15% rate were pretty close in tax burden to interest payments at the ordinary income tax rate (probably 35%) and were willing to pay a little tax premium in exchange for not having the worries that come with being leveraged. But, the tax premium involved in paying corporate level tax plus ordinary income taxes on future dividend payments out of earnings was probably too steep, so they leveraged.
A billion dollar loan against a business with $1.8 billion of annual sales and some brick and mortar assets that is otherwise debt free and is close to profitable (and probably has been in past years), particularly if enhanced by any guarantees or the like from the ownership group, doesn’t sound outrageously large.
While the deal sounds suspicious at face value, I suspect that there is more than meets the eye here (in a good way). Of course, a corporate tax system that provides an incentive to highly leverage a company with a cyclical business like this one, is clearly flawed.