Money... It's a Hit

Money.  Add that to the list of things I don't understand.  Give me a $20 bill and I know I can go buy dinner (if I don't leave a tip), take a date to a movie (no popcorn or sodas) or buy enough gas to get me to and from work for 3 days.  That part isn't the problem.  The confusion comes about when money enters the corporate equation.

From my viewpoint, if I have something I don't need and know someone that needs it, I'll either give or sell it to them for a fair price, with the price being inversely proportional to the need.  This is apparently the wrong way to do things.  It's certainly not the way to get rich.  Price in the real world goes up with need.  Watch gas prices before any holiday where people will be traveling to be with family and friends and you'll see what I mean.  To make matters worse, advertising is thrown in to create or increase a perceived need.  There is something to this madness, spending money creates jobs.  If every adult in America bought a new car every year, unemployment would disappear.  Unfortunately, the price of cars would increase significantly.

None of the above is relevant to what I want to write about today.  If you're confused, don't worry, it will probably get worse.

The Leveraged Buyout (LBO) is today's topic.  This type of financial transaction became popular about 30 years ago and had made many millionaires and billionaires.  In simplest terms an LBO is a way for a group of investors to buy another company.  Nothing ominous there.  If someone owns a bar and you want to buy the bar, you find out the price, talk a bank into loaning you what you need and everything is settled.  An LBO get's a little more complicated.  With an LBO, the original bar owner might find out he still owns the bar, even though all the booze has been sold, all the customers have been driven away, and the bar now has a huge mortgage attached to it.  Besides LBO, I'll be using another acronym for the Group of Buyers Seeking Leveraged buyouts, GBSL's (just think greedy, bloodsucking leeches).

The target of an LBO is usually a strong company that might have a weak spot.  Perhaps they have some new competition, or have had some recent problems.  After finding a target the GBSL's will put down about 5% of the money needed and get a bank to loan the other 95%.  If the LBO is a friendly takeover, then the GBSL's will approach the board of directors, sell them on the plan (usually by buying them out with promises of bonuses).  An offer is made, stock changes hands and the GBSL's now own the company.  Seems a reasonable transaction so far.  Now to get to the shady stuff.

If the company's stock is trading at $100/share and there are 1 million shares outstanding, it's going to cost about $50 million to get control.  It is possible, through rumor and stock manipulation, to lower that share price, perhaps by as much as 30%.  Which would mean the GBSL's can get a $100 milllion ($100m)  company for $35m, of which only $1.75m is their own money.  After the purchase, optimism (rumor and more stock manipulation) will probably result in an increase in share price.  Already they are making money and the fun is just beginning.  Since the GBSL's now own the company, the first thing to do is get money from the company to pay off the loan (plus interest) they used to buy the company, thus transferring their debt to the company.  The next step is to "improve" the company.  Improvements usually involve getting rid of things the GBSL's consider useless, like employees.

Less employees means lower costs, which makes the company look more profitable to investors, causing stock prices to increase again.  I almost forgot, the GBSL's should get some compensation for the way they've "improved" the company, so they agree to pay themselves a consulting fee for thinking of using the company's money to buy the company.  Brilliant.  Let's see where the company and GBSL's are now financially.  Company share price is now $120/share and the company is now carrying $35m of extra debt, but the savings from job cuts more than pays for the new debt.  The company has paid a $1.75m consulting fee to the GBSL's who now own $60m worth of the company stock.  Not a bad return on investment.  If it stopped right there the company might very well go on to make more money, add more employees through expansion and everyone is happy.  Wouldn't that be nice?

But, the GBSL's usually aren't satisfied with a 3500% return on their investment, and why should they be.  With a more profitable company, and for all the shareholders hard work, everyone deserves a dividend.  Now where will they find the money for that?  I know, let's borrow $100m so that every share gets a $100 dividend this quarter.  After all, the company has new owners (that just paid themselves $50m) and they are obviously destined for greatness.  Good news, now the stock price is at $140/share, double what the GBSL's paid for it.  Time to sell, get another $70m and take a well-deserved GBSL vacation.

In the end you have the GBSL's who have walked off with $120m, a company that suddenly finds itself buried in debt and will quite likely end up closing its doors.  The banks involved may not get 100% of their money (plus interest) back, but its not their money, so everything is good.  Unless you happened to be one of those employees.  This is what happened to Federated Department Stores, Revco, Kaybee Toys and AmPad, among many others.

Somehow this just doesn't seem right to me.  If I work for a company for 30 years and then find out that my job no longer exists and my pension has now been taken to pay off the bank, I probably am not going to be cheering for the GBSL's that just scored an incredible profit.  I once worked for a company that did something similar to an LBO, but it was all internal.  Within a few months they went from 600 employees to 12 employees.  Meanwhile the owners (8 of the 12 employees left) were raking in millions.

Since this is an election year, maybe we should take a look at the business model of the man who probably best deserves the title "Father of Our Country", Benjamin Franklin.  As a teenager, he ran away from his apprenticeship with his much older brother, left Boston and went to Philadelphia, where through hard work and a lot of smooth talking he became a very successful printer.  As he became more successful, he helped skilled apprentices set up their own printing shops and newspapers, by loaning them the capitol needed.  Many early American families owe their wealth at least in part, to Benjamin Franklin.  He donated his time, money and influence to help improve the city of Philadelphia and the Pennsylvania colony.  In his spare time, he wrote and distributed pamphlets with the intent of improving the lives of everyone.  He worked tirelessly to get the King of England to require the English nobility landowners to pay taxes on their huge estates in the new world.  Even then, the wealthiest did not feel like they should pay their fair share.

If you have a few million lying around and don't know what to do with it, getting in the LBO game is a great way to turn a few million into a few hundred million.  If, instead you're hoping that nothing goes wrong this month, so you can put a few dollars away, or can catch up on the bills you've had to let slide since the last setback, you might want to question whether you want a GBSL bringing an LBO to every American.  If that happens, well, we're all probably SOL.