Need Before Greed

Private Equity Funds

These exist to hunt for public companies which are performing poorly in the marketplace, buy them out, close unprofitable operations, layoff employees, recapitalize the companies, and bring them out public again. In doing, so they keep a majority share in the companies but recoup their original investment through issue of shares to the public. Then in due course they will repeat this process with other companies. The investment banks help them in this process by floating the reshaped companies go public again. The private equity companies make a killing and the investment banks get a hefty commission. Ultimately, the gullible retail investor is the one who is left holding the bag. All this is legal but the mechanism is heavily geared to benefit the vulture capitalists.

There is another operation which has been taking place in the last few years which is not very widely known. When a public company is controlled by one or more private equity funds, the management adds debt at a decent interest rate to attract funds from debt investors, especially in the current environment of low interest rates. Then they use the money raised to pay hefty dividends to the shareholders, the majority of the distribution going to the private equity investors. This activity reduces the risk of the private equity owners but saddles the company with unwanted debt. In due course when things go wrong, the vulture investors will resort to restructuring the company,  closing certain operations, causing layoffs, and walking away with their loot. The vicious cycle goes on.

Two recent happenings: BJ’s wholesale club (controlled by private equity investors) raised $643 million of debt in order to pay dividends to the owners. Likewise, HCA Holdings Inc., (a hospital chain operator) raised $2.5 billion in debt this year to pay $2 billion in dividends to the shareholders.   HCA Holdings Inc., was taken private in 2006 and went public in 2011 after some reshaping. Private equity funds Bain Capital and KKR each owns 20% of the company. They justify the issue of debt citing similar debt-holding by other companies. But should they issue debt just to pay themselves hefty dividends? That is the big $64,000 question. Money makes more money---doesn’t it? In that process when one makes money someone else loses because many times there is no wealth creation but only reshaping. The losers are past employees, and new individual shareholders.