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Besides cost cutting via layoffs being a favored (although by no means the only) strategy for PE firms, there's also debt servicing. Typically, PE companies bu

Besides cost cutting via layoffs being a favored (although by no means the only) strategy for PE firms, there's also debt servicing. Typically, PE companies buy the company while only putting down a small portion of the purchasing price. They finance the rest through banks. The whole concept is pretty similar to buying a house with a mortgage, except you're buying a company. The debt payments are then a tax write-off, and all/most available company cashflow is diverted to paying off that loan. The ideal company is one with reliable cashflows and access to a growing market (of which I'd say a large cloud infrastructure provider fits the profile). To improve cashflow: pay fewer people less, convert assets to cash, and/or make more money from your core business. Usually a mix of the three. From an organizational standpoint, you can think of it like Rackspace just took out a very large (maybe subprime) mortgage on the company and some new people are going to try to make sure that doesn't turn out to be a horrible bet, first for the investors, then for the company.

NetStrikeForce 10y ago
Nice explanation. What if the people that got the mortgage for the house just want to make it pretty an resell it? I guess that's the fear here, when the buyer is an investment company (house flipper) and not a technology company that wants to increase their market share or add technology / talent to their portfolio.
- shostack 10y ago
  And isn't that usually the case with PE? Are there any good examples of them NOT doing this?
frik 10y ago
Thanks for the insightful explanation! What do PE companies do with more than one company with kind of dated offerings in the same/similar niche? Reduce the fat, merge them and sell them to a large company? E.g. Qlik, Riverbed and Dynatrace https://thomabravo.com/portfolio/all/current/ https://thomabravo.com/portfolio/all/current/
- postgeographic 10y ago
  Yeah, that's called a buy-and-build strategy, or a bolt-hole strategy. A large number of industries or market segments that are fragmented end up consolidating this way. For example, Lumison is a data center business here in the UK, and they got bought out by Bridgepoint Development Capital. Subsequently BDC and Lumison went on to buy a few other data centers, making one larger data center with the attendant economies of scale
godzillabrennus 10y ago
I looked into the PE model after meeting a VC firm GP who wanted to find a way to crash that model into the VC model. Dave explained the formula real well but I've also see that a PE firm will sometimes try and raise additional debt financing to grow the business after it purchases the business with debt. Basically the wager is that they can fuel growth (sales) quickly and sell out for a high enough multiple that they make a ton of money in a relatively short period of a few years. This works in the PE world because these are businesses that have credit and can get debt financing. The typical VC backed company can't get debt financing because they are too risky (early stage) for a traditional lender. That basically but an end to that VC's plan.
narrator 10y ago
It also depends on the kind of PE firm. The vulture firms will buy a stable firm and load it up with debt doing stock buybacks and then cash out and let the company crater. Other firms, like Texas Pacific Group, are turn around specialists that take struggling firms and fix their business processes to make them run better and raise the stock price by actually building a better company. There are a lot more of the former than the latter, mainly because it takes some uncommonly smart people to run the latter kind of fund and just a bunch of bean counting jerks to the run the former kind.
- r00fus 10y ago
  So where does Apollo Global sit on this spectrum of PE vulture <-> turnaround ?
  - frakr 10y ago
    They own for-profit education companies like University of Phoenix. Read up on their history, especially the law suits, to get an idea of what the management's values are like: https://en.wikipedia.org/wiki/University_of_Phoenix https://en.wikipedia.org/wiki/University_of_Phoenix
    - ansible 10y ago
      Ugh, those guys. So... this is not good news for the customers of Rackspace.
      - codeisawesome 10y ago
        Whoa, you're username, nice. Anyway, Apollo Global is different from Apollo Group.
    - rattray 10y ago
      "management's values" are probably "make money" even for the turnaround PR firms. The real question is of "strategy", not "values", in the financial industry. Anyone have a tl;dr for Apollo on that?
e15ctr0n 10y ago
Buying a company with borrowed funds and using the company's cash flows or assets to repay the loan is known as a Leveraged Buy Out (LBO) [0]. It was very trendy in the 1980s but has recently made a comeback. A good book to read on one of the most notorious examples of an LBO is Barbarians at the Gate [1][2] which dealt with the takeover of RJR Nabisco, a large American food and tobacco company. For lighter fare, re-watch the 1990 movie Pretty Woman [3][4] but this time ignore the fluffy romance and focus on Richard Gere's character, Edward Lewis, as he goes about negotiating the LBO of a shipbuilding company. Edward Lewis was modeled on a real-life LBO guy, Reginald Lewis, who bought Beatrice International Foods from Beatrice Companies in 1987 in an LBO worth $985 million [5]. [0] https://en.wikipedia.org/wiki/Leveraged_buy_out https://en.wikipedia.org/wiki/Leveraged_buy_out [1] https://en.wikipedia.org/wiki/Barbarians_at_the_Gate:_The_Fall_of_RJR_Nabisco https://en.wikipedia.org/wiki/Barbarians_at_the_Gate:_The_Fa... [2] http://amzn.com/0061655554 http://amzn.com/0061655554 [3] https://en.wikipedia.org/wiki/Pretty_Woman https://en.wikipedia.org/wiki/Pretty_Woman [4] http://www.imdb.com/title/tt0100405/ http://www.imdb.com/title/tt0100405/ [5] https://en.wikipedia.org/wiki/Reginald_Lewis https://en.wikipedia.org/wiki/Reginald_Lewis
gaius 10y ago
Typically, borrow the money to buy the company, then transfer the debt onto that company's own balance sheet, meaning they have taken control of a company effectively for $0. Then the asset stripping begins.
- kiallmacinnes 10y ago
  Honest question: if it's that easy, why isnt everyone doing it?
  - charlesdm 10y ago
    1. You need to find a lender willing to lend you most of the acquisition capital. 2. You also need someone to put up the initial equity capital. 3. You need to find a viable company to be acquired that won't crash immediately upon acquisition, and it can't be too expensive. Your first goal is to recover your equity investment. Everything after that is basically profit. 4. Frankly, 99.9% of people have ethical issues (you risk the jobs of 100s of people by overleveraging) with PE deals or don't have the skills and/or intelligence (managing the financial side + running/growing a business is hard) to be able to execute a deal like that. If all you care about is making money, then private equity is probably one of the "easiest" ways to build wealth (for yourself, that is). At the end of the day, it's nothing more than buying a companies with a huge loan. There are some billionaire entrepreneurs who have used LBOs as their "empire building" tactic, i.e. Rupert Murdoch, John Malone, etc. Also, check out Amaya Gaming. Classic LBO play done by an entrepreneur.
  - gaius 10y ago
    It's one of those things that's easy if you're of the right class and have the right contacts. Another example would be Holmes raising billions for Theranos through people who were all friends of her family. You need to know the right people to stake you the initial sum (and who will collect their fee for doing so). A few years at a big bank, then Harvard Business School should do it. Oh and also you need to be completely amoral.
ottodidakt 10y ago
I hear that this financing model allows the PE firm to limit downside (to what they put down) while allowing for unlimited upside (since the equity is theirs). What's in it for the banks that finance most of it? Just the interest on unsecured loans? Aren't these interest rates typically worse than those on retail (house, credit-card, education) loans?
- charlesdm 10y ago
  Debt exists in certain tranches, i.e. there will be low interest secured debt, and higher interest unsecured debt. Banks tend to only lend secured debt against assets and/or cashflow. Unsecured debt is often offered by hedge funds (i.e. 6-8-10% instead of 2-4-5%) and is paid down first. Why do banks love PE deals? Easy: they make a ton of money off of these deals, with moderate risk. If the business goes under, they are first in line to be compensated. If they make 4% on a $500m loan, that's $20m a year.

NetStrikeForce 10y ago

Nice explanation. What if the people that got the mortgage for the house just want to make it pretty an resell it? I guess that's the fear here, when the buyer is an investment company (house flipper) and not a technology company that wants to increase their market share or add technology / talent to their portfolio.

shostack 10y ago
And isn't that usually the case with PE? Are there any good examples of them NOT doing this?

frik 10y ago

Thanks for the insightful explanation! What do PE companies do with more than one company with kind of dated offerings in the same/similar niche? Reduce the fat, merge them and sell them to a large company? E.g. Qlik, Riverbed and Dynatrace https://thomabravo.com/portfolio/all/current/ https://thomabravo.com/portfolio/all/current/

postgeographic 10y ago
Yeah, that's called a buy-and-build strategy, or a bolt-hole strategy. A large number of industries or market segments that are fragmented end up consolidating this way. For example, Lumison is a data center business here in the UK, and they got bought out by Bridgepoint Development Capital. Subsequently BDC and Lumison went on to buy a few other data centers, making one larger data center with the attendant economies of scale

godzillabrennus 10y ago

I looked into the PE model after meeting a VC firm GP who wanted to find a way to crash that model into the VC model. Dave explained the formula real well but I've also see that a PE firm will sometimes try and raise additional debt financing to grow the business after it purchases the business with debt. Basically the wager is that they can fuel growth (sales) quickly and sell out for a high enough multiple that they make a ton of money in a relatively short period of a few years. This works in the PE world because these are businesses that have credit and can get debt financing. The typical VC backed company can't get debt financing because they are too risky (early stage) for a traditional lender. That basically but an end to that VC's plan.

narrator 10y ago

It also depends on the kind of PE firm. The vulture firms will buy a stable firm and load it up with debt doing stock buybacks and then cash out and let the company crater. Other firms, like Texas Pacific Group, are turn around specialists that take struggling firms and fix their business processes to make them run better and raise the stock price by actually building a better company. There are a lot more of the former than the latter, mainly because it takes some uncommonly smart people to run the latter kind of fund and just a bunch of bean counting jerks to the run the former kind.

r00fus 10y ago
So where does Apollo Global sit on this spectrum of PE vulture <-> turnaround ?
- frakr 10y ago
  They own for-profit education companies like University of Phoenix. Read up on their history, especially the law suits, to get an idea of what the management's values are like: https://en.wikipedia.org/wiki/University_of_Phoenix https://en.wikipedia.org/wiki/University_of_Phoenix
  - ansible 10y ago
    Ugh, those guys. So... this is not good news for the customers of Rackspace.
    - codeisawesome 10y ago
      Whoa, you're username, nice. Anyway, Apollo Global is different from Apollo Group.
  - rattray 10y ago
    "management's values" are probably "make money" even for the turnaround PR firms. The real question is of "strategy", not "values", in the financial industry. Anyone have a tl;dr for Apollo on that?

e15ctr0n 10y ago

Buying a company with borrowed funds and using the company's cash flows or assets to repay the loan is known as a Leveraged Buy Out (LBO) [0]. It was very trendy in the 1980s but has recently made a comeback. A good book to read on one of the most notorious examples of an LBO is Barbarians at the Gate [1][2] which dealt with the takeover of RJR Nabisco, a large American food and tobacco company. For lighter fare, re-watch the 1990 movie Pretty Woman [3][4] but this time ignore the fluffy romance and focus on Richard Gere's character, Edward Lewis, as he goes about negotiating the LBO of a shipbuilding company. Edward Lewis was modeled on a real-life LBO guy, Reginald Lewis, who bought Beatrice International Foods from Beatrice Companies in 1987 in an LBO worth $985 million [5]. [0] https://en.wikipedia.org/wiki/Leveraged_buy_out https://en.wikipedia.org/wiki/Leveraged_buy_out [1] https://en.wikipedia.org/wiki/Barbarians_at_the_Gate:_The_Fall_of_RJR_Nabisco https://en.wikipedia.org/wiki/Barbarians_at_the_Gate:_The_Fa... [2] http://amzn.com/0061655554 http://amzn.com/0061655554 [3] https://en.wikipedia.org/wiki/Pretty_Woman https://en.wikipedia.org/wiki/Pretty_Woman [4] http://www.imdb.com/title/tt0100405/ http://www.imdb.com/title/tt0100405/ [5] https://en.wikipedia.org/wiki/Reginald_Lewis https://en.wikipedia.org/wiki/Reginald_Lewis

gaius 10y ago

Typically, borrow the money to buy the company, then transfer the debt onto that company's own balance sheet, meaning they have taken control of a company effectively for $0. Then the asset stripping begins.

kiallmacinnes 10y ago
Honest question: if it's that easy, why isnt everyone doing it?
- charlesdm 10y ago
  1. You need to find a lender willing to lend you most of the acquisition capital. 2. You also need someone to put up the initial equity capital. 3. You need to find a viable company to be acquired that won't crash immediately upon acquisition, and it can't be too expensive. Your first goal is to recover your equity investment. Everything after that is basically profit. 4. Frankly, 99.9% of people have ethical issues (you risk the jobs of 100s of people by overleveraging) with PE deals or don't have the skills and/or intelligence (managing the financial side + running/growing a business is hard) to be able to execute a deal like that. If all you care about is making money, then private equity is probably one of the "easiest" ways to build wealth (for yourself, that is). At the end of the day, it's nothing more than buying a companies with a huge loan. There are some billionaire entrepreneurs who have used LBOs as their "empire building" tactic, i.e. Rupert Murdoch, John Malone, etc. Also, check out Amaya Gaming. Classic LBO play done by an entrepreneur.
- gaius 10y ago
  It's one of those things that's easy if you're of the right class and have the right contacts. Another example would be Holmes raising billions for Theranos through people who were all friends of her family. You need to know the right people to stake you the initial sum (and who will collect their fee for doing so). A few years at a big bank, then Harvard Business School should do it. Oh and also you need to be completely amoral.

ottodidakt 10y ago

I hear that this financing model allows the PE firm to limit downside (to what they put down) while allowing for unlimited upside (since the equity is theirs). What's in it for the banks that finance most of it? Just the interest on unsecured loans? Aren't these interest rates typically worse than those on retail (house, credit-card, education) loans?

charlesdm 10y ago
Debt exists in certain tranches, i.e. there will be low interest secured debt, and higher interest unsecured debt. Banks tend to only lend secured debt against assets and/or cashflow. Unsecured debt is often offered by hedge funds (i.e. 6-8-10% instead of 2-4-5%) and is paid down first. Why do banks love PE deals? Easy: they make a ton of money off of these deals, with moderate risk. If the business goes under, they are first in line to be compensated. If they make 4% on a $500m loan, that's $20m a year.