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I think you may have missed the part where Toys 'R' Us' debt skyrocketed from $109M to $5B due to the leveraged buyout. The interest on that debt as well as the

I think you may have missed the part where Toys 'R' Us' debt skyrocketed from $109M to $5B due to the leveraged buyout. The interest on that debt as well as the exorbitant management fees did Toys 'R' Us in. https://www.bloomberg.com/news/articles/2018-03-09/toys-r-us-downfall-is-ominous-reminder-about-debt-laden-deals https://www.bloomberg.com/news/articles/2018-03-09/toys-r-us...

gvhst 9y ago
While I agree with you with respect to the over-leveraging of the business, management fees are charged to the LPs (Investors) of the fund and not portfolio companies.
- metabagel 9y ago
  Thanks. I stand corrected. :-)
JumpCrisscross 9y ago
> the exorbitant management fees These are charged to the fund (i.e. the investors), not the company. PE firms charge companies transaction fees. "Toys 'R' Us does say in its SEC filings that $47 million in transaction fees that it owed KKR, Bain and Vornado, have been waived. The advisory fees were also voluntarily reduced by the investment firms in recent years" [1]. Private equity isn't VC. When a holding goes bust, the fund loses a lot of money. That, in turn, sharply limits what fund managers can do and how much they can pay themselves, including from other better-performing investments. [1] https://www.forbes.com/sites/nathanvardi/2017/09/19/the-big-investment-firms-that-lost-1-3-billion-on-the-toys-r-us-bankruptcy/2/#785c558c73b0 https://www.forbes.com/sites/nathanvardi/2017/09/19/the-big-...
- metabagel 9y ago
  Sorry, advisory fees. We don't know how much they siphoned out of Toys 'R' Us over the last twelve years, and without that information it's premature to say that they lost money on the deal.
  - JumpCrisscross 9y ago
    > We don't know how much they siphoned out of Toys 'R' Us over the last twelve years Yes, we do. It's disclosed in SEC and bankruptcy filings; they lost money [1]. [1] https://www.bloomberg.com/news/articles/2017-09-19/bain-kkr-vornado-suffer-wipeout-in-toys-r-us-bankruptcy https://www.bloomberg.com/news/articles/2017-09-19/bain-kkr-...
    - metabagel 9y ago
      Thanks for that. OK, so Bain and KKR made back $470 million in fees. Marketplace says that Bain and KKR made money off of the deal. https://www.marketplace.org/2018/03/06/business/toys-r-us-and-how-retail-downturn-story-about-debt https://www.marketplace.org/2018/03/06/business/toys-r-us-an... "The private equity firms’ investors haven’t made money off this deal. But the firms themselves have. It’s unclear where Vornado ended up. But after collecting fees from Toys R Us, Bain and KKR each took home at least $15 million."
      - JumpCrisscross 9y ago
        > But after collecting fees from Toys R Us, Bain and KKR each took home at least $15 million With all due respect to you, the author of that article doesn't understand how PE funds work. (Most people don't. But one shouldn't write an article if that badly misinformed.) Private equity funds are structured assuming portfolio companies won't vanish. They may lose some money. But between 1998 and 2010 only 4.9% of PE-backed companies defaulted, and of those, 72% did a Chapter 11 or pre-packaged bankruptcy [1]. As a result, when funds get fees or interests, the general partners are allowed to pay themselves a little something up front. If it turns out they overpaid themselves in year 1, they can make up for it by underpaying themselves in year 7. Which makes a liquidation, like this one, nasty for the managers. First, their high water mark is toast. Second, most of that $15 million will find its way to the fund's limited partners. If the fund paid out its managers, clawback terms could be triggered. That means fuck year 7, you return the overpayment now. Private equity managers are smart. But their limited partners aren't dunces. We've gone through cycles, up and down, with PE. The terms have "learned". Liquidations of PE-backed companies are rare. Nobody is walking away from this happy or whole. [1] http://portal.idc.ac.il/en/schools/economics/about/documents/per_strömberg.pdf http://portal.idc.ac.il/en/schools/economics/about/documents...
- mbesto 9y ago
  > the fund loses a lot of money This isn't equivocally true. It all depends on how levered the investment is and how much debt they pulled off the books to pay back the banks (or their fund). The stereotypical PE fund looks like this: buy company for $100M with 50% debt and 50% equity. Meaning, investment banks give them $50M to buy the company at market rates and the PE firm spends the other $50M from their fund. Load the company up with debt and then pay off the senior credit facilities with the profits while the business slowly dies. In other words, it's very possible that PE firms and their lenders earn profits even if their portfolio companies go bankrupt. In the case of Toys R Us specifically, it appears they did a 17%/63% levered split...which frankly is exorbitant. Most market norms are more around 50/50: sank $1.3 billion of equity into the takeover of the Wayne, New Jersey-based toy company, financing the rest with debt, according to company filings. https://www.bloomberg.com/news/articles/2017-09-19/bain-kkr-vornado-suffer-wipeout-in-toys-r-us-bankruptcy https://www.bloomberg.com/news/articles/2017-09-19/bain-kkr-... > That, in turn, sharply limits what fund managers can do and how much they can pay themselves What are you referring to when you say "fund managers"? The LPs? The LPs are super diversified, so that's irrelevant. The GPs make their base salary from management fees and their bonus from carry on the return of the fund. The idea that a fund "loses" money isn't that black and white...their are intricacies into how this plays it out. Source: Wife is a PE firm founder and I advise PE firms.
  - JumpCrisscross 9y ago
    > The LPs are super diversified, so that's irrelevant Losing a dollar is losing a dollar, diversified or not. The investors in these PE funds lost money. Where they net out against other investments is irrelevant. > GPs make their base salary from management fees and their bonus from carry on the return of the fund Salary, yes. But good luck earning any carry on this fund. (They'll be lucky if DPI crosses 1x with a hole this big.) Agree that PE accounting is complicated.
    - mbesto 9y ago
      > But good luck earning any carry on this fund. Again, depends on who's left with the debt...the typical large cap PE playbook is to hand the debt off to the company, while the PE firm and the senior debt have been paid off by the time the company gets liquidated. I haven't reviewed all of the financials and the SEC filings, but normally if you're levered at 63%, then it's likely they were able to pay off the equity in short order. See case study here: https://d1ge0kk1l5kms0.cloudfront.net/images/G/01/books/stech-ems/AnIntroToInvestmentBanksHedgeFundsPrivateEquity_Toys_R_Us._V201080539_.pdf https://d1ge0kk1l5kms0.cloudfront.net/images/G/01/books/stec... Another trend that was gaining popularity in the private equity industry involved rapidly accessing the capital markets after closing a deal to raise cash to pay a large dividend to the private equity owners. Firms typically used the debt markets to finance these dividends, creating more highly levered, riskier companies. In some cases, dividends paid to private equity firms within one year of their original investment equaled the original equity commitment. In the Hertz LBO transaction, Clayton, Dubilier & Rice, Carlyle Group, and Merrill Lynch collected $1 billion in bank-funded dividends six months after buying rental car company Hertz for $15 billion.6 About four months later, Hertz issued an IPO to pay off the debt and to fund an additional dividend, resulting in total dividends paid to the owners that equaled 54 percent of their original investment of $2.3 billion (still leaving them with 71 percent ownership). Private equity funds also took cash out of their portfolio companies to pay large “advisory” fees to themselves. These fees exceeded $50 million on large transactions during the buyout phase and annual fees often continued throughout their ownership. In that same article they mention Toyr R Us had ~$600M in EBITDA in 2005 in which they could have easily paid off at the initial $1.3B that the PE firms put up in equity financing. They also paid 9x (!!!!) EBITDA for a Retailer....that's a ridiculous multiple with highly unlikely outcomes for multiple expansion. So you only have three options (1) debt pump and dump (2) consolidate the back-office (3) buy add-ons. This is all leads me to believe that the real suckers in this whole thing are the current debtors. Pure speculation on my side, but I really believe that Toys R Us was already on it's way out (e.g. Amazon). Bain/KKR trying to find deal flow where none could be found, figured they had two viable intertwined paths (1) try to sell it to Amazon (2) load it up with so much debt that if they couldn't sell it to Amazon, they wouldn't lose money if they paid themselves back before it went into bankruptcy. Capitalists place bets in things that go down too. PS - 1x DPI ain't terrible in a seller's market (which it has been for large cap in the last 10 years). I'm not sure what KKR or Bain fund this deal came out of, but the real truth will be in there.
jjeaff 9y ago
They may have done a bad job, but they didn't come out ahead. They lost a tone of money on the deal.

gvhst 9y ago

While I agree with you with respect to the over-leveraging of the business, management fees are charged to the LPs (Investors) of the fund and not portfolio companies.

metabagel 9y ago
Thanks. I stand corrected. :-)

JumpCrisscross 9y ago

> the exorbitant management fees These are charged to the fund (i.e. the investors), not the company. PE firms charge companies transaction fees. "Toys 'R' Us does say in its SEC filings that $47 million in transaction fees that it owed KKR, Bain and Vornado, have been waived. The advisory fees were also voluntarily reduced by the investment firms in recent years" [1]. Private equity isn't VC. When a holding goes bust, the fund loses a lot of money. That, in turn, sharply limits what fund managers can do and how much they can pay themselves, including from other better-performing investments. [1] https://www.forbes.com/sites/nathanvardi/2017/09/19/the-big-investment-firms-that-lost-1-3-billion-on-the-toys-r-us-bankruptcy/2/#785c558c73b0 https://www.forbes.com/sites/nathanvardi/2017/09/19/the-big-...

metabagel 9y ago
Sorry, advisory fees. We don't know how much they siphoned out of Toys 'R' Us over the last twelve years, and without that information it's premature to say that they lost money on the deal.
- JumpCrisscross 9y ago
  > We don't know how much they siphoned out of Toys 'R' Us over the last twelve years Yes, we do. It's disclosed in SEC and bankruptcy filings; they lost money [1]. [1] https://www.bloomberg.com/news/articles/2017-09-19/bain-kkr-vornado-suffer-wipeout-in-toys-r-us-bankruptcy https://www.bloomberg.com/news/articles/2017-09-19/bain-kkr-...
  - metabagel 9y ago
    Thanks for that. OK, so Bain and KKR made back $470 million in fees. Marketplace says that Bain and KKR made money off of the deal. https://www.marketplace.org/2018/03/06/business/toys-r-us-and-how-retail-downturn-story-about-debt https://www.marketplace.org/2018/03/06/business/toys-r-us-an... "The private equity firms’ investors haven’t made money off this deal. But the firms themselves have. It’s unclear where Vornado ended up. But after collecting fees from Toys R Us, Bain and KKR each took home at least $15 million."
    - JumpCrisscross 9y ago
      > But after collecting fees from Toys R Us, Bain and KKR each took home at least $15 million With all due respect to you, the author of that article doesn't understand how PE funds work. (Most people don't. But one shouldn't write an article if that badly misinformed.) Private equity funds are structured assuming portfolio companies won't vanish. They may lose some money. But between 1998 and 2010 only 4.9% of PE-backed companies defaulted, and of those, 72% did a Chapter 11 or pre-packaged bankruptcy [1]. As a result, when funds get fees or interests, the general partners are allowed to pay themselves a little something up front. If it turns out they overpaid themselves in year 1, they can make up for it by underpaying themselves in year 7. Which makes a liquidation, like this one, nasty for the managers. First, their high water mark is toast. Second, most of that $15 million will find its way to the fund's limited partners. If the fund paid out its managers, clawback terms could be triggered. That means fuck year 7, you return the overpayment now. Private equity managers are smart. But their limited partners aren't dunces. We've gone through cycles, up and down, with PE. The terms have "learned". Liquidations of PE-backed companies are rare. Nobody is walking away from this happy or whole. [1] http://portal.idc.ac.il/en/schools/economics/about/documents/per_strömberg.pdf http://portal.idc.ac.il/en/schools/economics/about/documents...
mbesto 9y ago
> the fund loses a lot of money This isn't equivocally true. It all depends on how levered the investment is and how much debt they pulled off the books to pay back the banks (or their fund). The stereotypical PE fund looks like this: buy company for $100M with 50% debt and 50% equity. Meaning, investment banks give them $50M to buy the company at market rates and the PE firm spends the other $50M from their fund. Load the company up with debt and then pay off the senior credit facilities with the profits while the business slowly dies. In other words, it's very possible that PE firms and their lenders earn profits even if their portfolio companies go bankrupt. In the case of Toys R Us specifically, it appears they did a 17%/63% levered split...which frankly is exorbitant. Most market norms are more around 50/50: sank $1.3 billion of equity into the takeover of the Wayne, New Jersey-based toy company, financing the rest with debt, according to company filings. https://www.bloomberg.com/news/articles/2017-09-19/bain-kkr-vornado-suffer-wipeout-in-toys-r-us-bankruptcy https://www.bloomberg.com/news/articles/2017-09-19/bain-kkr-... > That, in turn, sharply limits what fund managers can do and how much they can pay themselves What are you referring to when you say "fund managers"? The LPs? The LPs are super diversified, so that's irrelevant. The GPs make their base salary from management fees and their bonus from carry on the return of the fund. The idea that a fund "loses" money isn't that black and white...their are intricacies into how this plays it out. Source: Wife is a PE firm founder and I advise PE firms.
- JumpCrisscross 9y ago
  > The LPs are super diversified, so that's irrelevant Losing a dollar is losing a dollar, diversified or not. The investors in these PE funds lost money. Where they net out against other investments is irrelevant. > GPs make their base salary from management fees and their bonus from carry on the return of the fund Salary, yes. But good luck earning any carry on this fund. (They'll be lucky if DPI crosses 1x with a hole this big.) Agree that PE accounting is complicated.
  - mbesto 9y ago
    > But good luck earning any carry on this fund. Again, depends on who's left with the debt...the typical large cap PE playbook is to hand the debt off to the company, while the PE firm and the senior debt have been paid off by the time the company gets liquidated. I haven't reviewed all of the financials and the SEC filings, but normally if you're levered at 63%, then it's likely they were able to pay off the equity in short order. See case study here: https://d1ge0kk1l5kms0.cloudfront.net/images/G/01/books/stech-ems/AnIntroToInvestmentBanksHedgeFundsPrivateEquity_Toys_R_Us._V201080539_.pdf https://d1ge0kk1l5kms0.cloudfront.net/images/G/01/books/stec... Another trend that was gaining popularity in the private equity industry involved rapidly accessing the capital markets after closing a deal to raise cash to pay a large dividend to the private equity owners. Firms typically used the debt markets to finance these dividends, creating more highly levered, riskier companies. In some cases, dividends paid to private equity firms within one year of their original investment equaled the original equity commitment. In the Hertz LBO transaction, Clayton, Dubilier & Rice, Carlyle Group, and Merrill Lynch collected $1 billion in bank-funded dividends six months after buying rental car company Hertz for $15 billion.6 About four months later, Hertz issued an IPO to pay off the debt and to fund an additional dividend, resulting in total dividends paid to the owners that equaled 54 percent of their original investment of $2.3 billion (still leaving them with 71 percent ownership). Private equity funds also took cash out of their portfolio companies to pay large “advisory” fees to themselves. These fees exceeded $50 million on large transactions during the buyout phase and annual fees often continued throughout their ownership. In that same article they mention Toyr R Us had ~$600M in EBITDA in 2005 in which they could have easily paid off at the initial $1.3B that the PE firms put up in equity financing. They also paid 9x (!!!!) EBITDA for a Retailer....that's a ridiculous multiple with highly unlikely outcomes for multiple expansion. So you only have three options (1) debt pump and dump (2) consolidate the back-office (3) buy add-ons. This is all leads me to believe that the real suckers in this whole thing are the current debtors. Pure speculation on my side, but I really believe that Toys R Us was already on it's way out (e.g. Amazon). Bain/KKR trying to find deal flow where none could be found, figured they had two viable intertwined paths (1) try to sell it to Amazon (2) load it up with so much debt that if they couldn't sell it to Amazon, they wouldn't lose money if they paid themselves back before it went into bankruptcy. Capitalists place bets in things that go down too. PS - 1x DPI ain't terrible in a seller's market (which it has been for large cap in the last 10 years). I'm not sure what KKR or Bain fund this deal came out of, but the real truth will be in there.

jjeaff 9y ago

They may have done a bad job, but they didn't come out ahead. They lost a tone of money on the deal.