9 ms·

Wow, why don't people wise up to this PE trick? Seems like creditors would learn their lesson after so many examples...

by johntiger1 6y ago

razster 6y ago
Because the creditors make money off it as well.
- whatok 6y ago
  Can you explain how the creditors of 4bn in Neiman Marcus debt are making money off this?
  - 0x8BADF00D 6y ago
    Because they won’t default now.
    - whatok 6y ago
      Ok, a potential positive sum is definitely better than zero but once again, how exactly are creditors making money off this? The grandparent's post is implying that somehow no one is losing money in this situation. I'd like to hear how it works.
  - beamatronic 6y ago
    They probably sold the debt to another party
    - whatok 6y ago
      So you're saying that the original creditors made money off this and new creditors through secondary market transactions are left holding the bag? That's partially true but a massive portion of this debt is in pension funds or passive investments that track index funds. They track benchmark indices so they're buying these bonds at issue or shortly after. With no active management involved, they are also losing money when a company files.
- jariel 6y ago
  The creditors definitely won't make money. They are other banks, and probably all the suppliers who give to NM on credit and who won't get paid. Chapter 11 is by default bad news for creditors, it means they will get less than the agreed-to value of whatever.
  - danielisaac 6y ago
    They're not making any money, but they're not universally worse off. Depending on their status (e.g. if their debt is secured by a lien), it's totally possible that some classes of creditors could be reinstated with the same claims under the reorganization plan (assuming it gets confirmed by the court). Even if a secured class doesn't get the same value and votes against the plan, they're still entitled to a handful of protections under the Bankruptcy Code (§ 1129(b)(2)(A)). Less so for unsecured creditors and shareholders.
pjc50 6y ago
The "creditors" are usually another shell company of the PE firm, and the interest rates are absurd (I looked into the collapse of Maplin and it was something like 20%). It's basically an accounting trick to remove profits from the victim company in its declining years without having to pay tax on them.
- rwmj 6y ago
  I assume someone must lend the money (as it's not created from nothing). How does it work?
  - deleted 6y ago
    [deleted]
  - whatok 6y ago
    Private equity firms raise funds (usually have a 10yr investment horizon) and use these funds to serve as the equity tranche for a buyout that the remainder is financed with debt. Banks (or other investment firms sometimes nowadays) will provide financing for these buyouts and that financing is later refinanced with syndicated financing through loans or bonds. There are a decent amount of banks that were in the middle of this process, covid hit, and they are now stuck with those loans on their books.
    - black_puppydog 6y ago
      in other words, yes, it is created "out of nothing" (when handing out the loans) and once the "unexpected bad things" happen it becomes "real" (as in it is on the books and will now have to be accounted for properly)?
      - whatok 6y ago
        I'm not a fan of private equity but I'm also not a fan of rants directed my way when I'm answering a question someone asked. Please take this somewhere else.
devchix 6y ago
Please explain? Why is there the association that private equity creates corporate debt?
- topkai22 6y ago
  Private equity companies exist to purchase existing companies from their current owners and then run them better/extract more value from them. The canonical example of this is purchasing a public company by acquiring all outstanding shares. This is often a fantastically expensive enterprise that requires that the new owners raise tons of money. The new owners do this by structuring a deal where the company will take out a ton of debt (basically its entire market capitalization of the company, plus a premium) to purchase the outstanding shares. This is known as a leveraged buyout (LBO). So if a public company has $100M in outstanding shares and zero debt before they go private, by going private the private company will now have $100M of debt (rough numbers, illustrative but not necessarily realistic). That's why going private often results in dramatic sell offs and cost cutting- the new company needs to get the debt load down, and fast. Definitely read Barbarians at the Gates, it's a great book and explains a lot about private equity from a dramatic case in the 80s.
  - devchix 6y ago
    Thanks for that. But why is the company now worse off than before? A company can be funded with equity or debt (different terms and obligations, I understand) but if a company converts 100% of its outstanding shares to debt, why does anything change? I assume this is what happens when a company takes itself private to escape the grind of quarterly earning, short-term growth, tyranny of Wall Street analysts, etc. If I could run a company better/extract more value from it, say, by decreasing expense, increasing revenue, and therefore profits, I'd write myself a big check quarterly and continue running the company. Something else extractive and zero-sum (I gain but the company loses) is going on and I don't know what that is.
    - sfkdjf9j3j 6y ago
      The company is now servicing $100m of debt. That cash went to the previous shareholders in the buyout.
qppo 6y ago
People with other options don't take private equity buyouts. Some captains go down with their ships, others get on the first lifeboat.
- ttul 6y ago
  Or you take a partial life boat that makes you very comfortable and then if the firm collapses, oh well.
Ididntdothis 6y ago
I am pretty sure except the employees all participants are making good money off these deals.
- nogabebop23 6y ago
  yes, not sure what your neiman marcus pension will look like in 6-months...
- zone411 6y ago
  Except they are not. Ask shareholders and bondholders.
formercoder 6y ago
The web of incentives behind LBOs is very complex. They happen because in reality a lot of the time many of the people involved make money. This is availability bias. You only hear about the explosions. You don't hear about the thousands of LBOs that happen which never blow up.
- gamblor956 6y ago
  The financial structure of a LBO is that a PE fund uses the assets of an acquired company to pay for the acqusition. They generally put little if any of their own money down other than as earnest capital. They then take out additional loans using the acquired company assets as collateral and pay themselves distributions out of those loans. The acquired company is left to repay the massive and increasing debts. You don't hear about the successful LBOs...because they're extremely rare. The only LBOs that worked out for the acquired companies are for those like Hilton, which occurred right before interest rates dropped, allowing the acquired companies to refinance their debts at lower rates than incurred by the LBO. The recession that occurred right after that LBO also let them fire tens of thousands of workers and shutter hundreds of locations and blame the recession rather than the shitty PE management and pillaging. Toys R' Us and Neiman Marcus are the prototypical LBOs. Whether or not the LBO succeeds, PE gets rich, everyone else gets screwed.
  - johnvanommen 6y ago
    There's a great CNBC show called "The Profit" which really makes it easy for a layman to understand how private equity works. On the show, it's interesting to see how the investor who is putting up his money is often uninterested in investing in a company that's growing quickly and making good profit margins. I can only speculate on what the investor's true motivations is. But there was one episode in particular which was interesting: 1) The investor came in, offered up a few hundred thousand dollars for a 51% stake 2) He immediately had the company upgrade their equipment, purchasing new equipment 3) Eighteen months later, the company was bankrupt When all the dust settled, the company was re-packaged and sold to another company, the original owners were gone, and the manufacturing was sent overseas. When the investor was having them buy a bunch of equipment, I was definitely wonder if his prime motivation was to simply have some tangible assets that he could recover once the inevitable bankruptcy occurred.
tfehring 6y ago
No matter how risky it is, there's a price at which it's still profitable (in terms of risk-adjusted expected present value or whatever) to finance it. In this case, based on a sibling comment, that price was a ~8% credit spread - which, if there weren't a global pandemic, the creditors would happily be earning right now.
refurb 6y ago
What part of this approach is a "PE trick"? Taking on loans?

Wow, why don't people wise up to this PE trick? Seems like creditors would learn their lesson after so many examples...

razster 6y ago

Because the creditors make money off it as well.

whatok 6y ago
Can you explain how the creditors of 4bn in Neiman Marcus debt are making money off this?
- 0x8BADF00D 6y ago
  Because they won’t default now.
  - whatok 6y ago
    Ok, a potential positive sum is definitely better than zero but once again, how exactly are creditors making money off this? The grandparent's post is implying that somehow no one is losing money in this situation. I'd like to hear how it works.
- beamatronic 6y ago
  They probably sold the debt to another party
  - whatok 6y ago
    So you're saying that the original creditors made money off this and new creditors through secondary market transactions are left holding the bag? That's partially true but a massive portion of this debt is in pension funds or passive investments that track index funds. They track benchmark indices so they're buying these bonds at issue or shortly after. With no active management involved, they are also losing money when a company files.
jariel 6y ago
The creditors definitely won't make money. They are other banks, and probably all the suppliers who give to NM on credit and who won't get paid. Chapter 11 is by default bad news for creditors, it means they will get less than the agreed-to value of whatever.
- danielisaac 6y ago
  They're not making any money, but they're not universally worse off. Depending on their status (e.g. if their debt is secured by a lien), it's totally possible that some classes of creditors could be reinstated with the same claims under the reorganization plan (assuming it gets confirmed by the court). Even if a secured class doesn't get the same value and votes against the plan, they're still entitled to a handful of protections under the Bankruptcy Code (§ 1129(b)(2)(A)). Less so for unsecured creditors and shareholders.

pjc50 6y ago

The "creditors" are usually another shell company of the PE firm, and the interest rates are absurd (I looked into the collapse of Maplin and it was something like 20%). It's basically an accounting trick to remove profits from the victim company in its declining years without having to pay tax on them.

rwmj 6y ago
I assume someone must lend the money (as it's not created from nothing). How does it work?
- deleted 6y ago
  [deleted]
- whatok 6y ago
  Private equity firms raise funds (usually have a 10yr investment horizon) and use these funds to serve as the equity tranche for a buyout that the remainder is financed with debt. Banks (or other investment firms sometimes nowadays) will provide financing for these buyouts and that financing is later refinanced with syndicated financing through loans or bonds. There are a decent amount of banks that were in the middle of this process, covid hit, and they are now stuck with those loans on their books.
  - black_puppydog 6y ago
    in other words, yes, it is created "out of nothing" (when handing out the loans) and once the "unexpected bad things" happen it becomes "real" (as in it is on the books and will now have to be accounted for properly)?
    - whatok 6y ago
      I'm not a fan of private equity but I'm also not a fan of rants directed my way when I'm answering a question someone asked. Please take this somewhere else.

devchix 6y ago

Please explain? Why is there the association that private equity creates corporate debt?

topkai22 6y ago
Private equity companies exist to purchase existing companies from their current owners and then run them better/extract more value from them. The canonical example of this is purchasing a public company by acquiring all outstanding shares. This is often a fantastically expensive enterprise that requires that the new owners raise tons of money. The new owners do this by structuring a deal where the company will take out a ton of debt (basically its entire market capitalization of the company, plus a premium) to purchase the outstanding shares. This is known as a leveraged buyout (LBO). So if a public company has $100M in outstanding shares and zero debt before they go private, by going private the private company will now have $100M of debt (rough numbers, illustrative but not necessarily realistic). That's why going private often results in dramatic sell offs and cost cutting- the new company needs to get the debt load down, and fast. Definitely read Barbarians at the Gates, it's a great book and explains a lot about private equity from a dramatic case in the 80s.
- devchix 6y ago
  Thanks for that. But why is the company now worse off than before? A company can be funded with equity or debt (different terms and obligations, I understand) but if a company converts 100% of its outstanding shares to debt, why does anything change? I assume this is what happens when a company takes itself private to escape the grind of quarterly earning, short-term growth, tyranny of Wall Street analysts, etc. If I could run a company better/extract more value from it, say, by decreasing expense, increasing revenue, and therefore profits, I'd write myself a big check quarterly and continue running the company. Something else extractive and zero-sum (I gain but the company loses) is going on and I don't know what that is.
  - sfkdjf9j3j 6y ago
    The company is now servicing $100m of debt. That cash went to the previous shareholders in the buyout.

qppo 6y ago

People with other options don't take private equity buyouts. Some captains go down with their ships, others get on the first lifeboat.

ttul 6y ago
Or you take a partial life boat that makes you very comfortable and then if the firm collapses, oh well.

Ididntdothis 6y ago

I am pretty sure except the employees all participants are making good money off these deals.

nogabebop23 6y ago
yes, not sure what your neiman marcus pension will look like in 6-months...
zone411 6y ago
Except they are not. Ask shareholders and bondholders.

formercoder 6y ago

The web of incentives behind LBOs is very complex. They happen because in reality a lot of the time many of the people involved make money. This is availability bias. You only hear about the explosions. You don't hear about the thousands of LBOs that happen which never blow up.

gamblor956 6y ago
The financial structure of a LBO is that a PE fund uses the assets of an acquired company to pay for the acqusition. They generally put little if any of their own money down other than as earnest capital. They then take out additional loans using the acquired company assets as collateral and pay themselves distributions out of those loans. The acquired company is left to repay the massive and increasing debts. You don't hear about the successful LBOs...because they're extremely rare. The only LBOs that worked out for the acquired companies are for those like Hilton, which occurred right before interest rates dropped, allowing the acquired companies to refinance their debts at lower rates than incurred by the LBO. The recession that occurred right after that LBO also let them fire tens of thousands of workers and shutter hundreds of locations and blame the recession rather than the shitty PE management and pillaging. Toys R' Us and Neiman Marcus are the prototypical LBOs. Whether or not the LBO succeeds, PE gets rich, everyone else gets screwed.
- johnvanommen 6y ago
  There's a great CNBC show called "The Profit" which really makes it easy for a layman to understand how private equity works. On the show, it's interesting to see how the investor who is putting up his money is often uninterested in investing in a company that's growing quickly and making good profit margins. I can only speculate on what the investor's true motivations is. But there was one episode in particular which was interesting: 1) The investor came in, offered up a few hundred thousand dollars for a 51% stake 2) He immediately had the company upgrade their equipment, purchasing new equipment 3) Eighteen months later, the company was bankrupt When all the dust settled, the company was re-packaged and sold to another company, the original owners were gone, and the manufacturing was sent overseas. When the investor was having them buy a bunch of equipment, I was definitely wonder if his prime motivation was to simply have some tangible assets that he could recover once the inevitable bankruptcy occurred.

tfehring 6y ago

No matter how risky it is, there's a price at which it's still profitable (in terms of risk-adjusted expected present value or whatever) to finance it. In this case, based on a sibling comment, that price was a ~8% credit spread - which, if there weren't a global pandemic, the creditors would happily be earning right now.

refurb 6y ago

What part of this approach is a "PE trick"? Taking on loans?