
Private Equity Wants in on the Bailout? Spare Me - JumpCrisscross
https://www.bloomberg.com/opinion/articles/2020-04-02/coronavirus-private-equity-wants-in-on-small-business-bailout
======
cs702
Buffett on private equity:[a]

> For some years, these purchasers accurately called themselves “leveraged
> buyout firms.” When that term got a bad name in the early 1990s – remember
> RJR and Barbarians at the Gate? – these buyers hastily relabeled themselves
> “private-equity.” The name may have changed but that was all: Equity is
> dramatically reduced and debt is piled on in virtually all private-equity
> purchases. Indeed, the amount that a private-equity purchaser offers to the
> seller is in part determined by the buyer assessing the _maximum_ amount of
> debt that can be placed on the acquired company.

> Later, if things go well and equity begins to build, leveraged buy-out shops
> will often seek to re-leverage with new borrowings. They then typically use
> part of the proceeds to pay a huge dividend that drives equity sharply
> downward, sometimes even to a negative figure. In truth, “equity” is a dirty
> word for many private-equity buyers; what they love is debt. And, because
> debt is currently so inexpensive, these buyers can frequently pay top
> dollar. Later, the business will be resold, often to another leveraged
> buyer. In effect, the business becomes a piece of merchandise.

Left unsaid is what happens if things do _not_ go well. Saddled with as much
debt as possible, the business by design has been put in a position such that
it cannot survive even a modest decline in revenue without raising significant
additional capital.

Therefore, if government assistance is not forthcoming, the economic shock of
COVID-19 looks likely to put a majority of leveraged buyouts in bankruptcy.

[a]
[https://www.berkshirehathaway.com/letters/2014ltr.pdf](https://www.berkshirehathaway.com/letters/2014ltr.pdf)

~~~
dcolkitt
> Saddled with as much debt as possible, the business by design has been put
> in a position such that it cannot survive even a modest decline in revenue
> without raising significant additional capital.

I agree, but I think it's important to qualify what you mean when you say the
"business can't survive". Because this implies that if a company can't meet
its debt obligations that it will cease operations.

As long as operational cash flow is positive, then no amount of leverage or
debt distress will halt the continued operations. The business might "fail" in
the sense that the entity is legally re-structured and the equity owners, or
even junior debt owners, are zeroed. But there's no reason in a country with
well-developed bankruptcy law for this to have any impact on the employees,
customers or operations of the business.

The issue with coronavirus and failing businesses is that it's causing many
businesses to have negative _operational cash flow_. In this sense the
business may fail and the operations discontinued simply because revenue is no
longer exceeding expenses. But if the operations are cash flow negative (and
capital markets are unwilling to extend financing in the hope of future cash
flow) then the business will fail regardless of its capital structure or
leverage.

~~~
Decathect
I'm really curious what your point is, since the willingness of capital
markets to extend financing seems like it'd be very related to a company's
capital structure and leverage. Like, were the businesses in question not over
leveraged, they'd find it much easier to find the capital to continue
operations during a downturn.

~~~
dcolkitt
> extend financing seems like it'd be very related to a company's capital
> structure and leverage

This seems intuitively appealing, but is misleading. The Nobel-prize winning
work of the Modigliani-Miller Theorem[1] that a firm's capital or leverage
ratio does not prima facie have any impact on its weighted-average cost of
capital.

[1]
[https://en.wikipedia.org/wiki/Modigliani–Miller_theorem](https://en.wikipedia.org/wiki/Modigliani–Miller_theorem)

~~~
SilasX
Well, you have to take into account more stuff than what's one the prima
facie, like when all businesses have to run on 1/3 revenue, and (like in the
example in the link) can't even afford the interest payments that are due.
That tends to make capital more expensive.

------
Havoc
>But do they really deserve any part in a bailout?

Do any of these companies?

The whole concept of bailouts create bad incentives - to me that's more the
crux of the issue. But if you're gonna do them anyway then I see little
justification for including/excl some just because they're listed vs private.

Plus it makes way more sense to "save" the economy at grass roots level
anyway. I'd prefer more of a suddenly expanded social safety net type
situation. Similar to what the US is doing with corona checks and what Germany
is doing with blanket guarantees tp try and prevent layoffs.

~~~
TomMckenny
These two options for saving the economy: corporate bailout vs social safety
net essentially correspond with belief in trickle down vs Keynesian stimulus.
Stated even more bluntly, it is essentially whether you believe customers or
assets are most important for business.

It is why the current path begins to resemble 1929 where consumer buying power
spiraled downward. If the social isolation period ends with millions of
consumers cashless, and in debt then there will be no one for businesses to
sell to. In this cases, businesses would have to use any bailout money to
employ people unnecessarily for the months it would take until consumers have
spare cash: The months of paychecks it will take for them to pay outstanding
mortgage payments, back rent, personal loans, credit cards etc plus interest
on those. Bailing out consumers/employees avoids this convolution, does not
assume that business will act in this uncharacteristic money losing way and,
avoids extra expense/risk since consumer loans are higher interest rates/risk
than government borrowing.

Furthermore, the trend away from brick and mortar toward online consumption
may be enormously sped up by this social isolation period. In this case, many
of the businesses bailed out will never fully recover. Consumer spending power
is a much better way for the market to evolve than a government guessing which
companies are will be viable at the end of this.

~~~
bhupy
"trickle down" isn't a real thing, it's just a pejorative used against supply
side economics, which is a mainstream economic view.

The basic account of "trickle-down economics", goes something like this. When
you give a tax cut to a rich guy, he uses the money to buy party supplies for
a celebratory yacht party. The guy who owns the yacht party supply store sees
an influx of cash from rich guys spending their trickle down tax cuts on yacht
party supplies and orders a pizza to celebrate, and gives the pizza guy a big
fat trickle-down tip. As you can see, the tax cut started out at the rich guy,
but before long even the lowly pizza delivery guy is getting a piece of that
sweet trickle-down cheddar.

Notice an interesting thing about this account: it is fundamentally a _demand-
side_ story. In this story, the trickling down happens as a result of people
spending extra money on goods and services. It is not about creating supply.
So it's _not even an accurate representation_ of supply-side economics. People
rightly point out that it's a flawed story, because poorer people probably
have a higher marginal propensity to consume than rich people, so you'd be
better off giving the tax cut or equivalent transfer payments to poor people
if you want to stimulate economic activity. Well, yeah, no shit, that's
because this is a complete straw-man and no economist actually believes that
this story is true.

What some economists actually do believe is that the path to prosperity is via
the supply curve and not the demand curve. Making things cheaper to make and
cheaper to buy makes people better off faster than just giving them money to
buy things at existing levels of production. And the way to do that is
investment—investment meaning, in the economics sense, spending on things like
factories and equipment. There is a huge body of theory and evidence to
support this idea—higher levels of investment do lead to faster growth. So
supply siders believe that things like taxes on capital gains are harmful to
the economy on the margin because they reduce spending on investment, and may
even encourage spending on consumption, which is a bad outcome to the supply-
sider. They also believe in reducing barriers on production—things like
government regulation and income taxes. They also believe in, you guessed it,
helping make sure that corporations don't go out of business amidst a once-in-
a-century black swan event — call it a "corporate bailout".

~~~
TomMckenny
For want of an equally familiar term, "trickle down" is all I had. Apologies
if it is critical sounding.

The crisis will end with sky high unemployment, no consumer saving but
massively increased personal debt. To raise the deficit solely so companies
can make twice as many widgets with half the employees would be the worst
possible response. And even this assumes supply side policies do what they
claim.

~~~
bhupy
> The crisis will end with sky high unemployment

Nobody knows this for sure.

At the moment, the official policy of the Federal (and most State) government
is forced unemployment: a planned shutdown of the economy. To accommodate
this, the CARES act includes $2400/month (on top of State UI) unemployment
insurance, and that’s not even including the flat $1200 check. If you live in
Minnesota, you’re looking at $5,360/month (!!!). The full state breakdown can
be seen here [1]. In every state, the unemployment insurance is higher than
the median wage. Businesses know this, and are proactively laying off their
employees so that they may collect this benefit, with the intention of hiring
them back once the planned shut-down ends. This can only happen if the
businesses stay solvent, hence the corporate bridge loans.

[1] [https://imgur.com/a/AifRmdD](https://imgur.com/a/AifRmdD)

------
brenden2
What I learned in school growing up was that if I lose a bunch of money
gambling at the casino with my credit card, I don't get a free bailout from
the government. But maybe things have changed?

~~~
HashThis
The privileged class knows that congress sells us out. The privileged class
are just again working to rob the masses to wealth transfer more to the
privileged classes. Happens every year, some more visible than others.
Hopefully this is one time congress won't sell us out.

~~~
kitotik
> Hopefully this is one time

> congress won't sell us out.

Uh, didn’t it already happen, again?

Propping up aerospace and banks again with taxpayer money, sending only a
fraction (call it a “token”) to SMBs, with near unchecked disbursement powers,
seems like they’ve continued on their same general strategy of wealth
consolidation.

~~~
siruncledrew
When the first tweets from the executive branch were “OMG we need to save
Boeing!!!!” instead of “We need doctors and supplies!!!” that kinda summed up
where the priorities were.

~~~
kitotik
Exactly.

Made painfully clear with the messaging that “hey, a lot of people die from
car crashes and the flu every year” directly followed by quotes of “these
great American companies such as Boeing are NOT replaceable”.

IOW: old and/or poor people are commodities easily replaced.

------
theandrewbailey
If a company can issue stocks or bonds and needs to raise money, it should
issue stocks/bonds instead of getting bailed out by the government. If no
one's buying, talk to the Fed.

~~~
zzleeper
The problem is they were already operating on razor thin margins. Imagine
people walking through their lives with only $10 of savings, and hundreds of
thousands of dollars in debt. First time something happens, boom, you go
bankrupt.

Same with PE companies. They leverage up to the highest possible values, and
then a bit more. They knew the risks of doing so, but the risks were worth it
because they would make so much money if they paid off. But they didn't paid
off. Why should we bail them out?

In fact, is there something we can do to PREVENT these colossal leverage
figures? Banks don't care, regulators can't do much about it, PE companies
don't care, the companies being bought out don't have a say, and neither
consumers.

~~~
leveredequity
It's disingenuous to say PE doesn't care. They have every incentive to
preserve and generate equity value. That is literally their business.

However, the issue is employees are also hurt, not just equity and debt
holders.

Edit: I don't see how you can disagree with this statement. Literally the only
job of a PE firm is retain and create value for investors. They would be out
of business if they did not do that. Hence, they care about preserving
capital. With the caveat that this is in aggregate across the portfolio.

I don't disagree, however, that there needs to be significant regulation and
social safety support for workers. I believe there needs to be significant
changes to ensure we protect worker rights.

~~~
downrightmike
Buy companies, layoff and outsource staff. Over work those that are left. PE
is already bad for employees.

~~~
leveredequity
I work at a PE firm. There are multiple strategies employed, but the name of
the game is not to lose money. Disagree with the term "value creation" \- fine
- but my point is there is zero incentive to lose money. Otherwise, they would
be out of business in the long term.

I am arguing for worker protection. Not protection of equity value. You
inherently take on risk by deploying it, and should accept the realities of
that risk.

~~~
majormajor
> Otherwise, they would be out of business in the long term.

... that would be a fine incentive _if_ we don't bail them out. Otherwise...

~~~
leveredequity
Totally agree, I thought we were arguing to bail out employees here. That's
what I'm aware of based on what I've seen going on in the industry

------
socalnate1
If the real goal here is to save jobs, this is all completely irrelevant.

~~~
Pfhreak
Has PE had a history of net job gain, or at the very least saving the jobs
that were already there?

My impression, without any data on hand, is that PE firms tend to reduce the
number of jobs overall.

~~~
TrackerFF
As much crap as Michael Milken has gotten, I agreed what he said on junk
bonds: Dollar by dollar, junk bonds did create a lot jobs. They funded risky
businesses, in the same way venture capital does today. Problem arises when
they are used in deceptive ways.

------
hazeii
Matthew effect in full flight.

[0]
[https://en.wikipedia.org/wiki/Matthew_effect](https://en.wikipedia.org/wiki/Matthew_effect)

~~~
sytelus
Capitalism is itself a pure unadulterated implementation of Matthew's effect.
If you have capital of $X, you automatically are entitled increase in that $X.
If you have $0 then you work day after day to find _your share_ of global
wealth keeps dipping. This is typically gets sold as "risk vs reward" system
while the fact is that if you had invested in S&P500, your investment is
practically protected by the US Army and its arsenal of nuclear weapons. The
risk of your $X reducing to $0 over any conceivable long term is practically
nonexistant. You simply see your wealth grow unbounded without you doing
anything at all. You can count of US government to get you out of ditch even
though the vast majority of the population has no investments in S&P500. Sure,
folks screw up as always but that's the capitalism in essence and it gets
better as $X gets bigger.

~~~
SpicyLemonZest
Your premise just isn't true. A significant majority of Americans have
investments in the stock market.

~~~
quickthrowman
While that may be true, 1% of Americans hold 50% of total US equities. The
wealth gap is wider than it has been in 130 years, that is not good.

------
LatteLazy
I feel like this whole thing is a sideshow.

We should "bailout" based on just 2 criteria:

* would the business be viable if it weren't for corona and will it be viable after coronavirus?

* what's in it for us? We want equity, or juicy interest on the loan or you're industry needs to be a big net contributor of tax revenue.

We made a profit on the TARP activities. Let's do that again, then we can cut
taxes and expand services. Who doesn't like that idea!

~~~
themagician
It is precisely because of the predictable government response to corona that
many of these firms are viable at all. That is, many know that they can enter
into what is essentially a "bad faith" debt obligation because they know a
bailout will likley be available.

There hasn't been any real incentive to save or be fiscally responsible since
the 90's. Spend as much as possible. Take on as much debt as you can. If
things get bad you can either abandon ship and do it all over again or wait
for a bailout which is almost ingrained in the system at this point.

In fact the more debt you have the less you have to worry.

~~~
dillonmckay
Quite the moral hazard.

~~~
LatteLazy
Only if the industry being bailed out can somehow profit from causing the next
plague...

------
elliekelly
Perhaps they could find an opportunistic fund manager looking to invest in
some distressed debt. Surely these PE firms know a vulture investor or two...

------
mesozoic
We need more bankruptcy, businesses where the equity holders were too risky
getting transferred to the debt holders. Force companies who want bail outs
into bankruptcy, and if they let people keep their jobs let them hold some
small amount of the equity when the company is rebalanced. Let the system work
as designed instead of bailing out the bad decision makers.

------
marcusestes
Y’all do realize that private equity portfolio companies include every single
YC and venture-backed startup, right?

------
ur-whale
[https://archive.is/xnqEF](https://archive.is/xnqEF)

------
leveredequity
It's not about bailing out the investments, but about preserving jobs. Fine,
attach restrictions for taking bailout capital, but that should be the
purpose.

~~~
skitout
You can get different types of "bail out" for different types of companies...
It can be "much more expensive" for private equity firm than "normal" SME...
You save as many jobs and you save a lot of taxpayers money

~~~
leveredequity
My point is no need to target preservation of equity value but instead ensure
those facing job loss are supported. However, the current legislation doesn't
allow portfolio companies to take bailout capital as a result of restrictions
based on portfolio companies being "affiliates" of one another. Similar issues
are faced by VC portfolio companies.

