Leveraged Buy Outs: Sponsors when, investors lose.
Warren Buffet, Chief Executive Officer of one of the most successful mutual funds in the world, Berkshire Hathaway, doesn’t invest in overvalued companies. In Berkshire Hathaway’s latest acquisition of Oriental Trading Company, Buffet executed the purchase of a successful company that had been leveraged, over valued, looted and bankrupted to make it a good value for him.
Debt is good
The Leveraged Buy Out (LBO) has been a staple of private equity firms to acquire companies for decades. When done right, regardless of whether the targeted company succeeds or not, the financial sponsor or private equity firm realizes little risk and always gets the upside. If the company they purchase is profitable the private equity firm wins. If the company they purchase tanks, the investors the private equity firm lined up to purchase the debt take the lost. Because of the huge debt load the private equity firms saddle on the target company, most LBO’s can’t be sold until the debt is repaid or discharged through bankruptcy. Once the debt is gone, then the targeted company once again looks like bargain to investors like Warren Buffet.
The business is investment, not the business
The Oriental Trading Company started in 1932 and grew into a mult-million dollar business by offering affordable imported merchandise. They had millions of customers purchasing party supplies, crafts, novelties and decorations from their on-line store and catalogs. The founder’s son, Terry Wantanabe, sold his controlling interest in the company to the private equity firm of Brentwood and Associates in 2000.
A new sucker is born
In 2002 Brentwood and Associates began to expand the company. The increased expansion and period of healthy sales in the mid-2000’s convinced the Carlyle Group, another private equity firm, to acquire a 68% interest in Oriental Trading Company in 2006 for a reported $1 billion. As the recession battered the country, Oriental Trading Company filed for bankruptcy protection on August 24, 2010. They reported having:
$463 million in assets
$756 million in liabilities
$485 million in net sales
A going concern
With out the accumulated debt from the private equity firms, the company was in pretty good shape, it was truly a “going concern”. They still had a loyal following of customers that just weren’t buying as much as they use to. Given time and belt tightening, I am sure the company would have weathered the recessional storm like so many other businesses in the U.S. Unfortunately, it was burdened with debt that in no small measure went to pay huge corporate salaries and bonuses at the private equity firms. It was never the intention of these private equity companies to run the business, only manage the debt. They have no interest in the business, employees or customers.
The business people get stuck again
The big losers in bankruptcy are the unsecured creditors such as merchandise vendors and service providers. Those are the folks that don’t hold any sort of lien on extended credit for goods shipped. While there may be contracts to purchase goods, the extension of credit, bolstered by a the backing of big name private equity firm the Carlyle Group, can be in the millions of dollars with little security of ever getting paid except good will. These folks didn’t know that it was never the intention of the private equity firms to make good on the debts of the Oriental Trading Company. Private equity firms don’t attempt to repay debt, they sell it or get it discharged. They rarely take a loss like the vendors or the unknowing investors they line up to buy a corporate bond.
Another vulture visits the dying body
In 2011, another private equity firm, Kohlberg Kravis Roberts, bought some of the first lien debt. It sounds like KKR purchased some of the secured debt at a discount from another institution that decided the KKR offer was better than nothing if bankruptcy completely liquidated Oriental Trading Company. In other words, KKR offered a discounted amount to the lien holder, less than their investment, in return for the secured ownership stake. KKR, because they had looked at investing in Oriental Trading Company earlier, knew the value of the company. They knew that the company had not appreciable changed, it was the leveraged debt load that imploded the company. Through the bankruptcy organizational process, KKR’s debt purchase turned into a 1/3 equity stake in the company according to a New York Times story on the sale.
One big LBO game
With all the leveraged debt jettisoned, KKR and other private equity partners sold Oriental Trading Company to Warren Buffet for $500 million. Only six years earlier the Carlyle Group had purchased the same company for $1 billion. What happened to the $500 billion? That’s how investors get fleeced in America and the private firms like Bain Capital, Carlyle Group, Brentwood and Associates and Kohlberg Kravis Roberts play the game. And it is one big game to them.
Oriental Trading Company never ceased operation. They were still purchasing product and selling to their customers. Remember, they had $485 million in sales in 2010 and I am sure that has held steady or even grown. Oriental Trading Company is the same today as it was in 2000 when it was first sold.
Musical chairs all in good fun
In between 2000 and 2012, private equity vultures were playing a high stakes poker game with other people’s money and the game was rigged. No matter what happened to the Oriental Trading Company, all the managers, advisers, consultants and owners of the private equities firms got paid very well to push paper. Leveraged Buy Outs are a big game of musical chairs and the last creditor standing when the music stops is the one that gets stuck.
He’s a genius, subsidized by fleeced investors
But don’t think there are any hard feelings amongst the big players. The guys that run the private equity firms and participate in the LBO’s know it is just a big game. The Oriental Trading Company LBO will just be another story told between competing companies over a cocktail at the country club. In the end, everyone cheers that Warren Buffet bought another company at a great deal. The New York Times writes a feel good business story about a company surviving the recession. Warren Buffet and Berkshire Hathaway are portrayed like the geniuses they aren’t. The investors take it in the shorts so Buffet can look like the “Oracle from Omaha” when all he really did was perpetuate the sanctioned fleecing of investors through private equity firms and bankruptcy. Too bad that great deal was at the expense of investors who got fleeced in bankruptcy court. Thanks Warren, you make American business look so humane.