Gobble Gobble


In 2001, the Boston Red Sox hiked ticket prices just 24 hours after the New England Patriots had won their first Super Bowl. It was an egregious increase, but no one noticed.

People also don’t notice much on the day after Thanksgiving, because they either are suffering tryptophan hangovers or are in pre-stampede mode at the local Best Buy. Even the public markets take half the day off.

So it isn’t terribly surprising that hospital chain HCA picked Friday to disclose additional terms of its $21 billion sale to Bain Capital, KKR and Merrill Lynch. After all, $175 million in transaction fees and $15 million annual management fees aren’t something to promote (or list in the small print on an ER visit bill).

In addition, the management fee can increase annually beginning in 2008, while new owners will be entitled to: “a fee equal to 1% of the gross transaction value in connection with certain subsequent financing, acquisition, disposition, and change of control transactions as well as a termination fee based on the net present value of future payment obligations under the management agreement in the event of an initial public offering or under certain other circumstances.”

Once again, we are watching new private equity owners raid the corporate coffers for their own benefit (as opposed to for the company’s benefit).

Let me repeat that word: “Owners.” Shouldn’t it be implicit that owners will participate in company management? Do they deserve extra financial credit for paying active attention to their own control investment? And, even worse, why do they get paid to terminate said agreement? It’s a pre-baked golden parachute that presumes KKR is just as valuable to HCA while “not managing” as it is “managing.” I wonder if Daddy Thomson would agree that I’m as valuable when “not writing” as when “writing?” Methinks not.

The counterargument here is: “Hey, the private equity firms now own HCA, so they’re the only ones who get hurt if the company’s valuation is reduced.” Yes and no. First, value also is being reduced for any HCA employee holding company options (for the inevitable flip).

More importantly, not all private equity firms share either the transaction or management fees with limited partners. You remember limited partners, don’t you? They’re the ones who actually funded the buyout’s equity tranche.

Bain, for example, almost never shares any of those fees with LPs. Well, it officially does, but then takes out all of the unaccounted for consulting fees generated by affiliate Bain & Co. Even firms with more generous sharing – which usually means 50/50 or 60/40 in the LP’s favor – still apply carried interest, which means that even firms that give 100% to LPs may only end up giving 80 percent. It’s worth pointing out that buyout firms all used to take 100% of such fees for themselves, but progress in this area has still moved like stubborn molasses.

The solution: End management fee agreements, and probably transaction fees as well. Private equity is supposed to be about building portfolio company value over time – not about getting rich on Day 1.

 

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