The New York Times this morning has an article about Simmons Bedding Co., the mattress maker that has agreed to prepackaged bankruptcy that will transfer ownership from one private equity firm (THL Partners) to another (Ares Management). The main thrust is that THL made money on its original investment, in part via a dividend recap that ultimately helped drown Simmons’ balance sheet.
Nothing we didn’t already know, but a good reminder that we really need to start discussing what the future of leveraged buyouts will look like in a (somewhat) recovered economy. Have PE pros been sufficiently chastened by past excess, and the intentional removal of “risk” from what used to be a “high-risk” asset class (as Steve Schwarzman once argued)? Will dividend recaps, IPO fees and the like be shunned as greed-driven cannibalism – or will they be emulated as proper tactics for protecting LP returns and ensuring PE firm survival?
To begin, let me state that I do not believe there will be massive consolidation in the private equity market. Fund sizes may shrink from 2005-2007 levels – mostly corresponding to decreases in leverage availability – but I do not expect many notable buyout firms to fail. Lots of people point to the number of VC firms that disappeared following the dotcom bust, but few of those were VC firms of any significance (and today’s walking dead were felled by poor investing post-2001). As such, most of the firms doing tomorrow’s LBOs will be the same firms that did yesterday’s LBOs.
Next, I despise dividend recaps, fees and anything else a private equity firm uses to carve value out of its own portfolio companies. Call me naively sentimental, but I believe that PE firms should make money by selling a company for more than they bought it for. Buy low, sell higher.
The primary drivers of public company dividends are largely absent in private companies, and public company dividends are rarely (if at all) paid for by adding new corporate debt. IPO fees, portfolio company management fees and the like are even worse, because they often aren’t shared equitably with limited partners – although even equitable fee splits ignore the fact that PE pros already are getting paid to manage portfolio companies, via annual management fees (i.e., the double-dip).
So back to our question: Will such practices continue?
My gut feeling – and that’s all it can be at this point – is that private equity pros aren’t chastened. If banks again become willing to lard up portfolio companies, then PE pros will provide the slathering sticks. Just look at one of the NYT quotes from THL’s Scott Schoen: “We think the work we had done had positioned the company for us to reap the financial rewards that this economic cycle has taken away.”
Now Scott’s a pretty straight-shooter who probably (hopefully?) offered some deeper self-reflection that didn’t make it into print, but the message is still that private equity itself is not to blame for the current plight of private equity portfolio companies. Some deals were bad decisions from the get-go (per usual), some valuations were absurd (per usual) – but the basic transactional structures were reasonable, as evidenced by market approval at the time (i.e., by bankers who offered to be left holding the bag).
The overall economy is to blame, not us.
Little good can come by continuing bad past practices. Well, at least for portfolio companies and their workers. The private equity firms themselves will be just fine, so long as they don’t mind some bad press.