Having been born and raised in the country that changed the world with its manufacturing ability, capacity and innovations, I have no respect for the primary industry of the America of today – the business of moving money from one point to another, and making money off of the move.
Particularly this week, I have a hard-on about private equity, and it rose to the forefront of my thinking because of the publicity regarding the potential Burger King / Tim Horton’s deal.
If you somehow missed the story, Burger King, now on its sixth owner since it started, that owner being the private equity group 3G capital, has proposed to buy Canada’s largest fast food company, Tim Horton’s for USD $11.4 billion. (An astonishing 25 x Horton’s annual profit, 15 x EBITDA.). (This is as foolish a valuation as Boston’s Berkshire Partners purchase of a Chicago regional hot dog chain for a cool billion a month ago, or 14.3 X EBITDA).
There are the usual PR puff pieces about the logic – “synergy,” will help Horton’s expand in US and internationally, blah blah blah. Many financial writers have opined the transaction is the latest in the tax inversion mess, where US companies merge with companies in domiciles with lower corporate tax rates, and move their headquarters to those countries to lessen their US tax burden.
Burger King’s flacks have responded with the usual patter, “both companies will continue to operate autonomously and maintain headquarters at their present locations.” Whatever.
The purpose of private equity is ostensibly to purchase “under performing” companies, improve them to boost revenue and profits, and resell the companies or go public to generate a nice return for the shareholders/investors.
In order to increase profits at acquired companies, private equity has to do one of two things or both: boost revenue, cut expenses. Simple business.
When you buy into an industry that has very little potential of seeing skyrocketing growth (like restaurants), one is going to be forced to go the ‘cutting expense route,’ or, as in the Burger King deal, purchasing cash flow by buying another company.
What’s wrong with that you say? Isn’t that the “American way?”
In a word. No.
The private equity industry doesn’t create anything except wealth for the investors. Not jobs, not products, not innovation.
There are few ways to boost profits in a slow growth industry other than 1) cutting jobs, 2) decreasing quality of experience or ingredients, or 3) selling off real estate, 4) bullshit accounting and tax moves..
None of which require even a modicum of intelligence, which is good, because usually management at private equity has very little real world experience in running companies.
Even worse, private equity does all this with very little of their own money, usually saddling an acquisition with massive debt obtained from their “limited partners.” (outside investors). Frequently, the ROI for outside investors is minimal, as private equity firms get away with charging “monthly maintenance fees” and equity kickers on gains.
In a worse case scenario, if they totally screw up and have to declare bankruptcy, (as a good many private equity deals do), the debt (and outside investors) money goes away, and quite often this money has come from hard working Americans who actually DO create something – money from pension, retirement funds and the like.
Woe be to those outside investors under this scenario.
In media articles this week on the Burger King – Horton’s proposed transaction, Canadians are wondering (or fearful) that the marriage will affect Horton’s. It’s a rhetorical question if you agree with the points I’ve already made, above.
3G / Burger King (and Warren Buffet is in on the deal, too), will have to boost profits at Horton’s for their own return (Burger King is “public,” but only 30% of the shares are traded, 3G holds 70%), so, welcome the first round of cost-cutting, which not only costs jobs, but frequently leads to shuttering locations.
Another worse case scenario? The private equity group can’t find another private equity group to facilitate their exit of the company at a high enough gain, so they dump it into an IPO, take their profits, and not give it another thought.
It’s time to seriously regulate private equity. The firms used to be called “leveraged buyout firms”, so I’m not talking about putting in new rules that can be avoided by loopholes, like the US did for the banking industry after they caused the housing meltdown. The banking industry is back to the status quo, operating just like they did before wiping out a third to a half of homeowner’s equity in America.
No, there has to be rules for private equity when they acquire a company, regarding how long they have to hold it, what percentage of jobs they can cut, but most importantly, financial protection for the limited partners, including a severe reduction on the fees they pay the private equity fund.
Imagine giving someone your money and paying them double-digit fees to “look after it.” Insane.