June 28, 2012
The New York Times DealBook ran a piece by Richard Farley, who advises banks on leveraged buyout financing, that claims workers are better off in difficult economic times working for private equity-owned firms. Private equity, he argues, saves jobs. Farley makes two points to support his claim.
First, he notes that PE-owned firms are no more likely than other companies with similar credit ratings to experience financial distress. Fair enough. It’s the high debt load, not PE-ownership, that increases the risk of default. Indeed, a study of 2,156 highly leveraged companies, half owned by private equity and half not, found high rates of default in both during the last three economic contractions. A quarter of these firms defaulted between 2007 and the first quarter of 2010. The important point, however, is that high debt is typical of private equity buyouts of operating companies. It’s the companies that private equity acquires in a leveraged buyout – and not the private equity firms- that are saddled with these high debt loads, making them vulnerable to failure in tough times. Management fees and dividend recapitalizations that transfer money from the operating companies to their PE owners assures that PE will profit regardless of the company’s success.
Second, Farley points to a study by Moody’s that shows that PE-owned companies that default on their debt are less likely to declare bankruptcy. Though Farley doesn’t mention it, the Moody’s study attributes this to private equity’s greater ability to get lenders to exchange distressed debt for new debt due a few years in the future. These ‘amend and extend’ deals – less flatteringly referred to as ‘amend and pretend’ – allow equity sponsors to restructure the balance sheets of distressed companies they own to protect their equity stake. Distressed debt exchanges from 2008-2010 are coming due now and, according to a separate Moody’s study, a large percentage of these have failed. This is fueling an otherwise puzzling uptick in corporate bankruptcies since the fall of 2011.
Delaying bankruptcy is not the same as saving jobs.