The New York Times explains how PE firms managed to find profits on deals, even when they badly miscalculated and drove the firm into bankruptcy.
The prime example used is Thomas H. Lee Partners, which has made $77 million on the 133-year-old Simmons Bedding Company. Simmons will soon file for bankruptcy, which could cost bondholders $575 million. And before Thomas H. Lee, there were others: various private equity owners have made around $750 million in profits from Simmons over two decades.
NYT: These private investors were able to buy companies like Simmons with borrowed money and put down relatively little of their own cash. Then, not long after, they often borrowed even more money, using the company’s assets as collateral — just like home buyers who took out home equity loans on top of their first mortgages. For the financiers, the rewards were enormous.
Twice after buying Simmons, THL borrowed more. It used $375 million of that money to pay itself a dividend, thus recouping all of the cash it put down, and then some.
A result: THL was guaranteed a profit regardless of how Simmons performed. It did not matter that the company was left owing far more than it was worth, just as many people profited from the mortgage business while many homeowners found themselves underwater.
As the Times notes, “more than half the roughly 220 companies that have defaulted on their debt in some form this year were either owned at one time or are still controlled by private equity firms, according to analysts at Standard & Poor’s.”
Think of this as yet another symptom of the era of cheap money. Money came with such ridiculously generous terms that PE firms didn’t even have to have successful deals to make money — there were enough chances along the way to pay themselves dividends and collect fees, that it didn’t even matter if they drove the company into the ground, lost their investment, and had to declare bankruptcy.
Of course, the lenders get what they deserve. Our sympathies are with the scores of employees laid off at PE-owned firms (though to be fair, bankrupt companies don’t typically go out of business, and many of these layoffs were likely the result of the worst recession since the Great Depression, meaning they would have happened either way). It’s easy to villify the PE firms, but the root cause is cheap money and the perverse incentives created by it.