Three weeks ago, I published a diary about the movement of private equity firms into the life insurance and annuity industries. I suggested that given private equity’s track record, this laid the basis for the next big financial crisis. This diary sparked a lively debate, unfortunately only between two commentors. The first responder (VClib) suggested that I was too ignorant about private equity to write intelligently. The second (not a sockpuppet BTW) defended my position. What I took from the first commenter was private equity firms make lots of money for their investors therefore PE could never be a problem. As far as PE firms are concerned this is certainly true. However, the same could not be said for the firms which they purchase or the stakeholders in those firms. I suggested that should read the Wall Street Journal for information about PE firms tactics.
My faith in WSJ reportage was confirmed last week by an article, “Record Junk-Loan Sales Fuel Dividend Payouts”. (Oct 3) Corporations have been taking lots of high risk loans and issuing lots of “junk” i.e. high risk bonds. The WSJ continues:
“One major beneficiary of the boom: private equity. Companies owned by private-equity firms have sold over $60 billion worth of leveraged loans to pay dividends—another 21-year record.
Dividend payments can provide private-equity firms with extra cash and a temporary earnings boost. They also help pay out the firms’ investors that contributed money to buy the company. That group typically includes college endowments and pension funds, among other institutions.”
Further on in the article it is noted:
“Earlier this year, Asurion, an insurance provider for personal technology devices such as cellphones and tablets, sold $3.3 billion worth of loans rated single-B plus and single-B to finance a dividend to its owners, the second-largest deal this year. The loans raised the company’s debt total to over six times earnings before interest, taxes, depreciation and amortization, according to a report from Moody’s Investors Service.
Last month, Autokiniton US Holdings Inc., a parts supplier to the auto industry owned by KPS Capital Partners, sold a $375 million loan due 2028 to finance a shareholder dividend. Outsize demand from investors allowed the company to increase the size of the loan, which is rated single-B.”
This is typical Private Equity behavior, strip mining a firm’s assets to reward PE investors. Consider the first paragraph above. The insurer is raising the its debt to six times what is known as free cash flow, i.e. all the revenues a firm receives that is not needed to meet current obligations. This is not a long term strategy for the firm, but the PE investors will be richly rewarded.