Tuesday, July 05, 2005

The Province of Quick Buck Artists: Barbarians at the Gate

What is a leveraged buyout, the subject of this scintillatingly great book (also turned into HBO movie)?

A LBO, as they're called, is a buyout financed with debt.

Either managment or a private equity firm takes a publicly traded company private.

That takes money.

That's where debt comes in, and lots of it.

It is like a reverse IPO, and instead of equity, the money is typically pooled (well at least back then) using high yield junk bonds.

As I found out this morning, the IRS' decision to make interest but not dividends deductible from taxable income is what helped get LBOs off the ground.

This was obviously a more sound alternative to bank debt.
....the LBO phenomenon increased tenfold between 1979 and 1983..Substantial returns on investment turned LBOs into one of the most lucrative investment ideas of the 1980's, attracting many participants, including banks, insurance companies, Wall Street firms, pension funds, and wealthy individuals.
And the reason LBOs get executed to begin with?

A company is distressed and bloated.

Shareholders are suffering.

The one thing driving the RJR Nabisco CEO throughout the entire film is the damn stock price, rapidly collapsing after the company's new blockbuster cigarette folds during a late trial stage.

A buyout would instantly throw the company on a Mean 'n' Lean diet, shaving off its non-core businesses.

Not to mention that a buyout enables management to evade the stock market's wrath.

Typically, 2 things occur after the buyout: overlapping divisions are axed and multitudes of workers get the pink slip.

It is back to profits, boys.

And when the company has trimmed up and improved earnings, it is sold again at a high return.

In perhaps one of the most informative scenes in the movie, the laconic HenryKravis says "Debt can be good. Debt can tighten a company."

As is the case, however, while shareholders reap the gains, its the company employees who suffer.

That is LBOs in a nutshell -- lets talk about the spirit both the film and book capture.

Gordon Gekko said it best, "greed is good."

And the 1980s were a time of unparalleled corporate greed.

"Barbarians at the Gate" is a farcical look at just one aspect of that corruption.

As said, the movie pits stars Nabisco/RJR chief executive officer F. Ross Johnson against buyout specialists KKR as they battle to see whose wallet is bigger.
The majority of the film deals with the minutiae of back and forth backstabbing, blatant greed, under the table dealing, and assorted other highly unethical business practices...Repeatedly, these characters plot and plan to make a boatload of the green stuff while everyone else suffers the consequences. Layoffs don't mean a thing to these people as long as they can fill their pockets.
This is a tableau filled with CEOs, investment bankers, deal makers and PR cheerleaders, overly paid strategists and socialites -- and how they all came together in one pivotal moment in 1988 to construct what still stands as the biggest deal in the annals of Wall Street.

The funny thing is, only in our modern age could someone who walks away with 23 million after taxes be called a loser.

No wonder fellow 80s corporate raider Ted Forstmann once termed the LBO industry the "province of quick-buck artists."

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