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 Published
Tuesday, May 29, 2007
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This
Here comes private equity
by Stephen Butler
How do they rip us off? Let me count the ways.
Who is the "they" in they? Call it what you will; the
Establishment, Big Money, guys waiting to tee off at a restricted
country club.
And then there's today's granddaddy of them all, "private
equity."
Private equity is coming out of the woodwork these days and snapping
up major chunks of publicly-owned corporate America. This is not
all bad, I hasten to say, but here's the rub.
Basically, public companies like all the ones in which our mutual
funds invest can be bought at any time by anyone with enough money
to offer a deal to all the current stockholders. A deal that gives
every stockholder an immediate 10 percent to 20 percent return
over the current stock price.
Once the private equity firm has bought the company, the latter
is no longer traded and can no longer be owned by individuals.
It's owned by a handful of those guys standing on the first tee.
Their imperative is to make the company more profitable so that
they can sell it for a lot more than they paid for it.
I'm not one to scoff at a quick 10 percent to 20 percent return
on my money, but where we're all getting ripped off is in a situation
where our management team is retained by the private equity firm
and given a huge incentive to make the company more profitable
than it was when they managed it as a public company.
We should ask, "If they can create this magic as managers
of a private firm, what were they doing as overpaid managers when
the firm was owned by us?"
More insidious, as private equity gains so much traction, is
the possibility that management teams of public companies might
be deliberately sandbagging once there is any hint of interest
from private equity.
To deliberately run a company so that is only marginally profitable
leaves room for fabulous future profits once in private hands.
If this could be proven, it would be grounds for a jail term.
Unfortunately, it is perfectly legal and the statistics suggest
that it is happening.
A public company bought by another public company typically generates
a 20 percent premium over the current stock price. Neither management
team gets much more than they already had. The average for a private
equity buyout, however, is substantially less -- approaching just
10 percent more for us stockholders. This suggests that a management
that will receive a major share of the new company has a lot more
to gain by helping their future partners pay as little as possible.
When they flip the company three years later for a 100 percent
profit, that should have been our money instead of the measly
10 percent we received.
Fortunately, some major mutual fund companies have recently stepped
up the pressure on directors to veto those deals that are just
giveaways. T. Rowe Price is one of the more aggressive mutual
fund families taking this step, but all of them owe it to us shareholders
to march forward in lockstep.
Our retirement money represents majority shareholdings in most
of corporate America.
Meanwhile, Barney Frank is heading the congressional committee
that will be looking at the tax treatment of private equity management
companies.
Right now, when a company is "flipped" for a profit,
the private equity firm receives 20 percent of the profit and
they pay a capital gains tax of just 15 percent on that compensation.
You and I pay as much as 35 percent regular income tax on what
we are paid at OUR jobs. If the private equity managers actually
owned 20 percent of the company to start with, because they had
put up that percentage of the money, I could understand the capital
gains treatment, but not when their 20 percent is a payment for
a job well done. The rest of us who get paid for doing a good
job have to pay regular income taxes on the money.
From Al Capone to the corporate raiders of the 1980's, the tax
code has brought them down. Eighties' raiders looted pension funds
to pay off the proceeds of junk bonds used in takeovers, so Congress
slapped a 50 percent excise tax on any pension funds coming back
to a company. That may not have brought the practice to a halt,
but it slowed the rip-off and shared the proceeds with the taxpaying
public.
Today, the same outcome may be in the cards for private equity.
Higher taxes on the proceeds may not accomplish the sharing of
results with stockholders where they should be, but at least the
public as a whole will benefit.
That, and an economic downturn that buries some of the more wishful
"feeding troughs," will bring some sanity back to the
world of high finance.
The perpetrators will find themselves back where they belong,
struggling with that windmill at some miniature golf course.
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