Should PE targets be regulated?

Just wanted to get your thoughts on this, I normally don’t give these things a second thought but, seeing whats going on with Southern Cross Healthcare has really got me to thinking.

For those not familiar with it, Southern Cross is a British healthcare company who provides homes as well as care to over 750 elderly and infirm people outside London.

Blackstone acquired them in ’04, and did what they do best; they restructured the company to focus its growth on the purchase, flipping, and leasing back of care-home properties in the UK.

At the surface, it was a slam dunk; BX quadrupled its investment by the time they exited two years later, while Southern Cross became leaner and way more profitable that it ever was. But, a lot has happened between ’06 and today…


When the credit crunch hit, Southern Cross was left with large debts and a crippling rent bill, currently running at £250million a year, because it no longer owns the homes.

It recently unveiled losses of £311million in the first six months of the financial year and the firm which was once worth £1billion was valued last night at just £12million.

So a lot of old people might end up homeless, and as always, the blame is entirely thrust on the evil empire of finance. Not knowing all the details of the deal though, you really couldn’t blame Blackstone for what’s going on with at Southern Cross right now.

Thing is though, PE deals involve a lot of risk. Even if the titans themselves were to do them, there’s still the oft-chance of it failing. And there’s been a lot of that going on lately.

With the lives of almost a thousand 80 to 90-somethings in jeopardy with this one, should some companies have stricter PE acquisition rules? Or even made completely off limits?

The UK government thinks so, and I kinda agree. The best laid plans of mice and men, go oft awry, and while I'm sure BX did not intend for this to happen, I don't think they believed it would either.

How about you monkeys? Do you think PE targets should be regulated?

Might be missing something here, so I'm curious what you have to say.

Have a good one WSO.

 

Think its far too slippery a slope. You regulate hospitals, next you're regulating defense contractors, then distributors of critical commodities, then electronics, and on and on and on...

That being said, perhaps some kind of rule should be created ( a public interest clawback?) to combat this kind of thing.

Besides, if hospital chains aren't banned from taking on crippling amounts of debt themselves then they shouldn't be banned from doing it in service of a financial investor

 

Josh Kosman wrote The Buyout of America, basically saying how PE is going to destroy the economy and how PE ruins most of the businesses it buys out, while the PE companies make a considerable profit. He specifically discusses for profit hospitals as well.

This link is to his book's website: http://www.joshkosman.com/

If you look at the video from March 3, 2011 Watch the Panel Discussion, he specifically talks about PE Firms and Hospitals at 6.50.

The whole video's worth watching but that little byte is a nice perspective on the situation.

 

Greed is good, but the bottom line is that buy side firms are not incented correctly through current compensation practices.

Same thing with corporate governance. Greed is good, but only if management is incented to behave like owners. This just isn't true most of the time.

 
Best Response

I think Josh Kosman makes some valid points about the validity of the LBO model of acquisition and divestment but at the end of the day, it is up to the (potential) new owners of these business to evaluate the plausibility of running a business so heavily levered. I remember in my 3rd year corp fin class the professor cautioned all of us students that LBO's are better suited to mature business with minimal growth, stable cashflows and opportunities for expense optimization (cost reduction). A lot of the criticisms Kosman have more to do with poor buyout targets (companies needing access to capital to fuel growth, unstable cashflow etc.) than they have to do with PE. If the new owner is willing to take on the risk than what benefit would regulation do other than to hand hold the new owner.

 

How To Make Money - a Simple Guide for Big PE firms

1: Find healthy company with strong, predictable cashflows 2: Buy it 3: Load it up with debt 4: Sell all the assets, then lease them back. Keep all the cash this releases for yourself. 5: Slash CapEx 6: Watch cashflow rise due to decreased CapEx, ROC rise due to asset sales, and ROE rise due to overleveraging. 7: Float company on stockmarket before customers/journalists/regulators start noticing effects of CapEx cut (in Southern Cross's case, falling-down carehomes with out-of-date equipment and untrained staff.) 8: Take the money, fly to a beach in the Bahamas. Watch newly-floated company crash and burn. Laugh maniacally.

 
hedge the world:
How To Make Money - a Simple Guide for Big PE firms

1: Find healthy company with strong, predictable cashflows 2: Buy it 3: Load it up with debt 4: Sell all the assets, then lease them back. Keep all the cash this releases for yourself. 5: Slash CapEx 6: Watch cashflow rise due to decreased CapEx, ROC rise due to asset sales, and ROE rise due to overleveraging. 7: Float company on stockmarket before customers/journalists/regulators start noticing effects of CapEx cut (in Southern Cross's case, falling-down carehomes with out-of-date equipment and untrained staff.) 8: Take the money, fly to a beach in the Bahamas. Watch newly-floated company crash and burn. Laugh maniacally.

Nice. Notice how none of the above would make a company more valuable, but would make a company SEEM to be more valuable given the finanical metrics used to value companies.

--- man made the money, money never made the man
 
mr1234:

Nice. Notice how none of the above would make a company more valuable, but would make a company SEEM to be more valuable given the finanical metrics used to value companies.

Precisely.

Khalil:

PE bonuses are taxed at the capital gains rate and not the typical ~50% rate?!

The carry is taxed as cap gains, and for the senior people that will be the bulk of their compensation. That's why you get the silly situation, which Warren Buffet sometimes complains about, where senior PE and HF execs get taxed at a lower rate than their secretaries.

 

UGh...fuckin PE. Couple of things that bother me about PE and PE related matters:

*First, the fact that Southern Cross failed during the finanial crisis doesnt necessarily mean that it was BX's fault. There could have been many other contributing factors as well. A lot of companies failed during the financial crisis, including companies that weren't backed by PE financing. BTW, the fact that BX cashed out so well probably had more to do with the current trends in financial markets at the time, everything was over-valued in 2006.

*However, PE isnt about making companies more valuable. Its about financial engineering a company so that it is percieved to be more valuable given conventional metrics used to value companies. Think about it, why are so many PE guys ex-bankers and not ex-operations? Why do PE interviews stress finance so much over operations? WTF would an ex-banker know about operations?

*Buying assets from a PE group is stupid. Institutional investors, strategic buyers, public capital markets and other buy-side players dont seem to get this. By the time a PE firm is done working over (raping and pillaging) an asset, the value-add potential is gone and its a zombie asset (living dead). The PE seller gets the good deal while the buyer gets screwed with an over-valued portco.

*PE compensation is bullshit. It makes no sense that bonuses are taxed as capital gains when they are paid out as compensation. Compensation should be taxed as compensation, not capital gains. This is one thing about PE that can and should be regulated.

Alright, rant over.

--- man made the money, money never made the man
 
mr1234:
*PE compensation is bullshit. It makes no sense that bonuses are taxed as capital gains when they are paid out as compensation. Compensation should be taxed as compensation, not capital gains. This is one thing about PE that can and should be regulated.

PE bonuses are taxed at the capital gains rate and not the typical ~50% rate?!

 

This is actually a two sided coin, its not as common with the NY mega firms but it does happen quite often. The orginal owners of buy out targets can walk away extremely wealthy take few years off, wait for the company to crash and burn under its debt load, walk back in buy it for pennies on the dollar and seem like saviors. Remember now this is PE while not as risky as VC it is still very risky. Deals go sour all the time. A friend of my family you could say is a business owner. What he does is buys distressed companies and guts them, cleans up the shop and gets them profitable again. Then he proceeds to sell these companies to investment groups, often PE groups who often do not know the industry well or just dont know how to run business at all. He watches them load these companies up with mountians of debt, watches the avalance that ensuses, then goes back and buys the company back. Often for less then 30% of what he sold it for.

The problems with LBOs, esp with smaller companies, is the buyers truely have to understand the market. When they don't things go bad.

Follow the shit your fellow monkeys say @shitWSOsays Life is hard, it's even harder when you're stupid - John Wayne
 

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