BUYOUT FALLOUT

A new twist in the financing of corporate buyouts is enriching the purchasers and driving many an established old-line company into debt, layoffs, contraction or even bankruptcy – all this with meager public regulation.

The winners, according to a recent analysis by The Wall Street Journal, are big private financiers – hedge funds, buyout firms and venture capital firms. The buyout firms averaged 24 percent annual returns in the past two years, The Journal reported. And hedge funds, with assets of $1.2 trillion, often account for half the daily volume in the New York and London stock exchanges.

Among the victims, said the report, are Burger King, Intelsat Ltd., HCA Inc., Warner Music Group, Simmons Bedding Co. and Remington Arms Co.

Here’s the way it works: The buyers, often a consortium of private-equity firms and investment banking firms, pay millions, sometimes billions of dollars for a troubled company. They almost immediately recoup most of the purchase price in dividends and various fees charged to the purchased company, leaving it saddled with debt.

The Journal reported that when three private investment firms acquired the troubled Burger King Corp. in late 2002 the company paid its new owners -Texas Pacific Group, the private-equity arm of Goldman Sachs Group Inc. and Bain Capital – a total of $448 million in dividends and “professional fees” amounting to close to their original investment. The payments were all financed by new debt.

Intelsat, which operates communications satellites, was bought in 2004 by four private-equity firms with $515 million of their own money. But The Journal showed that the buyout firms took out $576 million in dividends and fees. Intelsat’s debt loan led to cuts in its credit rating, employee layoffs and cuts in retirees’ medical benefits, although the new management insists that the fees were justified and the new owners’ advice helped the company.

It is no wonder that pension funds, endowments and private investors are scrambling to get in the high returns and perceived low-risk hedge funds.

Yet, far from moving toward greater regulation, a little-noticed provision in a pending pension bill would permit hedge funds to accept pension-fund investments beyond the current limit of 25 percent of their assets. Another stimulus to further growth of the hedge funds is their lowered minimum investments, so that individuals can get in on the action for as little as $10,000 instead of the huge minimums that used to keep out all but the extremely rich, who presumably can afford the risk that goes with high returns.

Government regulation and scrutiny are essential to protect the integrity of existing firms and control this headlong expansion of private-equity manipulation.