By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street
Bankruptcy becomes an increasingly common “exit.” And the pension obligations?
On Sunday, storied gun maker Remington Outdoor Co. filed for Chapter 11 bankruptcy, buckling under its debts. Its intention to file for bankruptcy has been known at least since February, but sources told The Wall Street Journal that the filing was delayed after the school shooting in Parkland Florida on February 14 that re-awakened the national debate on gun regulations.
As part of the deal negotiated beforehand, shareholders will hand over the company to secured creditors, which include Franklin Resources and JPMorgan Chase’s asset-management division. In turn, these creditors will forgive part of the company’s debt. When it’s possible to do so, the new owners will unload the reorganized company.
Among the largest unsecured creditors listed in the petition are the Pension Benefit Guaranty Corp., which is the US government’s insurer for failed private-sector pension plans, and the Marlin Firearms Company Employees Pension Plan. Remington had acquired Marlin Firearms in 2008. So the idea is that the restructured company will walk away from its pension obligations.
Who Are the Shareholders that are Surrendering Control?
Fund investors of PE firm Cerberus Capital Management. Cerberus acquired Bushmaster Firearms International in a leveraged buyout in 2006. In 2007, it acquired Remington, and later put them under a holding company, Freedom Group Inc., that also acquired other firearms makers, such as Marlin in 2008. Cerberus was doing a classic “rollup” in the firearms industry.
Those were the heady days of the fabulous leveraged buyout boom with its “Merger Mondays,” as CNBC used to call it – as many of the mergers were announced early Monday, similarly to bankruptcy filings.
In a leveraged buyout, the acquired company is made to borrow the money for its own acquisition and pay those funds to the acquirer, which uses those funds to pay off the bridge loan originally taken out to fund the initial deal. In other words, the acquirer has little or no equity in the deal, and the acquired company has been loaded up with debt. Hence “leveraged buyout.”
The plan was to sell this structure at a big profit to the unsuspecting public via an IPO. But months after the Marlin acquisition closed, the Financial Crisis blew into the open. Then came December 2012, when a gunman used a Bushmaster rifle to kill 20 kids at Sandy Hook Elementary School in Newtown, Conn. Nine families of victims brought a wrongful-death lawsuit against Remington, alleging it was liable for selling a weapon unfit for civilian use. The case is before the Connecticut Supreme Court, and with this decision hanging over the company, potential buyers completely disappeared.
Knowing that trouble was brewing, Cerberus separated Remington Outdoor — the name Freedom Group had already been scuttled — from its funds in May 2015 and opened a door for its fund investors to get out. At the time, the Wall Street Journal reported:
Cerberus sent a letter to its investors, which include pension funds and endowments, telling them that it has separated Remington Outdoor Co., the maker of Remington and Bushmaster rifles formerly known as Freedom Group Inc., from its funds and will allow any investor wishing to cash out of the company to do so, according to a person familiar with the letter.
The letter claimed that the company’s value, including debt, was about $880 million.
The deal to allow fund investors to cash out had a typical private-equity structure that has doomed so many companies: Remington used the proceeds from a 2013 debt sale to pay off equity investors. So the money the company had borrowed for operating capital was suddenly gone. And Sunday’s bankruptcy had moved a step closer.
This scenario of pre-Financial Crisis LBOs now going bankrupt is playing out in other stressed industries, such as the brick-and-mortar retail meltdown, including the liquidation of Toys ‘R’ Us, or in the radio broadcasting sector with the $20 billion bankruptcy of iHeartMedia.
Here’s the thing: If a PE firm cannot exit the LBO profitably, either by selling it to a deep-pocket corporation, or by selling it via an IPO, it is stuck with the company.
What causes a company to file for bankruptcy protection isn’t declining sales or thin profits but debt (and sometimes other obligations) that it can no longer handle. A PE firm could invest equity in the company to pay down this debt burden, and it could invest equity to improve the company’s operations. But that’s a not its job. Its job is to load up the company with debt, extract cash, and then “exit” via a profitable sale either to another company with deep pockets or to the public via an IPO.
When those two potential exits are blocked, the company is left to bleed out. And once the last drop of liquidity is gone, the company files for bankruptcy protection. This is the increasingly common third exit for PE firms from their LBOs.
What are zombie retail locations worth? Some of them “little or nothing.” See Toys “R” Us and its commercial mortgage backed securities. Read… What Are Zombie Retail Stores Really Worth: Answers Emerge
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Heads I win, tails you lose capitalism. Really these are a symptom of too much money sloshing around Wall Street looking for a place to land.
Sounds like the discussion I was having with a friend. Happened on Sunday morning.
We were talking about the death of Elaine Herzberg up in Tempe. You know Elaine. She was killed by an Uber autonomous car that didn’t even slow down. And the car-minder didn’t notice Elaine until she had been struck.
Well, my bud was wondering where the need for autonomous cars came from. After all, he hadn’t heard any sort of clamor for them.
I gave him a quick and dirty history of monetary policy during the last decade. Y’know, how interest rates have been held down, and, thus, there’s a lot of money looking for a return. And it’s dumb money.
And then I asked my friend if he’d be dropping millions on ventures like autonomous cars and he said no. Not that he has millions to drop, but he likes his investments to pass the common sense test.
Its always worth pointing out in conversations like this, that there is actually nothing new in self driving car technology – the EU had a major project in the 1980’s, culminating in a Mercedes driving 150km at full speed on autobahns without any outside intervention in 1995. The project was abandoned largely because there was little public or commercial demand for it.
I recall sitting in lectures about it in 1989 – the motivation, so far as I recall, was entirely based on the idea that self driving vehicles would drive closer together and so increase the capacity of major highways, and so save money by postponing the need to build more.
PK, the way you describe it has been depicted quite well in the Tom Cruise film ‘Minority Report.’ Self-driving cars, on top of removing humans from the mindless drudgery that is a daily commute, would be able to move, speed up, and slow down in concert, allowing many more cars to utilize the same space at the same time.
Personally? Anything that gets me out from behind the wheel is a good thing, not because I’m bad at driving, but because I hate it. DUIs would become ancient history. And cars don’t need to be perfect drivers…just better than humans, which isn’t the highest bar to clear. Although I don’t want Uber and those scammers anywhere near the process.
With an aging population, self-driving cars will be a major boon for many elderly and disabled people. With so many people texting and driving, a large percentage of the population is effectively behaving like drunk drivers, even at 8 am, so self-driving cars should be able to cut down on the number of accidents significantly.
The disconcerting thing about the Uber crash is this should appear to its sensors as a blob of flesh and metal that extends up to head height and is moving in the adjacent lane towards this lane. A successful self-driving car will need to be able to observe and react to such things, even if it is something as simple as a cardboard box blowing across the road or a chair in the lane. They will also need to be able to pick up cyclists and horseback riders on the shoulder and edges of the road. So how did the sensor system miss a fairly large mobile mass that was moving predictably to intersect with the car? The cross-sectional area visible in the video is almost the size of a small car.
I will note that over the past year, I have had to identify and dodge a stuffed armchair and a bedframe that had fallen in interstate lanes (I was doing about 70 mph in daylight). Self-driving cars have radar and LIDAR and so should be able to discern these objects as potential hazards in all light conditions before I could. I get that they still have trouble with snow etc., but a clear night should be like daylight for a self-driving car.
As one of those aging folks, I look forward to a self-driving car that lets me get hither and thither. I also watched the video of the crash, and am not at all sure that I would have seen her –black clothing, dark background–until it was too late.
In your case you’d have to prove that it wasn’t your fault after being charged and arrested, unlike the Uber car!
You mean the system doesn’t use IR cameras for night driving?
. .. . .. — ….
“…So how did the sensor system miss a fairly large mobile mass that was moving predictably to intersect with the car?…”
I don’t think the ‘sensor system’ missed anything. The problem is the software; the so called AI system. There’s always gonna be a situation where the AI will fail. These are ‘expert’ systems; only as good as the ‘experts’ who code them. Think of how long it takes us to learn to drive, and even, as you pointed out, we still need to react to new situations. Aircraft Flight Control Systems can take off, fly to a destination, and land automatically. But I’d still want a pilot like Sully to land in the Hudson and save my sorry a–.
Driverless cars of acceptable safety may never happen, but the forces of monetization will somehow come up with ‘acceptable’ standards.
Like the maximum number of worm segments per 100ml in ketchup.
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I wish people would stop saying human drivers are a low bar. The average death rate is something like 1 death per 100 million passenger miles. That is insanely low – it will be a long whole before a computer can drive this well.
Good point. You inspired me look up the fatality stats:
“There were 34,439 fatal motor vehicle crashes in the United States in 2016 in which 37,461 deaths occurred. This resulted in 11.6 deaths per 100,000 people and 1.16 deaths per 100 million miles traveled. The fatality rate per 100,000 people ranged from 4.0 in the District of Columbia to 23.1 in Mississippi. The death rate per 100 million miles traveled ranged from 0.66 in Massachusetts, Minnesota, and Rhode Island to 1.88 in South Carolina”
http://www.iihs.org/iihs/topics/t/general-statistics/fatalityfacts/state-by-state-overview
I wish people would stop saying human drivers are a low bar. driving the 401 across Toronto on occasion I am always amazed there are not more accidents than there are. vehicles weaving in and out of lanes to gain 1 spot ahead in the fast lane. The driving must be pretty good, its the decision to do what they do that is stupid. I enjoy driving, always had stick shift and live in rural area with winding roads.
Say, does Dan Quayle still occupy a high-level position with Cerberus?
I remember reading an article where the twit referred to hedge fund dudes as brilliant rocket scientists and Dan Quayle at Cerberus immediately came to mind!
/sarc
Not really, since it is more so a further extension of money creation and that specific “entitlement” of the super-rich!
What isn’t in this article and chronically overlooked or purposively ignored is that PE/leveraged buyouts across the healthcare sector is a major cost driver for sky-rocketing prices over the past 16 years to 22 years.
Concurrently with that, and deeply connected with it, is the secondary external cost driver of speculation across the healthcare sector by hedge funds.
If you look at all the leveraged buyouts of hospitals, medical services firms, medical personnel firms, diagnostic equipment manufacturers, clinics, etc., etc., etc., you would be truly appalled but well informed!
The other down side to the leveraged buyout method, which isn’t in Mr Richters remit, but is still important is the downward spiral of labours returns involved. Absent any meaningful union countervailing power, the first entity ‘squeezed’, and the hardest hit is the workforce involved in the actual running of the businesses involved. This ‘squeezing of the labour, no less than ‘institutional’ investors, has a pernicious knock on effect. Laid off or down scaled workers have less to spend, so the local economy contracts, causing a cascade of degradations. I see this all around today. We seem to have a lot of ‘creative destruction’ today with no compensating creation.
The turn to the worse seems to have occurred when the government was perverted from serving the citizens and turned towards serving the elites. Something about a quote concerning a Tree of Liberty is nibbling at the back of my mind.
Absent any meaningful union countervailing power
Even with a competent union, there is no countervailing power in an LBO situation. Because you are not just negotiating with distant PE, who is more than willing to shut down your operation if you persist with intransigence; you are also negotiating, albeit indirectly, with distant banks, that will tell you to your face (been there) that they will pull financing if union doesn’t acquiesce to mgt. Yes, the membership can choose to roll the dice. But in virtually all of these situations with which I am familiar, the workforce is older and without good alternatives should they be put out of work, and so are very reluctant to do so.
Ah. I underestimated the power of a single union ‘shop.’
So, the next step is a coordinated strike against the ‘background’ players. (Not realistic right now, I admit.)
Seems we are near a fertile period for a “General Strike.” (An admittedly utopian hope.)
To the next step; how to effectively change the system itself. (Yet more animadversial musings.)
A reasonable government would do three things
1. Make this operation illegal
2. Nationalize any large profitable business headed to bankruptcy, distribute shares to workers, turn it into a co-op
3. Put every person involved in looting the company in prison or the guillotine
Federal Bankruptcy laws need to be changed to allow for (mis)management fees to be clawed back from Private Equity firms.
And moving unfunded pension liabilities up the claims ladder too.
“In a leveraged buyout, the acquired company is made to borrow the money for its own acquisition and pay those funds to the acquirer, which uses those funds to pay off the bridge loan originally taken out to fund the initial deal. In other words, the acquirer has little or no equity in the deal, and the acquired company has been loaded up with debt. Hence “leveraged buyout.””
I really don’t know what to make of this section. Illegal? Immoral? Reckless? Parasitic? Carnivorous capitalism? To have this allowed in any legal system seems, to my mind, totally FUBAR! As far as I can see, it seems that it is destroying perfectly good companies and putting thousands of people out of work so that a select few can grab themselves a bonus. Bah!
As Bill Munny said, “Fair has got nothin’ to do with it…….”
Its legalized theft. The government could stop it in a nanosecond. But it won’t, because elected officials interests are aligned with the vampires.
Where is the immorality of this?
Cerberus made a bad bet and the casino took their money. If the Cerberus money came from a public entity then the agents of that entity should be held accountable, but everyone else should know the risks.
Also, what responsibility does the company have to it’s workers? Do they owe the workers a job for life?
Not obvious that Cerberus made a bad bet (though obviously not a great one). My guess is that they extracted enough in fees over time to still be net positive on the deal. Also, don’t forget the tax loss carry forwards. One beauty of LBO’s is that they can be cash-flow positive but still after-tax money losers, so PE can both extract cash and benefit tax-wise. If they are cash-flow negative, then the carry forwards will be ginormous.
Should have said “pre-tax,” not “after-tax.”
Excellent commentary, and add to your comments that these PE/LBO firms are usually the ones making the bond offerings for the banks and investment firms.
Cerebus made a bad bet (deliberately make a risky bet) with other peoples money, including the employees pension funds.
If the companies were not so indebted then their financial position would not be so parlous.
If the US had France’s pension system this would not happen. The Pension fund would be funded, and held by a third party.
The “work now” and “you’ll get your reward later” is the same scam as practiced by the Church in the Middle Ages, with the exception of the money in the pension fund.
Such an uplifting view on society, Mrs. Thatcher. I have no particular love for Remington as a company, but there is value in a group of people working together on common goals. Private equity and leveraged buyouts exploit that value but add nothing to society in return.
Really? The people with real skin in the game get hosed by gamblers adding literally nothing in value to the production chain?
I think you’re mistaking legalism for moralism. Formal correctness is the last refuge of the scoundrel per the tao te ching.
But some of the money may be, in effect, coming from a public entity, see “Among the largest unsecured creditors listed in the petition are the Pension Benefit Guaranty Corp., which is the US government’s insurer for failed private-sector pension plans”
The PBGC’s accumulated results are covered by this (https://en.wikipedia.org/wiki/Pension_Benefit_Guaranty_Corporation)
“In fiscal year 2015,…. The agency’s deficit increased to $76 billion. It has a total of $164 billion in obligations and $88 billion in assets.”
To the extent that the funding level of the pension funds were decreased by the LBO, Cerebus took money from the PBGC.
The PBGC is another government insurance agency (see also flood insurance) that the politicians,of all stripes, have decided need not at least break-even.
It is outlawed, to some degree, in Japan, Germany, Denmark, etc.
There it occurs within the domain of organized crime!
(I believe the proper word is “amorality” . . .)
Does someone know of a list of LBO firms and their assorted offspring? I would use that list as one way to try to avoid such companies whenever possible. My personal avoidance list also includes Google and Facebook, so I use DuckDuckGo and have no use for social media. Count me in that old folks set that doesn’t need routine high school reminiscences. ;)
It’s really, really difficult and complicated to find it:
https://en.wikipedia.org/wiki/List_of_private_equity_firms
US Representative Claudia Tenney has been assured by Remington that there will be no job losses in her district: http://www.syracuse.com/news/index.ssf/2018/03/no_jobs_losses_in_ilion_from_remington_arms_bankruptcy_filing_tenney.html
Her district is one of the NYS Trump-country areas. Job losses are a major issue in this largely rural district with old rust-belt towns and industries. This is part of the split personality of the Republicans these days – they want to prevent job losses in these districts but want to be friendly to business, including PE, with minimal regulation.
Standard operating procedure. Just wait a year. Or six months. There will be job losses.
Or the factory itself will be sold off to, say, Norinco, and the remaining workers put on Chinese work and compensation systems.
Is the current administration, and it’s policy stances, part of the reason why some of these big lemons are dropping now? I mean aside from the obvious fact that executive branch policy has some influence on interest rates. An inability to turn over debt now that interest rates are increasing would seem to the biggest trigger, but….. most here know more than I do about the fundamentals behind these decisions.
Why now for really big bankruptcies?
Here’s the thing: If a PE firm cannot exit the LBO profitably, either by selling it to a deep-pocket corporation, or by selling it via an IPO, it is stuck with the company.
This line is very misleading. Many, many LBOs are already money-makers for PE well before the sell-on date. Does anyone know how much Cerberus put up out of pocket to gain control of Remington. My guess is almost nothing, which they would already have gotten out and more, possibly a lot more, via fees.
Someone had to lend the money for the LBO. They are about to lose it. One might hope that interest in investing in LBOs will deteriorate.
Keep dreaming, bubba! The lenders are typically the top banks and hedge funds.
who’s left holding the bag?
The same pension funds that bankroll the PE firms?
Yes, among others.
And if you wish to truly understand the how and the why of pension funds being involved in this, I would suggest you take a look at Ellen Schultz’s outstanding book, Retirement Heist.
I have two questions
1.) In a leveraged buyout, the acquired company is made to borrow the money for its own acquisition and pay those funds to the acquirer, which uses those funds to pay off the bridge loan originally taken out to fund the initial deal.
Hmmm, how is a company ‘made to borrow the money’? How does a PE firm ‘make’ the company buy itself? Doesn’t the seller have anything to say? And if so, why do they do it?
2.) If corporations are people, isn’t killing a corporation murder?
The pe firm buys the company from the owners with a loan against the company – not against the pe firm. The owners do it for the money. So do the banks and the firm.
It’s a set of interlinked deals that go together. Since there is no stakeholder rep for the workers, community, customers it’s a negative utility deal.
In the Japanese underworld this sort of thing is undertaken by the Yakuza, whereas in America and other countries it is the PE/LBO firms doing it.
Let’s not assume that the PE firm always exits if the company goes public via IPO. In many cases, the PE firm partners will sit on the board of directors of the new publicly traded company that they created so that they can still have a controlling interest and extract more cash from them. Since the board of directors pick the officers to run the company it is common that these PE Firm get awarded a disproportionate amount of stock options to further enrich themselves.
If you believe that the intent of an IPO is to raise cash for a new company that wants to go public. then you would be wrong. In addition to the exorbitant fees that the PE firm will charge their portfolio company for taking the public, the PE firm will also award itself with the proceeds from the IPO.
The icing on the cake is when they can take the company private again and keep the gravy train running. Take a look at the following link about how PetCo went from publicly traded to private, then back to publicly traded, to private again. The gift keeps on giving:
https://www.pecloserlook.org/wp-content/uploads/PetCoReport.pdf