Macey Versus Lenzner
A professor at Yale Law School, Jonathan Macey, has a piece in the Wall Street Journal defending private equity and pushing back against Robert Lenzner's article in Forbes that was mentioned here the other day.
Though I share Professor Macey's enthusiasm for capitalism and economic freedom, and I've admired his past writing about insider trading, I think Professor Macey takes his defense of private equity a bit farther than the facts warrant.
Professor Macey writes:
But a July 2006 Wall Street Journal article (free link here courtesy of the Pittsburgh Post-Gazette) by Greg Ip (since decamped to the Economist) and Henny Sender (since decamped to the Financial Times) told a different story.
The article begins:
Wrote Mr. Ip and Ms. Sender: "In many of their deals, the private-equity firms have turned the buyout game on its head. In the late 1980s, it was a high-risk, high-reward business that sometimes took years to pay off. Nowadays, buyouts can often generate income for the firms almost immediately, long before a significant turnaround in the company has occurred. And since acquired companies frequently borrow money to pay off the new owners, many are left saddled with debt."
The 2006 Journal story by Mr. Ip and Ms. Sender went on: "A slew of companies -- Burger King, Warner Music Group, mattress maker Simmons Bedding Co. and Remington Arms Co. -- have paid their private-equity owners large dividends mostly financed with debt. In late June, the parent of Hertz Corp. borrowed to pay a $1 billion dividend to Clayton, Dubilier & Rice Inc., Carlyle Group and Merrill Lynch, which acquired the company last December. They reaped that bonanza even though the rental-car company swung to a loss in the first quarter, primarily due to higher interest payments on debt incurred to complete the deal."
As for Professor Macey's Hertz "success story," it may have been a success for the private equity investors who exited and for the investment bankers who earned fees underwriting the public offering, but it's not clear that it's been such a success so far for those shareholders. The Hertz IPO was actually in 2006, not in 2010 as Professor Macey's article claims; it priced at $15 a share, and HTZ, which doesn't pay a dividend, is now at around $13 a share. Some success story. The Washington Post had coverage back in 2006 pointing out that "Hertz's three owners have paid themselves a $1 billion dividend and plan to use more than $400 million of the $1.6 billion in anticipated IPO proceeds to pay themselves another one. And, after the stock sale, the three investors will still control nearly three-quarters of Hertz, which would be valued at about $18 billion, including about $12 billion of debt."
The Economist had a piece (unsigned, but probably by Mr. Ip) in November detailing other ways that private equity investors, far from being last in line or waiting until a turnaround is a success before getting paid, charge fees to the companies they own:
I'm not saying that the private equity guys in any of these deals did anything wrong. If they own the companies, they can do what they want to them, including charge them fees, or borrow money for the purpose of paying themselves fees. The lenders and the IPO or other buyers next down the line are all grownups. But taking a hard or careful look at these practices isn't necessarily an attack on capitalism, either. Just because it's illegal for an insolvent company to pay a dividend (or a "fee," which may be subject to different law, which may have something to do with why it's called a fee rather than a dividend) doesn't mean it's never done, and in some cases it's not so clear-cut whether the company is or isn't solvent, or the situation may change over time.
Mr. Macey writes, "Unlike some other investors who trade in debt and derivatives, private-equity firms make money by investing in businesses that make things and provide services. This industry should be applauded, not attacked." Aren't investors in corporate debt also investing in businesses that might make things or provide services?
Some of the recent attacks on Mitt Romney and Bain Capital have surely been driven by politics, by envy, or by a hostility toward or confusion about markets or capitalism or business. But Greg Ip and Henny Sender (and even Bob Lenzner, though his piece used some considerably more inflammatory and broad-brush language) are not Michael Moore, and if Mitt Romney is going to run for president based on his record of success in the private sector, my own view is that the issues raised by the 2006 story by Mr. Ip and Ms. Sender, and by the November 2011 Economist piece, are within bounds.
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