It’s an era of Private Equity players. I see Blackstone and other private equity players buying out companies everyday, in every corner of the world. Target companies spread across many countries and industry sectors including FMCG, wireless, outsourcing and entertainment. So, who are the beneficiaries and the losers of these deals? An article in NY Times gives us great insights and real examples from the industry. Let me capture the gist here.
“PRIVATE equity firms have been spending billions of dollars to buy up public companies, and there have been clear beneficiaries. Foremost among them are the shareholders of companies acquired at rich prices, and the private equity firms themselves — which often treat themselves to special dividends from the acquired firms and then flip them back to the public at a tidy profit.
But there is another, less obvious class of beneficiaries from the private equity splurge — rival companies that go head to head in the marketplace with businesses that are laden with debt as a result of leveraged buyouts.”
How will the rivals benefit? The article explains that “That, at least, is the conclusion of several academics and some Wall Street analysts, who have found that onerous interest payments tend to have some unpleasant consequences for the acquired companies, including cutbacks in staffing, capital spending, research and other important areas. These cuts give rivals with better net cash flow a significant competitive advantage — a factor worthy of consideration by stock and bond investors. The financial pressures arising from leveraged buyouts could cause problems in a variety of businesses, from supermarkets to technology companies and casinos.”
This is surprising but true. The article gives good examples of various companies and industries. A good example is that of Freescale Semiconductor.
“Another factor is that debt levels have been rising in recent deals in a variety of industries, said Nicholas D. Riccio, principal credit analyst at S.& P. As a result, he said, companies in recent buyouts can be more vulnerable to sudden and unexpected revenue shortfalls.
This is what happened at Freescale Semiconductor just months after a consortium of private equity buyers led by the Blackstone Group acquired it for $17.6 billion last year. Motorola’s cellphone unit has been Freescale’s biggest customer, but in April Freescale reported that surprisingly “weak demand” had resulted in a decline in sales to Motorola. Freescale has since announced layoffs and spending cuts, reducing capital expenditures to 7 percent of sales from 9 percent.
This could be a boon to Freescale’s rivals in the wireless chip business, said Doug Freedman, a senior analyst at American Technology Research. “I wouldn’t be surprised if, as a result, guys like Infineon, Texas Instruments and Qualcomm benefit, “Mr. Freedman said. Freescale may curb investment in its wireless chip business or even sell it, he added, in either case presenting opportunities to rivals.”
The article concludes that “Companies with less leverage have a greater ability to take on new debt, and risks, of their own choosing.” This is an interesting insight as to how companies lose competitive advantage and power to think and act big because of LBOs (leverage buyouts). The moral of the story is that PE buyouts may not always be the best option for companies to catapult to the next level. Too much debt is too bad for any company’s health.