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Comment by guyzero | Hacker News Reader

So in case you're wondering how a bunch of radio stations got $20B in debt (yes, that's twenty billion US dollars) - the answer as always is a leveraged buyout.

From https://www.forbes.com/2008/05/14/clear-channel-buyout-marke...:

"Thomas H. Lee Partners and Bain Capital, agreed to a lower sale price of $17.9 billion or $36.00 per share of the radio company"

Wait, maybe the name "Bain Capital" rings a bell? That's because their leveraged buyout of Toys R Us saddled the company with so much debt they went completely out of business.

https://nypost.com/2017/09/21/bain-capital-has-now-plunged-t...

Also see https://dealbook.nytimes.com/2012/02/29/sorting-through-the-...

There's really no reason for iHeartMedia to have all this debt other than Bain Capital did their thing.

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According to this article, one reason LBOs are attractive derives from the US tax code:

A leveraged buyout (LBO) is a financial transaction in which a company is purchased with a combination of equity and debt, such that the company's cash flow is the collateral used to secure and repay the borrowed money. The use of debt, which has a lower cost of capital than equity, serves to reduce the overall cost of financing the acquisition. The cost of debt is lower because interest payments reduce corporate income tax liability, whereas dividend payments do not. This reduced cost of financing allows greater gains to accrue to the equity, and, as a result, the debt serves as a lever to increase the returns to the equity.

https://en.wikipedia.org/wiki/Leveraged_buyout

There have been significant changes to the tax advantages corporate debt had with the recent tax changes. Not all of these types of deals make sense in the future.

I can understand Bain's motivation - but why would a creditor choose to grant credit when the risk of bankruptcy is so high?

I mean, even if the creditors were promised an unbelievable interest rate of 20%, they still lose out if the company goes bust in the next 5 years.

When you require larger returns, you're willing to accept higher levels of risk (think of all of the pension funds with obligations where they calibrated their returns at 8% but are falling far short of that [1]). The debt for these sorts of transactions is referred to as "junk bonds" or high yield debt [2].

Sidenote: It's very important to understand risk when comparing returns, as returns must be risk adjusted to be properly compared. For example, 5% returns on bonds and 5% returns on equities are not the same based on the underlying risk of the asset class.

[1] https://www.bloomberg.com/news/articles/2017-08-02/5-is-the-...

[2] https://en.wikipedia.org/wiki/High-yield_debt

it's still hard to understand the motivation, because these husks of companies with large debts (like toys r us) keep ending up defaulting on their loans. so at the least, the people that make those big loans lost. I pay moderate attention to my 401k, but I notice (at least when I look :-)) when I have a giant loss. How can these bond or loan companies afford to lose so much and stay in business?

> How can these bond or loan companies afford to lose so much and stay in business?

Scale. The same way VCs only count on one or two wins to pay for the rest of the losses.

Not all of the stakeholders lose. The suppliers, employees and vendors of the company lose.

But the entities that write these loans make their money in different ways and may not actually lose as much as you think, or at all!

I'm not sure about this particular situation, but I was helping a finance friend with some risk modeling a few years back and realized that a significant portion of these high-risk loans are basically a game of hot potato.

Everyone knows the loan will not be repaid in full, so people hold the loan for a short window in order to collect that juicy interest payments, then sell it to the next sucker whose spread sheets convince them that they aren't going to be the one left holding the bag.

I guess they just like crashing companies while making a ton of money.

If you look at their list of previous acquisitions ( https://www.baincapitalprivateequity.com/portfolio ) there aren't a lot of survivors in 2018.

How do the PR guys blame Amazon for this?

The ToysRUs thing was such an obvious con. My son really digs certain Lego things and I stop by the store frequently. It was pretty obvious that it was being run into the ground... they would load up on inventory based on generous trade terms. The inventory in my local ToysRUs in November was aging and popular items like Lego and hot wheels were out of stock or merchandised to hide holes in the shelves.

Hopefully someone will buy at least the name out of bankruptcy and rejuvenate the company. There is definitely value to be had, we haven’t seen the last of ToysRUs.

I’m a bit confused...are you implying Bain Capital wanted these companies to go out of business? And if so, why? What’s the point of investing into something that you want to force go under?

No, Bain Capital wanted their fees and after the buyout servicing the deb wasn't their problem. I'm not the best person to explain LBOs really.

[removed] Please see exelius's sibling comment, as it's a better and more in depth explanation.

Why do all these CEO's (who I'm told are the smartest) and creditors keep on falling for this? I'm guessing they are getting paid off as well?

They would have to be, right? Otherwise I just don't see the point.

The creditors make sense - they're getting high rates of return to compensate for that risk. LBOs are net positive for creditors, even though a lot of them blow up.

But I can't explain what CEOs and shareholders are up to; surely they know when an LBO is over-leveraged and likely to bankrupt them. Can anyone explain why these offers keep getting accepted?

> why these offers keep getting accepted?

You only hear about the failures, not the successes. So the likely explanation is somewhere between, "because it works" and "because they don't have much choice."

I guess my confusion is what the successes even look like. Are these all companies that would fold if they didn't take the buyouts? Because otherwise I can't work out what the potential upside is.

Sometimes, though distressed investments are not their primary focus.

Also, they often buy and hold. So it's not like they go about gutting every company they acquire.

Here’s how an LBO generally works:

1. PE company secures a loan in the company’s name (usually contingent on a turnaround plan executed by the PE with a history of turning companies around)

2. Company turns around and loans the money for purchase to PE firm

3. PE firm buys the company

4. PE firm runs the company, normally collecting management fees (paid out of the pool of cash used to buy the company)

5. PE firm cashes out by IPOing the company (usually at the same or higher price paid during LBO process).

6. PE firm uses the proceeds from the IPO (which the PE keeps because they are the sole shareholders; NOT the company itself) to pay back the loan.

The PE usually breaks even on the transaction itself once transaction fees are taken into account; but they make a killing on the management fees (which can be hundreds of millions a year). Normally, the company is left in roughly the same situation as before the buyout, just with a lot more debt on the balance sheet.

So the part I've never understood is why companies accept these offer. Are we talking about hostile takeovers? Or just already-failing companies that accept the turnaround plan because they're short on options?

It looks like investors and the PE firm have obvious ways to profit here, but I can't work out what the company gets out of this.

That's really my question too. I can guess that if you are say the ceo with a golden parachute agreement if your company is bought out, then you want to 'sell' into this, cause you win, and you leave. But it's terrible for shareholders (eventual ones at least) and for employees, and I don't know if I've ever used this phrase, but it's terrible for the world, for my country.

And, who are the, apparent, idiots who invest in these companies during the IPO?

Institutional investors who need to place large sums of money without causing market shocks. Usually the company is much healthier on paper after the LBO; and to be fair some companies actually do turn it around and they end up being bargains. But a good number get caught in what I call the “PE Death Spiral” where they go through multiple rounds of LBOs and IPOs at a valuation growing right around inflation.

Yet every time they IPO their debt rating gets worse because they’re carrying more legacy debt, until finally it’s so laden no bank will fund another buyout, so there’s a fire sale on remaining assets and the company closes.

The company decision makers could be making a bad decision. They're likely in dire straits to be in this position in the first place. Add in shareholders, some slick marketing/badmouthing from Bain reps, and you have a good opportunity for people to act irrationally, in their personal dis-interest.

Also, you can imagine that Bain has a few inside managers who do very well personally from this kind of deal.

Usually this happens because the company has gotten into cash flow trouble. When that happens, the company’s creditors lose faith in its ability to invest capitol in productive ways. But an LBO is usually the option of last resort. If you don’t have cash to make payroll next month and you have 2500 employees, you take the LBO.

An LBO allows the company to raise cash to fund a turnaround; but the incentives of PEs are set up such that the PEs don’t need to actually turn it around to make money — aggressively cutting costs is often enough. The creditors don’t care because they get paid back on IPO and get to collect interest in the meantime.

The alternative is usually going to be a buyout by a competitor, chapter 7 reorganization or simply ceasing operations like Toys-R-Us is doing once their debt rating is so far past junk they can never qualify for an LBO. Then the company dies. This is the “service” PEs provide to the economy — they help wind down failing businesses in a somewhat orderly way while extracting maximum value into the economy from a company that is headed for the scrap heap. You can argue as to whether or not that’s valuable.

Thanks, this makes sense.

I could never understand why a company takes an LBO instead of just taking out a massive loan against their assets directly, but this explains it. A combination of "the existing team isn't trusted to use that money" and "the creditors can collect without a full recovery" explain it nicely; PEs might theoretically be more objective at deciding when to restructure and when to strip assets.

I've invested in private equity funds across the entire spectrum. I mainly focused on the small to medium end of the market...

The bankruptcies of the large LBO deals skew the public's perception of the industry. Sure it has faults but the reality is much more nuanced than some of the views outlined above.

Yes there are large private equity firms that will acquire companies and overload them with debt, cut costs and sell prize assets. Yes there are many other firms who operate very differently. In the smaller end of the market, debt loads are much more conservative and returns are generated through moving into new geographies (i.e. opening a new store in MA), moving into adjacent markets (i.e. we sell tables. Let's move into the chair market), let's hire more sales people, acquire complimentary products to cross-sell etc. The list goes on. There are many positive qualities to private equity but the industry is tarred because of the large amounts of money. People on the whole don't like large amounts of wealth.

So why does a company sell to an LBO? Could be any number of reasons. The founder might want to retire. Maybe the kids inherited the business and no longer want to run it. Maybe the business is in dire straits and the current owner lacks the skill or the patience to turn it around. Maybe a company wants to sell a non-core division. Maybe a parent company is financial trouble and will sell assets. Maybe the price is right.

What Bain Capital wants is to be able to make the short-term operating metrics look good enough to IPO the company and sell it at an inflated price to some buy side dumbasses who are left holding the bag when it goes bankrupt (mutual funds, pension funds, etc).

Why doesn't this poison the image of organisations that have been through Bain Capital then? Who would buy shares associated with this behaviour?

Dumbasses

That's what I wonder too. I would run the other way if I saw that Bain was involved. Since it appears that people are not doing that... I have to assume that, like most things in life, there is a lot here that I don't understand so my gut reaction is flawed.

Bain actually has a long history of successfully turning companies around via LBOs. So it's not that they are acting maliciously, but they are minimizing their risk and exposure in the event of a failure. And they way they do so is to push the exposure onto the downstream investors.

Saying they turn companies around is being generous. They typically don’t buy companies that are in the dumps, they buy companies that are humming along and might have room for improvement, cut expenses by firing employees, raise debt, and try to put the company in a good enough position to meet debt obligations. I wouldn’t credit them with turning too many companies around. If anything they are “turned around” from the debt laden messes that Bain creates into something the company looked somewhat similar to before the buyout.

They actually did turn around Toys R Us after acquiring it. In 2005, they were digging out from yet another failed attempt to reinvigorate their brand (which peaked in the 90s). They made strides in the late 00s with a big push into online, but growth stalled as competition from other retailers grew.

So if these companies are "humming along" why are they selling to Bain? If they're doing so great, why doesn't someone outbid Bain?

They sell to Bain because it’s easy, makes the shareholders happy, and the board and executives get rich from it. And to your second question, an interesting read from the FT https://www.google.com/amp/s/amp.ft.com/content/e1732e1c-fa7...

Why aren't these downstream investors pricing accordingly then? Less sophisticated than Bain? Or are Bain's successes enough to mollify any fears about their failures?

They also have a long history of running companies into the ground via LBOs.

Just look at Guitar Center. Unfortunately when they explode, they're going to take companies like Gibson and probably also Korg with them. Gibson is already in the process of unraveling right now. Their impending bankruptcy was obvious when they didn't have a booth at NAMM this year.

It's absolutely predatory behavior what they did.

Bain Capital's goal isn't to put the companies out of business, they are trying to extract as much money from and then sell off the businesses.

They don't care about long term. You could argue that they're setting up the companies for failure but that's not their intent. They do however have complete disregard for anything but making a profit.

One thing they like to do is sell off holdings and pocket the money. This hurts the company long term as it can't use those assets as collateral. An example of this is selling off store front property and then renting it back from the new owner.

Is the goal or intent not important anymore if the outcome is always disastrous for the company?

The goal is as much profit in the short term as possible. The intent is to extract profits. The impact, damage, consequences, whatever are not factored into the equation.

They aren't trying to bankrupt companies, they are aware that what they're doing is harmful, and they don't care if their short term actions do bankrupt the companies in the long run.

It's like a kid throwing rocks at cars. They aren't trying to cause an accident or injury anyone but their actions can only lead to bad things.

That problem is not necessarily what Bain does, it's that they don't care about how it impacts others. That's pretty much the problem with society today. They're like vampires extracting the wealth from these companies and leaving them by the side of the road. At the end of the day the profit at the expense of everyone else.

Bain didn't invest. The played a financial game and made a bunch of money out of it. Who cares what happens to these companies from Bain's point of view afterward. They extracted money out of company doing actual business and employing a lot of people for their rich owners. The rich got richer and not-rich people will lose their jobs. This is how our corrupted "finance industry" works.

I think it's good to think about their original intentions versus what happened, because for the PE firms the best case is to make a stronger company that can publicly IPO for billions of dollars. If they can't make that happen they run it into the ground and try to get out with what they can.

Then Bain Capital must be lying to themselves if they think they can help the company. I think they skip the middle step of trying to help the company and just sell off assets.

Could you please ELI5 "leveraged buyout" and what is happening here? I'm not very financially savvy but I'd like to understand what kind of dynamic is it that was able to bankrupt two companies worth so much. Thanks.

Not ELI5 but worth the read: http://observer.com/2017/04/iheart-radio-leveraged-buyout-do...

This is a poorly-written article with typos (e.g. '$10 million of new worth') confusing explanations.

For example, it says "In order to then balance the financial statement, there must be a debit of $20 million to equalize the new credit of $20 million ($30 million of loan less the $10 million of new worth that has been eliminated). To do this, a “plug” asset usually under the heading of goodwill (here for $20 million) is added to the asset side of the financial statement."

Most people reading this would conclude that 'goodwill' is some accounting thing that is required due to the use of debt, or because the company doesn't received the money from the lender.

But goodwill has nothing to do with debt. Whenever one company purchases another, paying more than the book value (accounting value) of the target (which is almost always the case), goodwill arises on the acquiring company's balance sheet.

Nice pointing out typos of the authors of this piece while being unable to grasp even simple concepts of the English grammar yourself ('doesn't received').

That said, the goodwill thing is clarified in the next sentence. Also, the text doesn't make the connection between goodwill and debt. In fact it is nice that you try to explain what 'most people' will think after reading this while in fact the only thing your post proofs is you poor understanding of intermediate level texts in english language.

I don't know why you try to discredit the text here.

I don't sweat typos in my HN comments. They're not newspaper articles.

I can assure you I'm able to grasp simple concepts of English grammar, but thanks for the feedback anyway!

The connection between goodwill and debt isn't clarified in the next sentence. I stand by my point that a reader unfamiliar with goodwill would, after reading the article, understand it to be the result of debt.

My comment about the article was motivated by the fact that I found it poorly written by the standards of newspaper journalism. No other reason.

No one pays for companies based on a multiple of their "net worth". No one is going to pay 3x of that "net worth" value and if they did, they probably wouldn't have to pay 10% interest in debt. Starting with such assumptions makes it very hard to place any faith in the rest of the example.

Of course they do. Just look at the stock market and the valuations in relation to Book Value.

Bain looked at the target company and thought "I can reconfigure this company so that it would be worth a lot more than the stock market currently says it is." Bain has successfully done this before, so they convince investors to loan them a bunch of money, and they buy the company with the loan (this is the 'leveraged' part), taking it off the stockmarket. The plan is to reconfigure the company and then put it back on the stockmarket at a higher price.

But, in these cases, when they got down to the hard work of re-configuring the target companies, they found out that they had done their sums wrong and that the interest on the loan was eating up all the money that was supposed to be used to make the target companies better and more valuable. Oops. So then they ran the companies into the ground and filed for bankruptcy so that they don't have to pay back the loan. This makes the investors mad, and Bain might not be able to play the leveraged buyout game any more, but they collected hundreds of millions of dollars in 'management fees' so they don't really care. And, hey, maybe some investors will still give them money because they certainly know what not to do next time.

Good origin story on Bain/Romney by Matt Taibbi in Rolling Stone: https://www.rollingstone.com/politics/news/greed-and-debt-th...

"Wait, maybe the name "Bain Capital" rings a bell?"

does mitt romney ring a bell.... bain is his

I think a trend we will continue to see is growing failures of the private equity market.

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