First of all the way that private equity works is exactly what he says. They take a healthy company, have it take out a huge loan, use that to buy out the current owners, and then hope to make money every way that they can. First, the private equity company gets paid for the deal. Next, they get paid to manage the company. Next, they look for every way to cut expenses to make the company's financials look better (even if only temporarily). And if they succeed, they flip it.
If it implodes, the debt goes away with the company and they don't get to flip it. But the private equity company already made a profit. So "the company survives" is a nice to have and not part of their business model.
The people who lend money for this are the ones at real risk. But if there is enough money looking for places to be lent, some of it will go to risky bonds.
Moving on, his definition of a zombie company is one whose earnings before interest, tax, depreciation and amortization (EBITDA) has not been sufficient to cover interest for the last 3 years. Such a company might actually be viable, but only if it has prospects of future earnings that are massively better than current ones. There are some companies for whom that is true, and no all zombies are actually going to fail long-term. Certainly Tesla and Moderna seem to have decent futures.
But most of them won't hit those dreams. Particularly not the ones that private equity got involved with. And the longer they last, the bigger the crater when they implode. But if you have extra rescue money that has to go somewhere, the zombies will be happy to take it to stave off disaster for a little while longer. And apparently they took a trillion dollars in debt in the last year.
How much of that trillion do you think that they will collectively manage to pay back? I mean, without taking on more debt down the road...
That’s how 1 small part of private equity, LBOs, work.
Private Equity encompasses a lot more than LBOs.
Secondly, if it’s so obvious that this is how LBOs always work, then why do the people giving out the loan agree to do so?
Like if you went to a bank and everyone in the world knows that your intention is to borrow money and then declare bankruptcy to avoid paying the bank back, they will not lend you money.
Why should that be any different for the larger companies? The reality is that entities lend them money because they largely succeed overall.
Next, your claim that LBOs buy healthy companies is almost certainly wrong. But even if that’s what they are doing, they are able to buy it because someone is selling it. IOW, because they are paying a premium on the current value placed on the company by others. So if they’re willing to pay a premium and still manage to flip it for more, isn’t that a sign of success? You took a business and increased its value dramatically. To the point where it pays for your many failures as well.
The problems with LBOs lie around the fact that the way they achieve a lot of their success is by making a lot of hard decisions that need to be made but the original ownership cannot. This might be the right thing to do to make the company more functional but it has a lot of side effects since it leads to significant and rapid job losses, etc. In a country where people are largely in debt, and rely on their company for almost everything including healthcare, this has serious knock on effects not just on the individual but their communities and then the entire country.
The solution isn’t to make companies less effective by making hiring and firing harder. The solution is to find solutions outside of this.
These could include universal income, better unemployment insurance, providing limited pauses on debt payments on losing a job, etc.
But it’s a lot easier to complain about evil PE firms instead so that’s what people do. Besides, talking about systems attracts fewer eyeballs than evil corporate overlords so that’s what we see.
Next, you are correct that LBOs buy lots of distressed companies as well as healthy ones. But if you look at the distressed companies that they buy, a large portion started off as healthy companies before they were first bought. And if they do proceed to bankruptcy, very frequently their only real problem is the crushing debt that the buyout left them stuck with. See, for example, Toys "R" Us.
Moving on, why do people loan money to them? There are a number of reasons. But one of the biggest ones is that banks are lending money created by the Fed to prop up the economy, on the bet that the Fed will create more money later to enable them to close out their position. This is a cycle that has been happening since QE started post-2008. Certainly that is a prime explanation for the eye-watering trillion dollars in loans to zombie companies since COVID started.
And finally, the "hard decisions" that you're talking about very often take the form of finding things that can be cut. Like maintenance. If you stop that, your costs go down, your revenue is untouched for a long time, your financials look healthy. The reason why the original management didn't decide that is because they were looking at what happens 20 years down the road, and recognized that failing to pay these costs would be a net loss. Or that failing to keep a hospital up to date will cost actual lives. But PE has a much shorter planning horizon, and figure that the next owner won't figure it out until after the PE company has their profit locked in.
Now none of this is to say that the other things that you recommend aren't good ideas. However when I go to a local hospital, my odds of dying are increased because it likely has been taken over by PE and they prioritized profits over lives in the cuts that they made to maintenance. I'm not OK with this, and would like to see the people running those PE companies have to face personal liability for the effects of their actions.
* Taibbi story claimed that PE firms were behind the 2008 crisis (obviously not)
* Taibbi claimed that Blackstone Group was "Democrat-leaning" (quite the opposite)
* Taibbi claimed that the major returns from PE LBOs came regardless of whether companies succeeded (which is false, and confuses downside protection in some deals with an actual portfolio strategy that can raise a fund)
* Taibbi claimed that after running with Milkin in the 80s, Bain Capital moved on to do LBOs in the tech sector during the first tech bubble
There were a bunch of other things, like refutable empirical claims (for instance, at the time, the numbers showed that PE deals didn't materially impact payroll, despite Taibbi's claims) but that stuff is boring, the more interesting things to me are the places where he's saying stuff that can't be true, like that PE firms were doing LBOs of unprofitable 2-year-old tech companies.
My take on Taibbi is that he has a gift for saying things that feel true, but a poor track record of reliably saying things that are true. That doesn't mean the opposite of whatever Taibbi is on about is false; it means that you can't tell from his writing whether it is, any more than you could by flipping a coin.
The original article is at https://www.rollingstone.com/politics/politics-news/greed-an.... I don't know whether I read it before, but I just skimmed it now.
The takedown was at http://finance.fortune.cnn.com/2012/09/04/greed-debt-and-mat... but has moved to https://fortune.com/2012/09/04/greed-debt-and-matt-taibbi/. It is behind a paywall and I didn't read it. However I can go off your cheatsheet for a sample.
Taibbi's response to the takedown is at https://www.rollingstone.com/politics/politics-news/bain-and....
Point by point.
1. Taibbi never claimed that PE firms were behind the 2008 crisis. In fact his article doesn't mention the 2008 crisis. And appropriately not since Romney exited Bain in 2000 and that crisis is not the subject of the article.
2. Taibbi's follow-up acknowledges that "Democrat-leaning" was a poor phrasing, and also his description was specifically of the Blackstone Group in the early 1990s. (The original phrasing did make that clear - read it for yourself.) And he has a point that they supported Bill Clinton in 1992, following which their chairmanm Roger Altman, left to be Clinton's Deputy Treasury Secretary.
3. When you talk about returns from PE LBOs you have to be clear about returns for whom. He enumerated multiple cases where the returns for Romney and Bain came regardless of whether the companies succeed. Whether they came for the PE funds that people invest in is a different story. And the examples that he gave are NOT downside protection.
4. Taibbi DID NOT claim that Bain Capital did LBOs in the tech sector. Go read what he wrote and verify that. Any impression to the contrary shows a lack of reading comprehension. What he DID say is that tech bubbles bring easy money, some of that money gets invested in PE companies, and with that "dry powder" they get to go shopping. But they don't go shopping for tech companies. Instead they do things like shop for toy companies and donut shops.
If you're interested in where he talks about PE firms doing LBOs of unprofitable 2-year-old tech companies, I strongly suggest that you pull out quotes of him saying that they do. You may have trouble though. He nowhere says that.
Your comment about a "poor track record of reliably saying things that are true" appears to be more appropriately applied to the criticisms of Taibbi than to Taibbi himself.
Like I said, I was working from notes. I reread his piece carefully. I don't find Taibbi's defense very persuasive; for instance, I think if you read his piece, it's pretty clear that he's suggesting that PE firms put up pennies on the dollar, and that they were in some manner culpable for the first dotcom bubble and for the 2008 crisis. I also think that even when Taibbi is "right", what he's mostly doing is hyperventilating over banal side-issues that aren't the real problem. I read his writing about downside protection for PE deals and wonder what he'd say about liquidation preferences.
But either way: I concede the point that Taibbi's LBO writing is mostly notable because Dan Primack took the time to write a takedown. It's not as bad as his NYC parking meter writing, or his Obama bailout writing, or, god help us, his writing on dark pools and HFT.
On the other hand: being (mostly) directionally right about LBOs is kind of a lay-up? Like, it was the plot of Wall Street.
The large media corporation NYT just reported out that RH had to draw down a $600B line of credit and take a $1B round of equity funding in large part because of capital requirements from clearinghouses. Taibbi's substack, on the other hand, seems to believe that jet planes will never fly again because of COVID.
FTA:
"How much does Sorkin think his exalted Delta Airlines would be worth now, if the Fed hadn’t stopped its death plunge last March? How much would any of the airlines be worth in the Covid age, with their fleets of mothballed jets?"
I believe it is true that the Feds kept Delta and other airlines afloat. Regarding the "Covid age" — could be simply 2020-2021. Or who knows? Bill Gates and others have suggested that 50% or more of business travel will never return.
Of course, that's not what I was talking about. I'm just giggling at the idea that alone among USA journalists, Matt Taibbi has had his mind addled by the Twitter, as discussed upthread. How is that "Russia-gate" investigation going now?
[EDIT:] As I've observed before [0], I still don't get economics advice from Taibbi.
Regurgitating a press release is not "actual reporting". We won't know what actually happened between RH and Citadel for some time, if ever. It's misleading to keep mentioning this in this context, because TFA doesn't address Citadel at all.
ISTR you have described RH as "a force for evil". I didn't disagree with you, but it's disappointing that your famous animus for one of the rare decent journalists in USA has preempted that judgment. Every time Taibbi is linked on HN you're around to slag him. You seem more opposed to Taibbi than you are to DNSSEC. When you read Taibbi you imagine things that are not in the text. What did he ever do to you? Did he cut you off in traffic? Did he steal your dog? What gives?
Those who don't see TARP as v1.0 and CARES as v2.0 of a giant transfer of wealth from those who can't afford lobbyists to those who can, simply aren't paying attention. One shudders to contemplate the calamity scheduled to justify v3.0.
[0] https://reason.org/commentary/new-york-parking-privatization...
The intentional misreading of the latest piece (vis-a-vis Airline comments) seems very odd.
You should create some competition for him with your own writings to demonstrate how mistaken my opinion is on this matter.
Can you define "crank" in the verb form you seem to be using it in here?
A common element seems to be Patreon or Substack.
Could well be 30%, but of course there's no definition for zombie. Functionally dead is a bit harsh as they're doing something to get paid, but they're not doing it efficiently and they're not being challenged, eg thanks to network effects or reg capture.
I'm not really here to debate the definition. It's his link that enumerates the companies I'm pointing out. Which is why I'm making the case that he hasn't really read the stories he's linking to.
We could go further into the analysis: a whole bunch of companies, like Delta, which Taibbi implies will never be worth anything again, are distressed because of the pandemic, which will clear up this year. Demand for the products of these kinds of companies will return and the list of "zombie companies" will change, as it has in the past (per Bloomberg, take Sprint as an example). But this is really dignifying Taibbi's polemic, isn't it?
The estimate from https://www.macroaxis.com/invest/ratio/XOM--Probability-Of-B.... is that it has a 36% probability of bankruptcy in the next 2 years.
In a longer time horizon, Exxon's finances are strongly dependent on petroleum revenue, but petroleum demand could easily fall.
The petroleum industry is projecting that when COVID ends, demand will come back. And they are projecting that as far out as 2050, gas will remain the dominant source of energy for transportation.
However neither seems likely to me. I believe that we will see a permanent shift towards more remote work. That cuts out both a lot of commuting. It also cuts out a lot of motivation for business travel. (Bill Gates estimates a 50% drop in business travel.) Both suggest a permanent drop in demand in the short-term. And in the long-term, the transition to electric vehicles seems likely to go much faster than the gas industry wants to believe. We are already seeing places like Washington State pass laws that all new cars must be electric by 2030. This suggests that the transition to electric will be eating into gas revenues fairly quickly. This is not a small issue - use of oil for personal transportation is somewhere near half of all oil usage in the world.
So you say that "nobody thinks that Exxon is about to go under". But I'm looking at it and I think that they are a company that structurally has financial trouble, in an industry that has market trends against it. No matter how big a household name they are, I would be very happy to take a bet that they go bankrupt in my lifetime.
But look: it's not my claim that Exxon is a good investment. In fact: Exxon's stock seems to have tracked the prevailing grim sentiment about the oil business. Rather, what I'm pointing out is that it doesn't seem reasonable to suggest that Exxon is "functionally dead", a "phony-baloney" company propped up by paymasters in the rigged financial services industry. Exxon is, as a company... kind of important? Like, it does a bunch of stuff?
Another example: Boeing. We're all aware of a big reason for Boeing's predicament. But Boeing didn't get there by being a "zombie" that wasn't doing real business; in fact, we can probably ruefully say Boeing did too much business on the 737 Max product. So there's another reason you can be on the "zombie" list: your company made a huge mistake that will take years to climb out from.
Moderna was also on the list Taibbi linked to. Because it was an R&D company that wasn't meaningfully shipping product. I don't know that we even need to talk about Moderna's financial prospects (I genuinely have no idea what they are) to dispose of the idea that it's a "functionally dead" "phony-baloney" company; it's a key, effective component of a strategy to rescue the world from a global pandemic. So there's yet another way to get bucketed as a zombie: you can be a startup.
My point --- I was too lazy to type it last night and am too lazy to come up with a way to say it succinctly now, sorry --- is that Taibbi is either taken in by or preying on a layman's understanding of the word "zombie" to drive a column about how 1/3rd of the market is kayfabe. There is probably a way to make that point, maybe without even having to argue that Ford Motors is a fake company. But Taibbi tried to make it by linking to an article that calls out Tesla and Moderna as examples of the "zombie" phenomenon; he either hasn't read his link, which basically refutes his argument, or he's assuming you won't. Because after he writes that link, he goes on to imply that "zombie" means here what a normal person thinks it means. And it does not.
Well I'm not normally a massive fan of his either. But he does have something here. I don't doubt that airlines will exist in the future, but why exactly must it be the same ones that exist now? The planes and the pilots will still be around, but why should they be run by the same companies? You could ask the same about many crisis era firms, they do something that should survive, but why should they survive? Why shouldn't there be some replacement, and why should the public prevent it? Doesn't this reduce opportunitie for newcomers?
So, just, real quick: has it in the medium-to-recent past been a good idea to bet on the idea that the airline business will be dominated by some new entrant, rather than the major carriers we have now? Since Southwest entered the market, has there been a shakeup in the top tier of airlines that brought a newcomer in? Like, I know Alaska and Jetblue are a big deal, but if airlines were smart phones Delta would be Samsung and Alaska would be, like, LG.
I'm happy to noodle about Delta's prospects, but you can look at his piece and see what he's actually saying about Delta, as an example of how the stock market is fake and props up companies with no prospects. But you know why Delta's 2020 revenues are where they are, and it's not because some permanent shift away from Delta.
I guess he didn't word it very well, because he does seem to suggest that some real businesses aren't doing much. I guess it's like his vampire-squid article, it's hyperbole.
The thing about low rates is we no longer discount the future. If rates were 10% and 2020 happened, Delta would be worth a whole lot less. This would allow new shareholders to buy into it. At the moment things are being valued like they're going to be great forever. Why should we all be tied to a really long and optimistic time horizon? It seems wrong, because there are things that you should expect to happen over 5-15 years.
Efficient Market Hypothesis conserved. You're welcome.
(As you're well aware, given your own long history here; I'm just stating the obvious out loud, I guess)
All that froth allowed finance companies to suck out hundreds of billions in fees, encouraged lunatic risk-taking in every direction and rampages of private equity takeovers, and kept a vast stable of functionally dead companies alive on cheap credit. Those so-called “zombie companies” make up roughly 30% of all corporations in America now, and they racked up over a trillion dollars in new debt since the pandemic alone.
His own link(!) points out that these "zombie companies" include the WSB long target AMC (fair enough), Tesla, and, wait for it, Moderna. Did he even read it? Or does he assume we won't?