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.
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...