The sky is gray, the beloved Red Sox are done (in Theo we blame) and Im refreshed after a weekend on Cape Cod. In other words, its time for some Monday Mouth-Off.
Todays edition isdevoted to last Wednesdaysdiscussion of James Surowieckis latest New Yorker column. In short, Surowiecki had argued that management buyouts are fundamentally flawed, while I found a few flaws of my own in Surowieckis argument. A huge response, and what follows is a sampling:
David: A few key points jump to mind after reading this article. Yes it is true that there are some conflicts of interest but there are also three other factors core Wall Street tenets that counter-balance this issue including the risk-reward mantra (CAPM model), free market economies and the freedom to take legal action.
- Risk-reward: One thing missing from the article is the emphasis on some of the failed MBO transaction. Having been on the buyer side (as an advisor) I can tell you that they are not all lay-ups. There are many risks in taking companies private including paying the premium to the market, paying the legal, banking and financing fees and trying to generate a return above a benchmark beyond all of the aforementioned. Yes, management knows where the bodies are buried but they are also the ones, in some cases who buried those bodies.
- Free market economies: If the MBO team is not offering the best price, someone else will. Each billion dollar fund and mega billion fund is just itching to put that money to work and if there is a bargain to be had (risk adjusted of course) they will take advantage of it and squeeze out extraordinary profits.
- Freedom to take legal action: Sometimes companies need to be private in order to accomplish some of the housecleaning needed to right the ship. As public companies if they did take such actions there would be tens of class action securities lawyers waiting for things to go wrong. As a private company there is, in most cases only a handful of financial firms/shareholders involved (and debt holders) who are sophisticated investors and understand the risks going into the deal.
Carol: I think that the article raises some good points and is on target in many regards.However, my biggest point of disagreement is the statement: With few exceptions, these restructurings could be done before buyouts. But theyre not, in part because executives would rather wait until they own a bigger chunk of the company. This accusation would probably hold true in some cases. However, I think its a simplistic view of reality. As you correctly point out, the LBO firms add value via their expertise in executing previous restructurings. In addition, these restructurings are hard work. To assume that, were it not for managements greed and self interest, these restructurings would seamlessly take place and result in shareholder wealth is shallow thinking. I think its often a matter of managements complacency or lack of expertise that creates inertia and the resulting failure to maximize value for shareholders. Lets face it, a little pressure from a knowledgeable third party who has a vested interest (i.e., the LBO firm) can make good things happen.
Ralph: One thing neither of you mention is that fairness opinions are almost always solicited by both the PEG doling the buying and the board of the seller. And that these fairness opinions usually come from a large independent IB with no vested interest in the transaction.
Michael: I agree with some of your comments, but the two academic studies cited are quite damning. If there is one thing we all should have learned over the last few years, when there is accounting smoke, there is indeed fiscal fire. Furthermore, the conflicts of interest listed are, in fact, quite serious, and I have lost every shred of faith that corporate boards will resolve them properly. Certainly the last few years should have taught all of us that corporate boards simply do not put stockholders’ interests ahead of management’s. Look at the unending list of outrageous and undeserved CEO salary packages if you need any evidence to that fact.
Tom: The New Yorker article is interesting, but wouldnt the potential legal liability of the independent directors be enough to over-ride any close relationship they have with their CEOs? In the Trans Union case many years ago, the directors were held personally liable for voting to sell the company without undertaking sufficient efforts to confirm they were getting an appropriate price. That is a heavy price to pay. Also, in my own personal experience on boards, the non-execs are usually harder task masters on the CEO and CFO than many (even independent) chairpersons are. The CEO does certainly have a conflict, but the NEDs are there to do whats best for the company and the shareholders.