Will Private Equity Be the Next Meltdown?

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The Buyout of America by Josh Kosman

Over the past decade, some 3,000 U.S. companies have been bought by private-equity firms. Their M.O.? Suck up companies with borrowed money, make them more efficient and then resell, turning a profit in the process. These days, nearly 1 in 10 nongovernmental employees works for a private equity–owned company, and that, says longtime industry reporter Josh Kosman, is a big problem. In his new book, The Buyout of America: How Private Equity Will Cause the Next Great Credit Crisis, Kosman argues that private-equity firms not only pillage the companies they buy, but also put the broader economy at risk by making those companies take on copious amounts of debt. TIME's Barbara Kiviat spoke with Kosman about where he thinks the industry is headed.

You predict that private equity will go through a shakeout similar to what we've seen in the housing market. How does that analogy work?
Private-equity firms used the same cheap credit that caused the housing bubble to buy companies. There are about 100 of these firms — KKR, Blackstone and Carlyle are some of the bigger ones — and they buy a company the same way we would buy a house. Put down about 20% and borrow about 80%. The big difference is, the company they're buying borrows the 80%, so they're the ones responsible for repayment. These loans were structured the same way and sold to the same people as mortgages. And the same kind of crazy prices were paid, so unfortunately we probably are going to see a private-equity meltdown just like what we saw in the housing market.

How bad do you think it will get?
The opinions on this shift, but the Boston Consulting Group in late 2008 predicted that about 50% of the companies bought in leveraged buyouts would default on their debt. If half default, and they fire about half of their workers — not the most aggressive estimate — then you're talking about 1.9 million unemployed.

Why haven't we seen more evidence of this yet?
I think the media hasn't put it together, but it actually is starting. The default rate for the past 12 months is roughly 12% — that's very high. Half of those companies that have defaulted, according to Standard & Poor's, had some type of private-equity involvement in their corporate life. A lot of those are PE-owned companies, ranging from Chrysler to the Tribune Company to Simmons Bedding. We've already seen the tip of the iceberg.

More broadly, what sorts of companies should we be worried about?
Unfortunately, private-equity firms infiltrated almost every industry — industrials, consumer goods, retail, hospitals, utilities — so a leveraged-buyout bust will be very widespread. TXU, which is now called Energy Future Holdings, one of the largest utilities in Texas, faces huge problems. They probably won't default on their debt until 2013, but at this point, and this is according to ratings agencies, it looks like they have very little chance of paying their debt. The range is from a huge utility like that to HCA, the largest hospital chain in the country.

And you think the private-equity industry will be the next one to line up for bailout money?
Yes. It's already happened with GMAC. You know, private-equity firms are very well connected. Four of the last eight Treasury secretaries currently work for private-equity firms.

Is there anything we could do now to prevent this wave from coming?
Probably not much. One of the main points of the book is to show how private equity and leveraged buyouts don't work, and even if the credit crisis I'm predicting doesn't happen — even if the economy recovers and some of the companies can refinance and push their debt off — the core practice is still destructive. Many of these companies will fall apart anyway. In the 1980s, when Michael Milken was funding buyouts, 52% of the biggest 25 companies acquired ended up going bankrupt. I did a study of the 1990s, ideal economic times, and with 6 of the 10 biggest buyouts, the companies clearly were worse off 10 years later. In three cases the results were mixed, and in one case the private-equity firm improved the business. This decade, 6 of the 10 biggest buyouts are already considered distressed, according to Moody's. The core practice does not work and rips apart our economy.