Wednesday, January 23, 2008

The Great Private Equity Cash Robbery of 2007



So, was yesterday morning’s 400-point opening decline the selling climax?

Did it happen that the market, in its infinite wisdom, finally entice all remaining weak holders of stocks to finally throw in the towel at precisely the wrong moment in the months-old downdraft whose smoldering flames caught fire over the weekend and engulfed markets around the world long after the real risks were apparent to anybody with eyes and a subscription to the Wall Street Journal?

Long time readers know that we here at NotMakingThisUp venture no such public opinions about the direction of either stock markets as a whole or the stocks within those markets.

But for anybody with more than a few years’ experience at this peculiar business—particularly anybody who was around that panic-stricken third week of October in 1987—there was something missing in yesterday’s headlines.

Anybody want to guess what that was?

Well, as far as NotMakingThisUp is concerned, the most obvious thing missing in all of yesterday’s headlines was this: no share buybacks were announced by any major company before, during or after the brief morning sell-off.

Not one.

During the panic of October 1987, grey-beards will recall, the tape was clogged not only with headlines of trading-halts amidst the worldwide rush to sell, but also with a steady stream of share buyback announcements by U.S. companies.

Coke, P&G and many others that week and in weeks subsequent to the Crash of ’87 used the substantial cash on their balance sheets to take advantage of the market dislocations that caused even the good stocks to be sold with the bad, and cannily bought their own stock back at deep discounts to its inherent worth.

Why then, were there no share buy-backs announced yesterday?

Could it be that the Great Private Equity Cash Robbery of 2007, in which previously healthy companies either “cleared” their balance sheets of cash—to use the euphemism employed by Steve Odlund, the Chief Cash Clearer at Office Depot—by buying back their own stock at bull-market peaks or faced the prospect of having it cleared for them by the Private Equity Cash Robbers?

We suspect that is precisely the case, and in continuing our look-back here at previous efforts to Not Make It Up, reprint this review of the Great Private Equity Cash Robbery of 2007 through the eyes of a made-up public company CEO ruefully ruminating on the after-effects of his effort to “return value to shareholders”:



Wednesday, August 08, 2007


The Shareholder Letter You Should, But Won’t, Be Reading Next Spring


Dear Shareholder:

Well, it seemed like a good idea at the time.

I am referring to your board’s decision to approve a massive share buyback and huge special dividend last summer, when the buzzwords going around Wall Street were “returning value to shareholders.”

Why we did it was this: a smart banker from Goldman Lehman Lynch & Sachs came in, all gussied up and looking sharp, and made a terrific PowerPoint presentation to the board with multi-colored slides that showed how paying a special $10 a share dividend, plus buying back a bunch of our stock at the 52-week high, would “return value to our shareholders.”

We should have thrown the fellow out the window, along with his PowerPoint slides, but what happened was, my fellow board members and I were so busy deleting emails from our Blackberries that we just didn’t notice the last slide showing (in very tiny numbers) the “Trump-style” debt we would be incurring to do so.

We also missed the footnote showing the fees that would go to Goldman Stanley Lynch & Sachs for the courtesy of their showing us how to wreck our balance sheet.

Those fees, I am embarrassed to say, amounted to more money than we made the quarter before we “returned value to shareholders.”

But the fact is, we’d been getting so much pressure over the last few years from the hedge fund fellows who own our stock for ten minutes tops, not to mention the so-called “analysts” on Wall Street (around here we call them "Barking Seals"), to do something with the cash...well, the truth is we just couldn’t stand answering our phones any more.

So, in order to finally start getting things done instead of spending all day explaining to these hedge fund fellows and the Barking Seals on Wall Street why we weren’t “returning value to shareholders,” we decided to do the big buyback and the big dividend.

And for a few weeks there, it was pretty nice.

The stock jumped, the phones stopped ringing, and the Barking Seals started congratulating us on the conference calls instead of asking us when we were going to get rid of our cash.

Unfortunately, not only did getting rid of our cash and taking on a huge debt load NOT “return value” to you, our shareholders, it actually crippled the company for years to come.

For starters, as you know, the aftermath of last summer’s sub-prime debt crisis is forcing perfectly fine companies to liquidate businesses at fire-sale prices…but we can’t take advantage of those prices, because we have no cash. And thanks to the debt we incurred “returning value to shareholders,” the banks won’t loan us another dime.

Secondly, as you also know, we’ve had to lay off hundreds of loyal, hard working employees to pay the interest expense and principal on all that debt, because unlike Donald Trump, we actually feel like we ought to repay our debts.

Furthermore, as you probably don’t know, we’ve also scaled back some interesting research projects that had great long-term potential for the company, but were deemed too expensive to continue in light of the fact that we have no cash.

Now, I’d feel a heck of a lot worse about all this if we were the only company suckered into buying our stock at a record high price and paying a big fat dividend on top of it.

But I’m happy to report there were others who also did the same stupid thing.

For example, Cracker Barrel, the restaurant chain that depends on people having enough money for gas to get to its stores along Interstates across America, spent 46 bucks a share for 5.4 million shares of its stock early last year to “return value to shareholders.”

Cracker Barrel’s stock now trades at $39.

And Scott’s Miracle-Gro, whose business is so seasonal it loses money two quarters out of four, put over a billion dollars of debt on its books with the kind of special dividend and share buyback we did.

Health Management Associates—a healthcare chain that can’t collect money from about a quarter of the patients it handles—paid shareholders ten bucks a share in a special dividend to “return value to shareholders” and then missed its very next earnings report because of all those unpaid bills and all that new interest expense it was paying.

Oh, and Dean Foods, a commodity dairy processor with 2% profit margins, returned all sorts of value to shareholders early last year—almost $2 billion worth—just before its business went to hell in a hand basket when raw milk prices soared.

So, you see, everybody was doing it.

And boy, do I wish we hadn’t.





Jeff Matthews

I Am Not Making This Up

© 2008 Jeff MatthewsThe content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

4 comments:

buckeye1 said...

It wasn't during the ever so brief "crash," but DirecTV announced a $1 billion buyback yesterday before the open. I think the obvious difference between yesterday and 1987 is 1987 lasted a whole day at least, while the Fed's cuts avoided a widescale full day "capitulation." Believe it or not though, there are a few companies out there that are still unlevered.

Mrk2Mrkt said...

Loved the 2007 post. Just came across this though:
http://www.forbes.com/feeds/ap/2008/01/22/ap4559729.html

Toby said...

Potash waited until Wednesday..

Aaron said...

Do you remember the story of the Sirens in Homer's The Odyssey where their songs were so beautiful that sailors enthalled by the Siren's melodies were led to shipwrecks?

So you're probably wondering what does greek mythology have to do with officers of publicly traded companies clearing their balance sheets of hard earned cash on ill-timed stock buybacks?

Those officers were led, in no small part, to buy back their stock not just by private equity shops, but by hedge fund managers and investment banks like the fictional Goldman Stanley Lynch & Sachs you mentioned in your earlier post.

The demands by those parties on the CFO's to buy back stock they owned at the time sounded like "music" to those officers in light of other, less sexy options (i.e., spending capital to improve operational efficiencies).

Alas, the spending was both ill-timed and unfortunate as the stock buybacks led to disaster because, as you have so eloquently mentioned, they were done at the wrong price (i.e., well above the companies intrinisic value).

Those "songs" on stock buybacks by private equity firms and hedge funds only led many public companies (thank you Bob Nardelli, formerly of Home Depot, for example) into disaster with many equity prices now in decline.

As my dad like to say, "What a waste!" Guess those corporate officers could have used some beeswax in their ears to drown out the sounds of insanity by Wall Street's Finest.