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With First Data sale, Hagerstown gets a taste of equity boom

April 08, 2007|By TIM ROWLAND

The corporate raiders say they have changed, and certainly to a large degree that is true. In fact, they bristle at any ancestral reference to the infamous "Bonfire of the Vanities" days in the '80s, when hostile takeovers and junk bonds became part of the American lexicon.

Indeed, there was nothing hostile about Kohlberg Kravis Roberts' agreement this week to purchase First Data Corp. for $29 billion. It was an attractive offer, and beneficial to the company and its shareholders.

Whether it will be beneficial to the people who work for First Data, including 2,000 in the local branch of the credit card processing center, remains to be seen.

KKR is a private equity company, which is a fancy way of saying it's just like you and me and a few of our friends - if we had several billion dollars in our checking accounts.

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But instead of doing what I would do, buying yachts, South Pacific islands and access to the Playboy channel, they buy companies.

Big companies such as First Data, however, cost a lot more than even these high-rollers have in their accounts. So they turn to some even richer friends, huge banks, from whom they can borrow. And the "leveraged buyout" is born.

Leveraged buyouts mean this: You purchase an entire corporation primarily with borrowed money. Typically, a private equity company will put up 30 percent of the cost itself and borrow the remaining 70 percent.

The company pays off this staggering loan with the profits earned by the corporation. A parallel might be if you were to purchase a $250,000 duplex. You put down 20 percent of the price and make the mortgage payments with the income you receive from renting it out.

So for $50,000, you have control of a $250,000 asset and, more importantly, it's income-producing potential. The income reduces the amount of the loan at the same time the asset (hopefully) increases in value.

In 10 years, you may sell the house for $350,000 and repay what's left of the loan, which by that time might be just $150,000. Subtract out your initial $50,000 investment, and that leaves you with a $150,000 profit. That's $15,000 a year on a $50,000 investment. Try making that percentage by purchasing shares of Home Depot.

If these private equity companies needed more of a sweetener, consider that since they bought the corporation primarily with borrowed money, their tax hit is much less than if they had paid for it all out of their own capital.

Likewise, the benefits to First Data itself are apparent. As a private company, it will no longer be beholden to complicated government regulations. Corporations have spent a fortune, and lawyers have made a fortune, complying with Sarbanes-Oxley law designed to increase corporate accountability. Thank Enron and its ilk for that.

Publicly traded companies are also slaves to the master of the quarterly statement. Executives are often shy about making decisions to improve the company long-term, because in the short run these decisions may hurt quarterly earnings, causing a Wall Street meltdown and fury from short-sighted shareholders. Private companies have no such restrictions.

So what's not to like? A couple of things. Some see private buyouts as an attack on the capital markets. The very things that made First Data attractive for KKR - an undervalued stock price and a history of producing mountains of cash - also made it attractive to small investors.

But with First Data off the market, small investors will no longer have the option to purchase shares. Only tycoons or pension funds have a shot at private-equity action, and if they snap up all the best companies, normal investors will have less from which to choose.

Another concern, faint as of now, is what impact these huge lending deals will have on the world's credit markets. What happens if something goes wrong, and the corporation stops producing enough cash to pay off the debt and this mother of all loans (and perhaps others as well) defaults? It's obviously a bit melodramatic to say that one day you might not be able to get a home loan because all the world's cash is tied up in private equity schemes, but where there are 30 percent profits there is risk. I don't have a clue how the world's credit markets play out if one day all the global liquidity we have today goes away; unfortunately, no one else seems to, either.

But finally, and closer to home, there are concerns how our local branch of First Data will be affected. We're told there's nothing to worry about, and perhaps there isn't.

But one of the ways private equity firms have historically guaranteed adequate cash flow - which is needed to repay their prodigious loans - is to strip the corporation down to bare bones and cut spending at every turn. Quite often, that has included workforce reductions.

And if the cash flow is going to debt repayment, that means less for investing back into the company - technologies it may need to keep up with the competition.

As noted in the beginning, private equity says it has changed. It is not in their best interests, they say, to run the company into the ground. No longer do hostile raiders prowl for asset-rich companies to commandeer, gut and leave to the boneyard of bankruptcy court.

To change public attitude toward leveraged buyouts, some private equity shops have recommended a major public relations campaign is in order to convince us folk that the tiger's stripes have changed.

Certainly they are correct in that today's takeovers are not the despicable bloodbaths of the '80s. But I think the jury is still out. Better than a PR firm, would be a demonstration by First Data's prospective owners that our local workforce, and other local workforces, will not be sacrificed on the alter of investment-banker enrichment.

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