When the shark bites |
Date: Monday, May 7, 2007
Author: David Olive, Toronto Star
A coterie of buyout shops, hedge funds and private-equity firms are on
the prowl for prey like Ragged Tooth sharks stalking their dinner. When
the world's biggest bank, with a stock-market value of $260 billion
(all figures U.S.), fears that even it might be a target in the current
wave of debt-financed takeovers sweeping North America and Europe, it's
a sign either that (a) no company's independence is safe, or (b) this
trend will soon peak, if it hasn't already. All the signs are there to suggest it's the latter case.
A rapid proliferation of buyout shops, hedge funds and private-equity
firms has resulted in too many prospective buyers chasing too few
worthwhile acquisition targets. That same proliferation of
wannabe takeover artists is pushing up the price of remaining
acquisition candidates to ludicrous levels, requiring successful
bidders to pile ever higher levels of debt on acquired firms, and
pushing the point at which deals turn profitable out to the point of
infinity. As the above would suggest, the return to investors from these takeover marauders is in steep decline.
Then there are the regulators, always late to the party, but on the
scene now, asking the bankers who finance takeover deals if they are
prepared for a worst-case scenario. And asking the investment-banker
handmaidens to the dealmakers the same question, in the context of lax
margin requirements on the Niagara of credit that has been made
available to takeover specialists. And there is the greed
factor – the growing realization, and in some case indignation – that
hedge funds, private-equity firms and the like skim off a management
fee equal to 2 per cent or 3 per cent of the portfolio's assets
regardless of its performance. Which would help explain why, in
these latter stages of the mania trend, the takeover artists have few
qualms about departing from the previous, disciplined criteria they
applied when assessing an acquisition target. Let it not be said that so-called activist hedge managers have lacked influence in reshaping the corporate landscape.
An obscure South Carolina private-equity investor named Jerry Zucker
succeeded in purchasing the iconic Hudson's Bay Co., not long after
counterpart Eddie Lampert pounced on venerable Sears, Roebuck & Co.
and merged it with his Kmart Holdings Corp. Carl Icahn,
playing the same game that was denounced as "greenmailing" back in the
1980s, agitated for change at media giant Time Warner Inc. – "change"
meaning a hefty dividend windfall for investors like Icahn. Kohlberg
Kravis Roberts & Co. (KKR), another name from the past, has
spearheaded an audacious takeover bid for BCE Inc., parent of Bell
Canada. BCE is thus "in play": the only question is who will end up
buying it, at what price and when exactly will BCE lose its
independence. Arbitrageur Nelson Peltz, yet another blast from
the past, has used minority stakes in H.J. Heinz Co. and Cadbury
Schweppes PLC to force asset sales at the former, and a break-up into
its confectionery and beverage components in the latter. And
the innocuous-sounding The Children's Investment Fund (TCI), actually
an activist hedge fund, has pushed for the breakup of the 183-year-old
ABN Amro Holding NV, one of Europe's largest banks. Worn down by TCI,
the Dutch bank succumbed earlier this year to the blandishments of
suitor Barclays PLC in a proposed $91 billion deal – the biggest
cross-border corporate merger in history. But TCI is not
satisfied. At this writing, it is pulling for a still higher $98
billion bid for ABN from a consortium of European banks led by Royal
Bank of Scotland. Meantime, TCI is contesting in court routine ABN
business dealings that meet with TCI objections. "ABN has become the
toy of hedge funds and I deeply regret that," ABN CEO Rijkman Groenink
told a Dutch judge during a TCI-ABN courtroom tussle late last month.
No longer clear on who owns your local paper? Blame the investment-fund
agitators, like Tweedy Browne Co., which triggered the unraveling of
Conrad Black's newspaper empire. Knight Ridder Inc., the former No. 2
U.S. newspaper chain, finally gave in to outside agitators and sold
itself to a much smaller chain, which has subsequently sold off Knight
Ridder's biggest properties. And mighty Tribune Co., owner of the Chicago Tribune, the Los Angeles Times,
many other papers and 23 TV stations, was forcibly sold last month to a
buyout consortium led by retired real estate developer Sam Zell.
Which makes the fears at Citigroup that emerged last week entirely
credible. True, factoring in the usual takeover premium, a $350 billion
takeover of Citi would be a stretch – a deal worth about three times
the GDP of Ireland. As with the Royal Bank of Scotland's
carve-up scenario for ABN, a syndicate of half a dozen global banks
could post the financing for a Citigroup and promptly recover their
investment by hacking Citi into its four major components: U.S.
consumer finance; offshore consumer finance; investment banking; and
wealth management. And the United States would thus lose its only global bank, just as Holland is about to lose one of its two world-class banks.
The buyout craze has provoked a revival of economic nationalism in
nations like Italy, Holland, France, Germany, Australia and Canada. In
the past year or so alone, Canada has seen the disappearance of Inco
Ltd., Falconbridge Ltd., Four Seasons Hotels Inc., Fairmont Hotels and
Resorts Ltd., Terasen Inc., Dofasco Inc., Algoma Steel Corp. Ltd.,
Intrawest Corp. and many other firms to foreign buyers.
Politicians in Europe have decried the buyout interlopers targeting
their steel, pharmaceutical and banking companies as "locusts." Sage
investors like Warren Buffett, scandalized by takeover prices now in
nosebleed territory, have decried the mountains of debt the acquired
firms now are required to shoulder. And central bankers
worldwide are publicly fretful about a buyout "industry" that is
loosely regulated, whose financing methods are convoluted and anything
but transparent, and has yet to be tested by hard times – a recession
or global credit crunch, for instance. Last Tuesday, Bank of Canada
governor David Dodge joined the chorus of concern about "an
inexhaustible supply of debt finance ... to take companies out of the
public domain." Some figures give an idea of a movement that's gone about as far as it can.
The number of hedge funds alone has more than doubled since 2000 to a
current 9,200 or so. Collectively they wield buying power of an
estimated $1.4 trillion to $2 trillion, before accounting for leverage,
which in some of the more precarious deals of late amounts to 25 times
the hard cash put up by buyout firms. Last year, hedge funds,
buyout shops and individual wealthy investors borrowing on margin were
carrying total debt of $4.9 trillion, up from just $1.8 trillion a mere
four years earlier. And every year, debt has become a larger portion of
the average deal. In 2001, debt and real cash invested by buyout
artists in the typical deal were roughly equal. Today debt comprises
about two-thirds of the average deal value. "There's leverage
everywhere – whether at corporations or broker dealers or hedge funds
or private-equity funds," Tanya Azarchs, senior credit analyst at
Standard & Poors Corp., told the Wall Street Journal last week. "It sort of feels like something's got to give."
The ideal target for a buyout specialist is a poorly run firm with a
clean balance sheet, whose corporate and industry fundamentals are
strong. With new and less complacent management, such firms can be
fixed with relative ease. Trouble is, after years of
relentless buying, such firms are now in short supply. "All the fruit
on the low-hanging branches is long gone," acknowledged Ken Griffin,
head of Chicago hedge fund Citadel Investment Group, in a recent Portfolio interview. "And now you've got to go find a ladder and pick the fruit off the very top of the tree." As viable deals have become scarce, investor returns from buyout funds have weakened. In
the 1990s, when obscure hedge funds and private-equity players were
scooping up obscure companies by the bushel, the average U.S. hedge
fund's return to investors was a heady 18.3 per cent. Last year it was
12.9 per cent, a lower return than the S&P500. The previous two
years saw dismal single-digit returns. What happened in the
meantime? The deals got bigger and more complex, and rampant
competition among the proliferation of predators chased up the price of
deals with even borderline appeal. The top dealmakers
themselves are doing fine, however, leaving pension funds and other
institutional investors to ask the proverbial question, "Where is the
customer's yacht?" Buyout, hedge fund and other takeover
machines do nicely with a typical upfront management fee of 2 per cent
of their portfolio, regardless of its performance, which translates
into billions of dollars in profit for the dealmakers. Last
year, the top 25 U.S. hedge fund managers pocketed a total of $14
billion in personal earnings, a big enough windfall to finance the
88,000-teacher New York City school system for three years.
The collapse last year of U.S. hedge fund Amaranth LLC, where some $6
billion in assets disappeared in a matter of days, was largely ignored
by other dealmakers. But it has galvanized regulators. The
Federal Reserve Board of New York, the U.S. Securities and Exchange
Commission (SEC) and other regulators are hastily devising
worst-case-scenario models. In private sessions with New York bankers
and securities firms, they're asking if Wall Street "can comfortably
manage" the collapse of one or more future Amaranths, in the words of
Timothy Geithner, president of the New York Fed. The regulators
also want bankers and other lenders to be more discriminate in their
lending practices, after years of relaxing their margin requirements in
order to drum up business. Annette Nazareth, an SEC commissioner,
warned a group of bankers in a speech last year that the SEC and
banking regulators now seek to prevent "an environment that encourages
a competitive `race to the bottom' concerning margin." When they
were still an emerging force to be reckoned with, an admiring author
Tom Wolfe described the new crop of dealmakers as the second coming of
the "masters of the universe" he chronicled in his 1980s bestseller, Bonfire of the Vanities. Most of the engaging characters in that novel came to a bad end. Let's hope the current mania hasn't gotten similarly out of hand, and that a messy end can be avoided.
If the world's biggest bank frets over talk of a hostile buyout, nobody
can feel safe from the recent takeover feeding frenzy. But haven't
things gone a little too far?
Unnamed
executives at Citigroup Inc. let it be known last week that they fear
their financial services colossus is vulnerable to a hostile takeover.