Re: Bubbles & rapacious behavior

["David B. Shemano" <dshemano@xxxxxxxxxx>]

Michael Perelman writes:

>> My intuition is in line with David's observation, but the Business Week article
>> suggests that the funds are able to extract $$ before the companies experience their
>> death throes.

It is always easy to find an outrageous example, but I think this misrepresents the reality on an overall basis.  It is not uncommon for a company to be balance sheet insolvent but have significant positive EBITDA (earnings before interest, taxes, depreciation and amortization).  Such companies are targets for the private equity funds, because if the debt holders can be convinced to take a "haircut", the company can then become very profitable for the equity.  The private equity funds have a lot of expertise in buying debt and equities of an insolvent corporation to maximize their leverage in a chapter 11 reorganization or out of court restructuring in order to end up with a profitable EBITDA business shorn from debilitating interest payments.

It is extremely rare for a company to load up on debt simply in order to distribute dividends.  Among other reasons, if the transaction renders the company insolvent, the transaction is treated as a "fraudulent transfer" and the company (i.e., the bankruptcy trustee) can sue the recipients of the dividends.  That is not to say that such transactions do not occur, but it is relatively rare.  The private equity funds are more in the business of getting their equity value through restructruing the existing indebtedness as opposed to increasing the indebtedness.

David Shemano