PDA

View Full Version : Stock ripoff/destruction story--interesting



Ghost
02-05-2010, 10:58 AM
For all who invest, this concept might be interesting. Probably a lot of it going around. Motley Fool sent me this. I suspect the takeaway is to look very closely at the debt load on any company you buy, to see if it is an issue. Who knows, this one may pan out, but it illustrates a sneaky way that it might not be. Especially if the folks who take over a company then sell it off.

The whole thing is available at:

http://www.fool.com/investing/small-cap/2010/01/29/avoid-these-cash-machines.aspx



One legendary private equity shop, Kohlberg Kravis Roberts (KKR), has perfected the ability to extract exorbitant sums of cash from companies in a perfectly legal way. Take a look at the recent stunt it pulled on Dollar General.

KKR and fellow investors Citigroup (NYSE: C (http://caps.fool.com/Ticker/C.aspx?source=isssitthv0000001)) and Goldman Sachs (NYSE: GS (http://caps.fool.com/Ticker/GS.aspx?source=isssitthv0000001)) took Dollar General private in July 2007 at a cost of $7.3 billion. They released the company back to the public markets this past November, offering about 10% of the shares in an IPO and retaining the rest. Following its launch, the company was valued at $7.2 billion.
Now, it looks like Dollar General's investors lost $100 million on the deal, so where's all this profit I'm talking about?

For that, you have to examine how Dollar General was used while it was private. When KKR bought Dollar General in 2007, it and fellow investors put up just $2.8 billion and borrowed the remaining $4.5 billion. At that time, Dollar General had just $260 million in debt, the interest on which it could easily cover with its earnings.

Fast-forward to November 2009 and the IPO. Dollar General suddenly had about $4.2 billion in debt, and its ability to support its own debt is severely crimped. In fact, the business has to pay about 39% of its operating income just in interest. Ouch!

That sudden debt spike shows that KKR and its co-investors simply transferred their borrowings of $4.5 billion onto Dollar General's balance sheet. For their efforts, they took home a 150% paper profit (based on the IPO price), excluding fees and the costs of some rather minimal work they performed in reorganizing Dollar General -- much of which was charged to Dollar General.

As a final kick to the curb, just before making it a public company, the private-equity giant paid itself and other investors a fat dividend, to the tune of $239 million -- more than double what Dollar General earned in that quarter. As a public company, Dollar General doesn't even pay a dividend. And that's not the amazing part...

handfulz28
02-05-2010, 12:56 PM
Let's see, it wasn't a bad deal at all for shareholders back when it was taken private:
http://74.125.47.132/search?q=cache:dLk0YX0p4gcJ:www.marketwatch.com/story/dollar-general-gets-73-billion-buyout-offer-shares-jump-28+dollar+general+buyout&cd=5&hl=en&ct=clnk&gl=us

KKR put $2.8 BILLION of its own cash in the deal. A couple years later they take out $700 Million, plus another $300 Million....on my feeble calculator that puts KKR $1.8 BILLION lighter in the checking account. :confused:

The new IPO goes off at $19.79/shr....hmmm, that's actually less than KKR paid originally. And today they're trading around $21/shr, and have been as high as $24-25 (these would be positive returns for shareholders). Oh, and they plan on expanding the business by 600+ stores this years and hiring 5000 people...

So who is a damaged party here? Whose cash supposedly got sucked out? DG didn't have much cash on their balance sheet when they were taken private; in fact they have twice as much cash today then they did then. This is nothing more than a classic LBO. The debt gets paid off over time and the equity holders enjoy capital gains.

Is this not capitalism in a free country?

The Hedgehog
02-05-2010, 02:40 PM
Ahh, the ole lever the company trick. Gets back to middle level finance and M&M Theory (not the candy) The value of a leveraged vs unleveraged company. These guys have been doing that for years.

I will have to ponder this for Dollar General. In my world stock holders don't get paid more for having excess capital. On the other hand, I see a bunch that are still around because they had it. Some other that got "paid more" are no longer around. Just like operating leverage, financial leverage increases risk. In a merger the shareholders get a premium up to the point the company is optimally leveraged. After that it is dollar for dollar if they sell.

In addition to levering the company, they made a number of operational improvements that should have enhanced shareholder value.

Ghost
02-05-2010, 03:01 PM
Yeah, I didn't really name this thread what I wanted and can't change that now. I think this particular one could go either way, but I was more interested in the general notion of companies being saddled with debt via takeover, and the effect on real value.