Friday, February 15, 2008

Of hula-hoops and leveraged buyout loans


By Brent Fullard, Catalyst Asset Management Inc.

The last time I checked, water doesn’t flow up hill.

And every fad has it’s day in the sun.

Do you think the boys at Wham-O-Toys went into business making hula-hoops in the late 50’s to get stuck with an inventory of millions of unsold hula-hoops when that fad went bust?

No, probably not.

But that’s exactly what happened to the Wham-O boys by not being attuned to the shifting sentiments of the marketplace, as retold here:

Richard Knerr, co-founder of Wham-O toys, dies
International Herald Tribune
January 18, 2008

“in the first year, Wham-O sold as many as 40 million hoops; by 1960, sales were at 100 million, a mark no other toy had ever reached. After too many households had two or three of the hoops, the fad evaporated, leaving Wham-O marooned on a mountain of tubular plastic. Total profit: only $10,000, a result of business inexperience and millions of unsold hoops.”

Now parallel this situation with that involving fads like sub prime mortgage conduits or asset backed commercial paper or even the fad known as leveraged buyout loans, as described in this sober account in today’s Financial Times:

Banks advised to walk away from big deals
Financial Times February 15, 2008
By Henny Sender

In which the statement appears:

“So far, leveraged buy-outs have usually collapsed when the private-equity firms involved – including Blackstone and Cerberus – have withdrawn from transactions.

Such moves have occurred as banks have been working behind the scenes to persuade private equity firms to abandon deals. Such indirect approaches are designed to prevent target companies from filing suits seeking to make sure deals close.

However, the chances of banks abandoning buy-out deals – such as those for Clear Channel Communications, the radio station owner and outdoor advertising company, and BCE, the Canada-based telecoms group – are growing as the market prices for the leveraged loans used in such transactions continue to fall.”

In the case of the BCE deal, the downside risk of a failed financing is a lot greater to the Ontario Teachers’ Pension Plan, than that experienced by the founder of Wham-O-Toys, since Teachers’ will be left with an outcome much worse than a warehouses full of unsold hula-hoops.

Their hubris will cost them a cool $587 million in what is called a reverse break fee. Their 58.7% share of a cool $1 billion fee payable if they along with their partners are unable to come up with the $28 billion in junk bond loans to load BCE up with, before they buy the company with a mere $8 billion of equity.

Talk about scorched earth, for the company since it already has $12 billion in debt. Somehow having BCE capitalized with 85% junk bond debt is supposed to help BCE achieve the Telecom Act policy goal, which is "to promote the competitiveness and efficiency of Canadian telecommunications?"

How does raising BCE's cost of capital by over 200 basis points (2%) do that?

Meanwhile, the risk that Teachers' is assuming is no different than when Lloyds of London underwrites the launch of a satellite. It's large. It’s lumpy. It’s unpredictable. It’s unmanageable. It can’t be hedged. In sum, it’s imprudent, as it may blow up on the launch pad and never get into orbit.

Which leads to two questions:

What's not to dislike about this deal?, and

Why is Teachers’ playing Russian Roulette with the assets they manage?


The cost of this $587 million crap shoot will be solely borne by the plan sponsor of Teachers’: The Ontario Government. And wasn’t it Dalton McGuinty who just ran on a platform of fiscal prudence?

Teachers’ reverse break fee is anything but prudent.

Especially when Catalyst Asset Management handed them a solution to this dilemma in a letter dated February, 4 2008? See Letter to Teachers’, with a cc to Dalton McGuinty

4 comments:

Dr Mike said...

The leveraged buy-out deal is virtually dead in the water according to the articles from the financial papers in the US

Greenspan`s mismanagement of all things financial has led the Americans down a path of destruction similar to that of a run-away nuclear reactor during melt-down.

This is about to place these large leveraged buy-outs , such as the BCE deal , into jeopardy.

This huge amount of debt must be serviced or it`s good bye Chicago.

If I was in Teacher`s position with large American backers , I would be getting very nervous--that break fee would be a nasty one to swallow & then try to explain to the teacher`s themselves why such a lame deal was made in the first place especially with other alternatives out there.

That`s what happens when all the options are not explored.

Just ask Jim Flaherty & his trust debacle which is just about ready to come back & bite him where the sun don`t shine.

I always wonder why the quality of leadership in this country can be so poor when we have a huge reservoir of excellent talent out there who are more than capable of taking-up the challenge.

Mike.

Xenos said...

Be worried for the people of Ontario.

The best result for Ontario will be to have the BCE deal collapse. If it goes ahead, the ugliness of junk bond will debt erode the future cash flow for OTPP. Who will pay for the resulting pension plan deficit?

Not the teachers of Ontario Teachers. Their pension deal is defined benefit. The people on Ontario will pay for the shortfall through a combination of higher taxes and lower services.

The provincial and federal Tories are becoming ever more brilliant. Lougheed and his Tory boys needed to do fifty bad deals to create a $36 billion provincial deficit. Now the ON Tories have perfected their game, and created a $36 billion deficit in just one deal. Awesome, eh?

Anonymous said...

It's a sad state of affairs when the only thing stopping the leveraged buy-out of blue chip Canadian assets is the sub-prime meltdown in the US.

I am continually amazed at the short-sightedness, and outright stupidity of the people who manage most of the planet's wealth.

To paraphrase an old saying: "If you're so rich, why ain't you smart?"

Dr Mike said...

For the members of the board at BCE:

"The whole problem with the world is that fools and fanatics are always so certain of themselves, and wiser people so full of doubts".

This could also apply to the front bench members of the Conservative Party in the HoC.


Mike