A Private Dilemma: Inside the Struggle of Private Equity-Owned Companies
“Private-equity (PE) firms run something of a shell game,” says Josh Kosman, author of “The Buyout of America: How private equity will cause the next great credit crisis.” “They buy companies with other people’s money by structuring acquisitions like mortgages. The critical difference is that while we pay our mortgages, PE firms have the businesses they buy take the loans, making them responsible for repayment.
“The whole industry was started in order to take advantage of a tax loophole,” says Kosman, a reporter for The New York Post who has covered the financial industry for more than 12 years. “It was not about, and never has been about, building strong, healthy companies.”
Like other industries with a stable revenue base and solid cash flow, the publishing and trade show industries have been infiltrated by PE ownership in recent years. The boom years of the ’90s brought an influx of cash from PE investors and selling prices too good for many show owners to pass up.
Fifteen years ago, none of the major media companies were owned by PE firms. Today, most of them are — Nielsen Business Media, Penton Media, Advanstar Communications Inc., Questex Media Group, Cygnus Business Media, Gartner, Access Intelligence, Sundance Business Enterprises and HMP Communications, just to name a few.
When the recession hit, the traditionally stable business-tobusiness media companies experienced revenue declines. Now, some of these PE-owned companies aren’t worth as much as the debt they owe from financing their leveraged buyouts (LBOs) when the economy was stable and credit was flowing. “If the credit markets stay frozen as they were in 2008, many PE-owned companies, even those that can make higher interest payments, will go bankrupt because there will be no one willing to refinance their existing loans when they come due in three to five years,” Kosman says.
Our industry has already seen shakeups in many PE-owned companies. At press time, Penton Media had just reached an agreement with its lenders on the terms of a restructuring through a pre-packaged Chapter 11 plan of reorganization expected to eliminate $270 million in debt. Cygnus Business Media, owned by PE firm ABRY Partners, and Questex, owned by PE firm The Audax Group, reorganized within the past year, after filing for Chapter 11. Last October, Advanstar reached an agreement with its lenders to eliminate approximately $385 million in debt. As part of the restructuring, Advanstar’s primary stakeholders — PE firms Veronis Suhler Stevenson (VSS) and Anchorage Advisors — agreed to inject $35 million in new capital into the company.
So are trade show and publishing businesses owned by PE firms headed for collapse as Kosman predicts for companies with PE ownership in other industries? EXPO talked to him about his controversial new book to find out how PE ownership, a tight credit market and the struggling economy could impact our industry in the years to come.
HOW PRIVATE EQUITY WORKS
Basically, a PE firm is an investment manager that makes investments in operating companies through a variety of investment strategies, including LBO, venture capital and growth capital.
PE firms generally receive a periodic management fee, as well as a share in the profits earned from each fund managed. PE firms, with their investors, acquire a controlling or substantial minority position in a company and then look to maximize the value of that investment. PE firms generally receive a return on their investments through an initial public offering (IPO); a merger or sale; or a recapitalization.
“The key point: It’s a financial model,” says Margaret Pederson, President, Amirexx LLC, who worked for PE owners as President of Exhibitions for Primedia (which later became Prism, and today is known as Penton Media). “That’s what they’re in it for — a financial return. They may be committed to your company and to your industry, but they still have to achieve their own financial goals.”
HOW WE GOT HERE
“PE firms, which in 2003 led buyouts of U.S. businesses that totaled $57 billion, just three years later, in 2006, quadrupled that figure to rack up $219 billion in LBOs,” says Kosman. “Buyouts in 2007 jumped to a staggering $486 billion.”
Not only were PE firms flush with cash, but they were also willing to pay the price. “Buyout firms were so successful in acquiring companies because they were prepared to pay very high price-earnings multiples,” Kosman says. “In fact, the average earnings before interest, taxes, depreciation and amortization (EBITDA) multiple paid by a PE for a company in an LBO increased 40 percent from 6.0 in 2001 to 8.4 in 2005. Meanwhile, the amount of cash that PE firms were putting down to buy businesses was actually falling, from 38 percent cash down in 2000 to only 33 percent in 2007.
“With the collapse of the dot-com bubble and in the wake of the big corporate accounting scandals, the stock markets were lackluster, and there were not many other places to invest if you wanted, or needed, the potential of big returns,” Kosman says. “Pensions were scrambling for high-yielding investments, and they were besieging the PE firms to take their money.”
As pension-fund money poured into PE funds, demand for new companies began to exceed supply. But that didn’t slow down LBO activity. “A contributing factor in the proliferation of LBO activity is the ability to earn substantial up-front fees that can total nearly 6 percent of the corporation’s purchase price,” Kosman says. “These fees are earned up front, largely divorced from the long-term risks of the transaction. The LBO sponsor, investment banks, bond underwriters, syndicating banks and others earn a substantial income if an LBO is completed, and thus have strong incentives to identify LBO candidates, arrange financing and conclude transactions.”
“I think it’s hard to point the finger just at the PE firms,” says Kerry Gumas, President and CEO for Questex Media Group LLC, which emerged from Chapter 11 and completed a financial restructuring and sale of its company from The Audax Group to were involved in providing the credit and setting the rules and guidelines. That’s just what was being done at the time.” a group of its senior lenders in December. “The banks themselves were involved in providing the credit and setting the rules and guidelines. That’s just what was being done at the time.”
PE firms historically have their buyout funds put down about 30 percent of the money in their deals, and the companies they buy borrow the money to finance the rest. “When you put together an LBO, what you essentially do is eliminate the 34 percent that used to go to the federal government in the form of taxes,” Kosman says.
THE PROS AND CONS OF PE OWNERSHIP PE firms typically hold a company for three to eight years, but the average is generally five years, says Chris Russell, Managing Director for VSS, which has a controlling interest in Advanstar and Access Intelligence, as well as a smaller interest in Schofield Media and Red 7 Media (owner of EXPO). Kosman posits that because the strategy of PE firms is to sell their businesses within several years, “they focus on quick, short-term gains and give little consideration to long-term performance.”
PE firms argue that’s not the case. “That hasn’t been our experience in the sectors where we participate,” Russell says. “We feel that we help these companies become more focused, more efficient, more strategic and more valuable. Often when we exit, the companies remain intact.”
“Operationally, working for a public company is not all that different than PE on day-to-day basis — they all want to create value through revenue, profit and margin growth,” according to one CEO of a b-to-b media company with PE ownership.
In addition, PE firms say they bring a variety of assets to the companies they buy. “Typically, we’re helpful with add-on acquisitions,” Russell says. “To date, VSS has invested in 63 platform companies, and, in turn, those companies have made 290 acquisitions. That’s really the strength that we bring to our management partners. We can help them identify and execute these add-on acquisitions, and we can help with sourcing and financing. At the board level, we can help determine if they’re strategic investments.”
Another pro: a good PE partner might be able to provide an outside perspective that can help companies see things and make decisions they might not be able to see or make on their own. Because they are so financially focused, they can often see patterns that suggest courses of action or opportunities that might not be as apparent to people who are not finance experts.
It’s hard to generalize when it comes to PE firms, Gumas says. “PE businesses come in different shapes and sizes,” he says. “Based on my experience, each situation is different, and each firm is quite unique in its investment approach. PE firms have played an important role in our industry over the last 15 to 20 years. They have provided a valuable source of financing, which has led to mergers and acquisitions and creating companies of scale in our industry.”
But Kosman maintains that the risks of PE ownership outweigh the benefits. “PE firms during the 2003-2007 buyout boom often had their companies use increased short-term earnings that came from reducing customer service, raising prices and starving them of capital — not to reinvest or pay debt, but instead as the basis to borrow more money, which they then gave their PE owners through dividends. Many of these businesses are now stuck with enormous debt and falling earnings,” Kosman says. “We try our best not to overleverage companies,” Russell says. “But in this last downturn, a couple of the portfolio companies were overleveraged, and we fixed that.”
There’s no denying that PE-owned companies in our industry have experienced layoffs and employed cost-cutting measures. “It’s hard to differentiate today whether you can attribute that to PE ownership or the economy,” Pederson says.
So are trade show and publishing businesses owned by PE firms headed for collapse? It depends on the strategies the PE-owned companies employ and the credit markets, which have loosened a bit since last year when the book was published.
“I think there has been a cyclical shift that everyone is going to have to deal with,” Russell says. “Good companies in any sector will survive and grow. Some will emerge from bankruptcy, and some won’t. I think there will be some consolidation to make some of these companies more efficient, but some are going to go away unfortunately.”
“There are PE owners in our business who have overleveraged, and it becomes problematic for the operating companies that have to fund an amount of debt they may not have had to before,” Pederson says.
But that doesn’t necessarily mean collapse. “Our PE sponsor was able to get the banks to take dimes on the dollar to retire debt,” according to a CEO of a major media company with PE ownership. “We emerged debt free, and the rest is history. Other companies, like Cygnus, Questex and Advanstar, have all had to give up significant equity ownership to their bank groups in exchange for reduction in debt to a reasonable level. I think there must be similar activity going on right now at Penton and Hanley Wood — two companies heavily leveraged.”
“I don’t think we’ll see leverage levels like we did from 2006 to 2008 for a long time,” Gumas says. “It will be years and years before we see 10, 11, 12 times leverage.” As more and more companies, like Questex, are forced to restructure their financing, banking institutions are likely to become the new owners of some significant players in the b-to-b media space. “How that could play out is yet to be seen,” Gumas adds.