Sunday, April 16, 2006

The New Corporate Raiders
The Burger King Story

Back in the 80s, when Kholberg Kravis Roberts ruled the world, companies were at their mercy. KKR would usually ante up 10%-30% of their own money and borrow the rest to buy out big companies. KKR would then round up a team of management and give them some equity to turnaround the company, at the same time selling bits and parts of the company to pay down debts to a more manageable level. Usually, they end up taking them private to do this, but not all the time. It will take anywhere from 5-10 years for each project to be completed. While it is easy to rubbish KKR as corporate raiders, they do add value, improve margins and processes before exiting.

Now, the new KKRs are the private equity buyout funds. Only, the strategy they employ is more pragmatic, risky and places the burden more on banks and minority shareholders. This group of corporate raiders tend to be more short term oriented, do not add much value, and exit as fast as they could. Some of the notable private equity groups include Texas Pacific, Apollo Management, DLJ Merchant Banking, One Equity, Bain Capital, Goldman Sachs Funds and even a reinvented KKR.

Texas Pacific, Bain Capital and Goldman Sachs Funds bought Burger King from Diaego in 2003. They managed to knock down the asking price from US$2.26 billion to just US$1.5 billion. All in, the three put up just US$325 million and borrowed the rest. They hired a top notch CEO to produce good figures. Last year, they arranged for Burger King to borrow an additional US$350 million so that Burger King could pay the new owners a special dividend of US$367 million – so that took care of their initial investment. They also got another US$30 million to cancel out a management contract of US$9 million a year to the three owners.

Now Burger King is slated to go for an IPO which will raise US$600 million, but a listed Burger King will have over US$1 billion in debt, which is more than double that of McDonalds and Yum Brands. The debt is effectively rated as junk status. For comparison, Burger King’s profit margin is just 2.4%, while Wendy’s at 5.9% and McDonalds clears at 12.7%.

To put in the “good figures” new CEO Brenneman closed low producing outlets quickly, introduced a number of new food items, opened smaller sized outlets/franchises, and advertised like hell (NFL games). To maintain good “same store sales figures”, the CEO pushed struggling franchisees to close their stores ruthlessly. In the end, the losers are the buyers of listed Burger King and the lenders.

Hence, a smart private buyout fund would target companies that can “easily be turnaround or have their figures re-worked”. Any company can be listed provided the figures are worked cleverly to ramp up revenue. If the company has a good product or brand name, it should be easy to refinance halfway in the process to allow for new owners to pay off their initial investment. Hence their risk is zero even before bringing it to an IPO. Too many of them have employed this tactic - getting the company to borrow to pay the new owners special dividends, way before the turnaround process is complete. This loophole needs to be looked at and controlled.

You cannot fault them for acting in such a pragmatic fashion if the lenders are willing. The investment bankers are also willing to bring such crap listed in order to increase market share of new listings. Hence more new listings via this route will be of poorer quality – all signs of a market that is taking on higher risk. Naturally all these would eventually fall flat as a secular market correction catches them or they self-implode once they cannot make debt payments. Welcome to the new decade of greed and mismanagement.

1 comment:

Kyle Potter said...

I love it. Great post :]

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