Job Creators?

November 21, 2012

Over the past 18 months, or so, we’ve been deluged with propaganda about “Job Creators” – mostly referring to private equity firms which are prone to swoop in, acquire companies which are ‘undervalued’ and turn them around for a healthy profit (to the private equity partners).

Some years ago, I recall taking an economics course which was anchored around some research conducted by noted M.I.T. economist Lester Thurow which he categorized as “The Zero-Sum Society”.

Thurow had examined a number of scenarios where costs and revenues were shifted between various public sector entities.  One entity would reduce taxes while moving services to another entity.  The service-receiving entity raised taxes to fund the shifted services.  The ultimate result:  a zero-sum outcome to taxpayers.

Today’s news that Hostess Brands – which was acquired out of bankruptcy by the private equity firm Ripplewood Holdings in 2009 – has received approval by the U.S. Bankruptcy Court for the Southern District of New York “for the orderly wind-down of its business and sale of its assets” is certainly not good news for the 18,500 Hostess employees who will soon be unemployed.

All in all, the ‘ripple effect’ of the Hostess Brands bankruptcy will be the closing of 33 bakeries, 565 distribution centers, 5,500 delivery routes, 570 bakery outlet stores, in addition to the loss of those 18,500 jobs.

This is just another example of Thurow’s Zero-Sum Game.  No value added, just a shift of wealth from one group or place to another.

In fairness, Ripplewood enjoys a pretty good reputation among its peers in the private equity sector – where the term ‘vulture capital’ seems to be growing in popularity.

Of course, Ripplewood’s goals generally mirror those of other similar firms:  Buy distressed companies at a fire-sale price; fix the problems; and sell the repurposed firm at a nice profit.

Over its 17 year history, Ripplewood has had some major winners, and it is no stranger to losers, or to the U.S. Bankruptcy Court for the Southern District of New York.

In March 2007, a U.S. investor group led by Ripplewood Holdings acquired Reader’s Digest Association out of bankruptcy for $2.8 Billion, including the assumption of debt.  When the dust settled, the equity investment was $600 Million, leveraged against debt of $2.2 Billion.

In August 2009, just 2 years after the Ripplewood acquisition of Reader’s Digest, the U.S. Bankruptcy Court for the Southern District of New York approved a “new & improved” voluntary bankruptcy of Reader’s Digest which reduced its debt of $2.2 Billion to $550 Million, and erased the entire equity investment from the private equity consortium.

The good news which emerged from the Reader’s Digest saga was that the company was able to continue operations, and effectively, no jobs were lost.

Back to November 2012:  Ripplewood’s initial strategy in the Hostess acquisition revolved around seeking major concessions from the unions which represent the majority of the workforce.

For the most part, Ripplewood did act like a responsible “gentle private equity investor”.

Despite the apparent odds against a rescue and turn around, Ripplewood continued to invest in Hostess to keep it going.  Ripplewood didn’t extract outrageous dividends or lay on more debt, beyond the 80% leverage they saddled the company with initially.

In the first year, at least, Ripplewood charged Hostess some management and consulting fees, although not obscene, generally thought to have been in the millions of dollars.

Observers contend that one of Ripplewood’s major blunders in their turnaround strategy with Hostess was to increase management compensation while it was seeking to constrain overall employee compensation and benefits. The Union representing the majority of Hostess employees zeroed in on huge increases in executive compensation (i.e. CEO went from $750,000 to $2,550,000) while the company was playing hardball with the union seeking major concessions, particularly in the area of pension and benefits.

All things considered, the timing of Ripplewood’s acquisition possibly was the final straw.  In 2009, we were in the midst of one of the worst recessions in U.S. history; commodity costs were very volatile; competitors with lower fixed and variable costs were consolidating; and Hostess was highly impacted by the cumulative effects of collective bargaining agreements.

At the end of the day, Hostess employees will lose their jobs; communities where Hostess facilities are located will lose both tax revenue and the multiplier effect of employee spending; equity will be destroyed; debt will be written down; unsecured creditors will be left holding the bag; but someone will profit significantly from the sale of the Hostess brand to a new private equity fund.

If mapped out very carefully, the effects of the zero-sum game generally look very much like the effects which resulted from the collective works of Robin Hood or Blackbeard the Pirate:  A zero value-added, zero-sum game where some get the spoils, some are left destitute.

Job creators?  Not so much…..

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