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Unwriting The Rewritten Rules For Buyouts

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We kinda love Andrew Ross Sorkin (pictured left with DealBreaker's John Carney and CNBC's Charlie Gasparino at the DealBreaker launch party, as photographed by Gawker's Nikola). We literally wake up with him every morning, frantically composing an aggregation of his aggregation of business news over at DealBook. He’s a nice guy and seems to be one of the smarter people doing business writing. I mean, we like him so much that when we last ran into him and he asked about our very own Bess Levin, we offered to introduce him to her. If you have any idea how closely we protect Bess, you know this is a very big deal.
But his essay in Sunday’s New York Times Business Section on management buyouts this weekend was a bit, uhm, innocent. Not clown-suit, Ben Stein level stupid. But just a bit too bright-eyed student essayish. After the jump, we dissect brother Sorkin’s Sunday sermon.
Rewriting the Rules for Buyouts [New York Times]

Let’s begin by saying that we agree that there are serious problems with management buyouts. But there are serious problems with almost everything in the world. Take women, drinking, winter, men’s footwear, to name a few of the worst offenders—just cause we can see the problems with these doesn’t mean we’re about to become celibate, barefooted, tea-totalers in the tropics. So the Ben Stein ban is definitely not on. And we’re even suspicious of any plan for reforming these things, management buyouts included.
Now lets get granular, and take at look at each of Sorkin’s four proposals.
1.Let minority shareholders decide too. Sorkin is concerned that controlling shareholders might use their control to exploit minority shareholders, and doesn’t think things like independent committee approval go far enough to remedy the problem. And he’s right, exploitation is always a possibility. But guess what? That’s priced into the market precisely because it is a possibility.
When you buy shares of a company controlled by a majority shareholder, you buy them at a discount precisely because being a minority holder in that situation is especially risky. Giving the minority shareholders a veto essentially amounts to taking the control premium away from the majority shareholder and bestowing it on the minority holders—a wealth transfer that bestows an enormous windfall on the minority holders. A windfall they didn’t pay for. What’s more, this is a one time deal, enriching those who happen to be minority shareholders when the new rule is passed but not benefiting future shareholders who will have to pay full price for their shares.
To use the analogy of the day, minority shareholders complaining about controlling majorities is a lot like someone who buys creamy peanut butter complaining they didn’t get chunks of whole peanuts. Sorry, but that’s what you paid for.
2.Use Truly Independent Advisers.
Okay. We know everyone is perpetually upset about conflicts of interest in investment banking relationships. And this may be Sorkin's best point. But (yep, there's always a but), while there are self-dealing costs associated with letting the bank running a buyout auction also arrange the loans funding the buyout, the alternative—Sorkin proposes an outright ban—might make such transactions even more expensive. Banking fees would likely go up to reflect having to involve even more players in the deal—including the costs of new lawyers and more due diligence. Is it really in shareholders interests to make deals more costly? Before we started putting up walls of this sort, we'd want a better breakdown of the costs and benefits.

3.Give Public Shareholders A Stake.
The real problem with letting public shareholders piggy back with restricted stock in private companies is that securities laws and the dynamics of regulation might make this impossible. After a few rounds of failed going-private deals with public shareholders taking a loss, pressure will mount to start upping the regulatory supervision of private companies. Take a look at what’s happening in hedge fundland if you want to see how losses create pressure for regulation.

4.Show Us The Business Plan.
We can see two problems with requiring management to disclose the business plan to the public before a going-private transaction. First, often the business plan is simply “more of the same, but with better incentives for insiders and less costs.” Very often that plan is something the public markets have already rejected. Second, if there really is a new plan in the works, disclosing it to the public might well undermine part of the strategy by inviting copycats. In fact, using a new, innovative and secret corporate strategy might well be one of the reasons for getting out of the public market.