29 September 2022

Once Again, We See That There Is Nothing That the Financial Industry Cannot Destroy

In this case, it is the private equity driven implosion of the enterprise software firm Citrix, where private equity companies loaded it up with debt for a buyout, and now that interest rates are up, the company is toast.

The PE firms generated enormous "Management Fees" for themselves, so they will be fine though.

Unless and until corporate bankruptcy laws are changed to inflict real pain on the Wall Street types, this will not change:

Fall is here, stagflation is in the air, and Bloomberg terminals are aflutter with news of a great “reckoning” for private equity, triggered by Federal Reserve rate hikes.

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[Apollo private equity head David] Sambur referenced a signature example of what he called the “reckoning”: the embarrassing scramble of banks to find buyers for bonds associated with the $16.5 billion leveraged buyout (LBO) of the enterprise software firm Citrix Systems. Banks loaned “affiliates” of Vista Equity Partners and Elliott Management $15.5 billion to close the deal back in January, but interest rates have risen an unheard-of three percentage points since then, and even with generous assistance from Sambur’s employer, banks have been forced to raise the yield on Citrix bonds commensurately to convince anyone to buy them.

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“It’s important to understand the vast amount of our fee revenue is agnostic to asset market’s valuations,” then-CEO Kewsong Lee told investors in the Carlyle Group’s publicly traded stock on its second-quarter call. “We’re not at a point where our ability to finance transactions is impacting our ability to get things done,” echoed KKR investor relations chief Craig Larson. Apollo’s chief financial officer emphatically declared that “market driven declines” had produced “only an approximate 1 percent drag on our management fees.” Blackstone made similar assurances.

When they say that, "T the vast amount of our fee revenue is agnostic to asset market’s valuations," they mean that they are looting the company, and they make out like raped apes in either case.

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Citrix Systems is a 33-year-old developer of enterprise software that enables remote work. Its profits and stock price soared in 2020, then crumpled in 2021, when vulture investment firm Elliott Management began accumulating a 10 percent stake in the company, apparently using derivatives as opposed to regular shares to evade regulatory scrutiny and/or juice returns. Elliott had more than doubled its money by “activist” investing in Citrix during the Trump years, when it controlled a board seat on the company. It sold its stake early in the pandemic, only to be lured back in October 2021 amid a surge in private equity tech buyouts, driven by the underlying premise that converting software sales into a subscription business was a new fail-safe proposition.

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Then in December, the news broke that Elliott’s private equity arm and Vista were proposing to merge Citrix, Tibco, Blue Prism, and Wrike, in a deal that would value Citrix at $13 billion, a roughly 30 percent premium to its stock price. The merged entity would eventually borrow $15.5 billion to consummate the deal, while raising an additional $2.5 billion in “preferred” equity shares from four private equity firms: Apollo, Blackstone, Carlyle, and Oaktree Capital Management. Elliott and Vista’s contribution to the transaction, meanwhile, seemed to be generally limited to the firms’ pre-existing shares in Citrix and Tibco.

The four software companies together had a combined EBITDA (earnings before interest, taxes, depreciation, and amortization) of roughly $1 billion in 2021, giving the deal a debt-to-EBITDA ratio of at least 15. The average 2021 vintage software LBO had a ratio around seven, which itself is very high. Some $741 million had to be earmarked to pay the fees associated with the brilliant underwriters who signed off on this transaction, plus another $375 million in dividends to the preferred equity holders. Even if Citrix could have borrowed all $15.5 billion at the going 2021 rate of 5.55 percent—and it doesn’t work that way—the first interest payment would have sent the company into default.

They knew that this was a basically pillaging the company

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A couple of high-profile european money managers have made waves over the past few months for likening private equity to a “Ponzi scheme.” Private equity has always been a game of getting your money out of a company early and often enough that you can still turn a profit if the whole thing winds up in bankruptcy court. (The aforementioned David Sambur memorably referred to this as the “cake and eat it too” method during the collapse of the Caesars casino empire.)

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In the old days, PE firms aimed to cash out of “investments” by taking portfolio companies public in an IPO. But in more recent years, the majority of private equity portfolio companies have been sold to other private equity firms. More recently, a new twist on the secondary buyout trend emerged when private equity firms began offloading portfolio companies to … themselves, via an incestuous innovation known as the “continuation fund” that swallowed $65 billion worth of private equity assets last year.

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Both private credit and continuation funds enable private equity firms to keep insolvent portfolio companies out of bankruptcy court and the public spotlight for ever-longer periods, making it harder for workers and other victims to claw back profits. It’s worth noting that corporate bankruptcy filings have slowed to a trickle amid the evaporation of the bond market, even though well over a fifth of the top 3,000 publicly traded companies are officially “zombies,” according to a Bloomberg analysis.

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In other words, while the Fed’s rate hikes, which may induce a global recession, punish the cheap-money bonanza that pushed private equity to great heights in recent years, nobody should assume that the industry has no recourse on the way down. They have ingeniously constructed a number of escape hatches, ones that need to be scrutinized and regulated.

They need to be prosecuted and frog marched out of their offices in handcuffs. 

It's the only thing that will stop them.

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