Management Buyouts could be suspicious

Yesterday all of a sudden Dell was trending on twitter as Michael Dell is buying back the personal computer downloadmanufacturer he founded and that carries his name for $24.4bn (£15.5bn).reported by the media.

This could be a cause for the concern :-

Many management-led buyouts have been successful enriching management at shareholder expense. how about the worst ones ?

The first issue is price. In such a buyout, a company’s executives have an incentive to pay the lowest price possible, yet they are also supposed to represent the interests of shareholders. That’s a fundamental conflict.

As a result, there is almost always a lingering suspicion that the top executives are timing the buyout to pay a discounted price or are otherwise taking advantage of their unique knowledge to underpay.

Lets try to take certain examples. I do not have the case studies but an extract from newyork times helping us to understand the scenario: –
In 2007, both HCA and Kinder Morgan were taken private by management and a number of private equity firms in huge buyouts. At the time, management teams at both companies were criticized for the timing and the low price paid. In the case of HCA, this was the second time the founding Frist family had taken the company private.

Sure enough, four years later both companies went public, making hundreds of millions for management. More recently, Kenneth Cole used a timely drop in the stock market to complete a $280 million buyout of his own company. Mr. Cole had to raise his bid by only 25 cents a share from the initial price offered.

In those cases, the issue was whether an appropriate price was being paid. In some recent deals, management actually lowered the offer price after announcing a higher one.

Take J. Crew, whose buyout group included the company’s chief executive, Millard Drexler. At the last minute, his bidding group dropped the price it was willing to pay by $2 a share. The J. Crew board still went ahead with the deal, probably because the directors felt they had no choice.

Why do boards allow this to happen? Directors often feel there is no choice and that if the board says no they will be left not only without a deal but with very unhappy management. And many times other bidders are not willing to jump in because they do not have management on their side.

The sentiment was aptly summarized back in 2007, when Institutional Shareholders Services recommended that its clients vote for the management buyout of OSI Restaurant Partners, the owner of Outback Steakhouse. I.S.S. stated:

We recognize the shortcomings in the process and the conflicts of interest of management and founders … but given the downside of a failed transaction resulting in a loss of premium and likely continued deterioration of fundamentals, support for the transaction is warranted.

In the buyout of RJR Nabisco – made famous by “Barbarians at the Gate” – the chief executive of the company, F. Ross Johnson, tried to organize his own buyout without knowledge of his board. He ultimately lost the frenzied bidding for the company in part because the board thought he was trying to to manipulate the directors into selling on the cheap.

Unfortunately, Mr. Johnson’s conduct is not some 1980s relic. In the case of J. Crew, Mr. Drexler planned a buyout with his partners for weeks without telling the board, using company information in the process.

Management-led buyouts have come under criticism when management joins with a private equity firm. The reason is that managers can simultaneously cash out some of their stock in the buyout while receiving yet more stock in the newly private company. It is a great opportunity that regular shareholders do not have.

While some management-led buyouts no doubt serve both shareholders and management, there are clear perils. Dell will need to file documents with the Securities and Exchange Commission describing its sale process and negotiations with its buyout group.

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