Feb 9, 2012 12:11 EST

Romney tax row may bite European private equity

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By Quentin Webb

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Mitt Romney’s low-tax private equity payouts caused a storm stateside. European buyout bosses are unlikely to run for high office. But, like the former Bain Capital boss fighting to clinch the Republican presidential nomination, they also cash in on “carried interest” schemes which usually avoid income tax. The system is due a re-think on both sides of the Atlantic.

Carried interest arrangements typically entitle private equity partners to about a fifth of the profits from a successful fund. These can be life-changing sums. Say a 1 billion pound fund at a 12-partner London PE firm doubles its money and “carried interest” kicks in after an annual hurdle rate of 8 percent. The lucky dozen could expect to receive an average 16.7 million pounds on top of regular pay and bonuses. Taxed as capital at the United Kingdom’s 28 percent, the partners take home 12 million pounds. If it were taxed as income at Britain’s top rate of 50 percent, the post-tax carry would be worth just 8.3 million.

The industry considers these payouts as rewards for patient entrepreneurship and therefore as capital gains. But while funds may need a decade’s nurturing, that rings hollow. Firstly, the capital staked is tiddling: the dozen in the example above may have invested a total of just 250,000 pounds. Secondly, outside investors usually also demand PE staff make separate “co-investments” on similar terms to everyone else. So they clearly doubt that partners’ “carried interest” puts real capital at risk.

Britain has half-reformed its system already, moving in two steps from sub-10 percent tax to 28 percent after a 2007 backlash. In Stockholm, an important hub for buyouts, the tax authorities now reckon carry is income and are pursuing cases against several big PE houses.

To be sure, European rates are already higher than the U.S. ones. Exchequers wouldn’t get huge boosts, since the industry’s still suffering bubble-era indigestion. And coordinated action would help, otherwise firms could simply switch between jurisdictions. Nevertheless, austerity has made financiers’ pay a political battleground and tax loopholes, real and imagined, are vulnerable. The tide may be turning.

Feb 6, 2012 16:32 EST

April Fool’s comes early to comical M&A market

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By Robert Cyran

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

It’s hard not to smirk at the latest transaction to shoot out of the M&A pipeline. America’s largest title insurer, the $4 billion Fidelity National Financial, is buying O’Charley’s, an owner of U.S. steak joints. Not only is it a deal ripe for bad jokes about a combination plate of mortgage deeds and French fries. It also defies all convention.

Fidelity specializes in the humdrum world of processing real estate documents to ensure sellers actually own the properties they’ve put on the block. O’Charley’s is a struggling casual dining chain serving up delectables like “New York Pizza Pasta.” Not even the most hubristic investment banker would pitch huge synergies.

But there’s a still funnier twist. Fidelity National’s chairman, William Foley, knows both mortgages and meat. The company is essentially his brainchild. He rolled up a bunch of smaller title insurers over a quarter century. During some of that span, Foley also ran CKE, parent company of the Hardee’s burger joints.

That may explain the direction Fidelity National has been moving. It already owns stakes in restaurants with revenue of $400 million a year – and recently sold its flood insurance business. Of course, insurers often seek ways to invest proceeds from premiums. It’s just they typically use an intermediary, like a private equity firm, instead of direct ownership of uncorrelated companies.

Investors aren’t so sure about Foley’s ambitions. Fidelity National shares fell over 1 percent on the O’Charley’s news. The 42 percent premium it is paying may impede any hopes of a reasonable return. What’s more, shareholders could be worried Foley will replicate the trouble he ran into at CKE when it expanded too rapidly.

Jan 31, 2012 15:12 EST

Gingrich makes Goldman 4-letter word – to no avail

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By Daniel Indiviglio

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The Florida Republican primary’s big winner tonight may be Wall Street’s most infamous bank. Front-runners Newt Gingrich and Mitt Romney are trying to connect one another to the financial crisis. Gingrich paints his rival as an agent of the giant vampire squid, while Romney criticizes his opponent for being paid handsomely for advising Freddie Mac to inflate the housing bubble. But in a state still in pain from the bust, Romney’s line is winning.

In Florida, the battle occurs through the airwaves. Romney, the former Massachusetts governor, has spent more than $15 million advertising in the state, four times as much as his competitor. One Romney ad, in particular, zeroed in on Gingrich’s role in the housing bubble.

It argued that the former House speaker was paid $1.6 million by Freddie “while Florida families lost everything in the housing crisis.” Such criticism strikes a painful chord in Florida. In Tampa and Miami, for instance, home prices are down about 50 percent from their peak, according to S&P/Case-Shiller’s indexes through November.

Though he doesn’t have the financial firepower of Romney, Gingrich is attacking from a different angle. He has been complaining loudly about his opponent’s connection to Wall Street, claiming that the crony capitalism he says is embraced by President Barack Obama would continue in a Romney presidency. Gingrich even asserted in a Fox News interview this week that Republicans would be letting Wall Street and Goldman Sachs buy the election if Romney wins.

Each criticism is a stretch. Gingrich’s advice hardly led Freddie to suddenly decide to lower loan standards and pour more gasoline onto the raging housing boom. Similarly, Romney is a client of Goldman’s and has received a hefty amount of campaign contributions from some at the bank, but that doesn’t mean he’s in bed with the squid.

Jan 24, 2012 07:31 EST

Endemol tussle shows trials of evicting LBO owners

By Quentin Webb

The author is a Reuters Breakingviews columnist. The opinions expressed are his own. Contestants live under constant threat of eviction on “Big Brother”, Endemol’s flagship television show. Creditors have found turfing out the company’s owners much harder.

After years of wrangling, hedge funds which bought the TV producer’s loans on the cheap are set to take sizeable stakes through a debt restructuring. That makes Endemol a textbook example of what the distressed-debt specialists which are pouring capital and manpower into Europe call a “loan-to-own” deal. But it’s also a case study in how difficult these victories can be.

Endemol offers three main lessons. First, a big firm’s many owners and lenders may pull in different directions, which can slow down or block deals outright. Some banks might balk at accepting shares in a debt swap. Endemol has three owners – Goldman Sachs, Silvio Berlusconi’s Mediaset, and co-founder John de Mol – and three main banks: Barclays, Royal Bank of Scotland and the Lehman Brothers estate. Despite protracted negotiations, neither Mediaset nor Barclays back the current deal, a person familiar with the matter said.

A second lesson is that boom-year buyouts weren’t just overleveraged. They often also came with loose loan agreements that leave owners lots of wiggle room to avoid a default. It took court threats to stop Endemol buying back its own debt on the cheap in order to flatter its loan covenants.

The third lesson is that private equity owners – in this case Goldman – can fight hard to avoid a default, even when logic may dictate they should just walk away. That’s because losing a banner investment is a reputational as well as financial blow.

It’s too early to say how well Centerbridge, Apollo, and the other hedge funds that will soon part-own Endemol have done. The restructuring may clear the way for a sale to a media group such as Time Warner. But for now the funds will become shareholders in an unlisted company. Only when they sell out will it be possible to say for sure whether the wrangling was worth it. Either way, future evictions are unlikely to be much easier.

Jan 19, 2012 16:45 EST

A speech on taxes that would help Romney’s run

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By Daniel Indiviglio

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The following is an imagined speech that Mitt Romney could deliver to handle attacks on his private equity background and low personal tax rate while simultaneously appealing to moderate U.S. voters to help his run for the White House.

Today, I have released my 2011 tax return for my opponents to scrutinize. This disclosure marks a perfect opportunity to explain a big portion of my tax policy and why it’s better than the president’s.

Some on the left will criticize the 15 percent rate I have paid, due in large part to retirement earnings from my time working in private equity. They’ll say it’s unfair that investment managers can sometimes qualify to pay the relatively low capital gains tax rate on their compensation through a loophole called “carried interest.” To those critics, I say: I agree.

This area of tax policy, like many others, demands reform. When investment managers are paid based on the return earned on capital invested by clients, rather than themselves, then that compensation should be taxed as regular income. This would raise my tax rate much closer to the top income bracket of 35 percent.

Eliminating the carried interest exemption won’t have any detrimental effects on economic growth. Careers in private equity will still be plenty attractive. Best of all, it won’t in the least deter Americans from investing in jobs or good ideas.

COMMENT

Low taxes on capital gains do not encourage investments. Reagan proved that with the 1986 Act when it equalized the tax rates for capital gains and ordinary income. The real justification for taxing investment income at lower rates than other forms of income is that those earning it contribute generously to campaigns.

The most common form of capital gain for the bottom 99% is from selling their house. The first $500,000 of gain already is exempt from tax. Few of the bottom 99% earn capital gains, anyways. FactCheck.org noted that over 80% of capital gains inured to and were realized by those earning $200,000+. See http://www.factcheck.org/2008/04/impact- of-capital-gains-tax-on-the-middle-class  /. Thus, saying you’ll eliminate capital gains taxes for the bottom 99% is a throwaway line.

And if this were done, it is inevitable that we would immediately see political pressure, backed by massive campaign contributions and “studies” from marketing shops masquerading as “think tanks”, to raise the threshold for taxing capital gains. And President Romney would support it.

Further, to the extent the Internal Revenue Code treatment of income creates incentives or disincentives, then taxing salaries and wages at higher rates than capital gains punishes working for a living. One need not ask whether that is sound policy.

BTW, Warren Buffet once proposed imposing a surcharge on short-term capital gains to discourage speculation. I suspect that short-term for Mr. Buffet is less than 10 years.

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Jan 12, 2012 17:23 EST

Carlyle’s big payday does private equity no favors

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By Jeffrey Goldfarb

 The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Carlyle Group isn’t doing its industry any favors. As part of the private equity firm’s initial public offering process, this week it revealed the lucre reaped by its three founders last year. David Rubenstein, William Conway and Daniel D’Aniello took home a combined $400 million in cash payouts. That’s on top of their nearly $4 million salaries and the profits on $200 million of distributions on personal investments in the firm’s funds. Carlyle’s timing is impeccable.

Given the firm is based in the nation’s capital it might have better attuned its disclosure to the political climate. Mitt Romney, the frontrunner for the Republican nomination, is smack in the middle of a pounding over his time spent running Carlyle rival Bain Capital. Fellow candidates, including Newt Gingrich and Jon Huntsman, who are no strangers to the benefits of private equity largess, have unleashed a full-blown roasting of Romney’s record. With the issue going mainstream as part of broad coverage of the race for the White House, it can’t help but damage private equity’s plight in the public eye.

Carlyle’s whopper payday won’t do much to help the image of the 1 percent. At least the firm can reasonably claim to have benefited the 99 percent, too. The pension funds representing teachers and other public workers that have entrusted their wealth to the firm’s funds will have taken a commensurate cut of Carlyle’s bumper year. And Rubenstein and his co-founders , who manage some $148 billion, remain strongly aligned with those alongside it: they plowed most of their earnings back into the funds.

But just as the fervor against private equity scales new heights, the Carlyle windfall provides a stark reminder of a major disparity. The firm’s senior members will pay only a 15 percent tax rate on the $400 million-plus of carried interest they snagged, instead of the 35 percent rate paid on wages. That means the three men cost Uncle Sam at least $80 million.

After multiple failed attempts to rewrite this particular wrinkle in the tax code, the tide may finally change in Congress now that even Republicans are taking the industry to task. Indeed, that could actually explain Carlyle’s high distribution rate last year. While the eye-popping riches won’t do the buyout business any favors, the timing may in fact have been just right for Carlyle’s founders.

Jan 12, 2012 09:43 EST

Ferretti’s yachts find fitting berth in China

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By Quentin Webb The author is a Reuters Breakingviews columnist. The opinions expressed are his own

Few companies embody the highs and lows of turbo-charged modern finance better than Ferretti. Once the luxury yachtmaker made a mint for private equity. Now a state-backed Chinese industrial conglomerate is buying it for at most a fifth of its peak value.

Ferretti’s financial journey launched in 1998. Previously family-owned, the firm became a small, wildly successful investment for a forerunner of Permira, the European buyout house. Turnover quadrupled in three years, and the backers made more than 50 times their money back in a 2000 flotation. That valued Ferretti at about 400 million euros including debt.

Two years later, luxury stocks were languishing. Another Permira fund bought Ferretti back, in an 833-million-euro deal. Ferretti gobbled up rivals, and sales soared yet higher, aided by the rise of the super-rich. Permira sold a majority to rival Candover in 2006. This “secondary buyout” valued Ferretti at 1.7 billion euros. Talk followed of a 3 billion euro flotation.

Then things went adrift. As the financial crisis set in, customers no longer felt filthy rich. High costs, plunging orders, and 1.1 billion euros of debt proved toxic for Ferretti. Candover lost control in 2009, hastening its own downfall.

Enter Shandong Heavy Industry Group-Weichai Group, which is taking control in a second restructuring. The lengthily named Chinese firm and Ferretti aren’t obvious bedfellows, but there is some logic. Shandong Heavy already makes marine engines. China is minting millionaires daily, and the only way is up for its tiddling yacht market.

The Chinese are paying 178 million euros for 75 percent of Ferretti’s equity and providing 116 million euros of new term debt, which implies an overall enterprise value of about 350 million euros. Major lenders RBS and Strategic Value Partners, a hedge fund, get the remaining equity for 25 million euros. Previous debt, totalling about 690 million euros, will be repaid at about 32 cents on the dollar, a person familiar with the matter says.

Jan 12, 2012 06:24 EST

Predictions 2012: Upside down and inside out

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By Robert Cole

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Planet finance has a propensity to turn itself upside down and inside out. It’s up to its old tricks again. A new collection of commentaries from Breakingviews sets the financial agenda for the next 12 months.

Click here for the e-book

In 2012, the euro poses question number one. Those looking on the dark side think the single currency will divide into a collection of national or multi-national coinages. If the euro does break up, the toll on jobs, economic activity, freedom of movement, and social cohesion would be huge. And that’s why it probably won’t fail.

Bright-siders at Breakingviews prefer to put a number on the odds of survival rather than extinction of the euro. Let’s say there’s a nine out of 10 chance that European monetary union will weather the storms of 2012 and beyond. Then the big question becomes, “How much will it cost, and how long will it take, to nurse the euro back to full health”.

Stateside, meanwhile, it is election year, and Barack Obama has a fight on his hands to stay in the White House. Financial markets will be on alert for swings in the presidential race and in the make-up of the new U.S. Congress. It is not just about the winners, but also about how successfully the world’s largest economy will deal with its budget gap and political gridlock.

Jan 11, 2012 18:31 EST

Double-dipping Twinkies tarnish bankruptcy process

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By Agnes T. Crane

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Wednesday marked a day of mourning for American junk food aficionados – and not for the first time. Hostess Brands, maker of the cream-filled bright yellow Twinkie snack, filed for Chapter 11 bankruptcy just three years after emerging from the court’s protection. That’s not just a kick in the gullet for Ripplewood Holdings, the private equity owner that sank $40 million into the baker last year. The company’s failure leaves a greasy stain on the American bankruptcy process itself.

Filing for Chapter 11 protection is supposed to give debt-laden companies a fresh start. General Motors, Chrysler, major U.S. airlines like United and others have used the courts precisely for this reason. It is easier to renegotiate labor contracts and ax unsustainable debt loads inside the courtroom. Hostess clearly didn’t go far enough in pruning its obligations the first time around. Its largest unsecured creditor isn’t a bondholder or bank; it is a pension fund. The company, in fact, blamed legacy pension and health benefit costs for its current predicament.

To be fair, Hostess isn’t the only repeat filer. Edward Altman, finance professor at New York University, tallies 215 so-called “Chapter 22” filings between 1984 and 2009. The main problem, it seems, is that companies are not emerging from bankruptcy in solid enough shape. One 2006 study found that firms had higher debt ratios compared with the industry standard even after substantially cutting their debt burdens in bankruptcy.

That’s hardly encouraging for firms like General Motors that have returned to the land of the living in recent years. Operating at a disadvantage when times are tough, especially if, like at Hostess, pension costs remain significant, is hardly ideal. Yet if a producer of baked staples like Wonder Bread and Ding Dongs can’t make it, investors should remain skeptical about just how effectively Chapter 11 can scrub away problems.

COMMENT

Chapter 11 is for creditors. It’s intended to be used when continuing the company will return more to existing creditors than an immediate liquidation (think 20 cents on the dollar instead of 5 cents on the dollar). It is not supposed to ensure the long-term viability of a company. It merely gives creditors a chance to come together a say, “after discounting the 20 cents/dollar forecasted return by the risk that the reorganized company will fail again, the expected return is still higher than the liquidation value of the company, so keep the company in business.”

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Jan 10, 2012 17:28 EST

Private equity skewered by Romney-bound arrows

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By Jeffrey Goldfarb

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Private equity is caught in the crossfire. Rivals for the Republican nomination for the U.S. presidency are leading a full-blown assault on front-runner Mitt Romney’s track record at Bain Capital. The attacks won’t stop Romney, but the collateral damage could hurt the buyout industry.

Only two months ago, KKR kingpin Henry Kravis warned his fellow buyout barons to beware the barrage. If Romney becomes the nominee, “they’re going to describe us all as asset strippers,” he said. But “they” were supposed to be the Democrats. Not even Kravis anticipated friendly fire.

Romney, to an extent, invited the onslaught. To burnish his economic credentials, he put forward an unsupportable claim about job creation during his time at Bain. But that doesn’t justify the absurd spectacle that has unfolded. Newt Gingrich, who once advised private equity firm Forstmann Little, claimed that Bain “looted” companies. Jon Huntsman, whose family’s publicly listed chemical business agreed to an ultimately unsuccessful $6.5 billion leveraged buyout in 2007, jumped on the bandwagon. So did Texas governor Rick Perry, even though his state’s teachers – whose retirement fund board he appoints – have invested in Bain funds.

Moreover, the GOP en masse has helped thwart repeated efforts to make buyout firms pay a fairer tax rate on a big chunk of their profits. And while Republicans in Congress took less money related to private equity than Democrats between January 2007 and June 2011, they still pocketed some $6.5 million, according to research firm MapLight.

The rhetoric is unlikely to derail Romney’s chances of taking on President Barack Obama in November’s election. The populist anti-private equity message from GOPers could, however, have staying power. For one, it gives fresh fodder to the Occupy crowd. It also will make it harder for Republicans to defend the industry when debates such as the one over taxing carried interest are rejoined in Congress.