When Kevin Harding heard last month that Mountain Equipment Co-operative was being sold to an American private equity firm, he was overcome with alarm.
A Vancouver-based business consultant who’s done some work for MEC, Harding’s fear was that Kingswood Capital Management LLC, the Los Angeles-based private equity firm that bought the Canadian outdoor sporting chain, would end up dismembering it.
That’s when he started Save MEC, a grassroots campaign with the goal of stopping the sale.
“It’s spotty, to thin gruel, to unknown,” Harding said of Kingswood’s business history.
“They haven’t really had a track record of being able to purchase these kind of companies and do anything with them. So there’s concern whether or not this is just a real-estate play.”
Attempts to reach Kingswood for comment went unanswered.
Harding has good reason to be worried, especially now — a B.C. judge approved the deal earlier this month.
In recent years, private equity firms and hedge funds have attracted controversy for the financial engineering they deploy to buy companies, often resulting in their acquisitions being weakened — or even going bust.
And a growing body of research suggests private equity firms and hedge funds don’t earn the fantastic returns they lead investors to expect.
“These organizations have created a tremendous amount of disruption and destruction in the face of a handful of successes that they claim are the reason they should be allowed to continue to operate,” said Mark Cohen, director of retail studies at Columbia Business School in New York.
Indeed, the landscape is littered with companies such as Kmart, Shopko, Toys “R” Us, Payless ShoeSource, Simmons Bedding Company, American Apparel, RadioShack, Neiman Marcus, J. Crew, Sports Authority and others that became insolvent after falling into the hands of private equity firms or hedge funds.
Much of the newspaper industry in Canada and the U.S. is controlled by such firms, including Postmedia, Canada’s largest newspaper chain, which is primarily owned by a New Jersey-based hedge fund.
Columbia’s Cohen has seen their methods first hand: from 2001-2004 he was CEO of Sears Canada Inc.
“In 2005, Sears Canada had some 30,000 employees, well over 200 stores, well over 100 full-line department stores and several hundred specialty stores,” Cohen said. “It was a $6.6-billion company … Sears Canada was a growing, successful and profitable business.”
But in 2005, American hedge fund buccaneer Eddie Lampert took over Sears Holdings, which included Sears Canada. Through his firm ESL Investments, Lampert loaded up Sears with debt, and was soon being accused of asset-stripping the company, which in turn undermined its capacity to remain competitive.
Lampert sold divisions, bought back shares and underfunded pension plans. “(Lampert) sold the credit-card business in Canada which was driving 61 per cent of Sears Canada revenue and was a very profitable business,” Cohen said. “He sold virtually all of the company’s best stores. He dividended out billions of dollars of cash.”
In 2017, Sears Canada went bust, with Sears Holdings doing the same the following year. During Lampert’s tenure, Sears closed 1,000 stores and laid off 260,000 employees while sagging under $5.6 billion (U.S.) in debt. Meanwhile, he made $1.4 billion for ESL from his Sear’s investment.
Then there was Toys “R” Us, bought in 2006 by private equity firms KKR and Bain Capital. They saddled it with more than $5 billion in new debt. With interest payments of more than $400 million a year, the company went broke in 2017, throwing 33,000 workers out of work (in Canada, Toys “R” Us remains in business).
Such collapses have raised the ire of America’s political class. Last year, Congress’s financial services committee held hearings, where New York Congresswoman Alexandria Ocasio-Cortez said private equity firms had destroyed nearly 600,000 jobs over the past decade in the U.S. By then, Sen. Elizabeth Warren was saying private equity firms were acting like “vampires.”
But private equity firms and hedge funds haven’t always had a bad rap, and here in Canada they appear to be less predatory. In the 1980s, the first generation of leveraged buyout kings stormed the citadels of the Fortune 500, shaking up companies to make them more efficient and profitable.
Now firms like Blackstone, KKR, Apollo, Bain Capital, Alden and Carlyle Group are goliaths, making their managers some of the richest people in the world. From 2006 to 2015, private equity firms created at least 19 new billionaires.
In Canada, private equity firm Onex Corp. founded by Gerry Schwartz in 1984 has become a powerful player on Bay Street, with $36 billion of assets under management. Last year, Onex made one of Bay Street’s biggest deals when it bought WestJet Airlines Ltd. for $5 billion.
Today, there are about 80 to 90 private equity firms in Canada, averaging $20 billion worth of deals every year (in comparison, private equity firms in the U.S. made $678 billion in deals). Between 2013 and 2020, Canadian private equity firms made 4,271 deals valued at an estimated $168 billion.
Kim Furlong, CEO of Canadian Venture Capital & Private Equity Association, says the Canadian private equity space is different from its American counterpart.
“(In Canada) they’re putting in the money, and a lot of growth capital is injected into these companies and all my members would say to me, ‘Kim, if I see a management team or a CEO heading out the door, then I don’t want to invest,’ ” Furlong said.
“They will have people that they can bring in to help management to adjust to a new strategy, but after they buy the company, they still expect the management of that company will stay the course and partner with them.”
The number of private equity-backed companies in the U.S. has increased to nearly 8,000 today from less than 2,000 two decades ago. The aggregate value of private equity-backed companies is $5 trillion — more than the GDP of Japan and Germany. They’ve snatched up everything from rugby teams, talent agencies, grocery stores, the zinc supplier for U.S. pennies, hospitals — even Jamie Oliver’s restaurant chain.
And the deals are getting larger: two years ago Thomson Reuters sold a 55 per cent stake in its Financial & Risk unit to Blackstone, the Canada Pension Plan Investment Board and GIC for $17 billion.
But while the success enjoyed by these firms speaks for itself, some say the very structure of the deals can weaken the companies they’re trying to turn around.
For one thing, they employ leveraged buyouts, where the purchase is made with debt financed with cash raised by issuing junk bonds. The new debt is then placed on the new acquisition’s balance sheet. They often bring in new management to streamline the company, which invariably means laying people off. Indeed, one study shows that on average, 13 per cent of workforces are cut two years after private equity firms buy a company.
To pay off the debt, the firms will sell assets — which is one reason they like to buy retail companies that own real estate.
“So they use the property that the retail companies has as the collateral for these huge loans,” said Eileen Applebaum, senior economist with the Center for Economic and Policy Research, a Washington, D.C.-based lobby group. “They pay off the loans, but now the retail establishment has to pay rent — they are now stuck paying rent.”
Applebaum says private equity firms will also load up their acquisitions with more debt to pay dividends to their shareholders. And they take out money by charging fees for accessing the private equity firms’ purported management expertise.
“They are making sure they get paid no matter what,” Applebaum said.
The story of Postmedia, Canada’s largest newspaper chain with 106 papers, raises questions in this regard. In 2010, a New York-based hedge fund, GoldenTree Asset Management, and a group of other Canadian and American hedge and private equity funds, bought the chain out of insolvency.
Since then, two American hedge funds — Goldentree and Chatham Asset Management based out of New Jersey — have largely controlled Postmedia’s fortunes, earning money on interest from the debt they hold, which currently totals $275 million, and by selling assets.
In 2016, Postmedia was reorganized and Chatham took over two-thirds ownership. Since then, Postmedia has shed 38 per cent of its staff, or 1,600 employees, closed newspapers, cut salaries and centralized editorial control. Annual revenues have fallen to $619 million last year from $860 million in 2016.
Newspapers have long been a declining industry, but private equity and hedge firms began buying them up because they still make money: as a result, funds like Alden Global Capital and Fortress Investment Group now control much of the sector in the U.S. But the effect on the papers themselves has been brutal: since 2011, when Alden took control of Digital First Media, the country’s second-largest newspaper chain, they’ve eliminated two out of every three staff positions at its media properties.
Has the arrival of private equity and hedge funds hastened the demise of newspapers? Ken Doctor, a leading news industry analyst, believes so.
“They’re all financial owners as opposed to strategic owners,” Doctor said. “Overall, they’ve cut more and more deeply in newsrooms. So their ability to do journalism in their local communities has diminished more than other places.”
All of this might be more palatable if the private equity firms and hedge funds earned the kinds of above-average returns one might expect for such a risky business.
The industry claims that investors are happy with returns: a 2020 study by the market data firm Preqin found 87 per cent of investors said that private equity returns “either met or exceeded their expectations,” and 86 per cent intend to allocate “as much or more to the asset class” than they did the preceding year.
However, Ludovic Phalippou, an Oxford University professor of financial economics, concluded that from 2006 to the end of 2019, private equity firms merely matched the performance of public equity markets. And the reason for this middling performance? Because they take back pretty much all of their outperformance in the form of large fees. Or, as Phalippou said, “private equity charges seven per cent of fees a year,” which totalled $230 billion from 2006 to 2015.
Keith Ambachtsheer, one of the world’s leading pension experts and president of Toronto-based KPA Advisory Services, says the data he’s seen on the performance of private equity firms is “that on average (compared to market indexes) you don’t gain … This is international, by the way.”
The private equity and hedge fund industries dispute this, arguing their returns outperform the markets if you track back prior to 2006. And Furlong of the CVCA says pension funds like investing in private equity firms “because they believe that the return there and the fees paid for that return is a fair investment.”
It’s not true these firms and hedge funds only do damage. In fact, Phalippou says given the goal of private equity firms to make money, there’s no incentive to destroy their acquisitions.
“One in 10 (acquisitions) goes bankrupt,” Phalippou said. “You can’t say because one in 10 companies goes bankrupt therefore the objective is to drive companies into the ground. How would you make money by driving companies into the ground?”
Indeed, a 2019 Harvard Business School study on the impact of private equity firm buyouts showed productivity increased at the companies they bought by 8 per cent on average after two years — “a striking impact given that targets tend to be mature firms in mature businesses.”
In 2011, Bill Ackman, the American hedge fund manager of Pershing Square Capital Management, began buying up stock of Canadian Pacific Railway Ltd. At the time, CP Rail’s stock was languishing at around $50 a share. Ackman pushed for a management shakeup and other changes: profits quickly climbed and by 2015 the stock was bumping up to almost $240.
Ackman sold his position in CP Rail in 2016 having made $2.6 billion in profits. “In that particular case they got rid of a pretty mediocre management and board and created a much more profitable company for the long-term,” Ambachtsheer said.
Canada Goose, the maker of parka jackets, was acquired by Bain Capital in 2013 when it was worth $250 million. Bain helped Canada Goose with an IPO when the Toronto-based company was worth more than $1.5 billion. Today, its stock market value is $3.6 billion.
So what will be the fate of Mountain Equipment Co-operative? Will it be one of the lucky companies that flourish after the buyout? Or will it be saddled with debt and stripped of its assets?
The American private equity firm that’s bought MEC has said little, although indicated it will keep 75 per cent of the company’s workforce and 17 of its 22 stores. Little is known about Kingswood, which was founded in 2013 but has only previously done four relatively small deals.
What observers agree on is that Kingswood is getting a valuable asset.
“(MEC’s) real estate alone is valued at about $140 million,” Harding said. “But really, the root concern from what I’m hearing from people out there is that this isn’t just your standard corporate acquisition — this is a forced sale of a co-operative and the member owners weren’t even offered the chance to participate.”
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