Let’s assume you’re a member of the Smith(1) family. Way back in the late 1890s your great-grandfather started a company that you still own. Back then it was a modest little thing and it barely survived World War I. But then along came the Roaring Twenties and the company began to grow. Alas, along come the Great Depression and the company nearly collapsed.
When your grandfather took over in the mid-1930s, the firm barely had a pulse. But Grandpa Smith was a good operator and he kept the thing alive until World War II came along. Then, thanks in part to some timely war contracts, the firm was rejuvenated. It prospered in the post-war boom and by the time Dad took over in the 1960s, it was one of the two or three leading firms in its industry.
You and most of your siblings went to work for the company in the 1980s, and by the late 1990s you all held senior executive positions. In 1999 Dad turned the CEO title over to you, but he stayed in place as Chairman of the Board to ensure that the Smith family philosophy would continue under your leadership. That philosophy was simplicity itself: never borrow money, watch the cash, and always be the best operator in the business.
Dad died suddenly in 2002, but by then your generation was fully in command. Unfortunately, the company’s leadership position in the industry was under assault. Other companies, unhobbled by the Smith philosophy, had leveraged themselves up and were growing much faster than you were, stealing market share. One dark afternoon, huddled in the family boardroom with portraits of the three patriarchs scowling down at you, you and your family board members decided to – ulp! – borrow a small amount of money and expand your plant. Times were different, and different times demanded different philosophies.
The expansion proved successful, and so you borrowed more money and built a second plant in North Carolina, where wage costs were lower. That move proved to be so profitable that you borrowed even more money and opened a plant in China.
You were acutely aware of the metrics in your industry and so you knew that your firm was worth about $100 million, net of the debt. In other words, that’s what you would pay for the company. You’d had offers in the past, sometimes higher than that, and if you’d been publicly held you’d have been under pressure to sell. But as a private firm you could take the long view. After all, under your leadership the value of the firm would surely grow faster than the broad stock market, especially after the family paid taxes on any sale.
But as 2006 rolled around, the buyout offers started ratcheting up. At first it was the hedge funds, looking to buy minority interests and get a board seat. But they were quickly outbid by the corporations. The stock market was booming and this gave the corporations a currency – their stock – that allowed them to bid high for what they wanted. But then the corporations were in turn outbid by the private equity boys, who could borrow cheap – thank you, Alan Greenspan – and leverage up to pay almost any price.
Under pressure from your family – who says only public companies can be pressured? – you reluctantly agree to hire a banker to sort through the offers. But you tell your cousins you have no intention of selling a firm that’s been in the family for four generations.
Then, a new player enters the field. Tired of being outbid, the hedge fund boys have come up with an idea. They’ve borrowed $2 billion cheap – thanks, again, A.G. – and are doing a rollup in your industry. The idea is to snap up four to six firms and then consolidate operations in the most efficient facilities – that is, in China. In a couple of years they’ll take the rollup public and cash out.
It’s a hard idea. It means shutting eight plants and laying off hundreds of employees, devastating two or three small communities. But, hey, no one ever said capitalism was all peaches and cream.
Fast forward to mid-summer of 2007. The stock market is nearing its all-time high and the M&A world is crazy busy. Your family has assembled in beautiful Aspen for its annual family meeting – it’s also the occasion of the company’s annual shareholder meeting – but the atmosphere in the charming inn is very tense. The family has dissolved into cabals, each advocating a different action. One cabal, consisting of cousins who have no active role in the firm, want to sell out now – take the best offer and run. A second cabal wants to set a price and tell the bankers to go get it. Then there’s you and your company-executive siblings, who don’t want to sell out, period.
You plead with your relatives. Sure, you say, the headline numbers on these buyout offers sound good, but there’s always a catch. Some are stock-only offers, and the stock isn’t attractive. Some are payouts over many years, contingent on the performance of the company under new management. Some are debt deals with big balloons at the end. But one cousin has shown up with her lawyer in tow, hinting that your failure to sell the company at these prices is a breach of fiduciary responsibility. Whatever happened, you were wondering, to our one big happy family?
Then, in the midst of all this dissension, an urgent call comes in from the bankers. They are speaking so excitedly on the phone that you can’t at first understand what’s going on. Then you get it and your knees collapse and you fall into a chair: the rollup guys are offering $500 million cash for the family company. There’re two catches: you have to sign a letter of intent in thirty-six hours and if the deal hasn’t closed in forty-five days the buyer can walk. You grab a plane to New York.
Forty days later you have $250 million cash. (You had to pay off the debt, set aside an escrow for taxes, and, of course, pay the bankers, lawyers, accountants, grips, riggers – oh, not the grips and riggers, it just seemed like it.) That money is sitting in money market accounts in large banks earning precisely nothing. It’s burning a hole in your pocket as you watch the stock market soar higher and higher. Naturally, you hire a financial advisor.
(1) Obviously, the Smiths aren’t a real family. However, everything in this post (and the next two posts) actually happened to a family I know, it’s just that they didn’t all happen to the same family. The Smiths are a composite, but a realistic one, I hope.
Next up: How Not to Invest a Fortune, Part 2: Other People’s Money
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Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.
