These private investors were able to buy companies like Simmons with borrowed money and put down relatively little of their own cash. Then, not long after, they often borrowed even more money, using the company’s assets as collateral — just like home buyers who took out home equity loans on top of their first mortgages. For the financiers, the rewards were enormous.
Twice after buying Simmons, THL borrowed more. It used $375 million of that money to pay itself a dividend, thus recouping all of the cash it put down, and then some.
A result: THL was guaranteed a profit regardless of how Simmons performed. It did not matter that the company was left owing far more than it was worth, just as many people profited from the mortgage business while many homeowners found themselves underwater.
Investors who bought that debt are getting virtually nothing in the new deal.
Corporate raiders redux. Risk-free return!
Buy a company. Sack it by putting it deep into debt. Write big checks to yourself. Then sell it before the company dies. Rinse and repeat.
What a scam.
I'm not sure who is at fault -- the private equity firms that put the debt out there, or the money managers taking the other end of that deal, allowing the entire value-destructive cycle to even happen.
Private equity is supposed to create value. For decades, some firms have been buying companies and actually improving the companies they own. But in fast times like the past decade, it's hard to avoid the lure of writing checks to yourself... because there's nobody watching.