On the heavy-debt road to big buyouts - some heavy risks in the offing
JAMES O'LEARY says he gets ``very disturbed'' by the leveraged buyouts and major corporate mergers surging through the United States. ``It is a reflection of the fact we have had a definite reduction of moral and ethical standards in the financial community,'' says the economic consultant to the United States Trust Company in New York. ``The degree of greed which exists is very bad.''
Dr. O'Leary is critical of the fat fees charged by the lawyers and investment bankers involved in such deals. ``They don't do a lot, but they get an awful lot,'' says the former director of some major companies that were taken over.
An expert in financial flows, he is appalled by the buildup in corporate debt resulting from such deals as the $13.1 billion buyout of Kraft Inc. by Philip Morris Companies agreed to last week. He worries about the $313 billion in equity that has been removed from the nation's stock markets for nonfinancial companies in the years 1984-87. That's about 10 percent of the nation's total supply of equity. A record additional amount, well over $100 billion, will be removed from the market this year. He questions the wisdom of the huge increase in corporate bonds ($341 billion, about two-thirds junk bonds) by these same mostly industrial companies in the 1984-87 period.
What will happen, he asks, if the US gets into another recession like that of 1982?
When a company has raised a good portion of its capital through the issue of shares, when hard times come it can stop paying dividends. With this cushion, it has a better chance of survival.
But in the case of a highly leveraged company, it must use a larger portion of its shrinking cash flow to pay the interest on its bonds or other fixed-interest loans, such as commercial mortgages.
O'Leary suspects that some such high-risk companies will go into default on their debts - ``collapsing like a house of cards.'' He's concerned that this could worsen the recession.
Already the bonds of some companies involved in leveraged buyouts (LBOs) or other takeovers have fallen in price because investors wonder whether the companies can handle their higher debt loads. This experience is making it more costly for even solid companies to sell bonds - they must pay a higher interest rate on them because investors want some insurance against possible takeovers.
Now, O'Leary complains, investors are discovering that almost no company is too big not to be subject to a takeover.
``In recent years, we have gone hog wild on deregulation,'' he says. ``The antitrust laws aren't being enforced anymore, opening this thing up to abuse.''
Takeover artists talk about the greater efficiency resulting from corporate restructuring, meaning mostly selling off units. In the 1960s and '70s, investment bankers engaged in promoting corporate conglomerations spoke of ``synergy,'' the complementary gains from multiple mergers.
Which is it? Academic researchers sometimes find that mergers and takeovers offer economic benefits, sometimes that they do harm. If it's such a tough call, the disruption in the lives of employees must be a factor worth considering.
Presidential candidate Michael Dukakis has said: ``We are witnessing a shortsighted, fast-buck, get-rich-quick investment strategy that may have helped create 14 new billionaires in this country last year, but which, at the same time, is tearing companies apart as if they were Erector Sets.''
That may be populism, but it hits the nail.