N ote to chief executive officers weighing that leveraged-buyout offer: You may have to give up the corporate jet.
Companies bought by private-equity firms are 32 per cent less likely to have a jet in the three years after the deal closes than in the year before, according to a paper written by the Federal Reserve Board’s Jesse Edgerton. The study, published on January 21, found that jet fleets at LBO-backed companies were at least 40 per cent smaller than those at similar publicly traded firms.
Buyout funds, which completed a record $1.3 trillion of deals from 2005 to 2007, have been criticized by labor groups such as the Service Employees International Union for being little more than financial engineers, relying on debt to make purchases and selling as soon as possible for a gain. Part of private-equity firms’ case is that they impose more financial discipline on a company, including cutting some perks corporate managers often take for granted.
“What the good investors do is go into a company, look for fat, and these guys are pretty good at removing it,” said Steven Kaplan, a professor at the University of Chicago Booth School of Business. “The trick is not to remove the muscle with the fat.”
The annual cost of operating a corporate jet could run as much as $5 million, with $1 million being typical, according to Edgerton, a Fed economist. While those amounts were not large compared to the revenue of companies he studied, they “could represent the tip of a larger iceberg,” he wrote. Edgerton declined to comment.
JUSTIFY EVERY EXPENSE
Private-equity firms also may look at costs such as golf memberships and elaborate corporate meetings when overhauling spending, said Jeff Bunder, global private-equity leader for New York-based Ernst & Young.
The pitch to newly acquired company managers is reminding them that a radically altered ownership structure means the shareholders paying for the perks were the managers themselves. They typically have larger stakes after the buyout and the potential for big paydays when the private equity firm sells the company or takes it public.
“You’re sitting around the table and have to think about it this way: Every dollar you’re going to spend is going to come out of your pocket,” Bunder said, noting that public companies tend to use the previous year’s budget as a starting point for increases, while a private-equity owner usually demands management start from scratch and justify every expense.
GULFSTREAM SOLD
To be sure, private equity is far from a spartan industry, and many of the biggest firms’ founders have their own aircraft. That includes Blackstone Group LP’s Stephen Schwarzman, Washington-based Carlyle Group’s David Rubenstein and David Bonderman of TPG Capital in Fort Worth, Texas.
In Schwarzman’s case, he owns his plane and is reimbursed by Blackstone for business use, which amounted to about $1.3 million last year, according to the New York-based company’s annual report. The other firms have similar arrangements with their plane-owning top brass.
Some buyout managers during the past year have reaped quick payouts in part by adding debt to companies they own and paying dividends to themselves and their investors. Aramark Corp, Burlington Coat Factory Warehouse Corp and Getty Images Inc paid such dividends.
When TPG and New York-based KKR & Co bought TXU Corp for a record $43.2 billion in 2007, among the first things the new owners cut was the company’s Gulfstream V jet, according to two people familiar with the decision, who asked not be named because the firm is privately held. Lisa Singleton, a spokeswoman for Dallas-based Energy Future Holdings Corp, as TXU is now known, declined to comment.
AGENCY COSTS
KKR’s penchant for cutting perks dates well before the TXU deal. In the aftermath of its $30 billion takeover of RJR Nabisco Inc in 1988, KKR sold seven of the company’s eight jets, along with more than 12 corporately owned houses and apartments, according to “Barbarians at the Gate,” the chronicle of the LBO written by Bryan Burrough and John Helyar.
Edgerton said the paper’s purpose was to examine how the objectives of management and shareholders could diverge in publicly traded companies — a concept known as “agency costs” — by looking at corporate jet use. While private jets can save firms time and money, it’s possible “that executives could overuse corporate aircraft if shareholders are unable to monitor or incentivize them properly,” he wrote.
In the study, Edgerton identifies three characteristics of private-equity ownership: “highly performance-sensitive managerial compensation, highly levered financing and active monitoring of firm activities by skilled professionals” from the fund.
‘MORE EFFICIENT FIRMS’
‘‘These changes are intended to transform firms into better-managed, more efficient organizations,’’ he wrote.
The pressure on private-equity managers comes in part from investors such as public pensions, which are under scrutiny from their members and beneficiaries. Funds such as the California Public Employees’ Retirement System have adopted new rules about how they interact with investment funds to which they commit money.
They’re also being more selective about where they invest, demanding more information from buyout managers as private-equity firms resume raising money and press for commitments.
‘‘Institutional investors have more bargaining power, and that means more scrutiny,” Kaplan said.
