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Wednesday, December 11, 2013

Deals from Hell

London, Ontario, has been hard hit by company closures, as has all of Southwestern, Ontario. With thousands of Canadians losing their jobs, Sun Media columnist Larry Cornies has come out in print as an apologist for the companies. The companies are only acting in the strategic interests of their investors, he tells his readers. Corporations must seek to maximize value for shareholders, he claims.

The problem with Cornies' argument is that the executives running companies do not always put the shareholders' interests first. They might but then they might not. In many cases, the executives are looking out for Number One, themselves.

Mennonite Mutual Aid
Mennonite Mutual Aid
The title of this post was inspired by a book of the same name by Robert F. Bruner, professor of business administration at the Darden School of Business at the University of Virginia. An article in The New York Times examining business mergers and whether or not they make good financial sense reported:

"Bruner is critical of this process [business mergers], which he calls financial cosmetics. 'It invites the creation of growth for appearance rather than growth that creates wealth for investors and society,' he says."

Another good name for this post would have been Pay Without Performance after the book by Harvard professor Lucien Bebchuk with Jesse Fried. Why? Because so many of the recent closures did not benefit shareholders to anywhere near the extent that the closures benefited the deal makers

Consider Heinz. If your grandparents had bought just 100 shares for $2500 when the company went public in 1946, you would have owned, after stock splits, 16,200 shares, which would have been worth almost $1 million at the time Berkshire Hathaway and 3G made their offer. Those shares were yielding $33,372 annually in dividends. (Admittedly, Heinz shares did enjoy a $12 pop thanks to the buyout.)

Over the years, Heinz, the-public-company, was a cash cow for its shareholders. Now Heinz, the-private-company, will be a cash cow for Berkshire Hathaway Inc. and 3G Capital. It will not be a continuing cash cow for its buy-and-hold shareholders.

To argue that Heinz, an American company, would not have closed its large, Canadian plant is impossible. I have no crystal ball. But I can tell you this: Bloomberg Personal Finance reports that annual interest expense at Heinz probably doubled to $560 million since the takeover. Plus, Nebraska-based Berkshire Hathaway now holds $8 billion in preferred shares paying a 9 percent dividend, or $720 million a year.

If $720 million sounds like a lot, it is. Going private may have eliminated the common-stock dividend but that dividend only cost Heinz about $665 million.

Larry Cornies tells us: "For a multinational like Heinz, the comparative costs of labour, raw materials, power, land, machinery and other inputs in some other part of the world forced hard decisions here."

He's right. But what Cornies doesn't mention is that Heinz posted $2.01 billion in ebitda last year on $11.5 billion in revenue. Ebitda stands for earnings before interest, taxes, depreciation, and amortization. After deducting those expenses, the company was awash in $325 million free cash flow. Heinz wasn't facing any immediate hard decisions.

The hard decisions materialized when Heinz became a private multinational saddled with a lot of expenses associated with going private. Heinz faced something in the neighbourhood of 2000 hard decisions. That's the number of jobs Heinz has cut since being taken private.

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One last thought. One that I couldn't fit into the post above. All shareholders are not as shallow as Cornies apparently believes or as amoral. Cornies is a Mennonite and proud to be a Mennonite. Yet, I believe, there are Mennonites who would take a different tack that he does in his Free Press piece.

The following is from Crossroads, Eastern Mennonite University:

"No business that wants to last can afford to ignore in its financial statements the depletion of its productive assets, yet that is precisely what the global economy is doing. . . . Disaster looms precisely because the current economic model has no built-in limits – no stopping point short of a crisis generated by environmental or social collapse."

James M. Harder and Karen Klassen Harder, Bluffton University

I'd like to see Cornies tackle the closure of so many Canadian plants, many successful. These Canadian businesses were bought by American interests, sometimes private equity firms, the work moved to the States and the Canadian operations closed.

Possibly Cornies should read David Steward's Doing Business by the Good Book. Steward writes: "The investment community can apply tremendous pressure to produce quarterly profits. This outside persuasion sometimes tempts management to think short-term, reduce expenditures, and forgo quality. . . . the demand put on management for three-month gains isn’t necessarily good for a company’s [or its shareholders] long-term interests.”

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