If you liked The Code of Capital you’ll like Plunder: Private Equity’s Plan to Pillage America by Brendan Ballou.
Though I’m not sure the book does a fully convincing job of teasing out the influence of coincident factors (most specifically a nationwide transition from brick and mortar retail to e-commerce), it does give a lot of illustrative examples where the smoking gun seems to be pretty clearly in the hand of how PE fundamentally works.
Notes and quotes…
655 And here’s where private equity showed its genius. Sun Capital, through Friendly’s, proposed to sell the business to… itself. One of Sun Capital’s subsidiaries was Friendly’s owner. But another Sun Capital subsidiary was its largest lender84 and had loaned Friendly’s $152 million, which had blossomed to $268 million with interest.85 Another affiliate provided $71 million to keep Friendly’s in business through bankruptcy (what’s known as debtor-in-possession financing).86 Sun Capital proposed to reacquire Friendly’s by forgiving these debts, a tactic known as credit bidding.
The 363 sale allowed for other companies to bid on Friendly’s, but most everyone else was at a huge disadvantage. Sun Capital was proposing to buy Friendly’s by forgiving debt—debt that was unlikely to be paid in full—while other potential buyers would need to pay actual money for the company. Moreover, Sun Capital was allowed to bid both the principal and interest for the company, meaning that it paid just $152 million for a possible $268 million bid. Nobody else could hope to pay so little for so much.
And nobody did.87 The auction for Sun Capital, which was to be held at Kirkland & Ellis’s New York office,88 was canceled for lack of interest.89 Sun Capital’s affiliate was able to acquire Friendly’s without so much as a fight.90
Reading the court documents, there is an absurd sense in which Friendly’s—and Sun Capital—talk about themselves in the third person, as if they were completely unrelated. To take one example of many, in an early filing, Friendly’s lawyers said that a “bidder” already expressed interest in buying Friendly’s, an encouraging sign and one that might incline the court toward approving Friendly’s requested auction process. But the lawyers added only in a footnote that the bidder was an affiliate of Friendly’s existing owner, Sun Capital.91 This wasn’t necessarily dishonest, but the effect was to make it seem like Friendly’s contemplated a genuine sale to a third party, rather than a reshuffling of Sun Capital’s ledgers.
But why go through this whole process at all? Why would Friendly’s declare bankruptcy, just to be sold from one Sun Capital fund to another? The answer was simple: pensions. At the time of bankruptcy, Friendly’s had $115 million in pension liabilities.92 By selling Friendly’s to one of its affiliates, Sun Capital was able to reacquire its own company free and clear of those liabilities. Instead, they were transferred to the Pension Benefit Guaranty Corporation. The PBGC was chartered by Congress to rescue underfunded pension plans and paid for itself in part through insurance premiums that healthy pension plans paid to it.93 But it was always meant as the destination of last resort, not as a convenient sucker for strategic bankruptcy reorganizations.
And so the PBGC objected to Friendly’s plan, correctly observing that “each and every party to this bankruptcy… is an affiliate of Sun Capital Partners, Inc.”94 The PBGC argued that Sun Capital’s loans to Friendly’s should probably be treated as equity—that is, further investments by the owner of the company—rather than as debt. This mattered because in bankruptcy a party can’t credit bid equity, and if the court granted the motion, Sun Capital would have to wager cash for the company like most everyone else. The PBGC also requested procedures that would encourage the winning bidder to assume the obligations of the company’s pension plan. But the court denied both these requests.95
The PBGC didn’t bother to make the more aggressive argument that the entire 363 sale process was invalid here. Such sales require good faith on the part of the buyer and seller, which can be undermined by collusion between the two.96 It seems unlikely that the court would have accepted this aggressive position, given that it rejected the PBGC’s more modest argument that Sun Capital’s debt should be treated as equity. But it could have been worthwhile to ask for discovery on whether—and to what extent—Sun Capital’s various affiliates communicated with each other and with their parent company before, during, and after the bankruptcy process.
Regardless, Sun Capital was able to reacquire Friendly’s free and clear of its pension obligations, without spending anything more than the money it lent its own portfolio company. Pensioners were the obvious losers in this process, who risked having their payments cut (the PBGC observed over the previous decade that it had been forced to cut $70 million in benefits to employees after 363 sales by debtors owned or controlled by private equity firms).97 Pension plans for more responsible companies lost too: they would have to pay the costs, through increased premiums to the PBGC, that Sun Capital was unwilling to.
877 Consider the case of Dr. Raymond Brovont, who was employed by Envision’s predecessor, EmCare, as the director of an emergency room in Overland Park, Kansas. EmCare had a long history with private equity: the firm Onex bought the company in 2004 and took it public the next year, though continued to own a majority of shares.34 Clayton, Dubilier & Rice bought the business in 201135 and took it public once again, though the company kept a substantial stake in the company until 2015 and kept affiliated directors on the board until 2017.36 Finally, KKR bought the business’s parent, now named Envision, in 2018.37
As medical director at Overland Park, Brovont worked under a number of private equity owners and investors and quickly felt that EmCare had dangerously understaffed his department. For most of the day, just one doctor was on call to treat patients in both the pediatric and ordinary emergency rooms. Yet at the same time, the hospital required an emergency doctor to attend to any code blues, situations in which a patient’s heart or lungs stopped working.38 This could occur anywhere in the hospital, and when it did, it often meant that the emergency room had quite literally no doctor available.
Brovont feared that this short-staffing violated the law, as well as the standards set out by the American College of Surgeons.39 And so he complained and ultimately organized a meeting between his emergency room doctors and an EmCare executive, Dr. Patrick McHugh. McHugh listened to the doctor’s complaints but offered an astoundingly tone-deaf reply. He wrote to all emergency room physicians, noting that for the hospital chain, “many of their staffing decisions are financially motivated. EmCare is no different.”40 “Profits are in everyone’s best interest,” he added. “Thank you as well for respecting my request to refrain from publicly voicing your concerns/objections until we are given a fair opportunity to address them.”41 In his email, McHugh even included links to EmCare’s stock and financial information. His comments were refreshingly honest, but they laid bare the basic problem: EmCare was apparently making decisions that affected patients and was doing so, it appeared, out of a desire for profits alone, untempered by, for instance, medical judgment.
After the meeting, no changes were made.42 Brovont raised the issue several more times with the EmCare executive, to no effect. And so Brovont wrote a formal letter, endorsed by all the physicians in the emergency department, complaining about the understaffing crisis. He never received a response, only a terse shot from the EmCare executive in the hallway: “Why would you ever put that in writing?”43 Six weeks later, Brovont was fired.
Brovont eventually sued the EmCare subsidiaries who employed him for wrongful termination.44 In the course of litigation, it was revealed that Brovont’s firing “petrified” the other doctors and created a “weird cult of coercion” and silence on the code blue policy.45 Eventually, and encouragingly, Brovont won nearly $26 million for his firing, including substantial punitive damages.46 After the judgment, however, the hospital declined to say whether it had actually changed the understaffing policies that Brovont had complained about.47
The debacle with Brovont was illustrative, but it wasn’t isolated. Like EmCare, Blackstone’s TeamHealth fired an emergency room physician—Dr. Ming Lin—after he complained about his hospital’s inadequate COVID-19 protections. In particular, Lin sent a letter—and posted its contents on Facebook—to the hospital’s chief medical officer, recommending that staff have their temperatures taken at the beginning of their shifts and that patients be triaged in the hospital parking lot.48 He also criticized as “ludicrous” the hospital’s practice of testing patients for COVID only after a prior influenza test proved negative.49 Doing so needlessly exposed both patients and doctors to increased risk, he argued. Shortly after Lin published his complaint, TeamHealth terminated Lin’s shifts with the hospital, telling Lin that while the company believed that his comments were “intended to be constructive… unfortunately it is not possible for you to return” to work.50 Ultimately the ACLU chose to represent Dr. Lin in a wrongful termination lawsuit, characterizing the matter as one of free speech. TeamHealth denied that it had fired Lin and told NBC that it offered to place him “anywhere in the country”; the litigation remains ongoing.51
1324 The situation was even worse in Bayonne, New Jersey, which had taken a similar deal with KKR and its operating partner a few years before. In announcing the agreement, the parties made big promises. A law firm hired by the water authority estimated that the city could save over $35 million over forty years.22 The CEO of the operating company extolled “KKR’s long-term vision,” which, he said, “brings credibility to address America’s water challenges.”23 The Clinton Global Initiative even featured the partnership as an innovative new business model in its annual meeting.24
In announcing the deal, Bayonne officials promised a four-year rate freeze, but unsurprisingly, that never happened. Because the city had guaranteed revenue to KKR and its operating partner and because people were using less water than expected, rates increased substantially almost every year.25 Moreover, Bayonne agreed to pay for any major infrastructure repairs itself and, if it needed any money to do so, to borrow specifically from KKR.26 In other words, the deal was almost comically lopsided. Yet despite the talk of KKR’s “long-term vision,” within a few years, the firm sold its stake to another private equity firm, in the same deal in which it offloaded its investment in Middletown, for $110 million.27 It nearly tripled its money on the Bayonne project.28
In the aftermath of the deal, citizens of Bayonne tried to find ways to escape their forty-year contract, or at least live under it. “I’ve become the water nazi,” one resident told the Hudson Reporter, “telling my family: ‘You’ve got two minutes in the shower.’” “I buy flowers that require little water because I don’t want to use my water,” she added.29 A third resident complained that she had been charged $900 for a single three-month period. “There is no water being used other than our faucets and our toilets and our shower,” she told the Jersey Journal. “I don’t know how to handle this.”30 Liens against properties for unpaid water bills rose dramatically.31
But there was little that residents, or Bayonne, could do. After hiring a law firm to review its contract, the city found that the only way it could escape its forty-year agreement would be to buy the parties out, for hundreds of millions of dollars. This was an unaffordable proposition. And so, while KKR left the deal after just a few years, having made tens of millions of dollars, Bayonne was saddled for decades with an agreement that its residents simply could not afford. Bayonne, like Middletown, had been played.
- Read Plunder: Private Equity’s Plan to Pillage America by Brendan Ballou