Hey. Here’s something I don’t understand so I was hoping you experts here would tell me. OK so I heard private equity firms sometimes buy up companies, and then load them up with debt and then those companies then go bankrupt. Toys R Us for example.
Here’s what I’m not understanding:
Are the private equity firms on the hook for the debt if the buyed-out company goes under?
Doesn’t their credit rating go down if that happens?
Why would anyone lend them money to do what they did to Toys R Us?
Yes, but if it’s a bankruptcy, they’ve got assets to give back to the leinholders in lieu of their debt. Debtors may not get full value of what they’re owed. What they actually get back would be negotiated.
Private equity doesn’t have a credit rating. At least, not in the Experian / Transunion sense of a single number. Each individual lend decision will be decided on the merits of how well the PE can sell the opportunity.
Because it’s high-risk, high-reward for the private equity firm. Consequently, the lenders will require high interest to lend to PE firms, so they are compensated accordingly for the riskiness of the loans they are making. The returns, both to the PE firm and the lenders, are uncorrelated with other asset classes, so it’s a good way to diversify and take a little risk with something you don’t fully expect to mature at 100%.
PE companies also pay back the loans they took out to do the leveraged buyout via equity extraction (dividends, management fees etc) and cost-cutting (layoffs, pension cuts etc)
End result is usually a company with higher gearing, financially fragile, and not able to absorb any economic tail risks.
Paper below, along with a relevant snippet. I’m not an author or contributor to this in any way. I do make my living by working with independent physicians to engage them in value-based care while letting them remain independent, so I feel like I should disclose that. There is evidence that PE increases cost in healthcare. I’d have to dig to see if I could find the other side, but there isn’t much evidence if any showing that there are gains in quality to justify the cost increase.
Several recent studies have assessed private equity’s ownership of physician practices. One study looked at specialist practices (dermatology, gastroenterology and ophthalmology) acquired by PE firms between 2016 and 2020. The researchers found that a PE-owned practice had a price 20% higher than at non-PE practices (Singh et al. 2023 Society of Actuaries Research Institute 2022). Another study analyzed prices for anesthesiology practices operated by physician management companies (PMCs), which are often backed by PE firms. This study found that unit price increases were 18.7% higher than nonPMC practices (La Forgia, Bond and Braun 2022). A third study found that in eight of 10 specialties reviewed, there were significant increases in price changes for PE backed firms following an acquisition compared to non-PE practices. The greatest differences were 16% for oncology practices, 14% for gastroenterology and 9% for OB/GYNs (Scheffler et al. 2023).
Additional evidence shows increases in income and prices for hospitals acquired by private equity firms. Bruch and his team found significant increases in inpatient charges per day and in net income among 204 hospitals acquired by PE firms from 2005 to 2017, compared with 532 control hospitals not owned by a PE firm (Bruch, Gondi and Song 2020). As noted in Section 2.1.4, 25% of emergency rooms in the U.S. are staffed by PE firms. In 2020, Congress passed the No Surprises Act, which eliminated surprise billing among emergency room physicians, a practice pioneered by PE firms that resulted in high out-of-pocket fees for health plan participants (Scheffler et al. 2023). Another recent study of ambulatory surgical centers (ASCs) found that PE-backed firms raised prices gradually over
four to five years, with the researchers’ final comparison showing prices 50% above the baseline levels (Lin et al. 2023).