December 12, 2016
The NYT ran a lengthy piece this weekend on how two private equity (PE) firms, Apollo Global Management and Metropoulos & Company, made a huge return on buying up the rights to Hostess Twinkies and a few of the company’s other brands, following the company’s bankruptcy. There are a couple of issues that deserve somewhat further attention than the article gives them.
First, while the article notes that its bankruptcy occurred under the ownership of Ripplewood Holdings, another PE company, it doesn’t discuss the issues which led to the original bankruptcy. Although the full story of Ripplewood’s control of Hostess would require another article of at least equal length, it provides a useful example of a private equity failure. Ripplewood borrowed heavily, putting the company in a precarious financial state. It also never made the investments necessary to modernize its facilities, putting it at a competitive disadvantage.
As the article notes, the bankruptcy relieved the company of its debts and pension obligations. The latter of which would fall to the Pension Benefit Guaranty Corporation (PBGC), which is run by the federal government. The PBGC is itself under serious strain presently, due to the collapse of many large pension funds. Furthermore, even if the PBGC is able to pay benefits at the legally guaranteed levels, most former Hostess workers will still see large cuts from the pensions they had earned while working.
This point is worth noting in the context of what appears to be the main basis for the huge returns earned by the two PE companies. It appears that they were able to buy the rights to Twinkies and other Hostess brands at a price that was far below the actual market value. While this indicated good insight on the part of the PE fund managers, if these brands had been sold for closer to the correct market value, there would have been more money to pay workers’ pensions and other creditors.
The other important item that needs qualifying in this piece is the implication that PE funds provide good returns for public pensions. The piece asserts:
“Teachers and firefighters also benefit from private equity.”
It later gives the testimonial of a former president of the retired teachers association in Texas on the benefits of private equity to pension funds.
It would have been useful to more carefully address the question of the returns to public pension funds from private equity. My colleague, Eileen Appelbaum, along with Rose Batt, has shown that the return on the median PE fund has not beaten the relevant stock index benchmarks since 2006. Furthermore, there is no longer persistence in returns so that PE companies that produce high returns in one period are no more likely to produce high returns in the next period than companies that had been bad performers in the first period. This makes it a very questionable proposition that PE funds are good for pensions.
As a final point, insofar as PE held companies tend to be more effective in avoiding their tax liabilities than the companies they buy, they will worsen the financial situation at all levels of government. If PE companies don’t offer higher risk adjusted returns than other investments, and end up losing tax revenue for governments, they would appear to be net losers at least from the standpoint of public pension funds, the opposite of what this article implies.
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