By Arthur Vidro
By Arthur Vidro
The parent company of Chuck E. Cheese filed for bankruptcy protection on June 24.
Where I grew up, the wealthier residents held birthday parties and other gatherings for children at the nearest Chuck E. Cheese.
I never entered the store, but there are about 600 locations nationwide. Some are still shut down because of the pandemic, some have reopened. Despite the bankruptcy, the stores are allowed to continue operations.
Its parent company, CEC Entertainment, couldn’t handle the debt load that was imposed on the company from a leveraged buyout.
What is a leveraged buyout?
It’s when an investor – be it individuals, investment firms, or even a long-established rival – purchases a company but doesn’t spend its own money to buy it. It gets financing via debt.
Sometimes this works out fine. Other times it’s a disaster. Disasters are more likely when, as happens far too often, the debt is foisted upon the bought-out company.
In big business, if company A buys out company B it thumps itself on the chest for having done so. Even if the deal was financed entirely with debt.
The prior owners – in most cases, stockholders – get a handsome payout, and the new owners stick the acquired company with the debt that was incurred to buy it. They hope that, over time, the purchased company’s profits will pay off the debt. But even if the purchased company never pays off its debt, the folks who bought it with leveraged debt are seldom hurt by the bankruptcy.
If the buyer has sold shares of the purchased company, or spun off pieces of it (perhaps selling corporate divisions or physical assets), they have created a nice profit for themselves.
But the purchased company itself often staggers, and sometimes collapses.
Back in February 2014, investment firm Apollo Global Management acquired CEC Entertainment for about $950 million.
Did Apollo Global shell out $950 million? No way. The deal was financed with debt.
Apollo Global had hoped to take CEC Entertainment public again. It wanted to issue stock for the public to purchase, and that money would have paid off the debt or else provide Apollo with a nice profit – well, that was the plan.
Instead, we have bankruptcy.
At the time it filed for bankruptcy, CEC Entertainment had more than a billion dollars in debt. In short, the full purchase price “paid” for CEC in 2014, CEC still owed to the lender.
Note that when CEC declared bankruptcy, with the intent of renegotiating or discharging its debt, it was CEC’s debt.
Apollo Global is not declaring bankruptcy. Apollo Global won’t be affected by the bankruptcy. Nobody running Apollo Global is losing their own money from the bankruptcy.
Remember Toys “R” Us? Its demise was similar.
Back in 2005, a consortium of three investment firms – Bain Capital Partners, Kohlberg Kravis Roberts, and Vornado Realty Trust – did a $6.6 billion leveraged buyout (pleasing the Toys shareholders and officers), taking the company private.
The investment firms financed the massive buyout with debt, which was placed on the back of Toys “R” Us.
Under the new ownership, debt at Toys “R” Us rapidly increased. Eventually, the debt load became too much to bear. When Toys “R” Us filed for bankruptcy it still had more than $5 billion in long-term debt. It couldn’t keep up with its debt payments. So it went belly-up.
Toys “R” Us filed for bankruptcy in 2017 and permanently closed its stores in 2018.
Note that Bain Capital didn’t go belly-up. Nor did Kohlberg Kravis or Vornado Realty. They all escaped the financial carnage.
Twenty years ago, people sometimes bought houses without putting any money down. The house would be bought entirely with debt. The collateral for the loan was the house itself. When the Great Recession hit, the value of a house often dropped below the amount that had been borrowed to buy the house. People lost their homes or walked away, and the banks and other creditors swooped in and resold the houses for whatever they could salvage.
Whether you are buying a house or a Fortune 500 company, if you are financing it primarily through debt, all it takes is one unexpected gust of wind to blow down your house of cards.
As the pandemic continues, those companies saddled with the greatest loads of debt are the ones most likely to go bankrupt.
Who’s next?
If you have consumerism questions, send them to Arthur Vidro in the care of this newspaper, which publishes his column every weekend.
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