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Special Report: How Fed policy enriches private equity, if not workers

Richard Smith stands in front of a factory owned by Platinum that he worked at for 20 years before it was closed in 2010 by the company in T
Richard Smith stands in front of a factory owned by Platinum that he worked at for 20 years before it was closed in 2010 by the company in T

By Carrick Mollenkamp

MACON, Georgia (Reuters) - Sanders Walker had been working for 13 years at a BWAY Corp factory in Macon, Georgia, when the word came down one September 2011 morning: The company, a maker of plastic and metal containers, was closing the plant. Walker, a quality manager, and about 70 other employees were out of work.

After an eight-month search, Walker got a job at another area factory, at sharply reduced pay. "Nobody wants to hire somebody that is 62 years old," he says. Walker and his wife, Shari, struggled financially. Facing foreclosure, they walked away from their home in July 2012. They now live in a mobile home at the KOA Campground in Forsyth, Georgia. Tending to the potted chrysanthemums and other plants around the place gives Shari something to do "besides worry," she says.

The private-equity firm that owned BWAY when Walker lost his job enjoyed a more satisfying relationship with the company.

High-risk debt issued by BWAY helped Chicago-based Madison Dearborn Partners LLC acquire the manufacturer in June 2010 for $915 million. In that partially debt-financed buyout, Madison Dearborn put up just $294 million of its own cash. A few months later, it paid itself a $138.4 million dividend from the proceeds of a BWAY junk-bond sale it helped arrange. Then, late last year, it sold BWAY to another private-equity firm in a leveraged buyout for $1.24 billion. BWAY then sold more junk bonds to generate a dividend payout for its new owner, Platinum Equity LLC.

All of these transactions were underpinned by unflagging demand for high-risk, high-yield investments like the junk bonds BWAY issued - demand fueled by "quantitative easing," the U.S. Federal Reserve's multitrillion-dollar bond-buying program to shore up the economy and create jobs after the 2008 financial crisis. Easy access to such credit, thanks largely to the Fed, has allowed private-equity firms like BWAY's owners to move aggressively to pay themselves dividends, reducing their own downside risk, while increasing the debt burdens of the companies they buy and sell.

RISING DEBT

At BWAY, debt has climbed as the Atlanta, Georgia, manufacturer has been flipped profitably from one private-equity owner to another in recent years. In autumn 2009, the year before Madison Dearborn bought BWAY, the company and its affiliates had total debt of $402.3 million, according to securities filings; now, that figure stands at $1.5 billion.

As its debt has grown, BWAY has cut costs while trying to bolster market share through acquisitions. Closing the Macon factory where Walker worked and another in Phoenix, Arizona, for example, was an attempt to realize "future cost savings," BWAY said in a regulatory filing at the time.

Madison Dearborn declined to comment. A spokesman for Platinum Equity said that in the past year, the firm has helped BWAY generate $51.5 million in additional earnings. "Not only have the improvements allowed us to recoup capital for our investors," he said. "But BWAY has re-invested substantially in the business and maintained a healthy balance sheet with ample liquidity."

Quantitative easing has had the intended effect of holding down interest rates, which has in turn encouraged borrowing by businesses and individuals with good credit and stabilized the housing market. But persistent economic uncertainty has dulled the positive impact of the Fed's program. U.S. gross domestic product has broken above a 3 percent annual rate of growth in only six quarters since 2009. Some of the money has instead inflated asset bubbles, to the benefit of mostly wealthy investors seeking high yields.

The Fed's "real intention was capital investment would be stimulated, jobs would be created, incomes of the 99 percent would rise," says Martin Fridson, a high-yield expert and chief executive of FridsonVision LLC, a financial research firm in New York. But, he adds, it's "not clear how effective that has really been. It's certainly clear that those who are wealthy enough to own a substantial amount of assets have been made even wealthier by the Fed policy."

A Fed spokesman declined to comment. Federal Reserve Vice Chair Janet Yellen, the nominee to lead the central bank, said at a Senate confirmation hearing last month that the Fed is monitoring the costs and risks associated with the stimulus program.

In its Uneasy Money series, Reuters has in recent months examined the effect of all this money sloshing around, showing, for example, how the yield chase has underpinned surging markets for bonds issued on pools of subprime auto and mortgage loans.

HEAPS OF JUNK

Among the biggest of the Fed-inflated asset bubbles is in the market for junk bonds. Last year, junk-bond issuance hit a decade high of $326.72 billion, rising from a trough of $62.9 billion in 2008, according to Thomson Reuters data.

Investor demand was so strong that, despite the flood of junk onto the market, yields fell below 5 percent for the first time ever in May this year, according to Barclays Plc. That compares with the historical norm of between 8 and 10 percent and the 20.5 percent yield touched in March 2009, in the depths of the financial crisis. Demand has slackened in recent months.

The plunge in junk yields has pushed investors into a particularly risky subset used several times by BWAY: payment-in-kind, or PIK, toggle bonds. These securities enable a corporate borrower to make repayments with cash or more bonds with even higher interest rates. PIK toggle sales so far this year, at $10.7 billion, compares with just $875 million in 2009, according to Standard & Poor's Capital IQ.

"PIK is back because PIK bonds give extra yield," says Adam Cohen, founder of Covenant Review LLC, a New York credit research firm. As an example, he cites PIK toggle bonds BWAY sold in October 2012 with a 9.5 percent coupon, rising to 10.25 percent if BWAY opts to repay with more debt. "That is some real money in a market where high yield can mean 5 percent," Cohen says.

This chain of effects originating from the Fed's bond-buying has not altered the private-equity formula: The firms buy companies using debt issued by the target, pay themselves dividends from more debt issued by the acquired company, and then take the company public or sell it to another buyer. To increase the value of their investment before they sell it, they typically try to improve operational results, through expansion, cost-cutting, consolidation and other means.

What has changed is that private-equity firms can now use more debt and less of their own money, reducing their risk and speeding up turnover times. Unrelenting investor demand for junk has meant that companies backed by firms like Madison Dearborn and Platinum can issue more of the bonds, more often, generating for the firms and their affiliates dividends to recoup big chunks of their investments quickly. So-called dividend recapitalizations by private-equity-controlled companies and funded by PIK notes total $8.23 billion so far this year, compared with zero in 2009, according to S&P Capital IQ.

Dividends "put more money into the sponsor pockets faster, which makes the sponsor, logically, more willing to take risks going forward," says Cohen of Covenant Review. "It puts more financial pressure on the whole firm to make interest payments, and that increased pressure can reduce the amount of cash left over to reinvest in the company."

HEAVIER BURDEN

The debt is leaving some companies in private-equity portfolios weaker. Their ratio of debt to earnings before interest, taxes, depreciation and amortization for companies issuing junk debt hit a low of 4.23 in the fourth quarter of 2011 and hovered below 5 before peaking at 5.08 in the second quarter this year, according to S&P Capital IQ. It has since fallen to 4.67.

At BWAY, the ratio hit a much higher 7 earlier this year, according to Moody's Investors Service. BWAY acknowledged the situation in its annual report for 2012, saying: "Our substantial level of indebtedness could adversely affect our financial condition and prevent us from making payments on our debt obligations."

BWAY's current owner, an affiliate of Platinum Equity, said through a spokesman that the private-equity firm's expertise at "early value creation" made the dividend possible, that increasing the manufacturer's profits is a top priority, that BWAY's leverage ratio is declining, and that BWAY has "consistently proven its ability to generate cash and pay down debt."

Mark Barnhill, a partner at Platinum Equity, added: "We're not financial engineers. We're operators who are hip deep in restructuring. We're rolling up our sleeves to generate change at the operational level that improves performance."

Founded in 1875 as a maker of pie tins, BWAY today is one of the largest U.S. manufacturers of paint cans, plastic pails and ammunition boxes, according to Moody's. The company's history as a darling of private-equity firms began in 2003, when New York-based Kelso & Co acquired it for $330 million, including the assumption of debt.

In what became the private-equity template for BWAY, the company pursued growth through acquisitions, snapping up three plastic-container makers in 2003, 2004 and 2006, respectively, by tapping loan agreements. By the fourth quarter of 2006, BWAY owed long-term debt of $418 million, up from $112.8 million in 2001.

The next year, Kelso partially cashed in by taking BWAY public at $15 a share. The deal raised $150 million. Kelso retained 44 percent of the company.

In 2008, BWAY closed plants in Franklin Park, Illinois, and Cleveland, Ohio. The next year, it closed some division offices and "eliminated" 25 salaried positions, according to a BWAY securities filing. Those cuts saved the company $3.1 million in 2009, it said.

Kelso declined to comment.

Around this time, the Fed initiated its first round of quantitative easing, which entailed buying as much as $1.25 trillion in mortgage securities and $300 billion in Treasury bonds, among other measures. In a March 18, 2009, statement, the Fed said: "Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending. … The Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability."

And thus the yield chase began. The sheer volume of Fed demand drove up bond prices, pushing down yields and prompting investors to hunt for better returns. Sales of junk bonds in 2009 more than doubled from the previous year to $146 billion.

LESS EQUITY REQUIRED

Kelso began looking for a buyer for its 44 percent holding in BWAY. In early 2010, Goldman Sachs Group Inc, acting as financial adviser, at one point told a BWAY committee that with demand strong in the bond markets, private-equity firms wouldn't have to kick in as much equity as they had in previous years to secure debt financing from banks, according to a securities filing.

Madison Dearborn in June 2010 completed the $915 million acquisition of BWAY. The deal involved about $689 million in debt financing and resulted in the paying down of $457 million of existing BWAY debt. Shareholders received $20 a share, a 15 percent premium to where the stock was trading before the deal was announced. An additional $5.5 million went to affiliates of Madison Dearborn for "transaction fees" and "out-of-pocket expenses."

As the deal was wrapping up in January 2010, BWAY decided to close a plastic-bucket plant in Toccoa, Georgia, it had acquired when it bought a company in 2004. According to a Georgia Department of Labor press release at the time, 90 workers would lose their jobs.

Richard Smith, a 21-year veteran of the plant, was at the meeting where a BWAY executive delivered the news. "Everything was good," he says. "Next thing you know, we had a meeting. … We're going to be shutting the doors." Smith had helped keep the machines running that produced buckets. "I was going to retire from that place," he says. "It was a good place to work. I had a good name."

Smith says BWAY offered him a job in another Georgia town, but he felt that he couldn't uproot his wife and family from Toccoa. He had been earning $760 a week at BWAY. Unemployment insurance paid him $280 a week for a year and a half. He now does maintenance work for a local disposal company for about $800 a week.

Meanwhile, Madison Dearborn's acquisition of BWAY closed in June 2010. Four months later, it pocketed about $138.4 million from a BWAY sale of PIK notes.

Moody's downgraded BWAY's "corporate family" rating to B2 from B1. Edward Schmidt, a packaging analyst at Moody's, said in a report at the time: "BWAY's pro-forma credit metrics leave little room for any negative variance in operating performance." He said the downgrade reflected a "deterioration in pro-forma credit metrics" and "the potential for free cash flow to be used for acquisitions rather than for debt reduction."

In October, BWAY acquired plastics maker Plastican Inc from a Leominster, Massachusetts, family for $40.9 million in cash. At the time, Plastican was operating plants in Macon, Georgia; Leominster, Massachusetts; Dallas, Texas; and Phoenix, Arizona.

BWAY began closing Plastican plants. Larry Williams was working as a quality manager at Plastican's plant in southwest Phoenix when the new owners "came in and said we have jobs for everybody," he says.

A December 2010 document reviewed by Reuters shows that BWAY had already drafted a $1.2 million plan that included moving newer machines out of Phoenix to replace older ones at other plants. The aim, according to the document, was "to increase our chances of success while reducing the risk of our customers feeling the effects of the moves."

"NEVER A GOOD THING"

BWAY told Williams it had a job for him - across the country in Lithonia, Georgia. He applied, ready to move his family, but "they put us off and put us off," Williams says.

The father of four still had three children at home. He finally landed a job in Phoenix at a company that makes reusable produce crates. He earns roughly what he made at Plastican. "It was a huge relief," says the 53-year-old. "Uncertainty is never a good thing."

When BWAY bought Plastican, Sanders Walker, the former quality manager now living with his wife in a mobile home, says a BWAY executive assured employees that the factory in Macon wouldn't close. In September 2011, BWAY decided to shut the Macon plant.

Platinum Equity, commenting for BWAY, said the company "made clear from Day 1, in the press release announcing the Plastican acquisition, that plant closings were likely." It said BWAY doesn't discuss individual employees or personnel matters. It also said BWAY helped those who were terminated in Macon and Phoenix, providing advance notice of the closures, severance and encouragement to apply for jobs at other BWAY plants. About 20 employees expressed an interest in staying with the company, it said; half were transferred to four different facilities.

Maintenance manager Kent Mize got a job one day after as a facilities maintenance manager for the Georgia Department of Defense. His earnings at Plastican peaked at about $58,000; he now makes $37,000. Largely because he couldn't afford the mortgage payments, "I ended up having to sell my home," he says in a voice raspy from treatments for throat cancer.

In the fall of 2011, as the third year of quantitative easing was coming to a close, the Fed increased its bond buying, and again in September 2012.

The following month, Platinum Equity agreed to buy BWAY from Madison Dearborn for $1.24 billion.

In the last full fiscal year under Madison Dearborn's stewardship, ending September 30, 2012, the number of hourly employees at BWAY fell to 2,400 from 2,600, according to securities filings. Net sales totaled $1.18 billion, up slightly from $1.16 billion in 2011.

Platinum Equity put up $269 million of its own cash to acquire BWAY. To help finance the rest, BWAY issued $335 million in PIK toggle junk bonds that paid a 9.5 percent coupon. Investor demand for BWAY's relatively high-yield junk was stronger than ever; similar bonds the company sold in 2010 had to pay a higher coupon of 10.875 percent. As a result of the deal, "we have a substantial amount of debt," BWAY said in its annual securities filing for 2012.

Platinum Equity, operating from offices in Beverly Hills, California, was founded in 1995 by Tom Gores, who immigrated to the U.S. from Israel with his family when he was four years old. Gores is also the majority owner of Palace Sports & Entertainment, which owns the Detroit Pistons professional basketball team.

Two months after Platinum Equity's purchase of BWAY, BWAY bought Ropak Packaging, another plastic-container maker, for $268 million in cash, financed with additional borrowing totaling $261 million and the use of a loan agreement.

In May this year, BWAY sold $285 million in PIK notes to pay a dividend to its new owner.

In a report issued after the payout, Moody's said the "debt-financed dividend, previous debt-financed acquisitions and PIK note debt in the capital structure demonstrate the company's financial aggressiveness." While noting BWAY's "dominant share in the U.S.," it also said that "BWAY's acquisitiveness and financial aggressiveness clearly heighten both operational and financial risk," and that after the dividend, "the sponsor retains little equity in the business."

"A PRETTY QUICK PULL"

The speed with which both Platinum Equity and Madison Dearborn were able to recoup a big chunk of their initial investments through PIK toggle sales "is a pretty quick pull of dividends," says Cohen of Covenant Review.

Platinum Equity also has done well as an adviser to BWAY, according to an August regulatory filing. An advisory affiliate of the firm received $5 million in fees for "financing advisory services" in the sale of the PIK notes. A few months earlier, it got $5 million for "transaction advisory services" on BWAY's acquisition of Ropak. In March of this year, BWAY paid the affiliate another $5 million to cover a "2013 annual management fee."

Platinum Equity said its "operational transformation" of BWAY resulted in a 31% increase in adjusted earnings before interest, taxes, depreciation and amortization to $180.5 million in the nine months ended September 30, 2013, from a year earlier, thanks largely to the Ropak acquisition, cost cuts and increased capital spending. It said executives have scoured BWAY for ways to improve operations. Among recent cost-saving measures: eliminating rubber gaskets that had been used in lids for plastic pails.

It also said BWAY's strong performance has "allowed BWAY to both reinvest in the company and return capital to shareholders." BWAY's sales, Platinum Equity said, rose 25% to $364.4 million in the quarter ended September 30 from a year earlier, while employment is up 25%, due mostly to the Ropak deal.

In April, one month before BWAY sold the PIK notes, it notified the Texas Workforce Commission that it would be shutting a Plastican plant in Dallas.

Platinum said it was moving production from one of BWAY's least efficient plants to one of Ropak's most efficient, in Mansfield, Texas. Sixty-nine people were laid off with the Dallas plant's closure.

(Additional reporting by Molly Hensley-Clancy in New York; edited by John Blanton)

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