[A-List] FT: 'Inappropriate capital structure' leads to take-over
jensenmk at plu.edu
Sun Jan 22 12:01:22 MST 2006
[Perhaps of interest in the context of 'financialization.' --Mark]
WHEN LOCUSTS COME TO THE RESCUE
By Patrick Jenkins
Financial Times (UK)
January 22, 2006
When Mehdi Biria and his family upped sticks from Iran in 1982 and moved to
Heidelberg in south-west Germany, he did not guess that within 20 years he
would be the owner of Europe's third biggest bicycle manufacturer less
still, that three years later the family business would have been snapped up
by an American "locust".
The "locust" in the words of Franz Müntefering, Germany's private equity-
and hedge-fund-hating deputy chancellor, was Lone Star, a Dallas-based fund
that has spent much of the past three years buying up the bad debts of the
Last month, it paid an undisclosed sum to take over Biria's assets, in
exchange for the debts the company had run up with its banks.
"This is a basically sound company," says Bruno Scherrer, head of Lone Star's
operations in Europe. "It was just run with an inappropriate capital
It is a tale that could be told across Germany, particularly among the
family-owned Mittelstand companies that form the backbone of Europe's biggest
Many company founders, keen to retain control over their empires, have been
loath to raise capital through external equity issuance and have relied
instead on standard bank borrowing for all their financing needs.
While this worked with few hitches for decades, the environment has changed in
recent years as the pressures on banks' lending policies have mounted. Even
the state-owned Landesbanken and Sparkassen, or savings banks, which have long
played a key role in supporting the Mittelstand, have found their ability to
lend undermined. The capital allocation principles of Basel II regulations,
due by 2008, have already ended a tradition of lending at uneconomically low
rates. Compounding that, the public-sector banks' state guarantees were
terminated last summer, slashing their inflated credit ratings and curtailing
their ability to borrow and, in turn, lend cheaply.
Reinforcing banks' changed attitudes has been the fall-out they felt during
the German recession of 2002 and 2003, when customers defaulted on their
borrowings and bad debts accumulated rapidly. For Biria, the supplier of more
than 3m bicycles to Deutsche Post, the German post office, the crunch came
when its lead bank, Landesbank Sachsen, pulled the plug.
By 2004, even as it was expanding production capacity to 800,000 bicycles a
year, the company could see the crisis coming and had begun its own search for
a buyer. "Lone Star was our own choice," says Gerhard Urbannek, who runs
Biria. The deal, he says, should help the company to regroup but it also gives
Lone Star an important platform to repeat the exercise elsewhere. "For them,
buying Biria should be a calling card for restructuring the German Mittelstand
He could well be right. Lone Star has singled out Germany as its key market
for investing in bad debt. It will invest a good half of its current $5bn
(£2.8bn) fund in the country and has already bought up assets with a face
value of 11bn (£7.5bn).
The firm made its name restructuring the bad debts of Japanese and South
Korean banks in the 1990s and it still owns big groups in that region Tokyo
Star in Japan, which it has cleaned up and part-floated, and Seoul-based Korea
Exchange Bank, which has been restructured and is for sale again.
In the first flush of Lone Star's life in Germany it acquired large bad debt
portfolios from big banks. It did the biggest deals with Hypo Real Estate, the
Munich-based mortgage bank, acquiring a record 3.6bn slice of loans in 2004,
and Dresdner Bank, from which it has acquired billions of euros of loans in
several slugs. All the while it has also been buying up, with less pomp,
individual loans from smaller banks.
Lone Star all but founded the market for buying German bad debt portfolios in
2003, when it acquired the assets of the defunct Gontard und Metallbank. But
competition, attracted by estimates that 300bn of the 500bn bad debts of the
whole of Europe are in Germany, has stiffened as other private equity buyers
and investment banks, led by Goldman Sachs, have pitched in.
Critics are concerned that the market is riding for a fall, as prices paid for
debts as a proportion of their face value have crept up. The average is now
estimated at more than 70 per cent, compared with perhaps 30 per cent in 2003,
constraining the opportunity for investors to work through the debts and still
make a profit.
Perhaps as a consequence, Lone Star appears to have switched its attention
away from portfolio deals. After consistently winning auctions for a couple of
years, it has been outbid on 4bn of recent distressed debt sales by HVB, the
Munich-based bank that is now owned by Italy's UniCredit.
Instead, its most recent focus has been on buying whole banks first the
Mitteleuropäsche Handelsbank (MHB), for its bad debts and its banking licence;
and, more ambitiously, just before Christmas, AHBR, the near-insolvent bank
that is one of Germany's top five mortgage lenders.
It is by buying whole banks that Lone Star believes it can capture the biggest
opportunities in the market. Financial details of the AHBR transaction were
not disclosed but Lone Star is thought to have been paid 600m to take on the
bank, which has assets of about 77bn but was near collapse after sustaining
losses on east German property lending and a misguided bet on interest rate
In addition to the potential return in restructuring the bad debts, the bank
will also have its own value and, as in Lone Star's Asian deals, the plan with
AHBR is to clean it up and sell it.
"There is a desire to keep this business going," says Mr Scherrer. "First, we
must deal with assets on and off the balance sheet. Then we must bring the
bank back to profitability. We could float it like we did in Japan or sell to
a strategic buyer."
Financial turnrounds such as that, and the handsome profits they generate for
investors, are precisely what have attracted the vitriol of patriotic
politicians such as Franz Müntefering. But Mr Scherrer's defence is
uncompromising. "We're not doing anything other than what's being dictated by
the market. Without a clear break from the past, AHBR had no future. It was a
choice between either liquidation or a solution like ours."
AHBR might be Lone Star's highest profile German project to date. But behind
the scenes the firm has continued to focus on working out the bad debts from
earlier deals. That process is long and involved and can lead the investor in
several directions. At its most abstract, an investor can generate a return
from repackaging debt portfolios and selling them on to other investors at a
higher price. More invasively, it can send in debt collectors or put a
borrower into liquidation.
But Lone Star and other big buyers of German distressed debts insist that is
not their prime target. Far more frequently, the endgame is a corporate
restructuring story, says Mr Scherrer, adding that there is nearly always more
value to be had in keeping a company alive rather than killing it.
"A lot of the companies [whose loans we have acquired] have the potential to
survive, turn around and thrive," he says. "Some people used to think of us as
vultures who would come in and destroy a company. Now they realise we can be
part of the solution."
As the billions of euros of bad debts that Lone Star has acquired are worked
through, attention will turn to individual corporate restructurings, such as
that of bicycle maker Biria. Thanks to the banking licence it has through MHB,
Lone Star can now lend fresh money to Biria while also adding more
sophisticated financing to create the most efficient capital structures.
Biria's founder is now 73 and retired. But the management, which has been
retained, does not talk like the frightened prey that politicians make them
out to be. "We have 400 staff and we expect that number to rise over the next
two years," says Mr Urbannek. "Our mid-term target is to increase production
to 1m bikes. And with Lone Star's support, we plan to take an active part in
the consolidation of Europe's bike makers."
HOW LONE STAR TAKES ON BAD DEBTS
¦ It buys up a bank's bad debts singly or in portfolios or, more dramatically,
acquires a whole bank.
¦ It pays a percentage of a loan's face value depending on how "distressed" it
¦ It works through those debts, selling some on and recovering others.
¦ In some cases, a troubled borrower's debt can be converted to equity, giving
control of the company to Lone Star. The company can then be restructured and
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