The sudden rise in interest rates is catching many leveraged-buy-out companies in a bind.
A recent article online tells another tale of woe. Employees at Jenny Craig, the weight-loss chain, are all being laid off, with the company going to a direct-sales online model, assuming they can find financing. What happened and why are all these companies going out of business?
Interest rates.
During the last three or four decades, we have seen the same pattern. A company is sold to "venture capitalists" or even to management, who "buys" the company by leveraging it with massive debt. Or the company, once listed on the stock exchange, "goes private" in a leveraged buy-out. The differences between company shareholders and company debt are minor and staggering. In both cases, the bondholders and shareholders make money from the company. But shareholders never have to be paid back, and usually aren't (other than through share buy-backs, which are usually a sign of trouble ahead) and what's more, shareholder's dividends can be adjusted based on profits - or even curtailed entirely.
Bond holders, on the other hand, have to be paid, a fixed amount, every quarter, on schedule, come rain or shine, profit or loss. And in bankruptcy court, bondholders often become the new shareholders of the resurrected company.
So why are companies like Jenny Craig going bust? Buried in the article is this tidbit:
The company operated about 500 company-owned and franchised stores in the United States and Canada, according to H.I.G. Capital when it acquired Jenny Craig for an undisclosed amount in April 2019. It now employs more than 1,000 people.
Interesting. In other words, they bought out the company and financed it with bonds or loans at a time when interest rates were at all-time lows. And now that money is harder to come by, due to stress in the banking system, those bonds and loans are coming due and they are having trouble getting financing. Even if there was money to borrow, it would be at a much higher interest rate. They may have been servicing that old debt - just barely - but now cannot function with higher rates.
There are other hints in the article as well. They have a number of franchisees and yet claim they want to close stores and go to an online model. How do you do that without buying out all the franchisee's contracts? Simple: Declare bankruptcy, take control of the company (bondholders become the new shareholders) and then wipe out the franchisee contracts in bankruptcy court - along with those pesky leases on company-owned stores.
Bankruptcy reform laws of the last few decades have taken all the "fun" out of bankruptcy - for Joe Consumer, who has to work-out his debts - but the fun is still there for Corporate Chapter 11!
Of course, people are arguing other factors are at work and they may well be, too. Weight loss drugs are flooding the market, and let's face it - a lot of people in America have simply given up on losing weight. In addition, there is a lot of competition in the business, including nutrisystem - and there are few barriers to entry in the business.
Other storied companies in this sector are also struggling. Weight Watchers - the granddaddy of them all, is closing "studios" and scaling back to reorganize. Part of the problem is that the pandemic normalized online interaction. Going to a "studio" for a humiliating "weigh-in" is seen as less attractive. The world has changed, and many people no longer feel comfortable even going out in public, lest some Tick-Tock "prankster" shoot a squirtgun at them, or a disgruntled "incel" fire a real one.
But I think the real issue is money - or the lack thereof. This rise in interest rates will cause a number of companies that were teetering on the brink, to go over.
And for the people foolish enough to get variable-rate mortgages back in an era of the lowest interest rates in human history, well, I don't feel too sorry for them when their monthly mortgage rate nearly doubles. I mean, you had a chance to lock in a 30-year loan at 3.5% and turned it down in favor of a half a point less in interest?
Foolish.
