Autotrader.com recently decided to borrow $400 million for a brand new venture.
Was it in the field of research and development? Nope.
New marketing studies to explore an emerging niche in their core business perhaps? Not quite.
Issue a one-time $400 million dividend to their private shareholders and executives just before the IPO? Bingo!
The ones who will be paying for the principal and interest on this debt will be the upcoming shareholders in the form of lower earnings, a lower market valuation, and one other not so little thing hidden in the prospectus.
They will have no voting rights. In a move oddly reminiscent of a typical one-sided contract between an estate owner and a sharecropper, the new shareholders will have absolutely no say so in the affairs of the soon-to-be public enterprise. Even though their financial resources will pay for a big part of it.
There have been plenty of other Wall Street sponsored ventures that have voyaged down this path with questionable results. The sports entertainment enterprise, World Wrestling Entertainment, used a similar family focus when it came to voting rights. Although The Rock, Steve Austin, and a multitude of other big stars have returned to the square circle between the IPO and the present day, the stock has plummeted nearly two-thirds from the IPO price.
Closer to home, Ford decided to concentrate their voting rights with the Ford family and historically, it harmed the company’s ability to reform itself during World War II, the recession of the early 80’s, and even in good times. Such as the last great strong automotive market of the mid-2000’s.
Ford and Autotrader are just two of dozens of automotive centered companies that pursue policies that protect ‘special’ investors and executives over the interests of public shareholders. Poison pills, white knights, and certain industry standards often keep the seas of change at bay when it comes to a publicly traded company. Until it is too late.
Just ask Roger Smith and Ross Perot.
Should we invest in them? Should anyone?
As much as I warn folks about Craigslist being the Wild Wild West of retail car sales, it looks like the culture of grabbing ill gotten gains is not solely a matter of the retail world when it comes to cars. Corporate greed, in the nastiest of incarnations, is still alive and apparently doing quite well.
I’d credit (at least in part) Ford’s ability to avoid bankruptcy to the fact that it was and is largely controlled by the Ford family.
jmo may be correct. However, I’d like to point out that Ford repeatedly took actions contrary to the long-term interest of the company because it “had” to keep paying dividends during tough times because they were the primary source of income for so many members of the family. Also, in the real world there is no way that Billy Ford would ever have become the leader of such a huge company.
The family dividends helped one of the heirs finance the movie called “Bongwater.” You can’t blame them for trying.
It can be easily argued that it was the Ford family that put Ford in that situation to begin with. Alan Mulally saved their asses.
Didn’t Bill hire Alan? As Chairman one of Bill’s primary duties is leading the board’s search for a new CEO. I’d say they picked pretty well.
There are two seperate issues here. The existence of ‘prefered stocks’ is problem number one, but in some sense the milder problem. The bigger problem is the hedge-fund type practice of milking cash out of a company by saddling it with debt. It is the corporate equivalence of people getting cash out of a second mortgage and then letting the house go into foreclosure.
In any event- who uses autotrader anymore? Who is dumb enough to underwrite Autotrader’s IPO?
Two separate issues here. One is family-held companies that go public and issue a special class of stock to themselves that is not marketable etc. Typically, the holders of that stock have a right to elect a majority of the Board of Directors, effectively controlling the company. The Washington Post Co. is that way; Cox Communications was that way before it went private. And, it may be that Ford Motor is that way.
If somebody loads a company up with debt before an IPO, this is going to be a factor considered by the underwriters in setting the price for the IPO.
In both cases, investors should RTFP before putting up their money.
After the dot-com bubble burst, anyone who invests in an IPO is a little crazy, as the buyers of Facebook shares in that IPO found out.
I don’t know how much performing SCSA is really capable of these days.
Used to work for them in the 90’s. Got so bad after I left that my department unionized. Do nay private sellers advertise with them anymore?
Yes it’s a pretty unscrupulous company, I worked for them back in the ’90s too. I can’t imagine anybody wanting to invest in them—especially in this day and age.
No private sellers on Autotrader anymore, I’ve heard it’s just dealers who advertise there. I put my car on Autotrader’s site 4 years ago and didn’t get one single response from the ad. I think I paid $30 for the ad so it’s not hard to understand why Craigslist dominates that market.
My experience was the opposite. I had to repost the ad every day, and while I got calls from Craigslist, it was a bunch of jags who weren’t serious (one thought I said 1000 bucks instead of 10000). Autotrader got the vehicle sold by the second day. It was a rather oddly configured truck. If I were dumping a old Neon for 2 grand, craigslist would be my clear choice. Any real money car I’d go on auto trader.
“Had to repost every day”?
Rules and fair play don’t apply to you?
So you had to repost it ONCE? (There was the initial post and one more on the second day,right?) You sold it by then, so what’s your beef?
When I bought my present car (new) I used Autotrader to search inventories and locate the dealer who had a hard-to-find stick shift model in stock. So that much was useful, and, as far as I know, unique among any car ad websites.
Who the hell is making these kinds of loans? Call me crazy, but if I ran a bank and a company came looking for $400 million, I’d ask them what they planned to do with it. If the answer was “Hand it over to our investors and executives as a thank-you for being so damn wonderful”, they’d feel my boot on their butt as they went out the door.
I completely agree…who is the genius that approves that large of a loan to be given back to investors! The only answer I can come up with is maybe somebody who has stock in them :p
Here are the geniuses -Wells Fargo, SunTrust Robinson Humphrey, J.P. Morgan, Goldman Sachs, and Fifth Third.
p/s http://www.leveragedloan.com/autotrader-com-launches-400m-of-add-on-pro-rata-loans-for-dividend/
as far as the banks are concerned, all they want is their money paid back
you can be sure they did their sums and they’re expecting the IPO to cover all repayments
Here’s the cool part….it will be taxed at the low dividend rate! And so, the gal who answers the phones for $15 an hour is socked with a higher tax rate than the investors who just walked away with nearly a half-billion dollars.
Investors, surely you mean job creators?
The usual suspects – Citi, B of A, Goldman etc. They make the loans to these hedge funds so the loan executives can get their year end bonuses and stay in their Park Avenue condos. To be fair, maybe the hedge fund may have saved Auto Trader and deserve to monetize their investment.
SOP on Wall Street.
http://www.nytimes.com/2009/10/05/business/economy/05simmons.html?pagewanted=all
Dunno if it’s true, but Bain Capital (Romney’s old firm) has been accused of this kind of business practices.
stuart
It is true. Well documented.
Not just Bain- it’s SOP for any number of private equity funds and hedge funds.
To quote my favorite boss,
“Thses guys should be tied to a fence and shot.”
$400 million to Autotrader? Seriously? *Sigh* We’ll be bailing that bank out now, too.
Flogging’s too good for some people.
If you want to find the cheapest advertised price on a vehicle with particular options AutoTrader can be helpful. Want to know the cheapest price on a new 2012 Impala within 500 miles of you? Autotrader is your place.
In my experience the used car ads have been hit or miss but if you know very specifically what you want and your willing to travel to find it, Autotrader is helpful.
(“Autotrader, show me every 2008-2009 Ford Taurus, Mercury Sable, and Ford Taurus X in a 500 mile radius with less than 75,000 miles. Oh and make sure that it has leather.”)
“As much as I warn folks about Craigslist being the Wild Wild West of retail car sales”
If you can Mr. Lang please write about CL issues. I see some, I would like to read your full opinion. You might have already wrote about CR I just never seen it. Thanx
I wrote this back in 2007.
https://www.thetruthaboutcars.com/2007/12/the-truth-about-craigslist/
It may be time for a slight revision.
Interesting article, although I have to agree with most of the commenters that the majority of “issues” with craigslist ads are universal to any ad venue, not unique to that one.
The truth about craigslist is that a lot people equate “no charge” with “anything goes”, and abuse the site accordingly.
Thank you Steve
Huh, interesting, I didnt know Mitt Romney ran Autotrader.
Do you guys have any idea how loans or IPOs actually work? I’m guessing that you don’t based on the comments. Well, one guy did point out the fact that any additional debt will be factored into the valuation and the stock price will be lower as a result. Banks will loan to anyone for any reason if they feel it’s a safe investment. 400M to autotrader is a safe investment and they couldn’t care less who it goes to as long as they’re getting a decent yield.
So help me understand this…what’s wrong with this scenario? Or is it just more uninformed commentators who fail to understand corporate finance? With Romney in the spot light suddenly everyone feels he is an expert on LBOs or PE…
What is wrong is that they are taking out a loan in the company’s name purely to line their own pockets with no value added to the company. Then saddling the company with that debt. Due to loan payments the company now has less working capital AND the stock value is lower making less money for the company. So the business and all the employees are in a worse position purely so that the top brass can stuff their pockets fuller instead of doing what is be best for the company.
I’m not seeing the problem here. No one is going to be forced to buy Autotrader.com shares. They are even being upfront about the dim prospects for post-IPO dividends.
The whole point of a firm is to return value to shareholders, either in the form of dividends or equity (retained earnings). Using debt for dividends is not the ordinary method, but in this case the existing shareholders are about to dilute much of their current equity in the firm through the IPO. It may actually benefit new shareholders that the originals got paid already and will be more inclined to hold their shares.
Without digging into their financials too much, it would seem Autotrader still is carrying a relatively small amount of debt. The IPO will significantly expand the firm’s equity, so new shareholders will actually see a lower debt/equity ratio than the private shareholders did. Whether it’s a good investment just depends on the expected return from Autotrader’s future operations. They seem to be doing nicely at the moment.
When insiders lever up a company for the purposes of cashing out, then potential future investors should be asking questions.
The press reports that the $400 million loan increased the company’s debt by 50%. That would suggest that the total debt is somewhere around $1.2 billion.
2011 revenues were about $1 billion; earnings were about $68 million. So margins are low, which makes for a fairly modest valuation.
Do the math. With $1.2 billion in debt, the company is probably fully levered or close to it.
Meanwhile, the existing investors lack enough confidence in the future of the company that they want to get the money now, while the getting is good. The low earnings give them good reason for them to be blase about the future of the business.
On the surface, this is a classic recipe for a mediocre to craptacular business, with too much debt, blah earnings and current investors who are happy to lever the balance sheet for their own personal benefit. This smells like a play to capitalize on the IPO market and the mini-tech bubble, structured in such a way that it demonstrates a lack of faith in the long term operations of the business. It’s not illegal, but it doesn’t make for an ideal investment.
Well that’s the point, market participants are free to evaluate the information and decide accordingly. There’s no morality tale like the original post tries to make out. The market will take the company’s position and activities into account and price accordingly.
With respect to leverage, the real issue is the ratio of cash flow to interest payments. I don’t know- is that information available currently? So long as they have enough interest coverage there shouldn’t be a problem (unless revenue drops of course).
Again, what if the dividends were intended to let the private shareholders hold onto their shares? That would be a vote of confidence, not a cash-out. If they start dumping them like mad, well, that would be a different story- and the market would take notice.
@drivelikejehu
How would loading the company with debt make it any easier for the private shareholders to hold on to their shares? It makes no sense. If the private shareholders wanted to hold on to their shares all they had to do was to not sell them, if they wanted to hold on to the shares but needed cash they could borrow with their shares as collateral.
Shareholders don’t want a loan, they want a return on their investment.
The basic value of a firm is its net present value, which is the discounted value of future net income. The shareholders basically own a piece of that future income. When a firm issues equity, the existing shareholders lose a portion of that because their shares have been diluted. The dividend was compensation for the coming loss of equity. Without it, the private shareholders may not have allowed an IPO to be declared in the first place.
“Well that’s the point, market participants are free to evaluate the information and decide accordingly.”
Nobody claimed otherwise. I know that you want to turn this into some sort of strawman argument in which Mr. Lang is fighting against the good forces of capitalism that you are going to zealously defend at all costs. (You Austrian economist/ Ayn Rand wannabes can be seen coming from a mile away.) But he asked the question “Should we invest in them? Should anyone?”, and my answer to that question is “probably not.”
“With respect to leverage, the real issue is the ratio of cash flow to interest payments”
An equity investor that is buying shares in a mature business with a high debt load should also be worried about debt as a percentage of valuation, since the valuation isn’t likely to increase by much and the future debt capacity of the company and its ability to borrow to pay for future expansion will be compromised accordingly.
But in any case, you miss the point. The company added a significant amount of debt to its balance sheet, yet isn’t going to use that debt in order to create future earnings. Soon, equity investors are going to being asked to commit cash to such an enterprise.
An investor is investing in future operations. Part of what the investor is buying is the strength of the company’s management team. In this case, the management is looking a wee bit cynical, since they’ve opted to lever up heavily in order to cash out the previous investors. Mr. Lang is questioning the wisdom of such an investment, and he’s wise to do that.
I certainly wouldn’t invest in it. But the very title of the post is “pat on the back,” which is a pretty clear normative statement.
“Soon, equity investors are going to being asked to commit cash to such an enterprise.”
Um, yeah- it’s called an IPO. The whole point is to raise cash.
Note that shareholders of a publicly-traded firm would never contribute additional capital. If the firm needed equity the only option is to issue more shares.
“… its ability to borrow to pay for future expansion will be compromised accordingly.”
You can’t say that without approximating the firm’s optimal capital structure. The debt load still seems pretty light to me, considering the fact equity is set to expand significantly with the IPO.
“Um, yeah- it’s called an IPO. The whole point is to raise cash.”
Um, the question that a potential future investor should be asking is “What are they going to do with the $300 million raised by the IPO?”
Since we know what they did with the last $400 million worth of debt, some doubts are warranted. Your devotion to laissez faire is touching, but due diligence is more useful than ideology.
When should an investor not be diligent?
Also, stop trying to make everything political. You don’t know what I believe and are just trying to cover for a lack of knowledge on subjects you nonetheless continue to discuss.
“Also, stop trying to make everything political.”
If you’re trying to win some irony award, then congratulations, you’ve already won today’s prize.
“just trying to cover for a lack of knowledge on subjects you nonetheless continue to discuss.”
No offense, but I probably forgot more about finance this morning over breakfast then you’ll know on the day that you retire. You sound like an overzealous undergraduate who took Atlas Shrugged a wee bit too seriously.
OK then, well just to make sure- so I know that I can trust your wisdom- could you answer this simple question for me?
What is the crossover point for these two projects-
A: $10,000 investment, cash inflow of $3,500 for four years
B: $14,000 investment, cash inflow of $4,800 for four years
Sorry to ask such an easy question; given your expertise it should take 30 seconds at most.
Great, now the kid wants me to do his homework.
PCH – not that I agree with everything drivelike is saying, but you do seem to be politicizing this unnecessarily.
To make the argument from the PE side – the PE firm has investors who expect a return on their funds. It’s the job of the PE firm to manage the companies in their portfolio, with the goal of increasing revenues/streamlining the business (yes, may mean firing people)/generally improving the outlook of the companies. *Assuming* that was done (I do not know the state of Autotrader’s financials when the PE firm took their initial stake), it’s completely reasonable for the PE firm, and their investors, to expect to be paid for their work.
They clearly took a look at Autotrader’s balance sheet and determined an additional $400m of debt would be manageable, and would similarly provide a solid payout for the PE firm and investors (I’m not making any statement about the reasonableness of $400mm, regardless if Autotrader can support it). It’s very unlikely the debt burden is ultimately crippling – while this of course has happened and does happen on occasion, it’s extraordinarily poor business for a PE firm to make a habit of crippling their portfolio companies, makes it difficult to negotiate future buyouts for starters.
So, is the $400m “pat on the back” excessive? Could be. I have no idea what kind of work the PE firm put in to Autotrader nor how successful these efforts were. Admittedly, at first blush it seems a bit ridiculous, but at the same time if the debt amount is entirely manageable, and the prospectus for the IPO fully discloses all requisite information, I can’t necessarily blame anyone. It’s the nature of the business. Of course, if you (meaning the general you) don’t like the business model, either come up with a better one or use regulations to change the business environment!
“They clearly took a look at Autotrader’s balance sheet and determined an additional $400m of debt would be manageable”
No, that isn’t clear at all. Without knowing some specifics that would suggest that top line revenue and earnings are both poised for growth, I would be inclined to presume otherwise.
I actually worked for a company that did this — we levered it up, suckered an investor into buying it, and then let them struggle with the resulting debt load, the benefit of which did not transfer to them. They didn’t understand what they were buying, and flailed with the result, despite having supposedly smart and sophisticated folks on their side of the table.
There seems to be a lot of naivete about finance here. The company made $67 million in 2011; if the $400 million costs them an average of 5% to service, then they’ve just added pre-tax interest expense of $20 million, on top of the load that has been added to the right-hand side of the balance sheet.
As an investor, I’d want to know that earnings could be increased accordingly, but my guess is that Autotrader is a generally boring business without much upside in it. Unless there are other businesses for it to acquire that can be used to expand its reach (they already bought KBB a couple of years ago), I’d have to question what I was buying if I was part of the $300 million pool.
C’mon, pch, you know no professor would give that easy of a question for an assignment. Why not take a few seconds and demonstrate your command of basic financing. Surely that’s not too much to ask of a self-described expert.
Pch101’s rules:
#1) Pch101 reserves the right to cherry pick sentence(s) or words from a paragraph; &
#2) Pch101 will have the last word.
p/s Please don’t bother wasting time.
I’m not sure what’s worse — Drivelikejehu’s belief that quizzing me is a reasonable substitute for his lack of analytical skills, or that he thinks that he could pose a question about NPV comparisons without providing the discount rate.
I asked for the crossover point. All the necessary information was provided. It takes about 10 seconds on an online financial calculator (google ‘datadynamica’).
If someone claimed to be a mathematician, but couldn’t compute 3*3, that would call the claim into question. On another thread, pch claimed to know all about accounting, but also couldn’t answer a very simple question in that field. The reason is that he doesn’t know what he’s talking about (i.e., is a troll).
To compare the NPV of two projects, one must have a discount rate. This is basic finance — even an undergrad class will teach you that.
Perhaps they’ll cover this in your junior year. If we’re still both here in 2015, then we can cover it then.
I didn’t ask you to compare their NPV, I asked for the crossover point between them (i.e., where NPV is equal). That is a very simple and straightforward question that you can’t answer, because you are spouting off without any clue.
The “crossover point” is the point at which two different projects have the same net present value.
To calculate net present value, one must have (a) the stream of cash flows for the project, (b) the cost of the project and (c) the discount rate. You provided (a) and (b), but not (c).
Funny, I thought that you were trying to prove that you were clever by asking a trick question. As it turns out, the only one who got tricked by it was you.
See you after junior year. I do hope that you don’t have to take the class twice.
Looks like you didn’t spend enough time on Wikipedia. You only need (a) and (b) to find the crossover point:
‘B’ ‘A’ difference
-14,000 – -10,000 = -4,000
4,800 – 3,500 = 1,300
4,800 – 3,500 = 1,300
4,800 – 3,500 = 1,300
4,800 – 3,500 = 1,300
Enter the difference into the financial calculator and compute IRR. The crossover point is 11.39%.
I’m out of the troll-feeding business, but for posterity I just wanted to prove you didn’t know what you were talking about. Thanks for the help.
Sure there is a “morality tale” here…but it’s too big for some folks to see. It’s not this one tree, it’s the whole darn forest.
The morality tale is that this company, like so many others, is no longer primarily about producing a product for consumers. It is a vehicle for fancy financial manouvers to try to squeeze as much cash out of it as possible, hopefully at the expense of some other hapless investors. It’s not a real company anymore – it’s purpose is not to produce anything with any social utility. It’s purpose is to make clever people rich at the expense of less clever people.
The problem is that so few people, including so many commenters here, see any problem with this. Too many people are too comfortable with the financial “industries” being the primary source of “wealth creation”. They produce nothing but financial risk, and that is also what they sell. The fact that J.P. Morgan is buying it should make us feel like it must be okay? Seriously?
To be fair, it is the government’s fault. The Fed’s systematically flawed policies produced the tech bubble, housing bubble, etc., resulting in a situation where the cost of capital is very low but businesses lack the confidence to make real investments. All that’s left is speculation games that benefit no one and add pointless risk to essentially government-backed financial firms.
Maybe we should get some more confident businesspeople. No one wants to do anything in America unless they have a monopoly.
It’s amazing the automotive empire Cox has built with the very successful Manheim auctions and finance, Black Book, Kelly Blue Books, Autotrader, Ove and more.
And this, dear friends, is why dealing with corporate America is to realize that there are guys staring at spreadsheets, analyzing each transaction, and asking, “How can we nail the customer for another $5”.
This is Autotrader winning the Monopoly game and dividing up the spoils. They have no real competition and the people that got them in this position want their share of the pie. Dealers have nowhere to go but weak sister cars.com or even more expensive TV/radio advertising. Maybe Bain capital can fund a competitor, not. Entry barriers are way too high. No low hanging fruit here.
Craigslist works because it’s basically a communist state run by a benign ruler. Craigslist is mediocre for dealers, too much clash of cultures.
It’s kind of a Catch-22. They took the loan so that if the stock price tanks (a la Facebook), they don’t lose everything. However, taking the loan almost guarantees that the stock price will tank. The thing is, I think the telltale issue here is the lack of voting rights with the new stock. Cox is basically just wanting to see how much it can get, but wants to make sure it can get something out of it. I think we might see more and more of this out of tech-related (especially internet-based) companies, as Facebook taught them that an IPO is not always a sure moneymaker.
“pay for placement” is the Autotrader mantra. This part is like the Monopoly game as well. Proof is that when the cars.com rep comes by to sell advertising, the first thing he says is “don’t drop AutoTrader” just don’t buy so much of their more expensive “pay for placement” packages.
I think this will be a successful IPO because AutoTrader certainly has an actual existing revenue stream with all the “hotels it owns on the Monopoly board”.
Eh, business as usual in the corporate/Wall St. world (I’ve seen this and much, much worse).
If the average American really knew what was going on in the boardrooms, there would be riots in the street (or maybe not, due to apathy or acceptance).