How Companies Unload Unwanted Subsidiaries

The Henny Youngman economic era—the time when desperate lenders begged borrowers to take their money—has ended, thanks to mortgage defaults and a sudden realization that debt can go bad. And now there is a different sort of Youngmanism at work. With credit suddenly no longer so free and easy, companies eager to raise cash or rid themselves of troublesome assets are imploring private equity firms to help them. Take my subsidiary, please!

In May, DaimlerChrysler, eager to end the ill-fated trans-Atlantic marriage of Daimler and Chrysler, struck a deal with private equity firm Cerberus Capital to take the stalling U.S. division off its hands. Cerberus agreed to invest $7.4 billion for an 80.1 percent equity stake in the company, with Daimler continuing to hold 19.9 percent. But most of Cerberus' cash would go into Chrysler's coffers, not into Daimler's. What's more, DaimlerChrysler agreed to lend about $400 million to the new company, and to pay off a chunk of the Chrysler unit's debt. But that wasn't the end. Daimler, eager to close the deal on Aug. 3, noted that "in light of highly volatile U.S. loan markets," it would make a $1.5 billion, seven-year loan to the newly formed company. Rather than simply sell Cerberus a banged-up used car, Daimler paid a ton for repairs, lent the buyer a chunk of the purchase price, and then committed to pay a portion of the vehicle's insurance. Daimler hasn't so much liberated itself from Chrysler as reduced its exposure to a business it no longer wants.

A second, and more dramatic, example came earlier this week with Home Depot. The company sought to undo the strategy pursued by ousted former CEO Robert Nardelli (who now runs ... Chrysler). Nardelli had sought to diversify by investing in a building-supply unit, HD Supply. In order to raise cash to help fund a massive $22.5 billion share repurchase, the new management put HD Supply on the block in February, and in June struck a deal to sell it for $10.325 billion to a consortium of private equity firms: Bain Capital, the Carlyle Group, and Clayton, Dubilier & Ric. Long story short, the housing market crashes, the debt markets tighten, and the private equity firms realize they've committed to purchase a declining asset at a high price. In August, they sought to renegotiate the deal. And after a game of chicken, Home Depot earlier this week agreed to different terms. The price was cut to $8.5 billion. Rather than sell the whole thing, Home Depot says it will invest $325 million in cash for a 12.5 percent stake in the company and guarantee a $1 billion loan. Instead of walking way with about $10 billion, the company now says it will net just $7.9 billion—and retain significant exposure to the business it no longer wants.

The next candidate is likely to be H&R Block's sale of its subprime mortgage unit, Option One, to Cerberus. In April, H&R Block agreed to sell Option One to Cerberus for an unfixed price—the "tangible net assets of the business at the date of closing, less $300 million." As losses have mounted, it's clear that Option One is a wasting asset. So, this morning, as it announced earnings, H&R Block said it was talking to Cerberus about modifying the sales agreement. H&R Block will likely end up subsidizing Cerberus' takeover of a business it no longer wants.

To a degree, companies helping buy-out firms take unwanted assets off their hands is simply another form of vendor financing, the practice of companies lending money to their customers. For decades, GMAC (now majority-owned by Cerberus) lent money to car buyers to buy General Motors cars, and then profited as the loans were paid back. Department stores lend money to their customers, who buy suits and home furnishings. The New York Times reports today that doctors are offering 0 percent financing to patients for laser eye surgery and tooth implants. But vendor financing can lead to trouble, especially when booms go bust. In the late 1990s, as competition heated up, telecommunications equipment companies such as Northern Telecom and Lucent loaned billions of dollars to fiber-optic cable companies and internet firms, who used the proceeds to purchase equipment. When the bubble popped, the vendor financers suffered doubly: Orders dried up when all their customers failed, and they suddenly found themselves sitting on loads of bad debt. Should these deals go bad, former parent companies like Home Depot and Daimler will find themselves swallowing huge losses. Until recently, publicly held companies saw private equity firms as nonprofit divorce counselors—people who would allow them to get out of failed marriages painlessly. Now, they're more like expensive divorce lawyers.

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