The Sellout of the Radio Industry

When Terry Gross interviewed Joshua Kosman, author of "The Buyout of America: How Private Equity Will Cause the Next Great Credit Crisis" on NPR’s Fresh Air recently, she nailed the issue from the start.

Gross said, “Honestly, like, I really don't understand how that works, that, like, I buy your company, and then you have to pay the debt for me to buy you? Like, why...?

Kosman’s answer was:

“It's really because of this giant tax loophole, and the giant tax loophole is called interest tax deductibility, and this is how - why LBOs are generally profitable for the private equity firm. Any company can deduct the interest they pay on loans from their taxes.

So if you buy a company, and you buy it with all this debt financing, well, now suddenly, you're basically not paying taxes anymore, and because of that, that company then can, in theory, use that money to pay off its debt quickly. Reality is this is not the way it typically plays out, but in theory, that's the way it works”.

Kosman’s theory starts to get a little too close to home for radio people.

“Typically what happens is the company is more profitable in one sense, its earnings increase, usually because the private equity firm is starving the company a bit of capital because that's - a private equity firm, and I should have said this at the start, they're in the business of buying and selling companies within four or five years. So there's no long-term interest”.

The end game for the private equity firms that now have the likes of Citadel and Cumulus on the ropes is to sell what they have acquired, but these companies are in such short pants, that they have to trade back equity for the huge debt that they cannot repay.

The recession hurts, no doubt.

But the real problem is that the debt was not repayable from the start.

Kosman shows how the private equity firms move to cut costs and artificially improve the balance sheet.

“So typically - and a Davos study shows this. Private equity firms eliminate more workers than their direct competitors, and at the same time, they usually decrease investment in research and development and capital expenditures. That helps the companies they buy pay off their debt more quickly.

And you know, typically, you know, while the companies become more profitable short-term, until that pressure causes them to be less competitive, what it also - but you know, at the same time, the company still has interest to pay on the debt. It may have to take - may be able to take it off your taxes, but you still have to pay the interest. So typically, these companies actually are much less profitable than when they buy them”.

The PE deals are no more than a financial crap shoot and when you hear what the failure rate may be from the last ten years of funding buyouts, you’ll see why.

It gives context to why the radio industry is in harm’s way because of venture capital.

Most people who don’t understand how buyouts work, still think they are basically a good thing. But America – if not just the radio industry – is increasingly being operated by private equity firms that overpay for companies and then follow a consistent formula that more often than not wrecks the company and sometimes the industry itself.

Private investors use the same cheap credit that caused the credit crisis in the first place. Private equity firms are the largest employers in the country when you aggregate them. A lot of the debt on these companies is beginning to come to pass now and an estimated 50% of those companies could end up filing for bankruptcy – 1.9 million people could be unemployed.

More home loan defaults – a potential freeze in lending – more economic woes.

That’s what’s happening right now in radio.

As debt comes due the companies end up in bankruptcy and a lot of people become unemployed. How could this be good for an economy? And as we said, with private equity firms as a group the largest employer of people in this country you can see why this recession is really a repression of capitalism.

This country and the radio industry was not served well by the private equity buyouts that have altered the business landscape and threaten it in the future.

This program with Joshua Kosman is so good – so on target that if you can find the time, listen here.

The buyout of America that Kosman speaks of was really a sellout to venture capitalists by greedy people who often sold excellent businesses for a high return that ultimately led to these businesses being tanked by the private equity firms.

That’s why Citadel has a date with a bankruptcy judge January 15th if it can’t come up with its loan repayments thus making loan sharks look legitimate.

Why Cumulus will be faced with the same fate in the year ahead if it can’t repay its loan payments.

Both will have to cough up much of their ownership stake as a punishment. Citadel will probably lose operating control.

Lee and Bain are private equity companies and they already have control of Clear Channel. Their mission which they have gladly accepted is to shrink the expenses and somewhere in the future increase the profits – until, that is – until they sell everything again. And watch the write-downs they take.

We often think of what has happened to the radio industry is the result of poor management. But it really is good management if by good management you mean playing out the game plan of private equity investors.

That plan – as you’ll see vividly in the next few months – is to take a growth industry and squeeze it for profits until it dies on the vine.

Then sell the assets and make another payday.

The hell with the public.

Screw the employees.

Then just like the predators they are, move on to greener pastures.

The Obama Administration is looking for ways to reign in the system that ruined a lot of businesses including the radio industry. I don’t know whether more government intervention is good or not, but in retrospect some form of oversight might have saved a perfectly healthy industry from investors who eat companies alive.

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