In today’s DealBook column in the New York Times, Stephen Davidoff celebrates the financial wizardry of PE firm Apollo Global Management and lauds its heroic actions saving real estate company Realogy from bankruptcy. But is the hoopla warranted?
In 2007 Apollo bought Realogy for about $8 billion, contributing $2 billion in equity and loading the company with $6 billion in debt. As Davidoff observes:
"Not only was the deal struck as the housing market was crashing, but Apollo saddled Realogy with too much debt. The company was left nearly bankrupt."
Revenues fell as the housing bubble burst, but Realogy management was stuck paying about $600 million a year in interest payments on all that debt plus $15 million a year in management fees to Apollo. To stay alive in these circumstances, Realogy management “savagely cut costs” according to Davidoff, eliminating a third of jobs and closing or consolidating over 350 offices.
Workers weren’t the only losers. Creditors also lost big time. As Realogy skirted bankruptcy, its debt fell in value to just 10 cents on the dollar. In a familiar move for Apollo which has done this with other deals weighed down by excessive debt, the PE firm bought up its own debt on the cheap. Apollo also announced that it would put more equity into Realogy to keep the company going. These steps moved Realogy back from the brink of disaster and yielded a healthy return as the loans Apollo it had bought from Realogy’s creditors recovered.
Apollo did fine, but clearly no value was created by its actions; instead, Apollo saw its returns go up but at the expense of Realogy’s creditors. This is what economists call rent-seeking: Apollo’s actions didn’t add value to Realogy and increase the size of the economic pie. But they did increase the size of Apollo’s slice of the pie by reducing the size of Realogy’s creditors’ slice.
Realogy is still not out of the woods. Apollo is planning to take the company public via an IPO, a risky bet for public market investors since Realogy still carries a large debt load and its revenues are likely to remain flat unless the housing market recovers. Incredibly, Davidoff finds Apollo’s behavior laudatory:
"Of course, Apollo had no one to blame but itself for Realogy’s precarious situation, having loaded it up with debt in the first place. Nevertheless, the story of Realogy shows how private equity firms can use financial wizardry to save a company, not pillage it."
Not pillage the company and its creditors? Really?