I'm a bit confused to why leveraging up companies this badly, without commercial need, isn't a violation of fiduciary duty of company leadership. I'm pretty sure that it'd be in several countries, e.g. Germany. You might not get into trouble without a bankruptcy, but there were one, you'd likely be personally liable to some degree.
They are the owners of the company. The leverage is just a technique to move future cashflows in to the present so they can pay their investors and move on to the next company. Would it be better to just allow the company to go completely out of business?
If the owners want to realize those future cash flows they can sell. Leverage unlike sale forces otherwise healthy companies into bankruptcy. The advantage is you can leverage more than the value of a company and then extract it without selling.
PS: Remember you can profit from preforming a useful economic function, or fraud making profit a poor yardstick for anything else.
If you truly believe this leverage will force the company in to bankruptcy, you should short Hostess stock (TWNK). It's currently trading at ~$12.50 per share.
Furthermore, if you believe it is possible to save a distressed company like Hostess and generate superior returns without dividend recapitalization, perhaps you should start a competing private equity firm.
While I'm familiar with the idea that healthy companies can be so leveraged for quick profits that they go out of business, I don't understand the mechanism. Is the idea that such over-leveraged companies cease to be otherwise healthy before they go out of business? If so, why? Is the management worse while they are over-leveraged? Is it a matter of market conditions worsening?
Why would an otherwise healthy company be liquidated if it couldn't service its debt? Wouldn't lenders rather sell the company as a profitable going concern than accept what's left after liquidating it? A reasonable valuation for a genuinely healthy company would be greater than book value.
I'm also confused about the practice of backs selling repossessed buy-to-let homes during a crash, evicting tenants in the process. Why sell low, rather than continue to collect the rent?
> While I'm familiar with the idea that healthy companies can be so leveraged for quick profits that they go out of business, I don't understand the mechanism. Is the idea that such over-leveraged companies cease to be otherwise healthy before they go out of business? If so, why? Is the management worse while they are over-leveraged? Is it a matter of market conditions worsening?
While debt servicing you have less liquidity. That liquidity might be required to react to changes in the market / stay competitive. So the long term health of the company is likely going to be impacted some.
If a company generates -1 to 10 billion per year and has 2 billion cash on hand and assets worth 5 billion, they can handle several bad years and will tend to be profitable and very stable. If someone then says they can probably make debt payments of 5 billion a year then they might be able to do that for a while, but it will eventually cause them to fail.
The important consideration is you have already made back your investment at this point so the owners don't care. In fact if the company fails that suggests you succeeded in extracting more money than it was worth.
I thoroughly agree with your 1st & 3rd paragraphs, but the situation described in your 2nd paragraph sounds like one in which the lenders are irresponsible, whereas the owners of the borrower alone seem to usually be blamed.
The second paragraph was exaggerated for effect. However, companies are not limited to bank loans, so it may be the bond market taking on these risks. Further, there is an information asymmetry with loans so a company may be cyclical in nature yet look really good over the last five+ years.
Well, in Germany (I've had a business there before moving to the US, that's why I know some about it), you're free to milk "your" company, but if you end up going into bankruptcy you'll likely be hold at least partially liable to the money you took out of the company, even if it's some form of limited liability company. So essentially, yes, to the banks. Not if all works out, but in the cases it doesn't. To my knowledge that's largely not the case in the US atm.
Banks in the US are free to demand personal liability that goes beyond the company if they feel the risk demands it. Of course, it's a free market, so if some banks are willing to make the loan without doing that they'll probably win the business instead.
That doesn't help previous creditors (including say employees, landlords, suppliers, etc), which now have to deal with a massively over-leveraged company, which is more likely to go out of business.
EDIT: grammar