Monday, July 09, 2007

Executive Compensation: The BCE Buyout

One of the more eagerly awaited documents in the coming weeks is the package delivered to BCE shareholders setting out the details of the proposed buyout. Will there be sticker shock when one sees the compensation paid to the executive team?

Until recently, leveraged buyouts were a vehicle used primarily by small cap and midcap companies who were looking for a way to rebuild value out of the public market's eye. Away from the need to meet quarterly revenue targets, it was reasoned, a company could focus on transformational change, shedding unis and people that were not profitable and investing in technologies and partnerships that would add long term value (but not necessarily short term revenue).

Another driver was executive compensation: in a privatized company, management could receive a significantly larger equity stake - usually 20%. In a multi billion dollar deal, that's a lot of coin.

Here's how management compensation usually works: Management is required to invest a portion of any proceeds they would have otherwise received on the sale of their shares into the LBO (usually 50-60%) in shares in the new private corporation. They also receive options (15% is typical). Any change of control bonuses or golden parachutes are extinguished, which is often a huge tradeoff by management.

Surely these numbers adjust downwards in a deal of this size, you may argue. This does not seem to be the case, Take a look at Sungard Data Systems, which at $11 billion was the largest LBO to date when it closed in 2005. The executive team received just under 20% of the company.

When an executive team owns a chunk of the company, what kind of behaviour does this incent? In order for their equity stake to be valuable, all the debt assumed to fund the buyout must be serviced and then extinguished quickly. When your core franchise is in decline,as is the case with BCE, you have to bet that cost-cutting and revenue from your other busineses will service the debt while you rebuild. If not, the breakup looms.

Assuming BCE follows the usual model(and time will tell), you have to grudgingly admire those of the BCE team that stay with the surviving corporation. They're taking on what is venture capital - scale risk themselves.

Stay tuned.

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