Bankruptcy becomes an increasingly common “exit.” And the pension obligations?

On Sunday, storied gun maker Remington Outdoor Co. filed for Chapter 11 bankruptcy, buckling under its debts. Its intention to file for bankruptcy has been known at least since February, but sources told The Wall Street Journal that the filing was delayed after the school shooting in Parkland Florida on February 14 that re-awakened the national debate on gun regulations.

As part of the deal negotiated beforehand, shareholders will hand over the company to secured creditors, which include Franklin Resources and JPMorgan Chase’s asset-management division. In turn, these creditors will forgive part of the company’s debt. When it’s possible to do so, the new owners will unload the reorganized company.

Among the largest unsecured creditors listed in the petition are the Pension Benefit Guaranty Corp., which is the US government’s insurer for failed private-sector pension plans, and the Marlin Firearms Company Employees Pension Plan. Remington had acquired Marlin Firearms in 2008. So the idea is that the restructured company will walk away from its pension obligations.

Who are the shareholders that are surrendering control?

Fund investors of PE firm Cerberus Capital Management. Cerberus acquired Bushmaster Firearms International in a leveraged buyout in 2006. In 2007, it acquired Remington, and later put them under a holding company, Freedom Group Inc., that also acquired other firearms makers, such as Marlin in 2008. Cerberus was doing a classic “rollup” in the firearms industry.

Those were the heady days of the fabulous leveraged buyout boom with its “Merger Mondays,” as CNBC used to call it – as many of the mergers were announced early Monday, similarly to bankruptcy filings.

In a leveraged buyout, the acquired company is made to borrow the money for its own acquisition and pay those funds to the acquirer, which uses those funds to pay off the bridge loan originally taken out to fund the initial deal. In other words, the acquirer has little or no equity in the deal, and the acquired company has been loaded up with debt. Hence “leveraged buyout.”

The plan was to sell this structure at a big profit to the unsuspecting public via an IPO. But months after the Marlin acquisition closed, the Financial Crisis blew into the open. Then came December 2012, when a gunman used a Bushmaster rifle to kill 20 kids at Sandy Hook Elementary School in Newtown, Conn. Nine families of victims brought a wrongful-death lawsuit against Remington, alleging it was liable for selling a weapon unfit for civilian use. The case is before the Connecticut Supreme Court, and with this decision hanging over the company, potential buyers completely disappeared.

Knowing that trouble was brewing, Cerberus separated Remington Outdoor — the name Freedom Group had already been scuttled — from its funds in May 2015 and opened a door for its fund investors to get out. At the time, the Wall Street Journal reported:

Cerberus sent a letter to its investors, which include pension funds and endowments, telling them that it has separated Remington Outdoor Co., the maker of Remington and Bushmaster rifles formerly known as Freedom Group Inc., from its funds and will allow any investor wishing to cash out of the company to do so, according to a person familiar with the letter.

The letter claimed that the company’s value, including debt, was about $880 million.

The deal to allow fund investors to cash out had a typical private-equity structure that has doomed so many companies: Remington used the proceeds from a 2013 debt sale to pay off equity investors. So the money the company had borrowed for operating capital was suddenly gone. And Sunday’s bankruptcy had moved a step closer.

This scenario of pre-Financial Crisis LBOs now going bankrupt is playing out in other stressed industries, such as the brick-and-mortar retail meltdown, including the liquidation of Toys ‘R’ Us, or in the radio broadcasting sector with the $20 billion bankruptcy of iHeartMedia.

Here’s the thing: If a PE firm cannot exit the LBO profitably, either by selling it to a deep-pocket corporation, or by selling it via an IPO, it is stuck with the company.

What causes a company to file for bankruptcy protection isn’t declining sales or thin profits but debt (and sometimes other obligations) that it can no longer handle. A PE firm could invest equity in the company to pay down this debt burden, and it could invest equity to improve the company’s operations. But that’s a not its job. Its job is to load up the company with debt, extract cash, and then “exit” via a profitable sale either to another company with deep pockets or to the public via an IPO.

When those two potential exits are blocked, the company is left to bleed out. And once the last drop of liquidity is gone, the company files for bankruptcy protection. This is the increasingly common third exit for PE firms from their LBOs.

What are zombie retail locations worth? Some of them “little or nothing.” See Toys “R” Us and its commercial mortgage backed securities. Read… What Are Zombie Retail Stores Really Worth: Answers Emerge

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