For some, debt pays off at tax time

Most have paid little or no federal taxes for years, partly due to tax savings from hefty debt loads they took on after private equity firms bought stakes in them, an Atlanta Journal-Constitution analysis of the companies’ financial disclosures shows. Interest on debt is tax-deductible for all businesses, but private equity firms take that to an extreme, sometimes borrowing up to 90 percent of the money used for a buyout.

Such buyouts by private equity players — now a $1 trillion industry — are one reason corporations’ share of America’s tax revenues have been shrinking for decades. That share has slipped from about a third of federal tax collections in the early 1950s to about 10 percent now.

That has meant individuals now pay a bigger share of the burden, while budget deficits and government debt have risen, leaving less discretionary cash to spend on defense, parks, roads and other services.

Private equity firms count on the tax savings to boost the value of their buyouts, said Steven Kaplan, a University of Chicago finance professor. They hope to then re-tool the companies to make them more valuable and then re-sell them at a higher price.

‘Table stakes’

“In some sense, the tax savings are table stakes,” said Kaplan. “They think they can do something to make the companies worth more…Sometimes they work better. Sometimes they don’t.”

For many of metro Atlanta’s big buyouts, the verdict is still out. First Data and a few other local buyouts were loaded with debt and high interest payments just before the Great Recession hit, wiping out their profits for years. But they’ve survived, and some are now profitable.

Private equity firms typically pool their own cash with money from college endowments, pensions and other institutional investors to buy several companies. But they borrow most of the money to buy the companies, using the target firms as collateral.

Most of the five metro Atlanta companies in the AJC’s analysis showed a precipitous drop in tax payments after private equity firms bought them or took large ownership stakes. The AJC looked at five firms that file financial disclosures with the U.S. Securities and Exchange Commission: First Data; Home Depot spin-off HD Supply; radio operator Cumulus Media; payments processor FleetCor Technologies; and medical supplier Immucor.

In 2006, before most of those firms’ new owners showed up, they reported current federal income taxes totaling almost $335 million.

By 2008, when all but one had new owners, their total current federal taxes were negative $689 million. Total tax payments didn’t rise to positive territory until 2013, when they reported almost $94 million.

Negative tax figures can indicate either tax refunds or tax credits that can be used to reduce future tax bills. HD Supply received $358 million in tax refunds from the IRS in 2009 and 2010 after a group of buyout firms paid $8.5 billion for it in 2007.

Some companies still paid income taxes after their buyouts. First Data disclosed that it paid $69 million in federal, state and foreign income taxes in 2008. It got $52 million in refunds in 2007, the year Kohlberg Kravis Roberts paid $27.5 billion for it.

First Data,which now has 1,600 employees in three metro Atlanta offices and 24,000 worldwide, didn’t make officials available for an on-the-record interview.

‘Met our obligations’

“We have met our tax obligations at the local, state and federal level,” First Data said in an emailed statement. “Tax reform is always an active topic for debate, but however the discussion unfolds, we will continue to meet our tax obligations as required by law.”

Many companies disclose their total federal, state and foreign income taxes paid in their financial reports, but few companies reveal their yearly payments to the IRS. Some experts consider their disclosures of “current” income taxes reasonable estimates of actual tax payments over time. These current tax estimates exclude amounts that may never be paid due to differences between IRS and accounting rules.

Almost all big businesses take on at least some debt and reap the tax savings that come with it. Just as Congress long ago made mortgage interest one of the largest tax deductible expenses for homeowners, lawmakers made interest on business debt tax-deductible more than a century ago. It is usually the cheapest money companies can tap for expansion.

For many companies, how much debt they take on is a key part of their financial strategy. By borrowing someone else’s money, their owners can expect higher returns — but at higher risk — than if they used only their own funds.

Private equity firms — once called leveraged buyout firms — put that strategy on steroids. Like home flippers in the heyday before the Great Recession, they aim to buy undervalued companies, mostly using borrowed money. They then try to fix them up — perhaps by hiring better managers and developing new products — and sell them at a profit, either to other companies or through a public stock offering to investors.

But like many of those home flippers who sank under high debt and falling home values during the 2007-2009 financial crisis, private equity firms have struggled with their 2005-2007 buyouts.

In First Data’s case, KKR, the granddaddy of private equity firms, borrowed about 80 percent of the $27.5 billion purchase price, including company debt that was assumed as part of the 2007 deal.

First Data has lost roughly $9 billion and gone through five management teams since then, and cut thousands of jobs during the recession.

Vic Syracuse, who joined the company soon after the buyout but left after 16 months, said debt pressures and a dysfunctional culture thwarted First Data’s makeover efforts. “It’s nice to see they’re making a profit, but it should have happened long ago,” said the former executive, who now runs Base Leg Aviation, a personal aircraft business in Locust Grove.

In its emailed statement, First Data said it has taken steps to restore profitability since a new management team was named in late 2013.

Last year, First Data raised $3.5 billion from investors, including about $1 billion from KKR, adding to its non-debt capital. The company also said it has invested in new products and acquisitions such as a mobile app for merchants’ loyalty card programs, and an expansion in Brazil. Its revenues grew 3 percent last year, to $11.2 billion.

“Now, with our business turning around, we’re more of an industry leader than ever, and still a vital part of Atlanta’s economy,” First Data said.