KKR buyout saddled First Data with massive debt

2006 (pre-buyout)……………..$2.5 billion…….$7.1 billion……..$1.5 billion…………29,000

2008 (post-buyout)…………..$22.1 billion…….$8.7 billion……-$3.8 billion………..26,600

2011 (latest annual data)……$22.5 billion…….$10.7 billion…..-$516 million………24,000

Source: SEC filings by First Data

When Kohlberg Kravis Roberts & Co. paid $27.5 billion for First Data Corp. back in 2007, the company may have looked a lot like those “can’t lose” real estate deals that many of Atlanta’s home flippers bought into just before the market tanked.

KKR, one of the world’s best-known private equity firms, is still smarting from completing one of its largest deals right before the nation entered its worst recession in decades. Five years later — long after a buyout firm has typically sold its acquisition to new owners — KKR’s First Data deal is still underwater.

And First Data, a $10.7 billion-a-year credit card processor that is one of Atlanta’s largest companies in terms of revenue, is still dealing with the aftermath.

The story of what’s happened to First Data since it was taken over by KKR is an instructive look into the growing impact of private equity firms here and around the world. KKR, Bain Capital and other private equity firms have bought up roughly $3 trillion worth of companies around the globe with the backing of pension funds, Wall Street banks, foreign nations’ investment funds and other backers.

After KKR bought First Data, thousands of jobs were shed. First Data’s debt rocketed past $22 billion — more than double its annual revenue — due to the junk bond-fueled deal. The company went from earning $1 billion-plus yearly profits to losses of hundreds of millions or even billions of dollars. And it recently had to renegotiate most of its debt to get more time to pay back the loans.

KKR “went really to the edge, and then the economy tanked,” said Eric Grover, a longtime veteran from the payments processing industry, now with consulting firm Intrepid Ventures. Since KKR’s acquisition, he said, First Data has done a good job of re-tooling and recovering under KKR’s direction. But the company remains vulnerable because of its huge debt load, he said.

“The good news is they have a long runway” because First Data got extensions on most of is debt to 2017 or after, said Grover. But, he added, “the business is over-leveraged.” If interest rates shot up, driving up the cost of its debt, “that company would tank,” he said.

First Data, with 24,000 employees, is the world’s largest processor of credit and debit card transactions. It moved its headquarters back to Atlanta from Denver in 2009, and now employs 1,200 in metro Atlanta and 200 in Columbus.

Other local companies wholly or partially owned by private equity firms include Alpharetta-based Colonial Pipeline (KKR); The Weather Channel (Blackstone Group) and Church’s Chicken (Friedman, Fleisher and Lowe). Bain Capital, the firm co-founded by former presidential candidate Mitt Romney, owns stakes in The Weather Channel, specialty credit card firm FleetCor; former Home Depot wholesale arm, HD Supply; and radio broadcaster Cumulus Media.

Private equity firms — once more commonly called leveraged buyout firms — amassed their huge portfolios using a strategy that hasn’t changed much over time. First, the firms assemble a buyout fund by wooing money from pension funds and other big investors who become partners in the fund. The buyout firms then use that money, plus billions more of borrowed money, to buy up companies in highly-leveraged deals that are akin to buying a house with a small down payment plus a big mortgage.

The buyout firms try to look for “fixer-upper” companies that are still basically solid. They spend a few years retooling them by cutting costs or coming up with new products or strategies, then sell them again to new owners or through a public stock offering. The buyout firms and their partners then split up the profits.

Critics say such deals often lead to lost jobs, and that the new owners sell off valuable assets and pay out cash to themselves, leaving the target companies crippled and vulnerable.

KKR is the grandaddy of the private equity industry, with a $66 billion portfolio that includes Toys “R” Us, Del Monte Foods, Dollar General, mattress maker Sealy Corp., the Nielsen TV ratings company and giant hospital operator HCA Holdings. Founded in 1976, KKR gained infamy for a time through its portrayal in “Barbarians at the Gate,” the book that detailed KKR’s bare-knuckled $30 billion deal to take over RJR Nabisco in 1989.

By the time KKR turned its attention to First Data, the buyout industry was in a full-blown boom, wrote Jason Kelly in his recently released book on the private equity industry, “The New Tycoons.” From 2005 to 2007, KKR announced almost $245 billion worth of deals, according to Kelly.

Through a string of dozens of acquisitions, First Data had grown into the world’s biggest credit card processor, accounting for roughly 40 percent of all credit and debit card transactions, said Wayne Johnson, an analyst with Raymond James & Associates in Atlanta. Serving millions of businesses ranging from little mom-and-pop shops to giant retailers like Walmart, First Data was pumping out $1 billion-plus annual profits in a booming economy.

“They’re the biggest in the space, and volume matters” because the biggest credit card processors also tend to have the lowest costs, said Johnson.

What’s more, First Data had just enough problems prior to the acquisition — a patchwork of outdated computer and communication systems and redundant operating centers — to be a buyout firm’s dream. Fix it up and then sell it for a profit.

KKR announced its deal to buy First Data in the spring of 2007. But even before KKR completed the deal in the fall, storm clouds were gathering. Amid a growing credit crunch on Wall Street, KKR had a difficult time getting balky lenders to back the deal, according to published reports.

But KKR forged ahead and completed the deal, unaware of how bad things would get. To run First Data, KKR recruited veteran executive Michael Capellas, who had run Compaq Computer and helped clean up WorldCom following its scandal. After KKR’s purchase, First Data immediately announced job cuts and other moves that slashed annual expenses by about $500 million a year, said Grover. Those moves included consolidating 13 data centers in the U.S. into just three centers in Nebraska and Arizona, according to company officials.

But such moves weren’t enough to counter the deepening recession in 2007-2009. Monthly credit card purchases declined for the first time ever, said Grover, and banks stopped making as many new credit card offers to consumers. Also, First Data’s massive debt load from the deal had swelled its annual interest payments from $248 million in 2006 to $2 billion in 2008.

After reporting a $1.5 billion profit in 2006, First Data lost $3.8 billion in 2008, and $1.1 billion in 2009.

“The whole deal was predicated on a robust economy,” said Chip Swearngan, First Data’s senior vice president of investor relations. “I don’t think that anyone would forecast … the Great Recession that fell upon this nation.”

By 2009, KKR had had enough. That year, KKR co-founder Henry Kravis joined First Data’s board, one of only two such businesses in KKR’s roughly 70-company portfolio where he holds a seat. Another senior KKR adviser became First Data’s chairman. KKR also revamped First Data’s management team and Capellas left. The company moved from Denver back to Atlanta, which it had left in 2001.

First Data also cut more jobs. Company-wide employment dropped from 29,000 at the beginning of 2007 to about 24,000 now. But the company has added about 650 people in Georgia since opening its Sandy Springs headquarters, said Swearngan.

Since First Data’s overhaul, the company has become a more efficient competitor, with improving finances, say company officials and industry analysts. First Data’s cash flows — the performance yardstick private equity firms use, rather than conventionally-measured profits — are expected to be nearly $2.5 billion this year, up more than 22 percent from 2010.

“It’s a work in progress,” said analyst Johnson. “I think that they are going to be a lot more competitive going forward.”

In 2010, First Data began renegotiating about $20 billion in debt that was to come due in 2014 and 2015, extending their due dates to 2017 and beyond. In many cases, the company ended up paying millions of dollars in fees and slightly higher interest rates — even as market interest rates fell, allowing many other companies to reduce their debt load. But First Data officials said the renegotiated debt deals amounted to a vote of confidence.

After the new debt agreements, everyone “breathed a sigh of relief,” said Grover. Without the deals, “it was very hard to see how they could possibly meet their obligations.”

If the economy keeps growing and interest rates don’t jump, said Grover, First Data probably has bought enough time to pay down its debt and someday provide KKR and its partners with their much-delayed exit strategy.

“They can grow their way out of this,” he said.