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Buyouts, Bread Sticks, Biscotti � and Challenges for the Obama Administration

Posted to the IUF website 19-May-2009

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The 136 workers on strike for 9 months at the Stella D'oro bakery at West 237th Street in the Bronx are a microcosm of working America. They are as diverse as the neighborhood - African-American, Latino, "ethnic" whites, even African. A majority are women, many of them mothers and grandmothers. Most of them worked at Stella d'Oro for years, even decades, before, as they tell it, being forced out on strike. Seven months into a bitter strike, they'll all tell you "We're going to stay out as long as it takes to get a fair contract."

Stella D'Oro is also a microcosm of what's been happening in corporate America for the past two decades � and what urgently needs to be fixed. Originally a family-owned firm founded in 1932 by Joseph Kresivich, an immigrant from Trieste (you can find his name on the memorial wall at Ellis Island), Stella D'Oro built up a loyal customer base for its range of high-quality biscotti, bread sticks, fudge and other specialty baked goods.

When the family sold the business to Nabisco in 1992, Stella D'Oro had 3 bakeries across the US with 575 employees and annual sales of 65 million dollars. But the 1990's were the decade which crystallized "shareholder value", the pressure to deliver constantly rising dividends and share prices. Fixed investment was increasingly viewed as a liability rather than an asset. Cash flow began to be diverted away from productive investment to finance dividends and share buybacks. Despite healthy earnings, companies began to borrow heavily to pay out even more cash to shareholders. From third quarter 2004 to third quarter 2008, the companies in the Standard & Poors 500 spent 2.6 trillion dollars on dividends and share buybacks - on $2.4 trillion in earnings. Whole or partial product lines - including profitable operations - were sold off and rotated through a succession of owners.

For many workers, the process ends with the sale of orphan brands, manufacturing sites and services to a private equity fund. From 2000 through 2007, some 3,000 US companies with a value of over one trillion dollars were acquired by private equity funds through leveraged buyouts relying on massive debt to finance the deals.

RJR-Nabisco was taken private by KKR for 31 billion dollars in the 1989 leveraged buyout memorialized in the book (and later movie) �Barbarians At The Gate." KKR couldn't build the Stella D'Oro brand or the company's other products: they were too busy scrambling to meet interest payments and get their cash out. The mega-LBO failed to yield the anticipated megaprofits, despite massive job cuts and plant closings. So RJR-Nabisco was dismembered; in 2002 Kraft bought Nabisco, and with it Stella D'Oro, originally with an eye on challenging other up-market bakery specialists.

With Nabisco reeling from the ongoing buyout damage, Kraft began by investing in new equipment and production lines in the Stella plant in Illinois. But Kraft succumbed to the pressure for "shareholder value". The company abandoned its investment, scrapped the newly updated plant, and sold on the remaining Stella operation.

The shrinking process under Kraft left Stella D�oro with one plant and annual sales of roughly $30 million. Shortly after the Stella sale, Kraft announced a 23% increase in quarterly earnings and the elimination of an unspecified 8,000 jobs worldwide. Financial analysts were pleased: Kraft was finally getting serious.

Kraft sold Stella D'Oro in 2006 to a private equity house, Brynwood Partners. No one outside of a narrow investor circle knows the sale price or the terms of the sale. Because private equity firms are exempted from disclosure requirements, the public - including the Stella D'Oro workers and their union, Local 50 of the BCTGM (the Bakery, Confectionery, Tobacco Workers & Grain Millers International Union) - know nothing about the financial situation at the company that was once their collective bargaining counterpart. They can't know how much debt went into the deal, though they can assume it was a healthy portion of the purchase price. They can't know the rates of interest or who holds the paper. They can't know who invested in the Brynwood fund that did the deal (like all private equity investors, Brynwood Partners' fundraising is staggered in cycles).

They can't know the business plan, but they have to assume that the company books, as with every leveraged buyout, are guided by a single imperative: cash in, interest out. And they can only assume that Brynwood Partners' motivation in buying the bakery that used to be their workplace was to pay down the debt, get their money out early and sell it off as soon as possible to another investor. Brynwood's investors would expect nothing less.

The first attack on working conditions at Stella D'Oro was indirect: management replaced the union distribution company with "independent contractors" working for inferior pay. Then when the production workers' union contract ran out in July 2008, Brynwood put its first and "final offer" on the bargaining table: wages for most workers would be cut by a dollar an hour over the next five years. That meant that workers earning $18 an hour today would be making $13 in 2013. The company's first and only negotiating proposal also included stiff additional health care premiums, the elimination of Saturday pay, the elimination of paid sick leave and reduced holidays and vacation time. Under the contract proposal, nearly every Stella D'Oro worker would be considerably worse off at the end of the contract.

When the company refused to budge, the union felt it had no choice but to go on strike - and the members have been walking the picket line every day since August 13 last year. Since then, the union has received three communications from management. Soon after the walkout, union members were informed that they were being replaced by "permanent replacements", with no right to reinstatement. A letter in December informed that nearly half the positions had been "permanently replaced." And management has come up with a modification to its contract proposals: replacing the company pension plan with a 401k stock ownership plan (hardly an enticing prospect these days).

The Stella D'Oro workers are determined to defend their wages, benefits and dignity, and they've continued to walk the line. No one has broken ranks, and they've received support from other unions, community activists, and borough and state political representatives. Union members recently turned out in force for a demo at Brynwood Partners's Greenwich, Connecticut headquarters, chanting "No contract - no cookies!" But they're up against a tough adversary, and the current legal framework for industrial relations and collective bargaining is not in their favour. It's been decades since workers saw anything resembling strong government sanctions for �surface bargaining�. While management has clearly shown less than good faith, there have been no consequences for delivering ultimatums rather than seeking joint solutions through the collective bargaining process.

The federal government�s National Labor Relations Board recently issued a complaint, validating the union�s charge that Brynwood had not bargained in good faith. But given the broken status of US labor law, justice from the legal system could take years to achieve, if ever.

�We have never had serious negotiations with Brynwood,� according to local union President Joyce Alston." The Stella D'Oro workers are at pains to emphasize that they're not asking for more. Given the dire state of the economy, most would be happy to keep what they have.

The dispute at Stella D'Oro is much more than a routine conflict over wages involving a union intent on defending members' living standards and a hard-nosed management struggling with a tough economic climate. At the heart of the conflict is the huge burden of debt weighing down the balance sheets of companies taken private through an LBO.

A leveraged buyout is at best a highly fragile construction. When a company's books are swamped with debt, a rise in interest rates, an increase in raw material prices or even a slight consumer downturn can sink it. It is now estimated that up to one-half of all the companies owned by private equity funds could soon be looking at bankruptcy. Default rates are on the rise, and a number of private-equity owned restaurants, retail chains and manufacturers have already had to close their doors.

Outstanding LBO debt is a ticking time bomb in the debt markets. Like the sub-prime debt, it has been sliced, diced, securitized and "warehoused" in obscure corners of the financial universe that are only now coming to light. Buyout debt the banks couldn't move off their books when the meltdown came is weighing down their balance sheets, further aggravating the crisis in the financial sector.

The Obama administration is now proposing that private equity fund bosses' earnings be taxed at a higher rate. Considering that KKR's owners took in 1.3 billion in profits in 2007, at the peak of the LBO bubble, and that they probably pay a lower rate on their earnings (taxed at the present low rate as capital gains) than the Stella D'Oro workers, it's a welcome proposal, and a timely one. But it doesn't address the tax break at the heart of the buyout model, which is the unlimited deductibility of interest for business tax, not the low rate of taxation on personal income for the buyout chiefs.

This massive regulatory subsidy, which encourages financial pillage while costing taxpayers billions of dollars in lost public revenue, is an open invitation to poison the books. As long as company balance sheets are forced to assume the burden of their own buyout and saddled with colossal debts, workers like those at Stella D'Oro will be forced to pay the price.

Stella D'Oro is a classic example of a profitable company which has been drained and shrunk in the quest for quick gains and then turned over to the financial markets to leverage out the last bit of cash.

There was talk about cleaning up the fallout from the 1980's LBO boom in the early days of the Clinton administration. It soon got sidelined by the savings and loan crisis - and financial markets were progressively deregulated to facilitate the use of increasing amounts of debt to drive profits to new heights. So when conditions were ripe - from roughly 2000 to mid 2007, when the credit crunch began to bite - we had LBO boom number 2. The funds had changed their name to the friendlier sounding "private equity", but the mechanisms were the same.

The acquisitions were now global, the buyouts were bigger, the leverage greater, and the damage will be far wider than anything seen in the 1980s, which for many workers were a disaster.

Politicians and ordinary citizens have finally woken up to the damage unleashed by highly leveraged financial instruments. Regulatory proposals are lagging behind. The Obama administration should take action now - because working Americans can�t stand many more Stella D�Oros.