Vulture Capitalism

640px-White-backed_vultures_eating_a_dead_wildebeest
Source: Wikipedia

Predictably, the Sears bankruptcy has attracted much wailing and gnashing of teeth around so-called “vulture capitalism” as practiced by hedge funds and private equity firms (here in the biz we use terms like “activism” or “distressed” investing). “Vulture” is of course used as a pejorative in these articles. Personally, though, I think practitioners should embrace the label.

In nature, vultures play an important role in ecosystems:

When vultures are unable to clean up the carrion in an area, other scavenger animals increase in population. The scavengers that tend to move in where vulture populations are low include: feral dogs, rats, and blowfly larvae. While these animals do help to remove carcasses from the landscape, they are also more likely to spread disease to human populations and other animals as well. In India, for example, the feral dog population increased significantly after vultures consumed cow carcasses poisoned with diclofenac, a painkiller. These feral dogs carried rabies and went on to infect other dogs and local people. Between 1993 and 2006, the government of India spent an additional $34 billion to fight the spread of rabies. India continues to have the highest rate of rabies in the world […]

[…] It is important to remember that even though the vulture species lacks the cute cuddly appearance of some endangered species, it is still a critical piece to a much larger, complex ecosystem. The world needs vultures to help control the spread of disease.

Likewise, vulture capitalists pick apart the corpses of dead and dying firms. Eventually that capital is recycled elsewhere in the market ecosystem.

Now, clearly this is not a pretty process. It is gruesome. It involves ruthlessly cutting costs; it involves firing good, hardworking people; it involves selling off assets and extracting cash instead of going through the “feel good” motions of reinvesting that cash into a dying enterprise. The firms that specialize in these activities are at the pointy end of Schumpeter’s “creative destruction.” It’s not exactly shocking that they’re unpopular with the general public.

But here’s the thing about “vulture capitalists.” They don’t feed on healthy companies. And there’s a good reason for this. Healthy companies are too expensive for distressed funds and buyout firms to get their claws into.

The popular notion that Sears, as a business, is dead money has been around since at least 1988. 1988! That’s thirty years. Three decades. Take a moment and think about that.

For thirty years now it’s been pretty clear the investment case for Sears rests largely on a sum-of-the-parts valuation of the real estate assets. There were very few possible worlds in which Sears would reinvent itself as a thriving retail business—particularly given brutal competition from Wal-Mart, Target, CostCo and others.

So when we talk about Sears we’re talking about the business equivalent of a sickly, dying wildebeest. Vulture capitalists consuming the carcass is simply the natural order of things. Even though hedge funds and private equity firms lack the cute, cuddly appearance of certain other market participants, they remain important pieces of a much larger, complex ecosystem.

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