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Harvard: Making a Profit

The Leveraged Buyout Controversy

And although some investors participate in `unfriendly' LBOs in which the takeover is made without the backing of management, Harvard is "not going to be involved in unfriendly deals because they'll loathe the publicity," says the investment banker.

But, as Scott says, in the leveraged buyout business "what's unfriendly is a little hard to tell."

That uncertainty about unfriendly takeovers is mirrored in the long-term prognosis for the leveraged buyout trend. While Harvard and other investors may be raking in the profits from LBOs today, economists say they think the buyout market will falter if the economy weakens.

"Generally speaking, LBOs are quite lucrative for investors," says Reich. But, he adds, "when the market turns sour, it may not be quite so lucrative."

Doug Henwood, publisher of the Left Business Observer,says "LBOs sort of made economic sense in the early '70s and '80s when they were small [transactions]." But "they no longer make sense because I don't see how we can finance the debt," he adds.

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Henwood says he thinks that if the economy went into a recession, those economic conditions combined with rising interest rates would throw as many as 10 percent of U.S. companies out of business if the LBOs continued.

And he says if a recession was anything like the one in the early 1980s, "people like Harvard would find their investments going bad."

Law says he also thinks there may be a recession in the near future, giving a "one-in-five chance" for a recession in the next year.

But the economic verdict is not clear. Steven P. Galante, managing director of buyout information at Venture Economics--a Boston-based business analysis firm--says, "there were a lot of LBOs in 1980 and 1981 and they went through that recession without any defaults."

"Generally," Galante says, "you don't structure a deal based on the best-case scenario."

All those economic debates, however, may eventually be moot if Congress passes laws hampering the leveraged buyout deals.

Since LBOs rely on the tax deductibility of loan interest, some takeover critics have suggested that this allowance be discontinued or decreased, thereby making LBOs less attractive, a Capitol Hill source says.

Other critics who are mainly concerned with the level of debt incurred in the LBO process have suggested that the tax deductibility be shifted towards cash expenditures rather than debt, thus encouraging LBO initiators to use money instead of loans.

But the congressional source says he "wouldn't be surprised if nothing is done [about LBOs] on the Senate side" because people have drawn a negative connection between the 1987 stock market crash and a House resolution, passed five days before the crash, that halted LBO deductions over $5 million.

And Galante says, "Congress has been historically reluctant to pass legislation to regulate the markets." Law agrees with this analysis, asserting that any action Congress takes "has as many problems as solutions."

But the Capitol Hill source says many government officials are concerned about the rise in LBOs because "debt is not as productive as research and development." And, he adds, there is an "undercurrent" of feeling in Congress that there are ethical problems with LBOs.

But, as Massie says, "Congress responds to major events." And, "in the absence of a major event, like another RJR, they probably won't do anything," he adds.

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