Another Greek tragedy

In the  run-up to the financial crisis, private-equity funds seemed to be trying to outdo each other in overpaying for assets. Yet many avoided the bulk of the losses when disaster struck. Often the industry would contribute only a sliver of equity, then quickly extract an equivalent amount or more through heroic feats of financial engineering—thus ensuring a quick profit, and leaving others to bear the pain if the acquired firm tottered under its new mountain of debt. Wily tax structures could help boost returns further.

In this section Down but not yet out RG-bargy True to form Torture by tariff The mocha hedge Pyrrhus would be proud Another Greek tragedy Forgive and remember Reprints Related topics Luxembourg Industries Financial services Private-equity firms Private equity

Now the chickens appear to be coming home to roost for the architects of one particularly egregious-looking deal: the takeover in 2005 of a Greek telecoms group, TIM Hellas, by funds set up by TPG and Apax Partners, two private-equity giants. One question is whether TPG and Apax put their own payouts from Hellas ahead of the financial health of the company. But aggrieved creditors go further. They allege that the transactions involved were not just imprudent, but fraudulent.

Hellas wobbled—and eventually toppled—after the private-equity sponsors increased its debt many times over in short order, while simultaneously extracting several times more money than they had put in. This prompted a legal battle with bondholders and the liquidators, which is still going on. The liquidators have accused the former owners of “duplicitous and catastrophic plunder” that amounted to “one of the very worst abuses of the private-equity industry”. Apax denies wrongdoing. TPG declined to comment.

The Economist understands that the two firms are also indirectly under assault from Luxembourg’s taxman, who has demanded a hefty payment from a Hellas vehicle after it allegedly mischaracterised distributions to its private-equity owners. On top of this, on June 8th Britain’s accounting regulator ordered that Ernst & Young (now EY), which had audited Hellas’s books, be “severely reprimanded” and fined for ethical breaches related to its work for Hellas.

The €1.6 billion ($2.1 billion) acquisition of Hellas, then Greece’s third-biggest mobile operator, was at the time the country’s largest leveraged buy-out. The fourth-biggest mobile operator, Q-Telecom, was subsequently rolled into it. The group was later renamed WIND Hellas.

At the time, Hellas looked to be in reasonable, if not stellar, shape: serving 20% of the Greek mobile market, it was making more than €110m in annual profit and its debt was a modest €187m. Within little more than a year of the deal, however, the group’s debt had been jacked up 15-fold. Much of this increase was the result of heavy borrowing to pay cash to redeem “convertible preferred-equity certificates” (CPECs), a bond-like instrument that can be converted to shares. The deal’s sponsors—vehicles set up by the private-equity firms to carry it out—had arranged for group companies to issue these notes to them in exchange for their equity contribution of €77m (the sponsors also lent the group more than €300m, which they later repaid themselves).

After siphoning out most of their investment through the CPECs, the owners sought to flip Hellas. When that failed, they quickly ramped up their withdrawals. This was done by arranging the redemption of most of the remaining CPECs at a controversial price.

Having allegedly taken out almost five times their total contribution (and almost 20 times their equity portion) in 18 months, the sponsors sold Hellas to an Egyptian investor in 2007. With insufficient income to service its debts, Hellas went into administration in 2009. The crux of the claims by creditors is that the money they lent was misappropriated. They thought they were financing Hellas’s operations, whereas in practice, they argue, the firm was “systematically pillage[d]” by the sponsors, rendering its debts unsustainable.

The story behind the bill of more than €200m that Luxembourg’s tax authority has presented to a Hellas vehicle gives a sense of the financial engineering involved. If the vehicle cannot pay, the private-equity firms themselves could eventually be on the hook. The ruling that led to the bill has not been made public; neither the tax agency nor the private-equity firms will comment. But it has been confirmed by well-placed sources.

The tax demand relates to the redemption of the CPECs, which are a uniquely Luxembourgish instrument. Holders receive regular payments, tied to the issuer’s profits. At maturity, typically a matter of decades, the note can be redeemed for cash at face value or converted into shares. CPECs can be accounted for as either debt or equity, depending on how they are used. This “hybrid” status opens up intriguing tax-minimisation opportunities.

The tax spat hinges on whether the company should have classified redemption payments made in 2006 as a dividend distribution (equity) or a loan repayment (debt). The private-equity partners who benefited from them said they were loan repayments that would deleverage Hellas. That led to favourable tax treatment, as Luxembourg levies a withholding tax on equity, but not on debt.

The tax authority argues that the distribution could be treated as debt only if it was used to reduce Hellas’s borrowings. It wasn’t, it believes, but was instead an improper dividend. Company filings suggest the owners were aware that such CPEC redemptions should be treated as equity; a financial statement for Hellas in 2006 said the firm “has concluded that [the CPECs] should be classified as equity”.


Hellas’s liquidators and debt-holders believe the Luxembourg ruling, if it stands, will bolster cases that are pending in American bankruptcy and state courts. “It validates our litigation, which turns on similar issues, such as the nature and purpose of redemptions, and the argument that withdrawals were taken from borrowed funds, not reserves,” says a creditor.

The liquidators’ complaint is a colourful read that compares the private-equity firms’ windfall to the sack of Troy. It has several angles of attack. The first is the contention that the speed of the owners’ withdrawals was reckless. By autumn 2006, a year after they first bought in, they had already recouped 90% of their total €390m contribution, mostly by getting Hellas companies to borrow heavily and pay them back with the proceeds.

That leads to the second line of attack: the questionable valuation of the CPECs as withdrawals accelerated. In December 2006, €973m was passed along to the owners, via a chain of Hellas vehicles, as the bulk of remaining CPECs were redeemed (see chart). This redemption was unlike earlier ones, which were done at par value (the amount the holders originally paid for them). It was priced at a whopping 35 times par. The company tried to justify this on the ground that this was the security’s current “market” value. This allowed the owners to extract a lot more for each CPEC they held. Strikingly, weeks later those CPECs that were still to be redeemed were once again valued at par.

The liquidators argue that the spike in the valuation was arbitrary and unfair, and that there is no evidence an independent valuation was sought, as required. Approval for the revaluations came from a board largely affiliated with TPG and Apax. (Nikesh Arora, heir-apparent at Japan’s SoftBank, was on the board of the main operating company at the time. Named by the liquidators as a defendant, he is understood to have settled their claims. Mr Arora declined to comment.) The handling of the CPECs showed “utter disregard” for fiduciary obligations to Hellas and its creditors, says a legal complaint. It also argues that the payments violated the terms of the CPECs because they lay outside the circumstances in which early redemption is allowed. “None of the preconditions for a CPEC redemption had been satisfied, let alone carried out at a preposterous multiple of 35 times par,” it states.

An Apax spokesman says, “Apax and TPG funds sold Hellas to a third party in a 2007 transaction that valued it at €3.4 billion, and it was not until three years later, on the heels of the global financial crisis, that the Hellas notes went into default. For these reasons and others we are confident that the plaintiffs’ claims will not succeed.”

The buyer in 2007 was Weather Investments, controlled by Naguib Sawiris, an Egyptian. It wrote a cheque for €500m and took on Hellas’s €2.9 billion of debt. A year or so later, Apax paid the same amount, €500m, for a 5% stake in Weather.

The new owner moved Hellas’s domicile from Luxembourg to Britain, which offers a speedy form of bankruptcy known as a pre-packaged administration. It entered such a process in 2009, causing much of Hellas’s debt to be wiped out. Weather then bought the company back for €50m in cash and certain debt guarantees.

Meet the agitators
The legal and tax battles over Hellas look set to continue for some time. Luxembourg’s move on the tax front is part of a wider trend. The Grand Duchy has been under pressure to crack down on its cushy tax arrangements with multinationals. The tax demand is “a positive sign that Luxembourg is finally showing it can be tough,” says Laurence Sudwarts, a bondholders’ representative. The OECD is leading the global charge to close loopholes like those created by CPECs. Hybrids are high up its agenda and are “on their way to being dismantled” in tax havens, says Pascal Saint-Amans, the OECD’s tax chief.

More drama is guaranteed in the courtroom, too. A group of out-of-pocket investors won a $565m judgment on one of their claims last year, but collecting will be a challenge since the ruling is against a Hellas vehicle, not the private-equity funds.

In March an American court denied a motion by TPG and Apax to dismiss an unjust-enrichment claim, saying the complaint “sufficiently alleges that the transfers…were made with actual fraudulent intent”. TPG and Apax are also trying to have legal standing in America denied to the liquidators, even though a third of the aggrieved debt-holders are in New York.

Some of the creditors are distressed-debt outfits that bought after Hellas hit trouble. They are a determined bunch. One, who bought in “purely to agitate”, says he “will never give up”. Overall, creditors are €1.4 billion out of pocket.

All of the claims that TPG, Apax and their funds and vehicles could ultimately be on the hook for add up to somewhere between €2 billion and €2.5 billion, including interest. In the worst-case scenario, a money-spinner could become a loss-maker. Small wonder they are fighting hard to persuade the courts that Hellas was a good deal done at an inopportune time, not a brazen piece of asset-stripping.