Private Equity, Intellectual Property, and Tax Manipulation

Private equity supposedly companies make their fortune with their deep insight into unlocking hidden value. In the case of Sears, this value is taking trademarks, shifting them abroad to tax havens, and then reducing taxes. Somehow, we should applaud this great feat of capitalist brilliance. Here is the story:

Berner, Robert. 2007. “The New Alchemy At Sears.” Business Week (16 April): pp. 58-60.

58: “BusinessWeek has learned that Sears has created $1.8 billion worth of securities based on the brand names Kenmore, Craftsman, and DieHard. In essence, it has transferred ownership of the brands to another entity, which it then pays for the right to use the brands. The deal, carried off last May, was the biggest “securitization” of intellectual property in history, according to Eric Hedman, an analyst at Standard & Poor’s, which, like BusinessWeek, is a unit of The McGraw-Hill Companies. The story hasn’t gotten out until now because the bonds haven’t actually changed hands — Sears is holding them in its Bermuda-based insurance subsidiary — and because Sears has never disclosed them, nor has it had to do so. But that could change if Sears were to decide to sell them to outside investors and collect the cash.”

58: “Don Davis, managing director and general counsel at Commercial Strategy, a Boston intellectual property consulting firm, says the potential for a market in bonds backed by intangible assets could be even bigger than the market for junk bonds, given that 70% to 80% of the total value of the stock market rests on intangibles such as intellectual property. “The scale is astounding,” he says.”

58: “The journey to figure out what’s going on inside Sears’ inner sanctum starts with some footnotes buried deep in financial filings. Sears has disclosed that it has created a “separate, wholly owned, bankruptcy-remote subsidiary” — essentially a company within a company. Called KCD IP (for Kenmore Craftsman DieHard intellectual property), the entity has issued $1.8 billion worth of bonds backed by the intellectual property of Sears’ three biggest brands, according to filings with the Patent & Trademark Office.”

58: “Sears has, in essence, created licensing income from whole cloth. First it transferred ownership of the brand names into KCD. Now, KCD charges Sears royalty fees to license those brands and uses the royalties to pay the interest on the bonds. It has sold the bonds to the insurance subsidiary, where, like any other security on an insurer’s books, it serves as protection against future loss. The insurer, meanwhile, protects Sears from financial trouble — and because it’s a subsidiary, it does so at a lower cost than Sears could get from an outside party. If you’re confused, that’s because it’s all circular: The payments net out to zero because Sears owns every piece. But that would change if Sears were to sell the bonds to outsiders. Then voila Sears would be holding up to $1.8 billion in cash, and investors would be holding the bonds.”

59: “The KCD bonds have a higher credit rating than Sears’ regular bonds. Moody’s Investors Service has given KCD an investment-grade rating of Baa2, four rungs better than Sears’ junk rating of Ba1. How so? If Sears were to go bankrupt, regular bondholders wouldn’t be able to get their hands on the Kenmore, Craftsman, and DieHard trademarks, the company’s crown jewels. They would go instead to the insurer.”


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