Private Equity Asset-Stripping Strategy Meets Charter Schools to Produce Even Better Looting

Eileen Appelbaum, co-author of the important book Private Equity at Work, flagged an important article in on how a secretive consulting firm that was previously investigated for corruption and a local law firm are engaged in complex, high cost bond deals to implement an asset stripping strategy that Appelbaum and her co-author Rosemary Batt have called out as a private equity enrichment scheme that impairs operating businesses. It’s bad enough to see this sort of thing take place in the dog-eat-dog world of Corporate America. It’s even worse to see it take place in charter schools, where the losers are students, by virtue of unjustifiably large portions of charter fees go to unproductive rental payments and financing fees, as opposed to education, and to taxpayers, who over time face inflated costs to fund profiteering masquerading as education.

If you live in the Philadelphia area, I hope you’ll read articles Charter schools building boom: Charters borrow nearly $500 million on taxpayers’ dime and raise holy hell about the String Theory charter schools, whose expansion plans need to be stopped in their tracks, as well as the roles of its highly paid fixers, the consulting firm Santilli & Thomson and the law firm Sand & Saidel.

The nub of the looting strategy is the acquisition and leaseback of lavish buildings to house charter schools. Because charters are correctly perceived to be risky tenants, bond financings for these purchases are at junk bond rates, meaning high financing costs are heaped on top of what would already be unjustifiably high rental charges, by virtue of putting schools in educationally unproductive glamorous digs. And of course, in an environment where it’s business as usual to lard up bond deals that could be done on a plain-vanilla basis with far more complicated deals that lower interest rates a smidge in return for allowing consultants to charge hefty fees and the financiers to dump risks worth more than the cost savings on the hapless borrower through derivatives, the financial rent extraction can occur at an even greater scale on a high-cost financing.

A 2014 post gives an overview of why the sale-leaseback scam is destructive in the private equity context:

For instance, one way that private equity overlords enrich themselves at the expense of the businesses they acquire is by taking real estate owned by the company, spinning it out into another entity (owned by the PE fund and to be monetized subsequently) and having the former owner make lease payments to its new landlord.

The problem with this approach is usually twofold. First the businesses that chose to own their own real estate did so for good reason. They were typically seasonal businesses, like retailers, or low margin businesses particularly vulnerable to the business cycle, like low-end restaurants. Owning their own property reduced their fixed costs, making them better able to ride out bad times.

To make this picture worse, the PE firms typically “sell” the real estate at an inflated price, which justifies saddling the operating business with high lease payments, making the financial risk to the company even higher. Of course, those potentially unsustainable rents make the real estate company look more valuable to prospective investors than it probably is.

The article describes how this strategy plays out in Philadelphia charter schools. Charter operator String Theory acquired a premier office building in 2013, renovated it, yet occupies only half the space for nine months of the year. And the immediate result of over-investing in real estate is whackage to the educational budget:

Shortly after moving into its flashy high rise, String Theory posted its first operating deficit. After revealing they were $500,000 in the red from paying out millions annually to bondholders, administrators told parents they were cutting certain classes and suspending bus service as cost-saving measures.

Worse, charter operators are increasingly resorting to these dodgy real estate deals (emphasis ours):

Charter schools used to inhabit repurposed supermarkets or old storefronts, but a analysis of bond documents showed that an increasing number — one out of three charters today — have bought or constructed newer and larger school buildings with tax-exempt bonds, paying millions in debt and fees to consultants along the way…..

“They’re getting bond ratings that have an eight or eight-and-a-half percent interest rate, whereas a school district getting [government] bonds to finance a project can get much lower interest rates,” said Bruce Baker, a Rutgers education professor.

This leaves charters spending more educational dollars on interest payments — $78 million over 30 years on top of String Theory’s $55 million bond, for instance — at rates that are double or triple what the district pays.

The financing process and real estate transactions themselves also entail millions in consulting and legal fees. Schools like String Theory can become enmeshed in complex and costly deals for marquee buildings that are difficult to sustain.

“There’s no real scrutiny of these deals, and charters end up saddled with big fixed costs,” said Michael Masch, former chief financial officer for the School District of Philadelphia. “They’re saying,‘Look at this really prestigious building we have, that’ll attract people.‘ But it’s a ridiculous amount of money to be spending on the facilities side.”

Today, an increasing number of charters are spending more of their budgets paying down debt than on actual instruction. In the case of String Theory, which enrolls 1,400 students, the school now spends nearly one third — $5.5 million — of its $16 million budget just to occupy the half-empty 228,000-square-foot high rise, along with two older, smaller schools in South Philadelphia. That figure is more than String Theory spends on teachers’ wages — $5.3 million.

Put another way, <strong>String Theory spends $3,895 per student on its building costs, nearly five times the $800-a-student average the district budgets for debt and building expenses.

The article points out that charter default rates are rising, which means that taxpayers can wind up in the worst of all possible worlds: with a default on the debt, and stuck with a white elephant of a building renovated to serve as a school, when that was probably not its highest and best use, and was likely undermaintained after its acquisition and conversion. But the Philadelphia Industrial Development Corp., the largest local economic development agency, has become “the de facto charter-financing vehicle in Philadelphia,” despite the loud objections of critics, since charter schools do not create jobs or foster economic development.

The String Theory case is hardly isolated. Again from the article:

In 2007, Independence Charter School issued a bond for $18 million dollars with help from the PIDC for the purchase and renovation of the vacated Durham Elementary at 16th and Lombard streets. That school had been built in 1907 and maintained by the district with tax dollars for a century. Now, millions in debt and interest from Independence’s charter bonds are also being paid off with tax dollars.

In situations like these, [Rutgers professor Bruce Baker said, taxpayers are paying for the same buildings twice, while relinquishing public ownership of those properties.

“It’s not that anyone is doing anything ‘wrong,’ ” he said, “But rather that public policy permits a bad deal for the public — one that essentially gives away a public asset while charging transaction fees along the way.”

And the story also looked into the role of consultants, at least as best it could. Troubling, there’s no disclosure of what if any services were provided, yet they reaped millions in fees in the handful of cases where the authors could get information:

Many of the recent charter bond deals have been helped by Santilli & Thomson, a New Jersey-based firm that has made millions off consulting contracts and bond fees…

However, a analysis of financial documents for several charter schools that received municipal bonds found Santilli & Thomson has billed at least $5 million since 2010…

What Santilli does to facilitate these arrangements is unclear…

Santilli & Thomson also works closely with the Center City law firm Sand & Saidel, which specializes in workers’ compensation cases, but provides legal services to a number of charter schools…

Along with the $5 million Santilli & Thomson has billed to charters between 2010 and 2014; Sand & Saidel has billed charter schools at least $1 million, according to financial filings. Each firm also collects a portion of the “cost of issuance” fees attached to bond deals, which can run into the millions. In the case of String Theory, $1.5 million worth of settlement fees were built into the $55 million bond deal, although it’s not clear how the money was split among different consultants.

As Appelbaum said via e-mail:

Tax-free junk bond debt financing! OpCo/PropCo model with one set of owners owning the facilities and the school operations and having the school lease classroom space from the property company! High real estate and transactions fees. High consultants’ fees on the deals. Lack of transparency.

It’s a Ponzi scheme – depends on the charter school company expanding the number of schools it owns and students it services in order to service debt, since payments from the School District are on a per pupil basis.

This can’t be a unique situation.

As we stressed, the more voters can do to hold state and local officials’ feet to the fire and demand more transparency and accountability, the greater the odds this Ponzi scheme can be stopped before it does greater damage. I hope you’ll circulate this post and the underlying story widely, and urge friends and colleagues to take action.

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  1. tegnost

    Fees, fees and more fees…and if we were to juxtapose this scenario with the stated reasons why we need charter schools it would create a lot of dissonance. Thanks yves, you’re the best of the best

  2. JTMcPhee

    …but Charter Schools are the Salvation of the Republic, am I right?

    Which followed a local story on how “our schools” are “failure factories” that can be “fixed” by what, privatizing them?

    Seems like there is no organizing principle around which the kind of learning and teaching that “we, the good, wise, honorable people” wish to see implemented might coalesce. Like with everything else, it’s all about crapification, corruption and looting… what “we” got left is brigandage, like after the disruption and decline of every other large imperial political economy I have ever read about. Take and grab, before the other guy, occasionally joining up with like-minded brigands in ad hoc groupings until the internal tensions that re-prove the adage about “no honor among thieves” break even those Mad Max associations, “gangs” as it were, down into smaller warring parts…

  3. Rob Urie

    The Philadelphia school system was taken over by the state in 2001 and is being run by committed neoliberal hacks from Harrisburg. ALEC (American legislative exchange council) was straight-out writing PA public policy until their ‘brand’ became toxic because of the serial disasters they created.

    The city can do little about the policies that the state is inflicting and the state legislature is immunized by both ideology and geography from the consequences of their looting. This political ‘architecture’ is a metaphor for class relations as they exist around the country.

    ‘Looting’ wouldn’t even be taken as a term of derision by the state legislature because, in true neoliberal form, all transactions that produce a ‘profit’ are self-evidently good no matter the costs.

  4. JohnnyGL

    Wow, between this story of looting and the private equity firms running refugee camps, there’s stiff competition for shameless parasitism going on these days!

  5. flora

    Thanks for this post. I’ve printed it out for future reference. This sort of scheme hasn’t made its way to my corner of the world yet. I’m sure it will.

  6. Kris Alman

    The rentier state of public education. Is there a big enough hose for the FIRE sectors that are replacing our entire GDP with negative externalities?

    Bill Gates has spawned a couple of trolls that are Grand Wizards of Vulture Capitalism.

    Former Gates Foundation consigliere Tom Vander Ark, who recently explained to EdSurge Why Private Capital Wins Out Over Philanthropy in the Game of Innovation.

    And former Microsoft CTO Nathan Myhrvold, who co-founded Intellectual Ventures, a “patent-holding” firm. According to Wikipedia, the vast majority of their revenue comes from buying patents, aggregating these patents into a single portfolio spanning many disparate technologies and tying these patents together for license to other companies under the threat of litigation, or filing lawsuits for infringement of patents, a controversial practice known as patent trolling.

  7. Left in Wisconsin

    Great post. As I’ve said many times, education privatization is one of the few remaining growth industries in our economy. And we are just getting started.

    1. RepubAnon

      Yes, K-12 education was always a prime ground for scammers – it’s really hard to measure what kind of education the kids are really receiving until the scammers have sucked all the resources out and filed bankruptcy. Then, the next wave of scammers rolls in.

  8. crittermom

    Great article! I had no idea.
    Thanks, Yves, for enlightening us to things like this. Wow.

    (I guess since the TBTJ banks got away with all they did, & continue to do, they set quite an example for others with no conscience or morals to satisfy their personal greed, as well).
    Enough is enough!

    1. Inverness

      Find your local grassroots groups that are fighting school privatization. In New York City, there’s GEM: Grassroots Education Movement. They also made a very good documentary which is available to the general public to let the general public know why charters and the for-profit movement is so bad for schools.

      I echo the other commenter who mentioned Diane Ravitch’s blog, which is not only a sounding board to stay current, but a way to find others fighting for public schools.

      It’s great to see NC covering this topic.

      1. Fool

        I read Ravitch’s blog and live in New York, and while I’m as critical and skeptical of the privatization of public education as any, practically speaking the charters can sorta thrive in the City because of the enormous financial and political support that they receive, which could hardly exist elsewhere. (Cuomo would bend over backwards to make the charters look good and get the support they need as the charters are pretty fundamental — literally and metaphorically — to his beef with de Blasio.) New York City is not the arena to wage this fight — though I suppose it may well end up being just that as Moskowitz wants a go at mayor.

        I don’t think it’s feasible to, like, end charter schools in New York City. I do however think it’s possible to prevent them from proliferating around the rest of the country so that kids, to the chagrin of Gary Becker’s rotting ghost, aren’t treated and valued on their merits as assets. (Because, y’know, they’re not assets, they’re kids!)

        The privatization of public education is an ugly, slipperly slope, but unfortunately its political referendum seems years away (as student debt and for-profit colleges are higher up on the to-do list). So until then, my question remains of how to halt this so-called “education reform”; alas, the private equity industry’s checkbooks hold more sway than local grassroots groups. :(

        1. Inverness

          Big money is behind many charters, not just the ones in New York City. I agree that the fight looks overwhelming, but defeatism isn’t the way to go.

  9. Shirley Ende-Saxe

    Anyone interested in more of the flimflammery of for-profit charter schools should take a look at Diane Ravitch’s blog. She documents the looting of taxpayers and public schools nation-wide on a daily basis.

  10. Chris Tobe

    We need to find out which Private Equity partnerships are funding these Charter schools. I bet some of these partnerships are in State Teacher Pension plans

  11. Daniel

    The journalist Dale Russakoff (former NYT education reporter) has just written a book about the Newark NJ education reform project and she has some good insight about charter schools as well as what she calls “the education industrial complex”. She was interviewed on the NPR talk show Fresh Air (based in Philadelphia) on Monday. The transcript (and podcast) are here:

    I found this article by Yves to create a very helpful complement to this discussion of Russakoff’s own findings.

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