Saturday, August 25, 2007

It Floats and Needs Flushing

After reading how the ballooning cost of shipping and logistics cut the amount of food aid to poor countries, I recalled The Carlyle Group's briefly owning a shipping company. They purchased CSX Lines in 2003, renamed it Horizon Lines, and flipped it for an easy double in just over a year's time. At the time I thought John Snow's CSX might have undersold at $300 million, but Carlyle's political influence may well have earned the premium resale price of $650 million. After announcing the deal, Standard & Poors put Horizon on credit watch. What did Carlyle do to earn the lofty price so worrisome to credit rating agencies?

First, they got Secretary of Transportation, Norman Mineta to sign a Capital Construction Fund Agreement with the company. The agreement provides numerous methods for Horizon to reduce their tax liability in order to fund new ships or other major capital purchases, perfectly legal under the law (last revised October 2006). While most companies have to generate sufficient income or borrow money to buy new assets, Horizon could use what they owed Uncle Sam to purchase new revenue generating vessels. The company received a reduction in their tax liability of $14.1 million in 2005 and $14.12 million in 2006 from this program according to their annual report.

The Department of Transportation made no public announcement regarding this agreement. Right after signing the deal, Sec. Mineta spoke in Hollywood, Florida. In his talk, the Secretary mentions two government efforts that help Horizon, the Jones Act and the cargo preference program. The Jones Act specifies U.S. flagged carriers must haul freight between Guam, Hawaii, Puerto Rico and the mainland. The cargo preference programs gives preference to U.S. flagged haulers on other routes.

In its annual report Horizon promotes itself as the number one Jones Act carrier. It also states on their corporate website it "serves several agencies of the United States government, including the Department of Defense and the United States Postal Service." How much of this business did Carlyle grow during their year and half of ownership?

Second, in 2004 President Bush signed into law a bill that granted even more preferential tax treatment to U.S. shippers. Taxes could be based on tonnage vs. the corporate income generated from vessels. Horizon jumped on this to drive taxes below zero. The British Treasury reported on such a tax. "A tonnage tax, which has increasingly been introduced, with some early success, by nations such as Norway and the Netherlands, creates an effectively tax-exempt fiscal regime for shipping companies."

The company had net income of $72.3 million in 2006, yet it has a net operating loss carry forward of $39.4 million for the same period? That is the result of two items, the Mineta capital construction fund agreement and the 2006 election of the tonnage tax enabled by Bush’s signing of the American Jobs Creation Act (of 2004).

The firm expects "future tax liability to be substantially lower than the 38% combined federal and state tax rate that the company would be at without the tonnage tax benefits". They calculated their tax rate to be an effective 9.5% based solely on the tonnage rules for 2006. Other tax benefits drove the number below zero, adding $43.5 million to their bottom line. Of the company's $2.16 earnings per share, tax benefits contributed $1.30. Who says there is no such thing as corporate welfare?

As for the American Jobs Creation Act, who knew creating jobs would cut corporate taxes dramatically and drive up corporate earnings? Remember this next time President Bush says there's no money to provide uninsured children with health insurance. Horizon's tax liability for 2006 alone would be $27.5 million without the Bush team shenanigans.

What happened to Sec. of Transportation Norman Mineta? He resigned from office on July 7th, 2006 and within six months snagged a slot on the Horizon Board of Directors. This after landing on the Carolinks Advisory Board alongside Senator Tom Daschle (formerly on the board of another private equity outfit). If we follow the Charleston, South Carolina connection it leads to another Carlyle sub, Vought Aircraft Industries. But that's another story of government largesse lavished on "strategic businesses". Two Carlyle subs have gotten Airbus like support from the feds. With two tax cuts and the board level appointment of an ex-Bush insider, it appears The Carlyle Group may have earned their double after all. It's a shame the children must pay.

P.S. Unfortunately the GAO report didn't identify the 14 haulers of food aid who comprise over 80% of the shipments. But in conducting my research I did find out about much about Horizon Lines! Could somebody please flush the floater...