Monday, April 23, 2012

Mitt Romney as leveraged buyout prince

Romney has claimed to have created 100,000 jobs at Bain and says that providing work for Americans was a primary company goal.

He cites Domino's, Sports Authority, and Staples, companies that added jobs after Bain bought in.

But Bain bought Domino's just months before Romney left to run the Salt Lake City Olympics, meaning someone else created those jobs. And he didn't manage Staples or Sports Authority; Bain was a minority investor.

By Romney's logic, any large investor - say, the Texas teachers' pension fund - also creates hundreds of thousands of jobs. The boast is so foolish that his campaign has since backed away from it.
- Pete Kotz, Mitt Romney, American Parasite Village Voice 04/18/2012

Pete Kotz' article looks at how Bain Capital worked in the years when Willard ran it. He co-founded the firm in 1984 and ran it until 1999. Bain bought companies using a financial device that in 1984 was still commonly called the leveraged buyout (LBO). "LBO" got such a bad reputation that its practitioners and the business press pretty much stopped using it, though the LBOs themselves continued. Essentially, an LBO allowed one company to buy another and load the purchased company up on debt, effectively making the purchased company finance the buyer's purchase.

Like any financial technique, an LBO can be used for constructive or destructive purposes. But when the laws allow the purchasing firm to essentially loot the purchased company legally, and gives the income so derived a lower tax rate than ordinary earned income, it creates a huge incentive to use it for destructive purposes. The argument in defense of operations like Bain's is that it increases economic efficiency. And given the near-theological faith that many economists place in their supply-and-demand graphs, there will always be economists ready to defend anything that happens as a result of operations like Bain's as the optimal outcome and the most beneficial. (Not even counting the ones directly hired to make the argument.) Kotz gives a good, accessible explanation of how it worked with Bain:

[Romney's] specialty was flipping companies—or what he often calls "creative destruction." It's the age-old theory that the new must constantly attack the old to bring efficiency to the economy, even if some companies are destroyed along the way. In other words, people like Romney are the wolves, culling the herd of the weak and infirm.

His formula was simple: Bain would purchase a firm with little money down, then begin extracting huge management fees and paying Romney and his investors enormous dividends.

The result was that previously profitable companies were now burdened with debt. But much like the Enron boys, Romney's battery of MBAs fancied themselves the smartest guys in the room. It didn't matter if a company manufactured bicycles or contact lenses; they were certain they could run it better than anyone else.

Bain would slash costs, jettison workers, reposition product lines, and merge its new companies with other firms. With luck, they'd be able to dump the firm in a few years for millions more than they'd paid for it.

But the beauty of Romney's thesis was that it really didn't matter if the company succeeded. Because he was yanking out cash early and often, he would profit even if his targets collapsed.
Kotz cites a couple of defenders of Bain's approach. If a private-equity firm actually provides additional funds and management expertise to help a company grow by enhancing their ability to borrow or just giving them better management, then that's an example of making money by investing in a business and developing it. Kotz cites one of what seems to be a genuine Bain success story:

In what was perhaps his crowning achievement, he bought the money-losing Wesley Jessen VisionCare for $6 million in 1994. Seven years later, it was sold for a dazzling $300 million. ...

But if critics are quick to disregard Romney's triumphs, defenders are equally swift to rationalize his catastrophes. They'll note that for all of Romney's bankruptcies, most were rescued by new companies and survive today. It's the final dollar tally that matters.

Yet they seem strangely incurious about the ruin he has delivered across the country.
Kotz cites studies of numerous Bain acquisitions and looks at some individual cases, like Bain's purchase of medical-equipment firm American Pad & Paper in Indiana, Armco steel mill in Missouri, Dade International of Illinois and Georgetown Steel in South Carolina.

Kotz also cites cases in which Bain persuaded local governments to provide public funds to support investments Bain wanted to make after purchasing a firm, like building a new factory, in which the governments got little for their money. Localities and states compete among themselves to provide local incentives for businesses to locate there, often involving using public funds for construction and infrastructure improvements to benefit a particular plant. And often the deals are structured so that the private company benefiting from it bears little of the risk if the company fails to deliver the jobs or other benefits that were assumed as part of the deal. (This is not to diss the importance of governmental infrastructure; I'm referring here to deals made with specific businesses over specific facilities.)

One of Kotz' examples:

Even a company Romney cites as one of his greatest achievements—Steel Dynamics, where he was a minority investor—was practically launched by corporate welfare. Indiana taxpayers gave the firm $77 million to open a plant. Residents of DeKalb County actually had their income taxes raised solely to help Romney and his friends.

Tad DeHaven calls it "theft and redistribution."

He's no yammering Trotskyite; DeHaven is a former budget adviser to Republican U.S. senators Jeff Sessions of Alabama and Tom Coburn of Oklahoma. Yet he notes that firms like Bain often get governments to subsidize their raiding parties.
Kotz makes an important point that I hadn't thought of before about Bain Capital:

On the campaign trail, Romney describes his work at Bain as resurrecting distressed companies. In this version, he's the white knight lifting troubled firms from the precipice of failure.

Not true.

Private equity companies like Bain rarely buy anything but profitable firms for one compelling reason: The patient must be healthy enough to be force-fed all that debt. So it's something of a misnomer for Republican opponents to slur him as a "vulture capitalist."

"Romney is not a vulture capitalist, as Rick Perry says, since vultures eat dead carcasses," notes Josh Kosman, who has written about the private equity business for 15 years. He's "more of a parasitic capitalist, since he destroys profitable businesses." [my emphasis]
Pete Kotz has done a really good piece of business journalism here. It's unusual in that it expresses some complex concepts in generally-accessible ways with oversimplifying. That's not easy to do.

On Romney's career at Bain Capital and at the consulting firm Bain & Associates, see also, Robert Gavin and Sacha Pfeiffer, Plenty of 'pitting' preceded Romney's profits Boston Globe/Deseret News 07/03/2007.

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