by Josh Kosman from Rolling Stone, May 23, 2012
By placing his career at Bain Capital at the center of his presidential campaign, former buyout artist Mitt Romney has put the private equity industry on trial.
About time.
Romney wants us to believe that critics of private equity are against capitalism. They’re not. They’re against a predatory system created and perpetuated by Wall Street solely to pump its own profits.
Defenders of private equity say firms like Bain, which Romney co-founded in 1984, exist to build businesses, creating jobs and prosperity all the while. "We started Staples, we started the Sports Authority, we started Bright Horizons children centers," Romney said at one of the GOP presidential debates last year. "Heck, we even started a steel mill in a farm field in Indiana. And that steel mill operates today and employs a lot of people."
And Romney also touts Bain's success at taking struggling companies and putting them on a path to profitability. "Sometimes we acquired businesses and tried to turn them around — typically effectively — and created tens of thousands of new jobs," he said at the same debate.
Romney’s whole election pitch turns on the story he tells about his time at Bain, which goes like this: I, Mitt, have a record of building businesses and creating jobs, and what I did for floundering companies, I'll do for the U.S. economy.
There's only one problem with Romney's story: It doesn’t describe most of what private equity firms actually do. The companies Romney holds up as successes – Staples, Sports Authority et al. – were not Bain private equity deals; they were venture capital investments in companies that Bain neither owned nor ran. All well and good: Venture capital is a good thing – essential for funding the growth of new and developing companies. But Romney didn't make his fortune through venture capital; he made it through private equity – and private equity, as President Obama pointed out this week, is a very different proposition. "Their priority is to maximize profits," the president said of PE firms, and "that’s not always going to be good for businesses or communities or workers."
Here’s what private equity is really about: A firm like Bain obtains cheap credit and uses it to acquire a company in a "leveraged buyout." "Leverage" refers to the fact that the company being purchased is forced to pay for about 70 percent of its own acquisition, by taking out loans. If this sounds like an odd arrangement, that's because it is. Imagine a homebuyer purchasing a house and making the bank responsible for repaying its own loan, and you start to get the picture.
O.K., but what about this much more virtuous business of swooping in and restoring struggling companies to financial health? Well, that's not a large part of what private equity firms do, either. In fact, they more typically target profitable, slow-growth market leaders. (Private equity firms presently own companies employing one of every 10 U.S. workers, or 10 million people.)
And that's when the fun starts. Once the buyout is completed, the private equity guys start swinging the meat axe, aggressively cutting costs wherever they can – so that the company can start paying off its new debt – by laying off workers and cutting capital costs. This process often boosts operating profit without a significant hit to the business, but only in the short term; in the long run, the austerity approach makes it difficult for companies to stay competitive, not least because money that would otherwise have been invested in expansion or product development – which might increase revenue down the line – is used to pay off the company's debt.
It takes several years before the impacts of this predatory activity – reduced customer service, inferior products – become fully apparent, but by that time the private equity firm has generally resold the business at a profit and moved on.
But what happens to the companies after they've been resold? It’s not a pretty picture, as I discovered while researching my book The Buyout of America. Consider a few numbers:
• Of the twenty-five companies that private equity firms bought in the 1980s that borrowed more than $1 billion in junk bonds, more than half went bankrupt.
• Of the ten biggest buyouts of the 1990s, six, including Saks Department Stores, fared much worse than they likely would have had they not been acquired in leveraged buyouts. Three of the 10 produced mixed results. Only one business performed better than its peers.
• As for the 2000s, four of the companies acquired in the ten biggest buyouts of this decade, including Dallas utility Energy Future Holdings, are already in considerable distress.
• Private equity-owned companies reduce jobs over their first two years of ownership by 3.6 percent more than their competitors, and that the worst job cuts come in the third year after a buyout, according to a study by the World Economic Forum.
And let's take a look at the record specifically of Bain Capital, which Romney owned from 1992 to 2001.
• 1988: Bain put $10 million down to buy Stage Stores, and in the mid-'90s took it public, collecting $184 million from stock offerings. Stage filed for bankruptcy in 2000.
• 1992: Bain bought American Pad & Paper, investing $5 million, and collected $107 million from dividends. The business filed for bankruptcy in 2000.
• 1993: Bain invested $25 million when buying GS Industries, and received $58 million from dividends. GS filed for bankruptcy in 2001.
• 1994: Bain put $27 million down to buy medical equipment maker Dade Behring. Dade borrowed $230 million to buy some of its shares. Dade went bankrupt in 2002.
• 1997: Bain invested $41 million when buying Details, and collected at least $70 million from stock offerings. The company filed for bankruptcy in 2003.
Romney owned 100 percent of Bain Capital making him involved in all these deals, which represented more than 20 percent of the money Bain made from its investment funds between 1987 and 1995. Bain’s focus during all this time was leveraged buyouts, and it had not made venture investments since its earliest days.
All of this is bad enough. But leveraged buyouts don't only hurt businesses, workers, and the economy generally – they also short-change taxpayers, via a giant loophole in the tax code that enables companies to deduct loan interest from taxes. The provision was originally intended to encourage borrowing to build new factories, not to finance leveraged buyouts. But, according to Notre Dame Professor Brad Badertscher, private equity-owned companies paid a 22 percent tax rate before being bought, and only 10 percent the year after being acquired. That adds up to a savings of $130 billion in taxes since 2000.
Private equity has legions of defenders, from Wall Street to Washington (the industry is very well connected; four of the past eight U.S. Treasury Secretaries have worked in it); but when they point to the relatively modest venture capital investments of companies like Bain, don't be fooled. Look instead to the way Bain and its peers made the bulk of their money – through leveraged buyouts – and see who made out best in most of the deals: the businesses or the private equity guys, like Mitt Romney.
Josh Kosman is the author of 'The Buyout of America: How Private Equity Is Destroying Jobs and Killing The American Economy'.
