A private equity operator, writing a few weeks ago in Bloomberg, described his analysis of Mitt Romney’s success as a private equity manager and found some interesting details (you might want to go back and read my earlier post on the real problems with private equity for a primer)
Thanks to leverage, 10 of roughly 67 major deals by Bain Capital during Romney’s watch produced about 70 percent of the firm’s profits. Four of those 10 deals, as well as others, later wound up in bankruptcy.
To put this in context, a study (pdf) on the private equity industry by the ICAEW, a trade group for Chartered Accountants in the UK, looked at the overall failure rate of companies acquired by private equity firms by firm size (<10 million pounds [green], 10-100 million pounds [blue] and over 100 million pounds [red])
During the years when Romney was at Bain (1984 –
2002 1999), the failure rate of large UK private equity deals was mostly between 10 and 20%. Private equity deals fail when the companies end up in bankruptcy, which happens because most target companies for private equity firms are in some form of distress, so this failure is to be expected. The high returns generated by successful deals is a way of compensating investors for the inevitable failures.
There may be small differences between the UK and the US private equity firms, but seeing 4 of the 10 deals that made Bain and their investors the most money end up in bankruptcy is surprising (and out of line with the overall industry rates of failures of all deals). If 4 out of 10 money-making acquisitions end in bankruptcy, the total rate of failure in the overall portfolio is likely to be much higher, and much further out of line from the private equity industry as a whole.
The aggressiveness with which Bain used leverage and used the borrowed money to pay itself management fees and dividends likely caused this higher rate of failure of their companies even while Bain profited. Anthony Gardner, writing in Bloomberg, describes one such company:
In 1992, Bain Capital bought American Pad & Paper (Ampad) by financing 87 percent of the purchase price. In the next three years, Ampad borrowed to make acquisitions, repay existing debt and pay Bain Capital and its investors $60 million in dividends.
As a result, the company’s debt swelled from $11 million in 1993 to $444 million by 1995. The $14 million in annual interest expense on this debt dwarfed the company’s $4.7 million operating cash flow. The proceeds of an initial public offering in July 1996 were used to pay Bain Capital $48 million for part of its stake and to reduce the company’s debt to $270 million.
From 1993 to 1999, Bain Capital charged Ampad about $18 million in various fees. By 1999, the company’s debt was back up to $400 million. Unable to pay the interest costs and drained of cash paid to Bain Capital in fees and dividends, Ampad filed for bankruptcy the following year. Senior secured lenders got less than 50 cents on the dollar, unsecured lenders received two- tenths of a cent on the dollar, and several hundred jobs were lost. Bain Capital had reaped capital gains of $107 million on its $5.1 million investment.
This strategy of making money on companies who later failed as a result of Bain’s actions leaves me unsure of why Mitt Romney’s business experience makes him qualified to help the US economy recover. As Gardner concludes, “While Bain Capital wasn’t alone in using financial engineering to turbo-charge its returns, it was among the most aggressive under Romney’s leadership. Enriching investors by taking leveraged bets isn’t a qualification for a job requiring long-term vision and concern for public welfare. It is appropriate to point that out to voters.”
And that is why it is fair to question Romney’s business track record which he uses as evidence he would make a good president. I fear he would do to America what he and Bain did to Ampad.