The referendum about Mitt Romney's business practices as CEO of Bain Capital is also a referendum about private equity. One month ago, on July 15, 2012, Anthony Luzzatto Gardner revisited the topic on the Bloomberg website: http://mobile.bloomberg.com/news/2012-07-15/romney-s-bain-yielded-private-gains-socialized-losses.html.
Mr. Gardner wasted no time, beginning his attack with the article's second sentence:
What’s clear from a review of the public record during his management of the private-equity firm Bain Capital from 1985 to 1999 is that Romney was fabulously successful in generating high returns for its investors. He did so, in large part, through heavy use of tax-deductible debt, usually to finance outsized dividends for the firm’s partners and investors. When some of the investments went bad, workers and creditors felt most of the pain. Romney privatized the gains and socialized the losses.
This is an issue I've written about before. The question that remains unanswered is this: What would have happened to these targeted firms had Bain Capital chosen to stay away? Would the workers have been better off? Mr. Gardner answers with a resounding yes, pointing out that many of the firms in question filed for bankruptcy after Bain's involvement. However, he writes about this in a vague manner:
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. It’s worth examining some of them to understand Romney’s investment style at Bain Capital.
What about the other 57 major deals? How many of them worked out for the workers of these companies? Mr. Gardner doesn't say.
What he does say is that Mr. Romney and Bain leverage their target companies with extraordinary debt, sometimes by as much as 40-to-1, and then quickly flip the companies away like refurbished real estate property, making large sums of money, but burdening the companies they leave behind with overwhelming debt that sometimes cannot be paid back. American Pad and Paper was one such company. Dade International was another. GS Industries is another, more well-known example.
Two points need to be made. The obvious one is that when Bain Capital sold these companies, someone was buying. Someone must have thought these companies were worth the money, even with the high leverage.
The second point was made by Josh Kosman in today's New York Post. He wrote the following:
Paul Ryan, who has some big Wall Street backers, has expressed support for a tax-reform bill that would make leveraged buyouts — central to the PE business — considerably less profitable.The Bipartisan Tax Fairness and Simplification Act of 2011 aims to lower the top corporate tax rate, without expanding the deficit, by closing loopholes and tax breaks — including one that encourages companies to load up on debt. The bill would limit interest tax deductibility that favors debt over equity.
Any change in the tax treatment of debt would threaten the lifeblood of the private-equity business — including Romney’s former firm, Bain Capital — which counts on the deduction to make debt-laden deals more profitable.
It looks like Mitt Romney made his fortune with Bain Capital just in time.
Short answer: No, they don't use too much leverage.
When someone sets the rules of the game, your job as a player is to maximize your chances of winning. If the government allows debt to be non-recourse in a corporate or LP structure, you load up the debt to maximize your returns. If the government provides tax incentives for debt instead of equity, you load up with debt. If lenders are willing to loan you money with a thin layer of equity capital...you get the idea.
If these firms were in good shape to begin with, it is highly doubtful that Bain would have been able to purchase them with a high profit potential. How many of these companies would have gone bankrupt anyway? How many were saved from bankruptcy because Bain got involved? Why does the public and/or politicians assume it is a profit seeker's goal to maximize employment at their firm?
This.
I'm not one to bash free market enterprise or complain about how the evils of finance surely outweigh the good, but I've read a few items on Bain that make my skin crawl. Take a look at this article if you have the stomach for it. Sorry for getting entirely off-topic--I should probably just post a new thread--but the "troubled teen" industry has always been of interest to me and I am deeply convinced that a) the public needs to be made more aware of it's practices and b) more oversight needs to be brought. In the context of Bain, too, it's pretty alarming that this shit happens in our country.
http://www.salon.com/2012/07/18/dark_side_of_a_bain_success/
I guess the notion that firms may engage in any and everything within their power to maximize profits--whether it be leverage, or simply lackadaisical training and employment practices in buyouts--is a delicate subject, and likely the one causing the uninformed to loathe it so.
Really? You're really gunna put that one on Bain? You don't have to hire PhDs to see that a kid, regardless of mental issues, isn't faking and is in fact in need of attention. Next step, hire people who can remember three digits, for example 911...
in theory - no in the real world - yes
Pretty much summed up finance right there.
Also, how is this news? My quick and dirty LBO screen, since sophomore year of college: Tax/Ebitda, Interest Expense/Ebitda, Capex. In my experience, Tax/Ebitda is very often the most compelling metric.
Sandhurst - When you say you screen for tax/ebitda, do you mean that you aren't interested in firms that pay high levels of tax? Or vice versa? If so, then may I ask why?
It means that I am. Basically, I am looking for a target that I can load up with as much debt as possible. My quick and dirty approach:
Tax/Ebitda (-) Capex/Ebitda (-) Interest expense/Ebitda (=) Score (as a % of Ebitda, higher being better)
Obviously there are other items that occur on the P&L after Ebitda, but this screen gives you a rough approximation of how much of Ebitda can be committed to new debt. Specifically, I do want targets that have historically paid high levels of tax, because in the buyout, that gives me more debt load without running a net loss and blowing up the deal.
Think about it: if a target is paying 40% tax year in and out, 1) it is probably a steady cash paying business (which is good), and 2) you can commit that 40% of Ebt, and say 30% of Ebitda, to new debt without affecting net income. So the "Score" on my screen is a proxy for new debt capacity, which is itself a proxy for LBO-attractiveness.
How is pre-buyout cash tax / interest relevant to the company going forward? Not including NOLs, the cap structure is going to be completely different so everything below operating income is going to change.
Sunt nisi nulla reprehenderit molestiae. Error impedit reiciendis recusandae. Sequi inventore debitis et. Asperiores placeat similique nemo quidem ipsam nihil mollitia eaque.
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