An excerpt of David Stockman's new book, 'The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy,' was published in Newsweek a couple of weeks ago. Stockman is not impressed with Mitt Romney's skills as a job creator, but rather than exploring the validity of this statement from a political perspective, I would rather examine Romney's behavior in the context of understanding private equity firms from a more informed point of view.
I understand Stockman's premise: Romney is not a grower of jobs, all the companies he touches go bankrupt, he came in at the right time (between two recessions), etc. It's the details I don't understand.
Stockman was in the same line of work that Romney was. How many of his companies went bankrupt? Was Stockman more ethical than Romney and if so, in what way?
Here's a quote from the article that epitomizes my frustration:
When the crunch came, the company had no assets to fall back on because Bain had hocked virtually everything; it sold all the company’s credit-card receivables to a third party, and among its 650 stores it owned exactly three! By my calculation, the capitalized debt embedded in its store leases was nearly $750 million and when added to its disclosed balance-sheet debt, the company’s true debt of was $1.3 billion or a devastating 25X its peak-year free cash flow...
I don't understand how so much debt is hidden or embedded in the store leases--unless he means that Bain used operating leases instead of capital leases that bypass the balance sheet and don't appear as long term debt. (As I'm thinking out loud, it makes more sense to me, but by not using the term "operating lease," it's not as clear.)
An operating lease shows up on the income statement as "rental expense." With a capital lease, the asset is treated in the same way as if it were purchased by the company (in this case Bain). There is an asset and a liability on the balance sheet for the leased asset. On the income statement, there is depreciation expense and interest expense instead of rental expense, so in the beginning of the lease, net income will be higher with an operating lease, giving the impression that the company is earning more than it really is.
But one of the things that a financial analyst will do is convert the operating leases into capital leases. Wouldn't this have been the case with the companies that were flipped by Bain?
I don't think Stockman made the case that the bankruptcies were CAUSED by Bain. Weren't these struggling companies that welcomed Bain's financial input on the verge of bankruptcy anyway? And if not, Stockman doesn't prove that the companies and their employees were in worse shape after Bain took over. On the other hand, is there any truth to the accusation that Bain and other private equity firms are so concerned about making as much money as possible that they don't care about the well-being of the companies in which they invest?
I find it ironic that both Romney and Obama amass huge amounts of debt in pursuit of their goals.
