Liberals and the mainstream media are celebrating Matt Taibbi’s attack on Mitt Romney and Bain Capital in Rolling Stone.
The problem? Taibbi’s analysis is deeply flawed.
It starts off early.
But what most voters don’t know is the way Mitt Romney actually made his fortune: by borrowing vast sums of money that other people were forced to pay back.
Throughout the article Taibbi ignores one key group – the lenders. If you were lending money to Bain Capital, would you do it if Bain Capital wasn’t required to pay you back? Maybe you would, but you’d probably have a good reason for doing so. Goldman Sachs plays the role of the lender in Taibbi’s story here. So does Taibbi think they’re suckers? He seems to think they’re evil greedy profit makers, in a previous Rolling Stone article about Goldman.
After several paragraphs of personal attacks on Romney, Taibbi starts to get back to his misconception of the problem:
He moved away from creating companies like Staples through venture capital schemes, and toward a business model that involved borrowing huge sums of money to take over existing firms, then extracting value from them by force.
Again we have Romney “borrowing huge sums of money.” From whom?
The meat of the analysis comes soon after:
Bain … seeks out floundering businesses with good cash flows. It then puts down a relatively small amount of its own money and runs to a big bank like Goldman Sachs or Citigroup for the rest of the financing.
Note two things here. First, the lenders Taibbi mentions are also hated evil profit suckers like Goldman Sachs and Citigroup. Second, this floundering company has good cash flow, which borders on an oxymoron. Floundering companies have problems. Apple Computer has good cash flow. Not that this is impossible, but it’s dubious.
The takeover firm then uses that borrowed money to buy a controlling stake in the target company …
But here’s the catch. When Bain borrows all of that money from the bank, it’s the target company that ends up on the hook for all of the debt.
Taibbi’s mindset assumes that Goldman Sachs and Citigroup and perfectly happy to lend money to Bain but in a deal where Bain’s not on the hook for the money.
Now your troubled firm – let’s say you make tricycles in Alabama – has been taken over by a bunch of slick Wall Street dudes who kicked in as little as five percent as a down payment. So in addition to whatever problems you had before, Tricycle Inc. now owes Goldman or Citigroup $350 million. With all that new debt service to pay, the company’s bottom line is suddenly untenable: You almost have to start firing people immediately just to get your costs down to a manageable level.
Again, imagine you’re Lloyd Blankenfein at Goldman. Are you going to lend $350 million to a company whose bottom line will now be untenable? That doesn’t seem very smart or profitable.
Fortunately, the geniuses at Bain who now run the place are there to help tell you whom to fire. And for the service it performs cutting your company’s costs to help you pay off the massive debt that it, Bain, saddled your company with in the first place, Bain naturally charges a management fee, typically millions of dollars a year. So Tricycle Inc. now has two gigantic new burdens it never had before Bain Capital stepped into the picture: tens of millions in annual debt service, and millions more in “management fees.” Since the initial acquisition of Tricycle Inc. was probably greased by promising the company’s upper management lucrative bonuses, all that pain inevitably comes out of just one place: the benefits and payroll of the hourly workforce.
So Bain has now sucked millions of dollars out of Tricycle Inc.: Tens of millions in debt service, millions for Bain in management fees, and millions in bonuses to the upper management. And it’s going to pay for this by taking money from future payments to the hourly workforce.
Once all that debt is added, one of two things can happen. The company can fire workers and slash benefits to pay off all its new obligations to Goldman Sachs and Bain, leaving it ripe to be resold by Bain at a huge profit.
How is this business resold at a profit? Who is the buyer who’s paying more for the company after it’s been destroyed like this? This is another player Taibbi glosses over in his description.
We started this story with the floundering Tricycle Inc. being bought for about $400 million, including $350 million from Goldman/Citigroup. We take out maybe $50 million in debt service to the lenders, profit to Bain, bonuses to management. So don’t we now have a company that’s worth $400 million minus $50 million, or $350 million. Paying off the debt to the lender means the company is now worth zero – $350 million minus $350 million.
And since it was floundering when purchased, that sounds like it was already unprofitable. With the damage done by Bain, it should be losing even more money than before. How does Bain sell this pathetic wreck to anyone for a profit? Mr. Taibbi – that doesn’t make sense.
But he continues with another alternative:
Or it can go bankrupt – this happens after about seven percent of all private equity buyouts – leaving behind one or more shuttered factory towns. Either way, Bain wins. By power-sucking cash value from even the most rapidly dying firms, private equity raiders like Bain almost always get their cash out before a target goes belly up.
So instead of paying back Goldman on the loans, Bain puts Tricycle Inc. into bankruptcy. Now Goldman loses its $350 million. In Taibbi’s story, Goldman is played for a sucker like this 7% of the time, and they fall for it repeatedly.
Taibbi offers a shorter real-world example:
Take a typical Bain transaction involving an Indiana-based company called American Pad and Paper. Bain bought Ampad in 1992 for just $5 million, financing the rest of the deal with borrowed cash. Within three years, Ampad was paying $60 million in annual debt payments, plus an additional $7 million in management fees. A year later, Bain led Ampad to go public, cashed out about $50 million in stock for itself and its investors, charged the firm $2 million for arranging the IPO and pocketed another $5 million in “management” fees. Ampad wound up going bankrupt, and hundreds of workers lost their jobs, but Bain and Romney weren’t crying: They’d made more than $100 million on a $5 million investment.
Notice who Taibbi ignores in his story. In a bankruptcy the lenders are the ones who really get taken to the cleaners. See Maggie Haberman on the Ampad bankruptcy.
Out of a debt load of $170 million owed to unsecured creditors, Ampad ended up paying out less than $330,000, the filings show.
Another detail is missing from Taibbi’s version – timing. Bain bought Ampad in 1992. A former Ampad worker tells the story differently:
[E]mployees were given months of notice before the closing, job transfer offers, severance pay, free outplacement assistance services and other benefits. Ampad — on the brink of bankruptcy when Bain bought it in 1992 — operated, provided jobs and positive economic impact for an additional 13 years on Bain’s watch.
There’s also this from Wikipedia on Ampad:
The company continued to enjoy 53 percent compound annual growth in net sales, which increased from $8.8 million in 1992 to $200.5 million in 1996, when the company became publicly traded.
So in the first four years that Bain owned Ampad, sales increased dramatically. Why is this detail missing from the Taibbi description (or for that matter from Haberman’s)?
Because it doesn’t fit with Taibbi’s hateful attitude toward Romney and businessmen.
Taibbi continues with this further down in the article:
The only ones who profited in a big way from all the job-killing debt that Romney leveraged were Mitt and his buddies at Bain, along with Wall Street firms like Goldman and Citigroup.
He still hasn’t explained how Goldman makes money when it loses so much on the bankruptcy of a company like Ampad. That pesky little detail deserves an explanation Mr. Taibbi. Someone has to be the sucker. It’s either the lender who loses the money loaned in the bankruptcy, or the buyer who buys the carcass of the former company. Who’s the sucker, and why did they fall for it?
Here’s another of Taibbi’s examples, involving KB Toys:
In a typical private-equity fragging, Bain put up a mere $18 million to acquire KB Toys and got big banks to finance the remaining $302 million it needed. Less than a year and a half after the purchase, Bain decided to give itself a gift known as a “dividend recapitalization.” The firm induced KB Toys to redeem $121 million in stock and take out more than $66 million in bank loans – $83 million of which went directly into the pockets of Bain’s owners and investors, including Romney.
Again we have banks lending hundreds of millions to a company with that money being passed through to Bain and Romney. These bankers have to be idiots.
Bain ended up earning a return of at least 370 percent on the deal, while KB Toys fell into bankruptcy, saddled with millions in debt.
According to the Wikipedia entry on KB Toys, KB’s assets were eventually sold through the bankruptcy for $2.1 million. So the bankers, who loaned nearly $400 million, got only $2 million back from this deal? Something’s missing, and you’re not going to get answers from Taibbi because that would require real analysis. For more substance, see this Wall Street Journal article on the KB Toys Bankruptcy. You have to wonder if Taibbi read it.
Taibbi loves to stress the harm done to the workers:
“The thing about it is, nobody gets hurt,” says Patnode. “Except the people who worked here.”
Despite going through two bankruptcies, the banks and other lenders to KB Toys apparently didn’t get hurt.
There’s more, but it’s the same thing over and over. Taibbi has some work to do.
Fundamentally Taibbi has no interest in how businesses raise capital. The owners of a business have a choice between debt and equity. This decision affects risk and profit. In business school a key concept is the debt-equity ratio. This is not new with Mitt or Bain. It dates back at least to Modigliani-Miller in 1958.
If the founders or owners of a company think expansion will be highly profitable, it makes sense to finance mostly with debt. This essentially caps the amount that the financing costs. If financed with equity, they would have to share more of the profit with the new investors, leaving less of the profit with the earlier investors.
From a lender standpoint, it doesn’t make sense to lend money to a company that is not likely to be successful. Under Taibbi’s version of events, no sane investor would have lent to Romney or Bain a second time. As a wise man once put it, a few hundred years from now:
Shame on you Mr. Taibbi, for trying to fool people. And dear readers, if you ever fall for Mr. Taibbi again, it’ll be shame on you. Mr. Scott says so.