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David Stockman is among other things a former Republican Congressman, former Budget Director under Ronald Reagan, author of The Triumph of Politics and a former managing director at Blackstone Group.
Below is an excerpt from Stockman's upcoming book published in Newsweek.
KG
Mitt Romney: The Great Deformer
Oct 15, 2012 1:00 AM EDTIs Romney really a job creator? Ronald Reagan’s budget director, David Stockman, takes a scalpel to the claims.
Bain Capital is a product of the Great Deformation. It has garnered fabulous winnings through leveraged speculation in financial markets that have been perverted and deformed by decades of money printing and Wall Street coddling by the Fed. So Bain’s billions of profits were not rewards for capitalist creation; they were mainly windfalls collected from gambling in markets that were rigged to rise.
Mitt Romney was not a businessman; He was a master financial speculator who bought, sold, flipped, and stripped businesses. (Charles Ommanney / Getty Images)
Nevertheless, Mitt Romney claims that his essential qualification to be president is grounded in his 15 years as head of Bain Capital, from 1984 through early 1999. According to the campaign’s narrative, it was then that he became immersed in the toils of business enterprise, learning along the way the true secrets of how to grow the economy and create jobs. The fact that Bain’s returns reputedly averaged more than 50 percent annually during this period is purportedly proof of the case—real-world validation that Romney not only was a striking business success but also has been uniquely trained and seasoned for the task of restarting the nation’s sputtering engines of capitalism.
Except Mitt Romney was not a businessman; he was a master financial speculator who bought, sold, flipped, and stripped businesses. He did not build enterprises the old-fashioned way—out of inspiration, perspiration, and a long slog in the free market fostering a new product, service, or process of production. Instead, he spent his 15 years raising debt in prodigious amounts on Wall Street so that Bain could purchase the pots and pans and castoffs of corporate America, leverage them to the hilt, gussy them up as reborn “roll-ups,” and then deliver them back to Wall Street for resale—the faster the better.
That is the modus operandi of the leveraged-buyout business, and in an honest free-market economy, there wouldn’t be much scope for it because it creates little of economic value. But we have a rigged system—a regime of crony capitalism—where the tax code heavily favors debt and capital gains, and the central bank purposefully enables rampant speculation by propping up the price of financial assets and battering down the cost of leveraged finance.
So the vast outpouring of LBOs in recent decades has been the consequence of bad policy, not the product of capitalist enterprise. I know this from 17 years of experience doing leveraged buyouts at one of the pioneering private-equity houses, Blackstone, and then my own firm. I know the pitfalls of private equity. The whole business was about maximizing debt, extracting cash, cutting head counts, skimping on capital spending, outsourcing production, and dressing up the deal for the earliest, highest-profit exit possible. Occasionally, we did invest in genuine growth companies, but without cheap debt and deep tax subsidies, most deals would not make economic sense.
‘The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy’ by David A. Stockman. 400 pp. PublicAffairs. $29.99.
In truth, LBOs are capitalism’s natural undertakers—vulture investors who feed on failing businesses. Due to bad policy, however, they have now become monsters of the financial midway that strip-mine cash from healthy businesses and recycle it mostly to the top 1 percent.
The waxing and waning of the artificially swollen LBO business has been perfectly correlated with the bubbles and busts emanating from the Fed—so timing is the heart of the business. In that respect, Romney’s tenure says it all: it was almost exactly coterminous with the first great Greenspan bubble, which crested at the turn of the century and ended in the thundering stock-market crash of 2000-02. The credentials that Romney proffers as evidence of his business acumen, in fact, mainly show that he hung around the basket during the greatest bull market in recorded history.
Needless to say, having a trader’s facility for knowing when to hold ’em and when to fold ’em has virtually nothing to do with rectifying the massive fiscal hemorrhage and debt-burdened private economy that are the real issues before the American electorate. Indeed, the next president’s overriding task is restoring national solvency—an undertaking that will involve immense societywide pain, sacrifice, and denial and that will therefore require “fairness” as a defining principle. And that’s why heralding Romney’s record at Bain is so completely perverse. The record is actually all about the utter unfairness of windfall riches obtained under our anti-free market regime of bubble finance.
RIP VAN ROMNEY
When Romney opened the doors to Bain Capital in 1984, the S&P 500 stood at 160. By the time he answered the call to duty in Salt Lake City in early 1999, it had gone parabolic and reached 1270. This meant that had a modern Rip Van Winkle bought the S&P 500 index and held it through the 15 years in question, the annual return (with dividends) would have been a spectacular 17 percent. Bain did considerably better, of course, but the reason wasn’t business acumen.
The secret was leverage, luck, inside baseball, and the peculiar asymmetrical dynamics of the leveraged gambling carried on by private-equity shops. LBO funds are invested as equity at the bottom of a company’s capital structure, which means that the lenders who provide 80 to 90 percent of the capital have no recourse to the private-equity sponsor if deals go bust. Accordingly, LBO funds can lose 1X (one times) their money on failed deals, but make 10X or even 50X on the occasional “home run.” During a period of rising markets, expanding valuation multiples, and abundant credit, the opportunity to “average up” the home runs with the 1X losses is considerable; it can generate a spectacular portfolio outcome.
In a nutshell, that’s the story of Bain Capital during Mitt Romney’s tenure. The Wall Street Journal examined 77 significant deals completed during that period based on fundraising documents from Bain, and the results are a perfect illustration of bull-market asymmetry. Overall, Bain generated an impressive $2.5 billion in investor gains on $1.1 billion in investments. But 10 of Bain’s deals accounted for 75 percent of the investor profits.
Accordingly, Bain’s returns on the overwhelming bulk of the deals—67 out of 77—were actually lower than what a passive S&P 500 indexer would have earned even without the risk of leverage or paying all the private-equity fees. Investor profits amounted to a prosaic 0.7X the original investment on these deals and, based on its average five-year holding period, the annual return would have computed to about 12 percent—well below the 17 percent average return on the S&P in this period.
By contrast, the 10 home runs generated profits of $1.8 billion on investments of only $250 million, yielding a spectacular return of 7X investment. Yet it is this handful of home runs that both make the Romney investment legend and also seal the indictment: they show that Bain Capital was a vehicle for leveraged speculation that was gifted immeasurably by the Greenspan bubble. It was a fortunate place where leverage got lucky, not a higher form of capitalist endeavor or training school for presidential aspirants.
VICTORY FROM THE JAWS OF DEFEAT
The startling fact is that four of the 10 Bain Capital home runs ended up in bankruptcy, and for an obvious reason: Bain got its money out at the top of the Greenspan boom in the late 1990s and then these companies hit the wall during the 2000-02 downturn, weighed down by the massive load of debt Bain had bequeathed them. In fact, nearly $600 million, or one third of the profits earned by the home-run companies, had been extracted from the hide of these four eventual debt zombies.
The most emblematic among them was a roll-up deal focused on down-in-the-mouth department stores and apparel chains that were falling by the wayside in small-town America due to the arrival of Wal-Mart and the big-box retailers. Bain invested $10 million in 1988 and nine years later took out 18X its money—that is, a $175 million profit.
Fittingly, Stage Stores Inc. was the last deal underwritten by the Drexel-Milken junk-bond machine before its demise. And the $300 million raised for this incipient LBO was exactly the kind of slush fund that Milken’s stable of takeover artists had used to acquire corporate castoffs and other bedraggled pots and pans that got rechristened as “growth” companies.
During the next eight years, Bain slogged it out, accumulating about 300 small Main Streetstorefronts under such forgettable banners as Royal Palais, Bealls, and Fashion Bar. Yet the company wasn’t making much headway. By 1996, it had paid back none of the Milken debt and was only earning $14 million—exactly what it had generated back in 1992 on half the number of stores.
In the spring of 1997, when Chairman Greenspan decided that “irrational exuberance” was not such a worrisome thing, Bain Capital decided to indulge, too. It caused Stage Stores Inc.—which was already publicly traded—to raise $300 million of new junk bonds and used the proceeds to buy a faltering 250-store chain of family clothing stores called C.R. Anthony.
These 12,000-square-foot cracker-box stores sold mid-market shoes, shirts, and dresses right in Wal-Mart’s wheelhouse. In hot pursuit of “synergies,” Bain promptly rebranded these Anthony stores to the purportedly more compelling Stage and Bealls banners. While the name change did nothing to ward off the grim reaper from Bentonville, it suddenly gave Stage Stores Inc. the “growth” story that Greenspan’s bull market craved. Within five months of this ostensibly “transformative” deal and long before the results of the ritual “synergies” and “rebranding” could be determined, the company’s stock price had doubled. Bain Capital and its partner, Goldman Sachs, quickly unloaded their shares at the aforementioned 18X gain.
As a matter of plain fact, the “transformative” C.R. Anthony deal was a bull-market scam. Almost immediately, results headed south. After growing 4 percent during the year of Bain’s quick 1997 exit, same-store sales turned to a negative 3 percent in 1998 and negative 7 percent in 1999, and were still falling when Stage Stores Inc. filed for bankruptcy shortly thereafter. The company hemorrhaged $150 million of negative cash flow during 1998-99—that is, during the two years after Bain and Goldman got out of Dodge City.
Bain Capital subsequently claimed the company was “a growing, successful and consistently profitable company during the nine years we owned it” but then immediately ran into “operating problems.” That was a doozy by any other name but typical of the standard private-equity narrative that confuses speculators’ timing with real value creation on the free market. The fact is, the bad inventory and vastly overstated assets that took the company down did not suddenly materialize out of the blue during the 24 months after Bain’s exit: they were actually the result of financial-engineering games from the very beginning.
Worse still, the Stage Stores deal embodied all of the hidden leverage that had become par for the course in the era of bubble finance. 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.
The bankruptcy forced the closure of about 250—or 40 percent—of the company’s stores and the loss of about 5,000 jobs. Yet the moral of the Stage Stores saga is not simply that in this instance Bain Capital was a jobs destroyer, not a jobs creator. The larger point is that it is actually a tale of Wall Street speculators toying with Main Street properties in defiance of sound finance—an anti-Schumpeterian project that used state-subsidized debt to milk cash from stores that would not have otherwise survived on the free market.
Bain’s acclaimed success with another retailer—Staples—is also not what it is touted to be. Tom Stemberg was a visionary entrepreneur who got $5 million of seed money from Bain in 1986 when it was still in the venture-capital business; the Milken-style LBO schemes came later. As it happened, Bain exited the Staples deal after only a few years with a $15 million profit, a rounding error in the scheme of things.
Stemberg made Staples a free-market success, a relentless generator of efficiency in the retail distribution of office supplies. Yet this honest capitalist efficiency, which benefited millions of customers, was achieved by a rampage of job destruction among tens of thousands of Main Street stationery and office-supplies stores and other traditional distributors. These now-defunct operations could not compete with Staples due to their high labor costs per dollar of sales—including upstream labor expense in the traditional, inefficient wholesale and distribution layers that stood behind Main Street retailers.
Ironically, the businesses and jobs that Staples eliminated were the office-supply counterparts of the cracker-box stores selling shoes, shirts, and dresses that Bain kept on artificial life-support at Stage Stores Inc. At length, Wal-Mart eliminated these jobs and replaced them with back-of–the-store automation and front-end part-timers, as did Staples, which now has 40,000 part-time employees out of its approximate 90,000 total head count. The pointless exercise of counting jobs won and lost owing to these epochal shifts on the free market is obviously irrelevant to the job of being president, but the fact that Bain made $15 million from the winner and $175 million from the loser is evidence that it did not make a fortune all on its own. It had considerable help from the Easy Button at the Fed.
THE $100 MILLION YELLOW PAD
American Pad and Paper was a 20-bagger—that is, $5 million was invested in 1992 for a $100 million profit, a miraculous outcome for Bain, but hardly so for the Ampad workers and shareholders left holding the bag when the company went bankrupt in 1999 with massive debt. Ampad has been the focus of competing narratives in the election, but what it truly represents is neither jobs destroyed or saved—just an exercise in LBO cash-stripping that would not occur in an honest free market where the central bank was not in the tank for Wall Street.
Ampad, owned by the giant paper conglomerate Mead Corporation, had plants in 14 states in the faintly archaic business of making notebooks, envelopes, file folders, and writing tablets—including the eponymous “yellow pad.” Not surprisingly, at a time when the Internet and paperless office were taking the world by storm, Mead discovered that Ampad was “not a good fit” and that its sale to Bain Capital was “an early step to increase productivity.” So the question recurred as to how spreadsheet-toting suits from Boston could resurrect what deeply experienced executives in Dayton, Ohio, knew to be a value-destroying sunset operation.
The answer was leveraged financial engineering—that is, the roll-up of similar pots, pans, and discards for an eventual coming-out party on Wall Street. To this end, Mead perfumed the pig on the way out the door. In conjunction with a sweeping corporate “restructuring” program, 13 manufacturing and distribution facilities were consolidated into six and a $90 million “restructuring reserve” was established to cover asset write-downs and severance costs for upwards of a thousand terminated employees.
So Bain Capital and the division’s senior management became the proud owner of a slimmed-down $100 million business that dominated the market for legal-sized yellow pads. Yet even with all of Mead’s pre-divestiture elimination of plants and jobs, Ampad’s earnings in 1991 (before interest, tax, depreciation, and amortization) amounted to the grand sum of $4.9 million.
Mead also topped up Bain’s tiny $5 million equity investment with short-term financing and generous loans to the divested executives. But despite these Band-Aids from a big company trying to rid itself of a loser, the results showed that the suits from Boston had not moved the needle at all. By 1993, earnings had inched up only to $5.1 million—meaning that after 18 months of effort, Bain had come up with only $1 million of value gain at prevailing cash-flow multiples. Accordingly, it determined that yellow pads were not enough, and in the summer of 1994 it launched a spree of acquisitions hoping that accordion-file folders and business envelopes were the way of the future! The market was held to be large—amounting to some 169 billion envelopes per year—but the snag was they sold for only 1.6 cents each. To make a difference to its profits, therefore, Ampad needed to sell 10 billion to 15 billion envelopes a year.
This turned out to not be a problem. Another group of leveraged operators had been at work for nine years consolidating the business-envelope sector under the Williamhouse umbrella and had accumulated numerous plants and properties. By 1995, the Williamhouse roll-up of envelope makers and distributors had accumulated $150 million of debt, about $250 million of sales, and a modest operating cash flow of about $16 million.
So in October 1995, Bain again rolled the dice on a “transformative” acquisition. It spent $300 million acquiring Williamhouse, assuming all its heavy debt. The purchase price at 18X operating free cash flow was on the far edge of risky, but once again the putative “synergies” proved compelling to Bain’s bankers at the Bankers Trust Company. They refinanced all of the huge Williamhouse debts and provided an additional loan of $245 million. As it happened, Bain only needed $150 million to buy Williamhouse’s stock and pay the deal fees. So it sent its bankers a case of champagne and helped itself to a $60 million dividend in compensation for prospective “synergies” from a day-old merger.
By year-end 1995, Ampad had added envelopes and accordion files to its yellow-pad portfolio, but in the process of its frenetic acquisitions, Bain had trashed the company’s balance sheet. Compared to $45 million of debt at year-end 1994, Ampad by June 2006 had 10X as much debt to service—$460 million!
It therefore desperately needed the promised giant synergies, but, alas, they were not arriving as scheduled. Ampad generated barely enough operating income during the first six months of 1996 to cover its swollen interest payments, causing it to report a negligible 5 cents per share of net income. Yet since Bain Capital had now harvested a dividend that was 12X its original investment, it was basically home free—with a call option on either operational miracles or clever marketing and accounting. Not surprisingly, Bain opted for marketing and accounting razzmatazz. In June 1996, it launched an IPO at $15 per share—or about 150X its actual annualized rate of earnings during the first half of the year.
The roadshow had an altogether different spin, however. The IPO boasted “pro forma” financials—that is, not actual sales and profits but “would have been” results. Thus, 1995 pro forma sales of $620 million reflected the full-year impact of its acquisitions—implying that Ampad was a born-again “growth” company. Compared to its actual sales of only $100 million in 1991, it had purportedly been growing at 53 percent annually. The fact that 90 percent of this growth was due to debt-funded acquisitions was presumably to be overlooked.
The magic wand, however, came in the pro forma “adjustments” to earnings. The company had actually reported 1995 operating earnings of a scant $1.5 million and a net loss after interest and taxes, but in a five-page bridge table that was a wonder to behold, the offering prospectus detailed several dozen pro forma adjustments that envisaged the newly minted amalgamation of companies—Ampad-Williamhouse-Globe-Weis-Niagara—as a gusher of profits. Its interest costs had tripled, but thanks to “synergies,” cost savings, and future operating improvements, the $1.5 million of actual 1995 earnings were to be viewed—through the lens of pro forma magic—as $57 million of operating income.
This $57 million result included a lot of chickens that had not yet hatched. For example, $8.5 million of higher operating income was to be from the Niagara Envelope acquisition that had not actually finalized as of the IPO prospectus. Likewise, a savings of $4.5 million was cited from closing Williamhouse’s New York City headquarters, even though rent and severance costs several times greater were buried in purchase accounting and would be paid for years to come.
Yet by July 1996, the Greenspan stock-market bubble had a good head of steam. This meant that Ampad had no trouble selling nearly $250 million of stock based on a prospectus riddled with pro forma adjustments to the point of incomprehensibility, and a growth story that strained credulity. Bain Capital was able to sell to credulous IPO punters another $50 million of its stock, bringing its return to over $100 million and the fabled 20-bagger. Meanwhile, the hedge-fund speculators pumped the company’s stock to a peak of $26 per share by late summer of 1996, making all the more evident that the Ampad deal was really about speculative mania on Wall Street, not a revival of “Old Yeller” from the bits and pieces of a dying industry.
The company’s combined debt and equity was then being valued at $1.1 billion—or a fantastic 35X the $30 million of operating free cash flow (EBITDA less capital expenditure) that Ampad actually posted during 1997. However, within weeks of the IPO and a profits warning, the fast money smelled the rat and followed Bain in scampering off the listing ship. Margins were being squeezed by the superstores faster than the promised synergies could be realized. By early 1999, the stock was delisted and when the company was finally liquidated in bankruptcy shortly thereafter, secured lenders recovered about $100 million and other creditors got zero—that is, the company was worth about 10 percent of its peak valuation.
Once again, the moral of the story is about the ill effects of bad public policy, not just that smarter speculators like Bain bagged the slower-witted. To be sure, private-equity sponsors usually don’t make huge profits on busted deals. I lost a bundle when my auto-supplier investment went bankrupt, and was prosecuted for fraud to boot. But the government eventually dropped the charges entirely because in the end it was a case of way too much leverage and bad timing in the midst of an auto-industry collapse that took down GM, Chrysler, and nearly every major supplier too.
The lesson is that LBOs are just another legal (and risky) way for speculators to make money, but they are dangerous because when they fail, they leave needless economic disruption and job losses in their wake. That’s why LBOs would be rare in an honest free market—it’s only cheap debt, interest deductions, and ludicrously low capital-gains taxes that artifically fuel them.
The larger point is that Romney’s personal experience in the nation’s financial casinos is no mark against his character or competence. I’ve made money and lost it and know what it is like to be judged. But that experience doesn’t translate into answers on the great public issues before the nation, either. The Romney campaign’s feckless narrative that private equity generates real economic efficiency and societal wealth is dead wrong.
A $165 MILLION SCORE ON EXPERIAN
In September 1996, Bain Capital and some partners bought Experian, the consumer-credit-reporting division of TRW Inc., for $1.1 billion. But Bain ponied up only $88 million in equity along with a similar amount from partners; all the rest of the funding came from junk bonds and bank loans. Seven weeks later, they sold it to a British conglomerate for $1.7 billion, producing a $600 million profit for all the investors on their slim layer of equity capital and after not even enduring the inconvenience of unpacking their briefcases.
Quite obviously Bain generated zero value before it flipped the property. So the fact that it scalped a sudden and spectacular $165 million windfall has nothing to do with investment skill or even trading prowess. Instead, the Experian Corp.’s $600 million valuation gain in just 50 days was an inside job. That explains how a division put on the auction block by one of the nation’s most prominent dealmakers, CEO Joseph Gorman, could have been so badly mispriced in the initial sale to Bain Capital and its partners—that is, how they got it for just 65 percent of what the property fetched only months later. In fact, the original auction had been run by Bear Stearns—and it became evident in March 2008 that Bear Stearns had never been in the client-service business; it had been in the brass-knuckled trading business, where it used its balance sheet to underwrite and trade immensely profitable “risk assets.” Not surprisingly, the private-equity houses were the premier source of profits for its trading and capital-markets desks—so its “investment bankers” needed little encouragement about where to steer corporate-divestiture deals.
In that endeavor, they got plenty of help from the inside management of spun-off divisions, which were usually marketed as a “key asset” of the business and eager to participate in the prospective LBO. Thus, Experian’s CEO, D. Van Skilling, and his lieutenants reaped millions from this Wall Street-orchestrated windfall before they had even been issued new business cards. Oblivious to the irony, however, Skilling defended Bain’s instant $165 million profit by insisting to Business Insider“there was never a hint of financial chicanery at all.” He had that upside down. The deal was pure chicanery, but not because the private-equity investors were underhanded. It was because they were artificially enabled by the central banking and taxing branches of the state—the true source of this kind of rent-a-company speculation.
THE WESLEY-JESSEN HOME RUN
Wesley-Jessen was a small specialist firm that did reasonably well in cosmetic eye-color lenses and toric lenses to correct astigmatism. In mid-1995, when Schering-Plough Corp. put it on the block, Bain Capital invested $6 million and reaped a $300 million profit for itself by 1999—making nearly 50X its investment in the same number of months. On an apples-to-apples basis, however, the company’s operating income rose by only 2X during the same period, by my calculations. The rest of the gain was due to massive leverage, the Greenspan bubble, and accounting moves that can fairly be called myopic.
Bain employed a hoary old dodge—having its accountants write off every dime of plant, equipment, and intangible know-how, reassigning roughly $40 million to the inventory accounts, and then charging it to income in the immediate two or three quarters. This trick eliminated all future depreciation, thereby magically adding $14 million to the pro forma operating income on Wesley-Jessen’s $100 million of sales. Investors were promptly told to ignore the resulting losses, of course, since these inventory charges were “non-recurring”! In fact, savings from pre-deal “restructuring” actions by the seller, plus the accounting magic, generated $24 million of freshly minted “operating income” before Bain’s turnaround squad even showed up at the company’s headquarters. The alleged “turnaround” of Wesley-Jessen was thus largely an artifact of Bain’s PR machine.
In the fourth quarter of 1996, the company borrowed $70 million to acquire a competitor, Barnes-Hind, from Pilkington plc. Before the ink was dry on the merger contract, Bain filed an IPO prospectus. While Barnes-Hind had an operating loss of $17 million the year before the merger, its results for that period were improved by $23 million owing to Bain’s pro forma adjustments—creating the appearance of another dramatic turnaround.
During the 12 months ending at the merger date, the combined companies had actually incurred a net loss of $27 million, but it vanished with the help of $50 million in pre-tax adjustments for merger accounting and prospective savings. So its pro forma earnings took on a decisively improved aura; it would have booked a $14 million profit, or about $0.73 per share.
Not surprisingly, the stock market eagerly scooped up $45 million of new shares at $15, or 20X these gussied-up earnings, just in time for the Fed to begin a new round of goosing in March 1997. And that proved propitious for Bain. Almost to the day on which its 180-day IPO lockup expired, it sold its first batch of shares in a secondary offering in a now red-hot stock market at a red-hot price that was up 60 percent from the IPO.
Wesley-Jessen had not then filed financial statements with even $1 of GAAP (generally accepted accounting principles) net income. But when Bain’s underwriters wired the proceeds in August 1997 the selling price was $23.50 per share. That’s 52X the $0.43 per share it had paid for the stock 25 months earlier. At the end of the day, massive leverage, fancy accounting, and bubble finance, not entrepreneurial prowess, were the source of Bain’s 50-bagger.
THE ITALIAN JOB
In November 1997, Bain Capital pulled off a veritable capitalist heist in the socialist redoubts of the Italian Yellow Pages. On a $17 million investment in the Italian phone book, it took out a profit of $375 million. This was not only a 22-bagger; for Mitt Romney, it was the ultimate in no-sweat riches. According to the company’s CEO, Romney’s sole involvement was a cameo appearance during a due-diligence session: “He came into the room, asked a couple of very sharp questions immediately, shook hands and left.” Twenty-eight months later, in February 2000, Romney’s former colleagues at Bain located him during his tour of duty in Salt Lake City, where they wired his share of the winnings: a reputed $50 million.
Bain and a syndicate of private-equity houses were originally brought in as a stalking horse to validate the government’s “privatization” machinations. At the time, the key Italian Treasury official was one Mario Draghi (now president of the European Central Bank). His assignment was to get the nation’s huge deficit down to a Maastricht Treaty–compliant 3 percent, and he elected to do so by means of a rent-a-balance-sheet ploy of the type then in favor. The short story is that Bain and the other investors paid 5X the company’s operating income for their shares, and were paid 100X operating income to leave when local circumstances obviated the need for the rental deal. That preposterous multiple expansion accounted for virtually all of Bain’s 22-bagger.
In the interim, the dotcom bubble reached it fevered peak—so Italy’s lumbering phone-book publisher had puffed itself up as a fleet-footed Internet company, claiming to be the next AOL. In the fog of 1999’s worldwide financial bubbles, a group of corporate raiders who did not have two nickels to rub together then got control of Italy’s storied typewriter maker, Olivetti, and parleyed massive borrowings through that vehicle into control of the Italian phone company. Now hoist atop a stupendous house of cards, the raiders next went after Italy’s gussied-up Yellow Pages, paying $24 billion—or 180X net income—for a business that was slithering into the sunset. In fact, it is currently worth perhaps 1 percent of Bain’s exit price through a deal that top-ticked Greenspan’s NASDAQ bubble in February 2000. Never have a group of private-equity men laughed more heartily on the way to the bank.
The Bain Capital investments here reviewed accounted for $1.4 billion or 60 percent of the fund’s profits over 15 years, by my calculations. Four of them ended in bankruptcy; one was an inside job and fast flip; one was essentially a massive M&A brokerage fee; and the seventh and largest gain—the Italian Job—amounted to a veritable freak of financial nature.
In short, this is a record about a dangerous form of leveraged gambling that has been enabled by the failed central banking and taxing policies of the state. That it should be offered as evidence that Mitt Romney is a deeply experienced capitalist entrepreneur and job creator is surely a testament to the financial deformations of our times.
From the Forthcoming The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy by David Stockman. Copyright © 2012 by David Stockman. Adapted by permission of Publicaffairs, a member of the Perseus Books Group. Stockman’s book will be published in March 2013
Below is an excerpt from Stockman's upcoming book published in Newsweek.
KG
Mitt Romney: The Great Deformer
Oct 15, 2012 1:00 AM EDTIs Romney really a job creator? Ronald Reagan’s budget director, David Stockman, takes a scalpel to the claims.
Bain Capital is a product of the Great Deformation. It has garnered fabulous winnings through leveraged speculation in financial markets that have been perverted and deformed by decades of money printing and Wall Street coddling by the Fed. So Bain’s billions of profits were not rewards for capitalist creation; they were mainly windfalls collected from gambling in markets that were rigged to rise.
Mitt Romney was not a businessman; He was a master financial speculator who bought, sold, flipped, and stripped businesses. (Charles Ommanney / Getty Images)
Nevertheless, Mitt Romney claims that his essential qualification to be president is grounded in his 15 years as head of Bain Capital, from 1984 through early 1999. According to the campaign’s narrative, it was then that he became immersed in the toils of business enterprise, learning along the way the true secrets of how to grow the economy and create jobs. The fact that Bain’s returns reputedly averaged more than 50 percent annually during this period is purportedly proof of the case—real-world validation that Romney not only was a striking business success but also has been uniquely trained and seasoned for the task of restarting the nation’s sputtering engines of capitalism.
Except Mitt Romney was not a businessman; he was a master financial speculator who bought, sold, flipped, and stripped businesses. He did not build enterprises the old-fashioned way—out of inspiration, perspiration, and a long slog in the free market fostering a new product, service, or process of production. Instead, he spent his 15 years raising debt in prodigious amounts on Wall Street so that Bain could purchase the pots and pans and castoffs of corporate America, leverage them to the hilt, gussy them up as reborn “roll-ups,” and then deliver them back to Wall Street for resale—the faster the better.
That is the modus operandi of the leveraged-buyout business, and in an honest free-market economy, there wouldn’t be much scope for it because it creates little of economic value. But we have a rigged system—a regime of crony capitalism—where the tax code heavily favors debt and capital gains, and the central bank purposefully enables rampant speculation by propping up the price of financial assets and battering down the cost of leveraged finance.
So the vast outpouring of LBOs in recent decades has been the consequence of bad policy, not the product of capitalist enterprise. I know this from 17 years of experience doing leveraged buyouts at one of the pioneering private-equity houses, Blackstone, and then my own firm. I know the pitfalls of private equity. The whole business was about maximizing debt, extracting cash, cutting head counts, skimping on capital spending, outsourcing production, and dressing up the deal for the earliest, highest-profit exit possible. Occasionally, we did invest in genuine growth companies, but without cheap debt and deep tax subsidies, most deals would not make economic sense.
‘The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy’ by David A. Stockman. 400 pp. PublicAffairs. $29.99.
In truth, LBOs are capitalism’s natural undertakers—vulture investors who feed on failing businesses. Due to bad policy, however, they have now become monsters of the financial midway that strip-mine cash from healthy businesses and recycle it mostly to the top 1 percent.
The waxing and waning of the artificially swollen LBO business has been perfectly correlated with the bubbles and busts emanating from the Fed—so timing is the heart of the business. In that respect, Romney’s tenure says it all: it was almost exactly coterminous with the first great Greenspan bubble, which crested at the turn of the century and ended in the thundering stock-market crash of 2000-02. The credentials that Romney proffers as evidence of his business acumen, in fact, mainly show that he hung around the basket during the greatest bull market in recorded history.
Needless to say, having a trader’s facility for knowing when to hold ’em and when to fold ’em has virtually nothing to do with rectifying the massive fiscal hemorrhage and debt-burdened private economy that are the real issues before the American electorate. Indeed, the next president’s overriding task is restoring national solvency—an undertaking that will involve immense societywide pain, sacrifice, and denial and that will therefore require “fairness” as a defining principle. And that’s why heralding Romney’s record at Bain is so completely perverse. The record is actually all about the utter unfairness of windfall riches obtained under our anti-free market regime of bubble finance.
RIP VAN ROMNEY
When Romney opened the doors to Bain Capital in 1984, the S&P 500 stood at 160. By the time he answered the call to duty in Salt Lake City in early 1999, it had gone parabolic and reached 1270. This meant that had a modern Rip Van Winkle bought the S&P 500 index and held it through the 15 years in question, the annual return (with dividends) would have been a spectacular 17 percent. Bain did considerably better, of course, but the reason wasn’t business acumen.
The secret was leverage, luck, inside baseball, and the peculiar asymmetrical dynamics of the leveraged gambling carried on by private-equity shops. LBO funds are invested as equity at the bottom of a company’s capital structure, which means that the lenders who provide 80 to 90 percent of the capital have no recourse to the private-equity sponsor if deals go bust. Accordingly, LBO funds can lose 1X (one times) their money on failed deals, but make 10X or even 50X on the occasional “home run.” During a period of rising markets, expanding valuation multiples, and abundant credit, the opportunity to “average up” the home runs with the 1X losses is considerable; it can generate a spectacular portfolio outcome.
In a nutshell, that’s the story of Bain Capital during Mitt Romney’s tenure. The Wall Street Journal examined 77 significant deals completed during that period based on fundraising documents from Bain, and the results are a perfect illustration of bull-market asymmetry. Overall, Bain generated an impressive $2.5 billion in investor gains on $1.1 billion in investments. But 10 of Bain’s deals accounted for 75 percent of the investor profits.
Accordingly, Bain’s returns on the overwhelming bulk of the deals—67 out of 77—were actually lower than what a passive S&P 500 indexer would have earned even without the risk of leverage or paying all the private-equity fees. Investor profits amounted to a prosaic 0.7X the original investment on these deals and, based on its average five-year holding period, the annual return would have computed to about 12 percent—well below the 17 percent average return on the S&P in this period.
By contrast, the 10 home runs generated profits of $1.8 billion on investments of only $250 million, yielding a spectacular return of 7X investment. Yet it is this handful of home runs that both make the Romney investment legend and also seal the indictment: they show that Bain Capital was a vehicle for leveraged speculation that was gifted immeasurably by the Greenspan bubble. It was a fortunate place where leverage got lucky, not a higher form of capitalist endeavor or training school for presidential aspirants.
VICTORY FROM THE JAWS OF DEFEAT
The startling fact is that four of the 10 Bain Capital home runs ended up in bankruptcy, and for an obvious reason: Bain got its money out at the top of the Greenspan boom in the late 1990s and then these companies hit the wall during the 2000-02 downturn, weighed down by the massive load of debt Bain had bequeathed them. In fact, nearly $600 million, or one third of the profits earned by the home-run companies, had been extracted from the hide of these four eventual debt zombies.
The most emblematic among them was a roll-up deal focused on down-in-the-mouth department stores and apparel chains that were falling by the wayside in small-town America due to the arrival of Wal-Mart and the big-box retailers. Bain invested $10 million in 1988 and nine years later took out 18X its money—that is, a $175 million profit.
Fittingly, Stage Stores Inc. was the last deal underwritten by the Drexel-Milken junk-bond machine before its demise. And the $300 million raised for this incipient LBO was exactly the kind of slush fund that Milken’s stable of takeover artists had used to acquire corporate castoffs and other bedraggled pots and pans that got rechristened as “growth” companies.
During the next eight years, Bain slogged it out, accumulating about 300 small Main Streetstorefronts under such forgettable banners as Royal Palais, Bealls, and Fashion Bar. Yet the company wasn’t making much headway. By 1996, it had paid back none of the Milken debt and was only earning $14 million—exactly what it had generated back in 1992 on half the number of stores.
In the spring of 1997, when Chairman Greenspan decided that “irrational exuberance” was not such a worrisome thing, Bain Capital decided to indulge, too. It caused Stage Stores Inc.—which was already publicly traded—to raise $300 million of new junk bonds and used the proceeds to buy a faltering 250-store chain of family clothing stores called C.R. Anthony.
These 12,000-square-foot cracker-box stores sold mid-market shoes, shirts, and dresses right in Wal-Mart’s wheelhouse. In hot pursuit of “synergies,” Bain promptly rebranded these Anthony stores to the purportedly more compelling Stage and Bealls banners. While the name change did nothing to ward off the grim reaper from Bentonville, it suddenly gave Stage Stores Inc. the “growth” story that Greenspan’s bull market craved. Within five months of this ostensibly “transformative” deal and long before the results of the ritual “synergies” and “rebranding” could be determined, the company’s stock price had doubled. Bain Capital and its partner, Goldman Sachs, quickly unloaded their shares at the aforementioned 18X gain.
As a matter of plain fact, the “transformative” C.R. Anthony deal was a bull-market scam. Almost immediately, results headed south. After growing 4 percent during the year of Bain’s quick 1997 exit, same-store sales turned to a negative 3 percent in 1998 and negative 7 percent in 1999, and were still falling when Stage Stores Inc. filed for bankruptcy shortly thereafter. The company hemorrhaged $150 million of negative cash flow during 1998-99—that is, during the two years after Bain and Goldman got out of Dodge City.
Bain Capital subsequently claimed the company was “a growing, successful and consistently profitable company during the nine years we owned it” but then immediately ran into “operating problems.” That was a doozy by any other name but typical of the standard private-equity narrative that confuses speculators’ timing with real value creation on the free market. The fact is, the bad inventory and vastly overstated assets that took the company down did not suddenly materialize out of the blue during the 24 months after Bain’s exit: they were actually the result of financial-engineering games from the very beginning.
Worse still, the Stage Stores deal embodied all of the hidden leverage that had become par for the course in the era of bubble finance. 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.
The bankruptcy forced the closure of about 250—or 40 percent—of the company’s stores and the loss of about 5,000 jobs. Yet the moral of the Stage Stores saga is not simply that in this instance Bain Capital was a jobs destroyer, not a jobs creator. The larger point is that it is actually a tale of Wall Street speculators toying with Main Street properties in defiance of sound finance—an anti-Schumpeterian project that used state-subsidized debt to milk cash from stores that would not have otherwise survived on the free market.
Bain’s acclaimed success with another retailer—Staples—is also not what it is touted to be. Tom Stemberg was a visionary entrepreneur who got $5 million of seed money from Bain in 1986 when it was still in the venture-capital business; the Milken-style LBO schemes came later. As it happened, Bain exited the Staples deal after only a few years with a $15 million profit, a rounding error in the scheme of things.
Stemberg made Staples a free-market success, a relentless generator of efficiency in the retail distribution of office supplies. Yet this honest capitalist efficiency, which benefited millions of customers, was achieved by a rampage of job destruction among tens of thousands of Main Street stationery and office-supplies stores and other traditional distributors. These now-defunct operations could not compete with Staples due to their high labor costs per dollar of sales—including upstream labor expense in the traditional, inefficient wholesale and distribution layers that stood behind Main Street retailers.
Ironically, the businesses and jobs that Staples eliminated were the office-supply counterparts of the cracker-box stores selling shoes, shirts, and dresses that Bain kept on artificial life-support at Stage Stores Inc. At length, Wal-Mart eliminated these jobs and replaced them with back-of–the-store automation and front-end part-timers, as did Staples, which now has 40,000 part-time employees out of its approximate 90,000 total head count. The pointless exercise of counting jobs won and lost owing to these epochal shifts on the free market is obviously irrelevant to the job of being president, but the fact that Bain made $15 million from the winner and $175 million from the loser is evidence that it did not make a fortune all on its own. It had considerable help from the Easy Button at the Fed.
THE $100 MILLION YELLOW PAD
American Pad and Paper was a 20-bagger—that is, $5 million was invested in 1992 for a $100 million profit, a miraculous outcome for Bain, but hardly so for the Ampad workers and shareholders left holding the bag when the company went bankrupt in 1999 with massive debt. Ampad has been the focus of competing narratives in the election, but what it truly represents is neither jobs destroyed or saved—just an exercise in LBO cash-stripping that would not occur in an honest free market where the central bank was not in the tank for Wall Street.
Ampad, owned by the giant paper conglomerate Mead Corporation, had plants in 14 states in the faintly archaic business of making notebooks, envelopes, file folders, and writing tablets—including the eponymous “yellow pad.” Not surprisingly, at a time when the Internet and paperless office were taking the world by storm, Mead discovered that Ampad was “not a good fit” and that its sale to Bain Capital was “an early step to increase productivity.” So the question recurred as to how spreadsheet-toting suits from Boston could resurrect what deeply experienced executives in Dayton, Ohio, knew to be a value-destroying sunset operation.
The answer was leveraged financial engineering—that is, the roll-up of similar pots, pans, and discards for an eventual coming-out party on Wall Street. To this end, Mead perfumed the pig on the way out the door. In conjunction with a sweeping corporate “restructuring” program, 13 manufacturing and distribution facilities were consolidated into six and a $90 million “restructuring reserve” was established to cover asset write-downs and severance costs for upwards of a thousand terminated employees.
So Bain Capital and the division’s senior management became the proud owner of a slimmed-down $100 million business that dominated the market for legal-sized yellow pads. Yet even with all of Mead’s pre-divestiture elimination of plants and jobs, Ampad’s earnings in 1991 (before interest, tax, depreciation, and amortization) amounted to the grand sum of $4.9 million.
Mead also topped up Bain’s tiny $5 million equity investment with short-term financing and generous loans to the divested executives. But despite these Band-Aids from a big company trying to rid itself of a loser, the results showed that the suits from Boston had not moved the needle at all. By 1993, earnings had inched up only to $5.1 million—meaning that after 18 months of effort, Bain had come up with only $1 million of value gain at prevailing cash-flow multiples. Accordingly, it determined that yellow pads were not enough, and in the summer of 1994 it launched a spree of acquisitions hoping that accordion-file folders and business envelopes were the way of the future! The market was held to be large—amounting to some 169 billion envelopes per year—but the snag was they sold for only 1.6 cents each. To make a difference to its profits, therefore, Ampad needed to sell 10 billion to 15 billion envelopes a year.
This turned out to not be a problem. Another group of leveraged operators had been at work for nine years consolidating the business-envelope sector under the Williamhouse umbrella and had accumulated numerous plants and properties. By 1995, the Williamhouse roll-up of envelope makers and distributors had accumulated $150 million of debt, about $250 million of sales, and a modest operating cash flow of about $16 million.
So in October 1995, Bain again rolled the dice on a “transformative” acquisition. It spent $300 million acquiring Williamhouse, assuming all its heavy debt. The purchase price at 18X operating free cash flow was on the far edge of risky, but once again the putative “synergies” proved compelling to Bain’s bankers at the Bankers Trust Company. They refinanced all of the huge Williamhouse debts and provided an additional loan of $245 million. As it happened, Bain only needed $150 million to buy Williamhouse’s stock and pay the deal fees. So it sent its bankers a case of champagne and helped itself to a $60 million dividend in compensation for prospective “synergies” from a day-old merger.
By year-end 1995, Ampad had added envelopes and accordion files to its yellow-pad portfolio, but in the process of its frenetic acquisitions, Bain had trashed the company’s balance sheet. Compared to $45 million of debt at year-end 1994, Ampad by June 2006 had 10X as much debt to service—$460 million!
It therefore desperately needed the promised giant synergies, but, alas, they were not arriving as scheduled. Ampad generated barely enough operating income during the first six months of 1996 to cover its swollen interest payments, causing it to report a negligible 5 cents per share of net income. Yet since Bain Capital had now harvested a dividend that was 12X its original investment, it was basically home free—with a call option on either operational miracles or clever marketing and accounting. Not surprisingly, Bain opted for marketing and accounting razzmatazz. In June 1996, it launched an IPO at $15 per share—or about 150X its actual annualized rate of earnings during the first half of the year.
The roadshow had an altogether different spin, however. The IPO boasted “pro forma” financials—that is, not actual sales and profits but “would have been” results. Thus, 1995 pro forma sales of $620 million reflected the full-year impact of its acquisitions—implying that Ampad was a born-again “growth” company. Compared to its actual sales of only $100 million in 1991, it had purportedly been growing at 53 percent annually. The fact that 90 percent of this growth was due to debt-funded acquisitions was presumably to be overlooked.
The magic wand, however, came in the pro forma “adjustments” to earnings. The company had actually reported 1995 operating earnings of a scant $1.5 million and a net loss after interest and taxes, but in a five-page bridge table that was a wonder to behold, the offering prospectus detailed several dozen pro forma adjustments that envisaged the newly minted amalgamation of companies—Ampad-Williamhouse-Globe-Weis-Niagara—as a gusher of profits. Its interest costs had tripled, but thanks to “synergies,” cost savings, and future operating improvements, the $1.5 million of actual 1995 earnings were to be viewed—through the lens of pro forma magic—as $57 million of operating income.
This $57 million result included a lot of chickens that had not yet hatched. For example, $8.5 million of higher operating income was to be from the Niagara Envelope acquisition that had not actually finalized as of the IPO prospectus. Likewise, a savings of $4.5 million was cited from closing Williamhouse’s New York City headquarters, even though rent and severance costs several times greater were buried in purchase accounting and would be paid for years to come.
Yet by July 1996, the Greenspan stock-market bubble had a good head of steam. This meant that Ampad had no trouble selling nearly $250 million of stock based on a prospectus riddled with pro forma adjustments to the point of incomprehensibility, and a growth story that strained credulity. Bain Capital was able to sell to credulous IPO punters another $50 million of its stock, bringing its return to over $100 million and the fabled 20-bagger. Meanwhile, the hedge-fund speculators pumped the company’s stock to a peak of $26 per share by late summer of 1996, making all the more evident that the Ampad deal was really about speculative mania on Wall Street, not a revival of “Old Yeller” from the bits and pieces of a dying industry.
The company’s combined debt and equity was then being valued at $1.1 billion—or a fantastic 35X the $30 million of operating free cash flow (EBITDA less capital expenditure) that Ampad actually posted during 1997. However, within weeks of the IPO and a profits warning, the fast money smelled the rat and followed Bain in scampering off the listing ship. Margins were being squeezed by the superstores faster than the promised synergies could be realized. By early 1999, the stock was delisted and when the company was finally liquidated in bankruptcy shortly thereafter, secured lenders recovered about $100 million and other creditors got zero—that is, the company was worth about 10 percent of its peak valuation.
Once again, the moral of the story is about the ill effects of bad public policy, not just that smarter speculators like Bain bagged the slower-witted. To be sure, private-equity sponsors usually don’t make huge profits on busted deals. I lost a bundle when my auto-supplier investment went bankrupt, and was prosecuted for fraud to boot. But the government eventually dropped the charges entirely because in the end it was a case of way too much leverage and bad timing in the midst of an auto-industry collapse that took down GM, Chrysler, and nearly every major supplier too.
The lesson is that LBOs are just another legal (and risky) way for speculators to make money, but they are dangerous because when they fail, they leave needless economic disruption and job losses in their wake. That’s why LBOs would be rare in an honest free market—it’s only cheap debt, interest deductions, and ludicrously low capital-gains taxes that artifically fuel them.
The larger point is that Romney’s personal experience in the nation’s financial casinos is no mark against his character or competence. I’ve made money and lost it and know what it is like to be judged. But that experience doesn’t translate into answers on the great public issues before the nation, either. The Romney campaign’s feckless narrative that private equity generates real economic efficiency and societal wealth is dead wrong.
A $165 MILLION SCORE ON EXPERIAN
In September 1996, Bain Capital and some partners bought Experian, the consumer-credit-reporting division of TRW Inc., for $1.1 billion. But Bain ponied up only $88 million in equity along with a similar amount from partners; all the rest of the funding came from junk bonds and bank loans. Seven weeks later, they sold it to a British conglomerate for $1.7 billion, producing a $600 million profit for all the investors on their slim layer of equity capital and after not even enduring the inconvenience of unpacking their briefcases.
Quite obviously Bain generated zero value before it flipped the property. So the fact that it scalped a sudden and spectacular $165 million windfall has nothing to do with investment skill or even trading prowess. Instead, the Experian Corp.’s $600 million valuation gain in just 50 days was an inside job. That explains how a division put on the auction block by one of the nation’s most prominent dealmakers, CEO Joseph Gorman, could have been so badly mispriced in the initial sale to Bain Capital and its partners—that is, how they got it for just 65 percent of what the property fetched only months later. In fact, the original auction had been run by Bear Stearns—and it became evident in March 2008 that Bear Stearns had never been in the client-service business; it had been in the brass-knuckled trading business, where it used its balance sheet to underwrite and trade immensely profitable “risk assets.” Not surprisingly, the private-equity houses were the premier source of profits for its trading and capital-markets desks—so its “investment bankers” needed little encouragement about where to steer corporate-divestiture deals.
In that endeavor, they got plenty of help from the inside management of spun-off divisions, which were usually marketed as a “key asset” of the business and eager to participate in the prospective LBO. Thus, Experian’s CEO, D. Van Skilling, and his lieutenants reaped millions from this Wall Street-orchestrated windfall before they had even been issued new business cards. Oblivious to the irony, however, Skilling defended Bain’s instant $165 million profit by insisting to Business Insider“there was never a hint of financial chicanery at all.” He had that upside down. The deal was pure chicanery, but not because the private-equity investors were underhanded. It was because they were artificially enabled by the central banking and taxing branches of the state—the true source of this kind of rent-a-company speculation.
THE WESLEY-JESSEN HOME RUN
Wesley-Jessen was a small specialist firm that did reasonably well in cosmetic eye-color lenses and toric lenses to correct astigmatism. In mid-1995, when Schering-Plough Corp. put it on the block, Bain Capital invested $6 million and reaped a $300 million profit for itself by 1999—making nearly 50X its investment in the same number of months. On an apples-to-apples basis, however, the company’s operating income rose by only 2X during the same period, by my calculations. The rest of the gain was due to massive leverage, the Greenspan bubble, and accounting moves that can fairly be called myopic.
Bain employed a hoary old dodge—having its accountants write off every dime of plant, equipment, and intangible know-how, reassigning roughly $40 million to the inventory accounts, and then charging it to income in the immediate two or three quarters. This trick eliminated all future depreciation, thereby magically adding $14 million to the pro forma operating income on Wesley-Jessen’s $100 million of sales. Investors were promptly told to ignore the resulting losses, of course, since these inventory charges were “non-recurring”! In fact, savings from pre-deal “restructuring” actions by the seller, plus the accounting magic, generated $24 million of freshly minted “operating income” before Bain’s turnaround squad even showed up at the company’s headquarters. The alleged “turnaround” of Wesley-Jessen was thus largely an artifact of Bain’s PR machine.
In the fourth quarter of 1996, the company borrowed $70 million to acquire a competitor, Barnes-Hind, from Pilkington plc. Before the ink was dry on the merger contract, Bain filed an IPO prospectus. While Barnes-Hind had an operating loss of $17 million the year before the merger, its results for that period were improved by $23 million owing to Bain’s pro forma adjustments—creating the appearance of another dramatic turnaround.
During the 12 months ending at the merger date, the combined companies had actually incurred a net loss of $27 million, but it vanished with the help of $50 million in pre-tax adjustments for merger accounting and prospective savings. So its pro forma earnings took on a decisively improved aura; it would have booked a $14 million profit, or about $0.73 per share.
Not surprisingly, the stock market eagerly scooped up $45 million of new shares at $15, or 20X these gussied-up earnings, just in time for the Fed to begin a new round of goosing in March 1997. And that proved propitious for Bain. Almost to the day on which its 180-day IPO lockup expired, it sold its first batch of shares in a secondary offering in a now red-hot stock market at a red-hot price that was up 60 percent from the IPO.
Wesley-Jessen had not then filed financial statements with even $1 of GAAP (generally accepted accounting principles) net income. But when Bain’s underwriters wired the proceeds in August 1997 the selling price was $23.50 per share. That’s 52X the $0.43 per share it had paid for the stock 25 months earlier. At the end of the day, massive leverage, fancy accounting, and bubble finance, not entrepreneurial prowess, were the source of Bain’s 50-bagger.
THE ITALIAN JOB
In November 1997, Bain Capital pulled off a veritable capitalist heist in the socialist redoubts of the Italian Yellow Pages. On a $17 million investment in the Italian phone book, it took out a profit of $375 million. This was not only a 22-bagger; for Mitt Romney, it was the ultimate in no-sweat riches. According to the company’s CEO, Romney’s sole involvement was a cameo appearance during a due-diligence session: “He came into the room, asked a couple of very sharp questions immediately, shook hands and left.” Twenty-eight months later, in February 2000, Romney’s former colleagues at Bain located him during his tour of duty in Salt Lake City, where they wired his share of the winnings: a reputed $50 million.
Bain and a syndicate of private-equity houses were originally brought in as a stalking horse to validate the government’s “privatization” machinations. At the time, the key Italian Treasury official was one Mario Draghi (now president of the European Central Bank). His assignment was to get the nation’s huge deficit down to a Maastricht Treaty–compliant 3 percent, and he elected to do so by means of a rent-a-balance-sheet ploy of the type then in favor. The short story is that Bain and the other investors paid 5X the company’s operating income for their shares, and were paid 100X operating income to leave when local circumstances obviated the need for the rental deal. That preposterous multiple expansion accounted for virtually all of Bain’s 22-bagger.
In the interim, the dotcom bubble reached it fevered peak—so Italy’s lumbering phone-book publisher had puffed itself up as a fleet-footed Internet company, claiming to be the next AOL. In the fog of 1999’s worldwide financial bubbles, a group of corporate raiders who did not have two nickels to rub together then got control of Italy’s storied typewriter maker, Olivetti, and parleyed massive borrowings through that vehicle into control of the Italian phone company. Now hoist atop a stupendous house of cards, the raiders next went after Italy’s gussied-up Yellow Pages, paying $24 billion—or 180X net income—for a business that was slithering into the sunset. In fact, it is currently worth perhaps 1 percent of Bain’s exit price through a deal that top-ticked Greenspan’s NASDAQ bubble in February 2000. Never have a group of private-equity men laughed more heartily on the way to the bank.
The Bain Capital investments here reviewed accounted for $1.4 billion or 60 percent of the fund’s profits over 15 years, by my calculations. Four of them ended in bankruptcy; one was an inside job and fast flip; one was essentially a massive M&A brokerage fee; and the seventh and largest gain—the Italian Job—amounted to a veritable freak of financial nature.
In short, this is a record about a dangerous form of leveraged gambling that has been enabled by the failed central banking and taxing policies of the state. That it should be offered as evidence that Mitt Romney is a deeply experienced capitalist entrepreneur and job creator is surely a testament to the financial deformations of our times.
From the Forthcoming The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy by David Stockman. Copyright © 2012 by David Stockman. Adapted by permission of Publicaffairs, a member of the Perseus Books Group. Stockman’s book will be published in March 2013
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