The Bane of Bain

Nowhere has Obama’s ignorance of capitalism become more apparent than his recent attacks on Romney’s tenure at Bain

"I think my view of private equity is that it is set up to maximize profits," the smartest man ever to be President said, proving his cluelessness about private equity, business, and capitalism.

“Maximize profits”? Well, duh, yeah. When I took Economics 101, which is only an elective in the Bachelor of Community Organizing curriculum, I do recall reading something about profit maximization as the goal of business. Doing that requires jumping through a lot of hoops – like creating a product or service that free markets will buy, finding and keeping good employees, and taking lots of risks (like losing everything if management fails to stay on its toes.) Detroit and the rust belt are good examples of what happens when profit maximization ceases to be a business goal.

Having no record to run on, the Obama reelection campaign launched a broadside against Mitt Romney’s long association with Bain & Company. One video ad shows a former steel worker calling Bain a “vampire” that “sucked the life out of us.” Another worker adds that Bain “walked away with a lot of money that they made off of this plant.” Joe Biden, who would have made a better carny barker for the bearded lady tent than VP, chimed in with his canned anti-Wall Street rhetoric babbling something about America ought to be a country that makes things again.

A few words about the steel company that Bain allegedly raped and pillaged … before Bain even got into the picture, its management had driven the workforce down from 4,500 to less than 1,000. As is the modus operandi in private equity (PE) firms, Romney and Bain thought this was a potential turnaround under good management. It acquired the company, GST Steel, in 1993, replaced management, merged it with another steel company Bain had acquired, making it one of the largest mini-mills in the country, persuaded banks to lend money to it, spent $100 million in modernization, and held it for eight years – hardly the acts of a looter. The plant was unionized, one of several factors that has kept American steel from being competitive in a global marketplace in which the Japanese have driven the price of steel below the cost at which Americans can make it. The company bankrupted in 2001.

That union part, incidentally, was conveniently left out of the Obama ad, and oops, I forgot to mention … Romney had left Bain two years before the GST bankruptcy to become President and CEO of the Salt Lake Organizing Committee for the 2002 Winter Olympics and Paralympics. Darn facts – they are such pesky things!

As a follow-up, the Obama campaign released another video ad featuring Bain’s past investment in American Pad & Paper, known as Ampad. The story spin was to show Ampad as another victim of PE avarice, driven into bankruptcy and job losses. Bain's $5 million investment resulted in more than $100 million in profits. Bain neutralized the attack ad with a written statement saying that during the four year that Bain owned Ampad, the business grew and jobs were created. Ampad’s bankruptcy occurred four years after Bain had sold the company. Minor detail.

Out of the mouths of fools foolishness comes. Such is the fodder for the Reelect Barack Obama to Four More Years of Economic Black Holes and Lost Years campaign. If private equity firms bought companies, gutted them, and left the carcass to move on the next victim, the industry would be out of business quickly. Banks would no longer lend the millions needed to restructure PE-owned companies. Investors, mostly institutions – i.e. pension funds, including $220 billion of public employee unions’ pension funds – which hate publicity, especially when it’s bad, would cease providing capital.

Private equity makes money by enhancing the value of the firms they buy or invest in – not by looting them. They are not long-term investors. Generally a PE firm will hold a company for an average of about five years before making its exit because the providers of private equity – institutions and wealthy people – want their capital back (with a return) so they can redeploy it in other investments even if it means foregoing future profits. But nobody loses money taking a profit, sooner rather than later. So, private equity’s strategy is to get in, fix what’s broke, and sell its stake at some future time either to another PE firm or to the public in an IPO. The only way this exit strategy works is the new buyer sees value that can grow in the future and earn more profit.

The history of PE – aka venture capital – is long and varied. The American colonies were created with an early form of venture capital. Later, planters created plantations that were backed by capital sponsors in England who were called “adventurers” – a term that morphed into venture capital in the ensuing years.

Around the beginning of the 20th century, railroads were the new, new thing. Building them required more capital than one person or family could supply. The risks of building the cross-country lines required stern stuff in addition to capital. Most railroad entrepreneurs lost their shirts. A few didn’t, among them Cornelius Vanderbilt, Leland Stanford, James Hill, Edmund Harriman, and Mark Hopkins whose names would head family dynasties in later years.

The 1890s were years of economic turbulence and a third of the railroad track mileage then existing went into receivership. A primitive form of PE financing existed then in the form of merchant and investment bankers. Merchants who had the wealth to finance their own activities began to finance the activities of other merchants and ultimately became merchant bankers. J.P. Morgan was among the first and best known of them in this country. Investment banks were an outgrowth of the need for foreign capital in the development of railroad lines. J.P. Morgan blurred the lines distinguishing merchant and investment banking by stepping into distressed railroads, taking management control, and restructuring the underlying capital. He was hated and feared because he was good at it.

Morgan later expanded into other industries. Approaching Andrew Carnegie to sell his steel company to him, which he intended to merge with other steel companies he controlled, Morgan asked Carnegie to name his price. Carnegie wrote $480 million on a sheet of paper – a staggering sum at the time which Carnegie thought would kill the deal. Morgan glanced at the figure and said, “I accept this price.” The steel companies were merged into the new United States Steel Company, which was capitalized at $1.4 billion in bonds – the currency Morgan used to pay Carnegie and his partners in perhaps the first leveraged buyout. “How does it feel to be the richest man in the world?” Morgan asked Carnegie, knowing he had made the wealth possible. The Federal government spending for that year was $524 million.

After World War II, there was a dearth of capital available to start new businesses during the boom following the war. American Research and Development Corporation (ARDC) was founded in 1946 to provide “venture” capital. In 1957, two MIT engineers formed a company to make computers that were smaller, cheaper, and easier to use. They called their company Digital Equipment Company (DEC) and sold a 70% interest to ARDC for $70,000. When DEC went public eleven years later, ARDC’s stake was worth $450 million – an annualized return of more than 100% -- a rapacious vampire if there ever was one. Of course, this return was netted against the many ARDC investments which failed, which is the nature of venture portfolios.

Two years after receiving a joint Juris Doctor and Master of Business Administration from Harvard University as a Baker Scholar, Mitt Romney entered the management consulting industry at Bain & Company. He rose to become its Chief Executive Officer during a period in which Bain was in serious financial crisis. Noting that when consultants were successful they increased the value of their client companies substantially, Romney reasoned that if the consultants could buy their troubled clients’ companies, they could pocket the gain in value on an exit instead of a relatively small consulting fee. Thus, in 1984, he co-founded Bain Capital, a private equity investment firm spin-out that became one of the largest PE firms in the nation and quite profitable.

Bain has done quite well for its investors, the companies it invested in or acquired, and therefore it has done well for itself. Since Bain Capital was formed, its portfolio at various times has included AMC Entertainment, Aspen Education Group, Brookstone, Burger King, Burlington Coat Factory, Clear Channel Communications, Domino's Pizza, DoubleClick, Dunkin' Donuts, D&M Holdings, Guitar Center, Hospital Corporation of America (HCA), Sealy, The Sports Authority, Staples, Toys "R" Us, Warner Music Group, and The Weather Channel.

Bain’s success and the important need it and other PE firms fill in providing high-risk capital caused the leading lights of the Democrat party to criticize Obama’s reelection campaign tactic of demonizing Romney’s Bain tenure. Moreover, when Romney left the Bain firm, which he had turned around, he successfully turned around the failing Salt Lake Winter Olympics. Thus, Cory Booker, the mayor of Newark, Ed Rendell, former two-term Governor of Pennsylvania, former Representative Harold Ford Jr. (D-TN), and Deval Patrick, Governor of Massachusetts believed Obama’s demonization of Romney would only draw attention to Romney’s successes.

Moreover, at the same time Obama was criticizing Romney and Bain on one hand, he was taking in money with the other hand from fundraisers hosted by PE leaders such as Hamilton E. James, COO and president of Blackstone whose website claims it to be “one of the world's largest private equity fund businesses." Other bagmen (Obama’s handlers call them “bundlers”) are significant players in the PE industry and didn’t like being slandered by the guy for whom they were raising campaign cash.

In 2008, PE firms donated $3.5 million to Obama’s campaign, and he has gotten more for his 2012 campaign. Pinning the “destroyer of jobs” label on Bain in particular and PE firms in general wasn’t enthusing the PE bagmen, and it doesn’t square with facts. Firms restructured by private equity lost only 1% more jobs than other comparable companies in their industry, according to the National Bureau of Economic Research. The bane of Bain is a loser’s pitch – just like the people who put it together and the guy who delivered it.

It’s hard to make the distinction that Romney’s association with Bain was bad whereas firms like Vestar Capital, which resuscitated Birds Eye are good. In 2002, Birds Eye, the famous frozen food company, was losing $131 million on $1 billion in sales. Vestar shrunk the workforce from 4,000 to 1,700, provided the needed capital and management, and by 2009 had Birds Eye making a $54 million profit on $936 million in sales. Despite the job loss, was society better off? With a $185 million positive profit swing on virtually the same level of sales before and after the restructuring, does anyone wonder what the 2,300 “lost” jobs ever did for Birds Eye?

In contrast let’s look at Obama’s kind of capitalism – crony capital projects. They are little more than politically-motivated handouts from government which are disguised to look like “investments.” His green energy fiascos come to mind.

The Obama administration granted SunPower, a green energy venture, a $1.2 billion loan guarantee. At the beginning of this year, it owed more than it was worth. Then there’s Brightsource, another green energy black hole and the recipient of a $1.6 billion loan guarantee. Its major accomplishment to date has been to lose $177 million. Oh, and there’s Solyndra, which I blogged about last year. It got $535 million in loan guarantees from us taxpayers and went bankrupt, leaving us standing at the alter like a jilted bride.

As revealed in in his book, Throw Them All Out, Hoover Institute scholar Peter Schweizer revealed that 71% of the Obama Energy Department grants and loans went to "individuals who were bundlers, members of Obama's National Finance Committee, or large donors to the Democratic Party." In a gambit that would make the PE firms green with envy, these Obama cronies raised a total of $457,834 for his 2008 campaign, but they got grants or loans of nearly $11.4 billion. PE firms, eat your hearts out. That’s a return on their campaign “investment” of almost 25,000%! Organized crime isn't that profitable!

Last month when Obama was trying to draw a distinction between Romney’s success at Bain and the role of the presidency, in which business success, according to Obama, means zilch, The Great One said that the president's job isn’t "to make a lot of money for investors …" Well, he sure seems to be making a lot of money for his political investors, albeit at taxpayer expense.

Unlike private equity, in which investors voluntarily put their money at risk, crony capitalism takes money from taxpayers by force of law and “invests” it in government-favored projects, like those listed above. The taxpayer/investor has no say in the use of the funds appropriated by force. And government bureaucrats, who lack the business success derided by Obama’s critique of Romney’s PE background, make incompetent investment decisions, as is clearly evident in the results of their misadventures. These were never viable business ventures to start with … they were scams cooked up by political con artists, which explains why more than 100 green energy criminal investigations are underway in the office of the Energy Department’s Inspector General.

Team Obama is about to release a third video campaign ad about the bane of Bain targeting the “Wal-Mart Moms” whom they believe will be the swing in the swing states. The focus is on the job losses caused by Bain PE investments – and by implication, Romney’s fault. How they expect to spin this into a positive for reelecting Obama is anyone’s guess. Lying might work.

To that end, the Gaffe of the Week prize goes for this Obama lollapalooza: "We've created 4.3 million new jobs over the last 27 months, over 800,000 just this year alone. The private sector is doing fine."

Let’s unpack Obama’s assertion.

The Bureau of Labor Statistics publishes employment data. According to these tables, in January 2009, the month in which Obama was crowned, the private sector employment was 110,985,000. The latest figures are preliminary and for the past 18 months the preliminary figures have been adjusted down by the actual figure, but let’s use the preliminary number. In May 2012 private sector employment was 111,040,000. Thus far during Obama’s tenure, the private sector has created 55,000 jobs. That’s 0.05% or five one-hundredths of one percent! And that’s through May; we have months to go.

If we look at total employment – private and public – the BLS data tables show January 2009 employment at 142,187,000 and May 2012 employment at 142,287,000. That’s 100,000 jobs or a job growth of 0.07%. Now, in the part of the country where I live, we call that flat – not 4.3 million new jobs.

But during the time Obama has been President, working his Obamanomics magic, the available labor force has grown but employment has not. What happened to the rest of the available labor force? They are unemployed. James Pethokoukis of the American Enterprise Institute puts the real unemployment rate at around 11% rather than the official unemployment rate of 8.2% published by BLS, because the latter is based on a sample of 60,000 households and counts as “unemployed” only those actively looking for employment. Those who have ceased to look for a job, given up, or taken a part-time job are not counted.

No sitting President since Franklin Roosevelt has won re-election when unemployment was over 7.2% on election day.

And Obama … you ain’t no FDR.