Bloomberg on Romney’s bust-out operation

Anthony Gardner, himself a private-equity operator, has crunched some numbers:

10 of roughly 67 major deals by Bain Capital during Romney’s watch produced about 70 percent of the firm’s profits. Four of those 10 deals, as well as others, later wound up in bankruptcy.

Gardner then explains, using some of those big deals (including Ampad and GS Steel) as examples, how the asset-stripping operation worked: Bain would buy control of a company using a little money and a lot of debt, load up the target with still more debt, pay out big chunks of the loan proceeds to itself as fees and share buy-backs, and then let the now-worthless company die, sticking creditors, workers, and sometimes the government with the tab.

I’m sure there’s a legal difference between this sort of operation and the classical “bust-out scam” (aka “long firm fraud”) for which small-time grifters go to prison. (Bust-out scammers buy a retailer of, for example, cameras. They then place big orders with a bunch of suppliers, getting routine 30-day trade credit, sell the stuff quickly for whatever it will fetch, move the proceeds to other bank accounts, and go out of business, leaving the suppliers stuck.) But I’m damned if I can see any moral difference.

And the notion that Romney is somehow not responsible because the actual bankruptcies only took place after he stopped active management of Bain whenever that turns out to be) is just absurd. What ought to count is when the fatal blow was struck, not when the medical examiner signed the death certificate.

Update  John Cole beat me to the “bust-out” comment; he has video.

Comments

  1. Zach says

    It’s funny how people who do this in business and real-estate moguls are lauded for their financial wizardry while people who just bought the house that their realtor/banker said they could afford are blamed by many for the entire financial meltdown.

    This is another thing that hasn’t really bubbled up in the campaign yet. Maybe because it’s difficult to explain in a few seconds. I think this is pretty clear: “How can Bain “buy” companies and then renege on pensions and debt obligations without the mothership going bankrupt as well?” I’ve recently wondered whether this sort of practice could be remedied with a very high-class debtors prison where the largest shareholder of a corporation has to serve some token amount of time for any outstanding debts upon bankruptcy.

    • says

      The whole idea of corporations (limited liability) is to let investors and managers off the hook. Once the money gets paid out as dividends or management fees or licensing fees, it’s gone, unless you can prove that there was self-dealing involved and that prices were substantially different from an arm’s length transaction. (And who has the money to prove that when the company has just gone belly up?)

      But it gets better. When a company goes belly-up, its assets get sold to pay off some fraction of its liabilities. So top managers can put a company into bankruptcy, then get together with a group of investors who will buy the name, trademarks, production facilities, office furnishings and so forth at a fire-sale price — which then goes to satisfy the demands of suppliers, unpaid workers, the workers’ pension fund and so forth. In theory there’s a creditor’s committee that makes sure the price isn’t too low, but in practice things don’t always go as they do in theory.

  2. sd says

    Look, I get that you REALLY don’t like Mitt Romney. But the gullibility with which you take in every single bit of anti-Romney punditry is shameful.

    Let’s take a look at Mr. Garner’s piece. First off, while Mr. Gardner is indeed currently a “private equity operator” to use your term, you neglected to mention that he is a former Democratic party operative, having served in the Clinton Administration in the departments of state, commerce and treasury and before that in the Carter administration. But that’s neither here nor there.

    Mr. Gardner starts off his line of argument with this:

    “Thanks to leverage, 10 of roughly 67 major deals by Bain Capital during Romney’s watch produced about 70 percent of the firm’s profits. Four of those 10 deals, as well as others, later wound up in bankruptcy. It’s worth examining some of them to understand Romney’s investment style at Bain Capital.”

    Note Mr. Gardner’s use of the word “later” in the second sentence. The use of the word is technically accurate, though as we will see it’s carrying an awful lot of weight on its narrow little shoulders. The first Bain Capital deal that Mr. Gardner mentions is Accuride:

    “In 1986, in one of its earliest deals, Bain Capital acquired Accuride Corp., a manufacturer of aluminum truck wheels. The purchase was 97.5 percent financed by debt, a high level of leverage under any circumstances. It was especially burdensome for a company that was exposed to aluminum-price volatility and cyclical automotive production.”

    “Bain Capital acquired Accuride” implies that there was a company called Accuride, humming along blissfully until Bain Capital swooped in and bought it. But there was no such company. Accuride was formed by Bain Capital as part of the carve-out of a small division of Firestone. In the period that Bain Capital owned the business (under 2 years) it expanded the number of production plants and grew the operating earnings of the business substantially. So in other words, Bain Capital bought a division of a larger company, invested to expand its capital base, re-structured the company and drove up earnings, and sold it at a huge profit to another large company having substantially increased its value.

    Now Mr. Gardner is indeed correct that Accuride “later” went into bankruptcy. Specifically, it went into bankruptcy in 2009 – 21 years after Bain Capital sold the company to a conglomerate. That Mitt Romney sure has a long reach! Accuride, FWIW, is still going strong.

    Mr. Gardner then moves on the Ampad: “In 1992, Bain Capital bought American Pad & Paper by financing 87 percent of the purchase price.” Again, this seems to imply that there was a company called “American Pad & Paper” or “Ampad” operating independently that was bought by Bain Capital. But again, there was no such company. Ampad, as an independent company, was formed in 1992 by Bain Capital when it bought an under-performing, sub-scale division of Mead Corporation. Again, rather than bleeding the business dry, Bain Capital went on to invest millions of dollars in subsequent bolt-on acquisitions in an attempt to create a business of sufficient scale to compete in the rapidly consolidating paper and office supplies industry, eventually growing the business from ~$100M in annual revenues to ~$650M in annual revenues. Ampad did eventually enter bankruptcy – in the year 2000 – 4 years after its 1996 IPO. I suppose you’d classify that as “later” as well. That’s right – Bain Capital took the company public in 1996 and dropped its ownership stake to ~1/3 of the equity in the company. Bain Capital did indeed continue its involvement through the bankruptcy, but following the 1996 IPO the company could have reduced its debt burden at just about any time quite simply by issuing additional common stock. Companies tweak their capital structure all of the time by issuing new debt to buy back shares and by issuing new shares to pay down debt.

    Mr. Gardner then moves onto the story of Dade: Bain Capital’s acquisition in 1994 of Dade International, a supplier of in-vitro diagnostic products, was 81 percent financed by debt.” Once again, one would be forgiven for assuming that “Dade International” was a stand-alone company. In fact, it was (you guessed it!) an under-performing and sub-scale division of another large company – in this case Baxter International. Dade International was formed in the carve-out transaction itself, and once again, Bain Capital subsequently invested millions of dollars to grow the business through complementary acquisitions designed to give the company a sufficient scale and technological footprint to become competitive.

    Mr. Gardner rounds out his tour of Bain Capital portfolio companies that “later” entered bankruptcy with the story of GS Industries. Yet again though, this is a case where Bain Capital bought a small, under-performing company (in 1993) and spent several years investing in acquisitions and expansion in an attempt to make the business viable. And specifically in this case the company was making steel using inefficient blast furnace technology that was rapidly being supplanted by much more efficient electric furnace technology. GS Industries also eventually went bankrupt (in 2001) – just like scores of other small steel producers that breathed their last breaths in a year when global steel prices collapsed. I’ll accept that Bain Capital “killed” GS Industries as soon as someone can point me to an independent US steel company using blast furnace technology that thrives today.

    But the broader problem with the whole “Bain Capital strip-mined companies” thesis is that it makes little economic sense. Bain Capital has been an enormously successful investment firm for many years now. If it developed a legitimate reputation* for buying companies, sucking all of the life out of them, and then either dumping them on the next sucker or sending them into the death throes of bankruptcy, then it would very quickly find that:

    1) It would be unable to successfully sell its holdings to other private equity firms for an attractive price
    2) It would be unable to successfully sell its holdings to strategic buyers for an attractive price
    3) It would be unable to successfully IPO its holdings for an attractive price
    4) It would be unable to raise debt capital at an attractive price (i.e. interest rate)

    But of course, none of these four effects – none – is apparent in the market at all. Bain Capital routinely sells its portfolio companies to other PE firms, strategic buyers and the public markets for very attractive prices – prices that allow Bain Capital to consistently generate market-beating IRRs for its Limited Partners. And Bain Capital has no problem raising debt capital at market rates.

    While it is true that in some cases Bain Capital made money on companies that were ultimately unsuccessful because they were paid management fees by those companies during the time that they owned the businesses, a deal in which Bain Capital collected fees and special dividends, but later lost its equity stake via bankruptcy, would in every instance have been much less profitable for the firm that a deal in which they could have sold their (levered) equity at an attractive multiple. Their incentives were always to make their portfolio companies as successful and healthy as possible, because that’s how they got paid the truly big bucks. In some cases they failed to do this. But so what? They made risky investments that sometimes paid off and sometimes didn’t.

    *As opposed to an election year “I’ll believe anything bad that someone tells me about the other party’s nominee” reputation

    • James Wimberley says

      Are you claiming that the dangerously increased gearing that Bain applied to its charges, and the very large management fees it extracted for the leeching, were motivated by a sincere fiduciary concern to maximise the long-run return to all the stockholders, and not just to the insider investors with Bain Capital?

      “Would you buy a used car from this man?” ran the famous 1960 poster attacking Richard Nixon. In Romney’s case, many did.

      • sd says

        I’m not sure I understand your question. As a general rule (and there are exceptions – though rare) Bain Capital and related firms don’t invest as one investor along many in publicly traded companies – they take companies wholly private (sometimes in conjunction with one or two other PE firms). During the time that they own their holdings there are no other stockholders aside from “inside investors with Bain Capital.” And the limited partners of Bain Capital (e.g. CalSTRS, The Harvard Corporation, etc.) aren’t exactly complaining that they’re getting screwed. Indeed they seem to line up every few years when Bain Capital goes to the market to raise a new fund.

        If you’re suggesting that Bain Capital screws over subsequent investors in their portfolio companies (for example, public shareholders who buy a stake in such companies following an IPO), then I’m suggesting to you that:

        1) The ownership of Bain Capital’s portfolio companies is no secret generally, and is exhaustively disclosed at the time of IPO
        2) The debt level of those companies is similarly exhaustively disclosed

        If it were the case that Bain Capital were routinely and systematically gimping up their portfolio companies in order to boost their own returns around the margin, or if the levels of debt applied to those companies were some sort of serious, permanent hindrance to their viability, then this would effect the exit valuations of those investments, which would depress Bain Capital’s carried interest – by far and away the largest driver of the financial returns of Bain Capital. One needn’t believe in the inherent altruism of Bain Capital to accept this – one need only to recognize that other private equity firms and the holders of large pools of publicly invested equity capital (i.e. the buyers of the vast majority of shares in a typical IPO) are not generally stupid and have no reason to want to donate money to the Bain Capital General Partners’ Enrichment Fund. Not to mention the knock-on effect on the ability of the firm to raise subsequent funds from Limited Partners.

        Again though – even if Bain Capital were routinely taking companies public with “dangerously increased gearing” then following the IPO of those companies the new shareholders, acting via the new management teams would be perfectly able to quickly re-engineer the capital structure by issuing more equity shares in a secondary offering and using the proceeds to pay down debt. Public companies lever up and down their capital structure all of the time by doing this. And when Bain Capital (or any other investor – public or private) levers up a company the cost of the debt applied goes up along with the Debt/Equity ratio. In other words – there is a natural check on the degree to which a company can be levered in that lenders demand an increasingly high premium on their lent funds to compensate for the increased risk associated with full or partial default. Now lenders of course sometimes make mistakes, and they sometimes under-estimate the risk of a loan. But lenders that do this regularly don’t remain in business for very long.

      • politicalfootball says

        There are a lot of fudge-words in this analysis. “Operating” profit, revenue and “investment” all look like proxies for another concept: “Excessive debt.” One particular trick of private equity is to run up excessive debt to pay dividends to the owner.

        And why distinguish between underperforming units and underperforming independent companies? Is there some special virtue in buying non-public companies?

        But so what? They made risky investments that sometimes paid off and sometimes didn’t.

        This would be more persuasive if you were using it to discuss investments that failed to pay off. In fact, Bain succeeded by risking companies’ viability. It’s true that Bain companies didn’t always fail. It’s even true that Bain would have made more money if the companies they strip-mined didn’t subsequently fail. But by pocketing borrowed money, they limited their risk.

        And Bain Capital has no problem raising debt capital at market rates.

        Not sure what this means. Everybody raises capital at “market rates.” And certainly Bain Capital has always been a good credit risk. But what rates did the companies in the Bain portfolio pay?

        • sd says

          “There are a lot of fudge-words in this analysis. “Operating” profit, revenue and “investment” all look like proxies for another concept: “Excessive debt.” One particular trick of private equity is to run up excessive debt to pay dividends to the owner.”

          No – “Operating profit,” “revenue” and “investment” are all accounting terms with specific and universally understood meanings that I used properly in the above post.

          “And why distinguish between underperforming units and underperforming independent companies? Is there some special virtue in buying non-public companies?”

          I made the distinction to point out that in almost every single example cited there is no stand-alone “company” being bought. The company came into existence as a result of the original Bain Capital transaction. Its not as if they were buying companies in these cases with decades of successful operation as stand-alone entities that miraculously fell into hardship after being acquired by Bain Capital.

          “And Bain Capital has no problem raising debt capital at market rates.

          Not sure what this means. Everybody raises capital at “market rates.” And certainly Bain Capital has always been a good credit risk. But what rates did the companies in the Bain portfolio pay?”

          Oh my goodness that’s so wrong. Borrowers with riskier credit profiles based on their prior history pay higher interest rates than do other borrowers. As a point of fact, Bain Capital doesn’t pay higher rates on the debt it applies to its portfolio companies than is typical for companies in the same industry, of the same size, and of the same debt/equity ratio.

          • Clark says

            I am absolutely no fan of Mitt Romney, but sd makes good points. When I read the piece myself, my first question was that if Bain was a serial plunderer, they would not be able to make money so easily. What occurs to me is that the PE industry, much like Wall St, seems to be organized so that PE firms like Bain make money coming or going, unlike most of us Americans who actually bear the risks of failure along with the potential benefits of success. That is a good point, and should be highlighted, but that is a different point than painting Romney’s operation as a scam or vulture capitalism per se.

            Precision in argument is important, and I wish the piece or the analysis did a better job of making the argument.

          • sd says

            Clark,

            While it is true that Bain Capital has tended to make money off its investments even when the underlying businesses performed poorly, this is largely a result of two factors:

            1) Companies owned by Bain Capital pay management fees to the firm. That said, they do in fact receive management services in return. Bain Capital has an in-house advisory group that provides analytical and other management support and that occasionally places temporary executives with portfolio companies (i.e. interim CFOs, COOs, etc.). Typically the people in this group are not the same people primarily involved in investment activities – they are a separate pool of professionals. This may or may not be money well spent (which is of course arguable), but I will say that I have interacted with several of these people throughout my career and every single of them was exceptionally smart and savvy, and I know (from conversations with headhunters) that they are paid very well. So Bain Capital provides an expensive service to the companies it owns and charges them for it. Again – it may or may not be money well spent but its not shady.

            2) In many cases, Bain Capital re-capitalized its investments (thus recouping the money paid for its initial equity stake without drawing the equity down to zero) at one or more points during the period of ownership. But its very difficult to do this unless the company itself is doing quite well (again – lenders are very unwilling to provide additional debt capital for a dividend re-cap unless there is tangible and documentable proof that the company’s operations are improving). And even if they are, the original debt covenants on an LBO typically forbid any such re-cap unless certain specific operational or financial milestones are met.

            Let’s say you buy two shares of stock in company A for $50 each. The value of the company runs up to $110 per share. You sell one of your shares (recouping your initial $100 investment plus a $10 profit) and still hold half of the equity. If the company later tanks and the share price drops to zero have you done something unethical? After all – you invested some money, sold off part of your investment to lock in a gain, and were later quite disappointed to see the remainder of your investment lose value. You clearly would have been much happier had the company not tanked – you would have made even more money. Indeed, had the share price risen to $70 and stayed there you would have made a much greater profit ($40) overall.

            The thesis that Bain Capital regularly and intentionally stripped out healthy businesses to make a quick profit is silly not because Bain Capital is especially noble or heroic but because Bain Capital always made MUCH more money on an investment that was exited at a healthy terminal valuation than they did on an investment that ended up in distress – regardless of how much fee income was extracted from the company or how much was pulled out in a dividend re-cap.

          • Clark says

            While it is true that Bain Capital has tended to make money off its investments even when the underlying businesses performed poorly, this is largely a result of two factors:

            To be clear, I explicitly am not making the argument that “Bain Capital regularly and intentionally stripped out healthy businesses to make a quick profit” because I don’t have evidence to back such a claim, and that was, in fact the thrust of my comment. However, your arguments are not contradicting my claim about Bain making money coming or going.

            1. Sure, Bain sold these companies hired guns at a premium – I am not sure why this necessarily counts as virtuous. Especially when the company is paying for it by taking on huge, huge leverage and debt. Of course, this is fine if it pays off, but when it doesn’t, the creditors are left holding the bag while Bain got paid a ton for this supposedly smart management who themselves got huge salaries while running the company into the ground.

            2. Your second point also bolsters my comment that Bain makes money coming or going. A good example is the recent Groupon fiasco, where Mason and his cohorts drew in tons of financing when they were private and used it to pay themselves tens to hundreds of millions, even though the underlying fundamentals were weak. Sure, they would have made much more money if the fundamentals were strong, but that’s neither here nor there – the fundamentals weren’t, but Mason still did very well at the expense of creditors and employees.

            This is an important point – celebrating Romney’s ability to make money in PE is not the same as celebrating the virtues of American business. Nor is decrying his wealth an insult to American entrepreneurship.

            For instance, I am currently starting a small business based on technology I invented as part of my PhD. I don’t get paid tons whether it succeeds or fails. If it succeeds, I hope to do well. If it fails, well, I have lost a few years, tons of money, the opportunity cost of an alternative career, and quality of life. The difference to me between success and failure is not between a 500 million and 100 million payout as it seems to have been in the case of Romney.

          • Byomtov says

            sd,

            Let’s say you buy two shares of stock in company A for $50 each. The value of the company runs up to $110 per share. You sell one of your shares (recouping your initial $100 investment plus a $10 profit) and still hold half of the equity. If the company later tanks and the share price drops to zero have you done something unethical?

            That depends. If you sold it on the open market you haven’t done anything unetical. But if you have sufficient control over the company to induce it to buy back your share with cash it needs to keep operating then yes you most certainly have behaved unethically. And we’re not talking about 10% returns here either.

    • Byomtov says

      Let’s see. Bain sold Accuride at a huge profit. OK. But the details here are little hazy. It went bankrupt but is still “going strong” you say. In other words, it stiffed its creditors. Still, I’ll give you Accuride.

      But what about Ampad? Here’s the full story from the article:

      In 1992, Bain Capital bought American Pad & Paper by financing 87 percent of the purchase price. In the next three years, Ampad borrowed to make acquisitions, repay existing debt and pay Bain Capital and its investors $60 million in dividends.

      As a result, the company’s debt swelled from $11 million in 1993 to $444 million by 1995. The $14 million in annual interest expense on this debt dwarfed the company’s $4.7 million operating cash flow. The proceeds of an initial public offering in July 1996 were used to pay Bain Capital $48 million for part of its stake and to reduce the company’s debt to $270 million.
      From 1993 to 1999, Bain Capital charged Ampad about $18 million in various fees. By 1999, the company’s debt was back up to $400 million. Unable to pay the interest costs and drained of cash paid to Bain Capital in fees and dividends, Ampad filed for bankruptcy the following year. Senior secured lenders got less than 50 cents on the dollar, unsecured lenders received two- tenths of a cent on the dollar, and several hundred jobs were lost. Bain Capital had reaped capital gains of $107 million on its $5.1 million investment.

      So all that growth yielded enough operating profit to pay about a third of the interest bill. Of course it would have been fine without that $18 milllion in annual fees to Bain. For what, I wonder?

      Did Bain control Ampad? Ownong one third of the equity in a public company is plenty enough, virtually always, to control it. And your glib statement that it could have sold equity to reduce debt is sheer speculation, poorly founded at that. It owed $400 million. With pre-tax profits of $22 million (adding back the Bain fees) the equity probably had negative value. And would Bain have surrendered those fees to make an equity sale even remotely possible? I don’t think so.

      Incidentally, your insistence on the validity of terms like operating profit and revenue gives the game away and undermines your argument. Yes, they are reasonably well-defined. And that definition ignores debt and interest payments. So Ampad, for example, can be forced into banruptcy by Bain’s manipulations, even though it was producing an operating profit.

      Take away the repayment to Bain, and the ridiculous fees, and the company would have been fine.

      Dade? Funny. Your benign description hardly fits the facts.

      Bain Capital’s acquisition in 1994 of Dade International, a supplier of in-vitro diagnostic products, was 81 percent financed by debt. Of the $85 million in equity, about $27 million came from Bain with the rest coming from a group of investors that included Goldman Sachs Group Inc. From 1995 to 1999, Bain Capital tripled Dade’s debt from about $300 million to $902 million. Some of the debt was used to pay for acquisitions… But some was used to finance a repurchase of half of Bain Capital’s equity for $242 million — more than eight times its investment — and to pay its investors almost $100 million in fees.

      Dade was left in a weakened financial condition and couldn’t withstand the shocks of increased debt payments when interest rates rose and revenue from Europe fell because of a decline in the value of the euro. The company filed for bankruptcy in August 2002, because of its inability to service a $1.5 billion debt load. About 1,700 people lost their jobs while Bain Capital claimed capital gains (net of its losses in the bankruptcy) of roughly $216 million, an eightfold return.

      So they did make some acquisitions, but over half of the $602 million increase in debt went right out the door to pay Bain back eight times its investment, and to pay investors $100 million in more “fees.” Then they went broke because they couldn’t pay the interest. This is your idea of a big success story – job creation – etc.?

      And you whitewash GS as well.

      In the two years following the acquisition in 1993 of GS Industries, a steel mill, for $8 million, Bain Capital increased the company’s debt to $378 million on operating income of less than a 10th of that amount. Some of this was used to pay Bain Capital a $36 million dividend in 1994. That degree of leverage was excessive in light of the cyclicality and capital-intensive nature of the steel industry.
      By the time the company went bankrupt in 2001, it owed $554 million in debt against assets valued at $395 million. Many creditors lost money, and 750 workers lost their jobs. The U.S. Pension Benefit Guaranty Corp., which insures company retirement plans, determined in 2002 that GS had underfunded its pension by $44 million and had to step in to cover the shortfall.

      So they ran up the debt, stole the pension money, and GS went broke. More job creation?

      The fact is, Bain simply sucked these companies dry. You say,

      While it is true that in some cases Bain Capital made money on companies that were ultimately unsuccessful because they were paid management fees by those companies during the time that they owned the businesses, a deal in which Bain Capital collected fees and special dividends, but later lost its equity stake via bankruptcy, would in every instance have been much less profitable for the firm that a deal in which they could have sold their (levered) equity at an attractive multiple.

      But that makes no sense. We see that Bain took massive amounts out in fees and repurchases. Why do that, if it prevented the greater profits that you claim would have been available otherwise? Did they simply blunder?

      • sd says

        Whoa boy, where to begin…

        “But the details here are little hazy. It went bankrupt but is still “going strong” you say. In other words, it stiffed its creditors. Still, I’ll give you Accuride.”

        It went bankrupt in 2009 (Anything happen in 2009 that might have effected the fortunes of an auto parts company? I forget). It emerged from bankruptcy sometime after, and if operationally and financially strong today. This happens all of the time – companies get into financial distress, they declare bankruptcy and re-organize, and emerge stronger. Yes creditors “get stiffed” but that’s why corporate loans are priced at higher interest rates than t-bills – they are not risk-free securities. But in any event, the 2009 bankruptcy happened 21 years after Bain Capital sold the company. If you think that somehow Bain Capital is to blame for this you’re living on a different planet.

        “So all that growth yielded enough operating profit to pay about a third of the interest bill. Of course it would have been fine without that $18 milllion in annual fees to Bain. For what, I wonder?”

        First, the $18M in fees was a cumulative number over a 6 year period, not an annual number. Second, the numbers quoted in the article for operating cash flow and interest payments were for 1995. No detail is provided for prior or subsequent years. And the company successfully IPO’d in 1996. If it were in such dire financial distress how did it convince a bunch of arm’s length investors to buy up shares in an IPO at a price that was sufficient to pay down debt and to provide a return to the equity holders at a higher valuation than they bought it? Mr. Gardner is VERY selective in which numbers he provides…

        “And your glib statement that it could have sold equity to reduce debt is sheer speculation, poorly founded at that.”

        No – public companies sell equity in secondary offerings to pay down debt all of the time.

        “It owed $400 million. With pre-tax profits of $22 million (adding back the Bain fees) the equity probably had negative value.”

        Nope – again it IPO’d in 1996 at a price high enough to generate hundreds of millions of dollars (some of which was used to pay down debt) and to provide the equity holders with appreciation vs. their original purchase price. And again – you mis-read the time period of the fees number.

        “And would Bain have surrendered those fees to make an equity sale even remotely possible? I don’t think so.

        So even if you were right that Ampad was paying Bain Capital $18M a year in fees (and you’re not), you’re suggesting that Bain Capital would rather earn $18M in fee income and drive its remaining equity stake to zero value in a few years than to give up the fee income and exit their investment at a positive valuation. Given that Bain Capital would exit at a multiple of EBITDA, they would be utter fools to prefer a few limited years of a cash payment over a onetime capitalization of the cash flows from that payment.

        “Take away the repayment to Bain, and the ridiculous fees, and the company would have been fine.”

        Oh really? Can you point to other US paper and office supplies companies that were “fine” in the late 1990s as Office Depot, office Max and Staples were rolling up the office supplies channel and squeezing suppliers?

        “Then they went broke because they couldn’t pay the interest.”

        They didn’t “go broke” they entered bankruptcy, briefly, in 2002 (years after the debt in question was accumulated). The bankruptcy was preceeded by a loss of revenues in Europe following a decline in value of the Euro – a structural shock that would have likely resulted in layoffs regardless of who owned the company and how the capital structure was set up. At the time of bankruptcy Bain Capital’s remaining equity stake was wiped out, the company quickly re-organized and emerged from bankruptcy, and was subsequently sold to Siemens. Dade-Behring remains in business to this day, is the market leader in it’s segment of the biomedical test equipment market, and employs thousands of people. When Bain Capital originally purchased “Dade International” (which again – did not exist as a stand-alone company prior to the transaction) it was a small, sub-scale medical devices company with an uncompetitive technology platform. Why the hell do you think Baxter International, it’s parent corporation, was so eager to unload it?

        “So they ran up the debt, stole the pension money, and GS went broke. More job creation?”

        The pension at GS Industries was chronically under-funded for decades. Its financial viability was tied to the ongoing health of the underlying business. Bain Capital invested millions of dollars in subsequent acquisitions in an attempt to make GS competitive, but in 2001 it became impossible for a sub-scale, US-based steel company utilizing blast furnace technology to remain in business. Dozens of other similar companies dies in the same period. Given the precarious financial condition of GS specifically, it likely would have died several years earlier had it not been bought by Bain Capital. Hell – Bain Capital paid $8M to buy the entire company in the early 1990s. Do you think a lot of healthy companies with good long-term prospects and hundreds of workers sell for $8M? This was a longshot mission that failed.

        • Byomtov says

          Sd,

          Ampad:

          “So all that growth yielded enough operating profit to pay about a third of the interest bill. Of course it would have been fine without that $18 milllion in annual fees to Bain. For what, I wonder?”

          First, the $18M in fees was a cumulative number over a 6 year period, not an annual number.

          My mistake, but it makes things worse. That means they wouldn’t have been able to pay the interest even had they not had to pay the fees. And you’re claiming that the fees were for expert mangement services from Bain? These experts let Ampad take on interest payments in excess of operating profits. Not smart, really, especially since the paper business is knownto be quite cyclical.

          the numbers quoted in the article for operating cash flow and interest payments were for 1995. No detail is provided for prior or subsequent years. And the company successfully IPO’d in 1996.

          Yes, when the numbers were current. How were they able to do an IPO? I don’t know. I don’t know the pricing or anything else about the IPO. And the IPO market isn’t the best example of efficient securities markets, as I’m sure you’re aware.

          public companies sell equity in secondary offerings to pay down debt all of the time.

          If they can.

          “It owed $400 million. With pre-tax profits of $22 million (adding back the Bain fees) the equity probably had negative value.”

          Nope – again it IPO’d in 1996 at a price high enough to generate hundreds of millions of dollars (some of which was used to pay down debt) and to provide the equity holders with appreciation vs. their original purchase price. And again – you mis-read the time period of the fees number.

          This time you misread the period involved. The $400 million in debt was in 1999, three years after the 1996 IPO. There is no reason to think they could have done an IPO then, There is every reason to think they couldn’t, not least that they chose to go into banruptcy. Correcting my misreading of the fee schedule again strengthens my case. I assumed that they were generating $22 million, but clearly they were not, making it even more likely that th eequity value was negative.

          you’re suggesting that Bain Capital would rather earn $18M in fee income and drive its remaining equity stake to zero value in a few years than to give up the fee income and exit their investment at a positive valuation. Given that Bain Capital would exit at a multiple of EBITDA, they would be utter fools to prefer a few limited years of a cash payment over a onetime capitalization of the cash flows from that payment.

          And yet they did take huge amounts out of the company at various times, not only in fees but in dividends and share buybacks financed by borrowing.

          And no, Bain Capital would not “exit at a multiple of EBITDA,” for several reasons. The most important is that the equity of companies with lots of debt is not valued as a multiple of EBITDA. That would be quite foolish, since such a valuation would completely ignore the company’s debt load. And given its debt load it’s unlikely that the company would have been sold at all, fees or not. Just look at the outcome of the bankruptcy. Secured lenders got fifty cents on the dollar, unsecured got .2 cents on the dollar. And you’re claiming they could have sold equity?

          • sd says

            Byomtov,

            Of course it would have been possible to sell additional equity. To use an example:

            Say we have two companies – Company A and Company B – that are otherwise identical but for the fact that Company A is financed with 20% Equity and 80% debt while company B is financed with 80% equity and 20%.

            Now, your thesis seems to be that Company A is in an unsafe, precarious position. Perhaps. But if Company B is a healthy and attractive company, then what would stop Company A from selling enough equity in a secondary offering to pay down debt to the point where its capital structure would mirror that of company B? Nothing is the answer. Because in the secondary offering in this example you’re not asking investors to buy into a company with the capital structure of Company A, you’re asking them to buy into a company with the capital structure of Company B (which is what Company A will look like after the transaction). The offering documents on either an IPO or a secondary sale clearly lay out the number of shares being offered, which allows one to estimate with decent accuracy what the post-sale capital structure will look like.

            Companies – even highly levered companies – do this all of the time. Indeed, it’s very common for a company to be purchased by a private equity firm and levered up, then taken public again in an IPO after which the company levers down by selling more equity. There are transaction costs of course so there is some friction, but those costs rarely stand in the way of a re-financing move that makes sense.

          • Byomtov says

            sd,

            M&M analysis is useful sometimes, but let’s not overdo it.

            That all works fine if there is equity value there – that is if the enterprise value exceeds the face (not market) value of the debt and the firm’s operations are not suffering from the debt load.

            Simplify your example just a bit. Company B is 100% equity, worth $50 million, say, at current market prices. Then A is also worth $50 million (debt plus equity) at current market prices. But suppose A’s debt has a face value of $60 million. How will it sell equity to restructure its balance sheet? Maybe it can. Maybe it can persuade the debtholders to take a writedown and accept $50 million in equity proceeds in exchange for their debt. Or maybe not. Maybe the debtholders, especially the secured debtholders, who are not getting their interest payments after all, would rather seize the assets and sell them off, right now.

            In a frictionless world, with no classes of debt, and so on, I suppose you could view even that as “selling equity.” Hand off the company to the debtholders, period. That’s the equivalent of selling $50 million of equity and paying off the written down debt. But in the real world, things are different. First of all, the debtholders don’t want to own the firm. That’s why they’re lenders to begin with. Second, firms, at least industrial firms, don’t just operate smoothly and then go under one sad day. As the situation deteriorates so does the company. Key employees leave. Equipment is not maintained. quality declines and customers leave, etc. Financial distress is costly. And of course, selling equity takes time, and the deterioration does not stop to wait. At some point you no longer have a going concern.

            It’s all very well to talk about “two otherwise identical firms,” but that’s a textbook artifact. There’s really only one “identical” firm, and if it’s in trouble it may very well be unable to sell equity and refinance.

            You’re right of course that firms do this often. But that hardly means any firm can do it any time it wants.

          • J. Michael Neal says

            sd, please explain how Bain managed to turn Dade’s $82 million in equity (not assets; equity) into $484 million in equity in four years. Unless it somehow managed this feat with something other than accounting shell games, Dade became a company with negative equity. In other words, Bain’s extraction alone almost certainly turned a company with positive net value into one that was, at least technically, insolvent the moment they paid themselves.

          • sd says

            J Michael Neal:

            You ask how “Dade’s” equity could grow from $84M to $484M in 4 years.

            First, in the period in question “Dade” was merged with two other companies – a division of DuPont and German diagnostics company. So the appropriate baseline for the comparison is not the $84M in initial equity in Dade International, but rather that number plus the initial equity values in the two other companies. If for example the equity value of each of the other businesses was $50M then the appropriate comparison is not $84M to $484M but rather $184M to $484M. If the equity value of each of the other two businesses was $100M then the comparison is $284M to $484M. Numbers matter.

            Second, the profitability of the business improved during this period (likely from a mix of vanilla performance improvement actions and the cost synergies involved in the combination of the three companies).

            Third, the revenue growth rate of the business improved during this period (likely from a mix of vanilla performance improvement actions and the channel and customer synergies involved in the combination of the three companies).

            Fourth, from the mid 1990s to the late 1990s prevailing market multiples expanded.

            So greater equity base + higher margin + higher growth rate + higher multiple for any given performance level = higher equity value. Whether the valuation at $484M was reasonable or not is a question that can only be answered with much more detailed information than is publicly available (one would need detailed financial information on the three combined businesses before and after the various merger transactions for that). But if the businesses experienced meaningful margin expansion during this period and/or a meaningful increase in their revenue growth rate than an increase in equity value of this magnitude would not be especially unreasonable (remembering that $84M is not the appropriate baseline). Keep in mind that Baxter International, a conglomerate that owns lots of relatively unrelated healthcare businesses, wanted out of this business. Which is a good indication that it was under-performing at the time of the transaction.

            Further, the debt holders who provided the initial debt financing for the purchase of the “Dade” business unit from Baxter International would almost certainly have demanded highly restrictive covenants that would have forbid any re-financing of the company (including any dividend re-cap) unless certain specific performance milestones were achieved. Such covenants are, for understandable reasons, standard in private equity backed transactions. Its not as if a private equity firm can just make up a valuation for the purposes of a dividend re-cap without any external oversight from parties with a vested interest in making sure that the amount of cash taken out of the business isn’t dangerously high.

          • J. Michael Neal says

            If for example the equity value of each of the other businesses was $50M then the appropriate comparison is not $84M to $484M but rather $184M to $484M.

            Wrong, at least sort of. The $484 million is the figure for Bain’s share of the equity. Hoechst AG retained 32.5% of the company, which meant that the original acquirers didn’t see all of the increase in equity. If you look at the 10-K for the period in question, the entire increase in Additional Paid in Capital (from 87.2 million to 468.4 million) stems from the valuation of Hoechst’s contribution at $403.7 million. Interestingly, the total for shareholder equity goes from -25.0 million to 204.1 million the same year, suggesting that, absent Hoechst’s new equity commitment, the company was already in the hole.

            http://sec.gov/Archives/edgar/data/942307/0000950131-98-002246.txt

            See in particular Note 4 Behring Combination.

            Second, the profitability of the business improved during this period (likely from a mix of vanilla performance improvement actions and the cost synergies involved in the combination of the three companies).

            Enough to justify a sixfold increase in equity held by Bain over four years? I don’t see it, at any rate. Here are the numbers for net income from the company’s SEC filings in millions:

            1992: 22.1
            1993: (1.9)
            1994: 35.8
            1995: 12.7
            1996: (105.3)
            1997: (142.6)
            1998: 43.5
            1999: (38.5)

            I sure as hell can’t find an increase of profitability that would justify an explosion in equity value.

            As for your point three, yes, revenues exploded, but they weren’t making any money on it. And interestingly, the amount of shareholder equity claimed on the consolidated balance sheets for 1998 and 1999 was 249.3 and (142.8) respectively, which again suggests that Bain paid itself a larger dividend than there was equity to begin with, even though they were no longer the sole shareholder.

            Fourth, from the mid 1990s to the late 1990s prevailing market multiples expanded.

            Well, yes, but so what? We learned shortly thereafter than those multiples ranged anywhere from simply wrong to blatantly fraudulent. This isn’t a defense that Bain overvalued the company so that they could justify stripping out a lot of money.

            Further, the debt holders who provided the initial debt financing for the purchase of the “Dade” business unit from Baxter International would almost certainly have demanded highly restrictive covenants that would have forbid any re-financing of the company (including any dividend re-cap) unless certain specific performance milestones were achieved.

            If you can provide any evidence of these restrictive covenants, I’d be happy to look at them. However, the numbers as reported by Dade International and then Dade Behring tell a pretty clear story of equity stripping.

  3. Ebenezer Scrooge says

    The main difference between a bust-out scam and an LBO operation is advice of counsel. In a rule of law society, that is a pretty significant difference. I agree with Mark that the moral difference isn’t all that great, although I could draw a few deontological distinctions based on knowledge of the likelihood of consequences emerging from an action, and the intent to create such consequences. But the key point is that I’d rather live in a pettifogging society than a moralistic one.

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