How to Extract Wealth, Mitt Romney Style: The Bain Bust Out

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Meet the new CEO

Over at the Agonist, Numerian describes how someone, for instance, someone whose name rhymes with Pitt Glomney, could buy a company, often manufacturing companies (which typically aren’t known for their sudden increases in profits), and then, within a couple years, make a tremendous profit–on the order of a ten-fold increase. Keep in mind, Bain Capital didn’t get lucky once or twice, they generated these kinds of profits repeatedly, again often in industries with relatively low profit margins. The short answer is that you perform the financial equivalent of a mob bust out. Here’s the special sauce (boldface mine):

1) Neutralize a possible battle with the board of directors of the target company by giving them preferential personal benefits from the buyout. Starting with the CEO, the buyout firm offers him a guaranteed role as CEO of the new, private company. He and his fellow executives receive a generous allotment of private ownership shares, which will make them very wealthy once the firm is brought back to public ownership. Similar arrangements are made with key members of the board of directors.

2) Buy up a majority of the common and voting stock of the company. Once 51% or more of the public stock is sold to the buyout firm, the game is over, and with management and the board intimately involved in the buyout, there is little chance that a shareholder revolt will erupt to prevent the takeover.

3) Install the new management team and make sure the buyout firm has a majority of the shares in the private company, and a majority of seats on the new board of directors, giving it full voting control.

4) Join the Globalization movement in a big way, by closing down as many manufacturing plants as possible and moving manufacturing to China, Thailand, Mexico, etc. Force unions to accept renegotiation of their contracts in order for the company to impose lower salaries, benefits, and retirement obligations on the workers. Impose these reductions automatically on non-union employees, firing as many of them as necessary, and cancelling benefit programs altogether where possible. When it comes to health care benefits, for example, the goal is to get as many workers on a 39 hour week so they are considered part time and not eligible for health care. The local emergency rooms can bear this burden rather than the company.

5) Take control over the pension plan and change the assumption of future annual returns from 8% to something like 10% or even 12%. Never mind that actual annual returns have been running at 3% at best – everyone knows the stock market produces at least 8% annual returns in the long run. With a much higher return assumption, you discover that the pension plan is now overfunded, so you can bring $250 million of the plan’s reserves back into retained earnings for the company.

6) Borrow at least $1.0 billion whether you need it or not. Say it is for a rainy day.

7) After about a year, with all these cuts in expenses, the company is beginning to show some profits. Therefore, declare a $500 million dividend for the owners, i.e., for the buyout fund. Take this money directly out of retained earnings, which means the $250 million pension plan savings are de facto transferred to the pockets of the leveraged buyout owners, and $250 million of the proceeds from the loan are given to the owners as well (debt which the company still has to pay back). [Mad Biologist: for instance, Domino's Pizza]

8) By 18 months, the profitability is respectable, but more important, the return on equity is looking great. This is because the equity in the company has been dramatically reduced through fat dividends to the owners. The leverage ratio – the amount of debt compared to equity – is looking horrible, but the stock market doesn’t look at leverage. The stock market only looks at profitability and the return on equity. Therefore, it is time to cash in and sell out. The buyout firm arranges for an IPO – an initial public offering of common stock. Wall Street firms like Goldman Sachs and JP Morgan get a very generous 7% of the proceeds of an IPO, so they have every incentive to get as much stock sold as possible at the highest price possible. They hype the new stock to the public, and the IPO is a big success. The leveraged buyout firm says “adios” to the employees, communities, customers and new shareholders of the company, which by now is financially much weaker than it was before and less able to survive in the market.

If you can pick up some tax breaks while you’re at it, more power to you.

This is not value investing. This is not making a company ‘mean and lean’ so it can compete, no matter how much progressive useful idiots claim otherwise. Instead, it is hurting the competitiveness of U.S. companies (boldface mine):

Sanderson agrees that China’s cheap steel imports on the American marketplace hurt the Georgetown mill’s production and profitability.

“But if (Bain Capital) had only invested in the mill instead of taking everything from it, we would have been able to sustain that (dumping) like we had in the past,” he said.

John Ethridge, a retired Georgetown Steel worker, said Bain Capital “treated us like dirt.”

“They brought a bunch of people in here who thought they knew how to do our job, but they had no idea what they were doing,” Ethridge said, adding that needed equipment and plant upgrades were often delayed or ignored.

Ethridge, who worked at the Georgetown mill for 35 years, said Bain Capital was more interested in how much money it could take from the plant rather than investing anything into it.

This is not Schumpter’s creative destruction, this is looting.

When the mob does this, we recognize it as fraud. When men from good schools with nice, conservative suits do this, it’s called financial engineering, even though it’s really no different in kind (video has not-safe-for-work language).

We are governed by sociopaths, so why not elect one as president?

An aside: As several commentators have noted, including James Galbraith and Bill Black, you can’t understand the housing crisis or several other significant economic phenomena without viewing this as a criminological problem. Economics really needs to incorporate power imbalances, bribery (legal or illegal), and fraudulent behavior (again, whether legal or illegal). And, no, I have no idea how to model this.

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