The Great Deformation (104 page)

In a nutshell, that's exactly the story of Bain Capital during Mitt Romney's tenure. The
Wall Street Journal
examined seventy-seven significant deals completed during that period based on fund-raising 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 of investments, but ten of Bain's deals accounted for 75 percent of the investor profits.

Accordingly, Bain's returns on the overwhelming bulk of the deals—sixty-seven out of seventy-seven—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.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 ten “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 which both make the Romney investment legend and also seal the indictment: they show that Bain Capital was nothing more than 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. No training school for presidential aspirants, Bain Capital during Romney's watch was actually the stage set for the Truman Show of bubble finance.

VICTORY FROM THE JAWS OF DEFEAT: HOW BAIN MADE $600 MILLION ON THE WAY TO THE COURTHOUSE DOOR

The startling fact is that
four of the ten 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 2000–2002 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 eighteen times 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 cast-offs and other bedraggled “pots and pans” that got rechristened as “growth” companies.

During the next eight years Bain slogged it out, accumulating about three hundred small Main Street storefronts under such forgettable banners as Royal Palais, Bealls, Fashion Bar, and Stage Stores. 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's” stores to the purportedly more compelling banners of its “Stage” and “Bealls” lineup. 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 eighteen times 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 1998–1999; that is, during the two years after Bain and Goldman got out of Dodge City.

Bain Capital subsequently claimed the company was “growing, successful and consistently profitable during the nine years we owned it” but then immediately ran into “operating problems.” That was a whopper 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 which took the company down did not suddenly materialize out of the blue during the twenty-four 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; that is, it sold all the company's credit card receivables to a third party and among its 650 stores it owned exactly 3! 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 twenty-five times 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 five thousand 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 which 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 Bain 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 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 thousands of businesses and hundreds of thousands of jobs which Staples eliminated on the way to its current head count of 50,000 part-timers and 90,000 total were the office supply counterparts of Stage Stores Inc. At length, Wal-Mart eliminated the cracker-box stores selling shoes, shirts, and dresses that Bain kept on artificial life support and replaced their jobs with back-of-the-store automation and front-end part timers in its own giant stores. The pointless election-year exercise of counting jobs won and lost owing to these epochal shifts on the free market was 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 (Ampad) was a twenty-bagger; that is, $5 million was invested in 1992 for a $100 million profit; a miraculous outcome for Bain and Romney, but hardly so for the Ampad workers and shareholders left holding the bag when the company bankrupted in 1999 with massive debt. Ampad was the focus of competing narratives in the election, but what it truly represented was neither jobs destroyed or saved—just an exercise in LBO cash stripping that would not occur on 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 fourteen 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 spread-sheet-toting suits that Romney sent 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 like and 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, thirteen 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 upward of a thousand terminated employees.

So Bain Capital and the division's senior management became the proud owners of a slimmed-down $100 million business that dominated the market for legal-sized yellow pads. Yet even with all of Mead's predivestiture 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 eighteen 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 10–15 billion envelopes a year.

This turned out to be not 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 November 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 sanity, 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 on top provided an additional loan of $245 million. As it happened, Bain only needed $150 million to buy William house'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 ten times 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 five cents per share of net income. Yet since Bain Capital had now harvested a dividend that was twelve times 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—a truly crazy valuation of 150X its actual annualized earnings during the first half of the year.

The road show 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.