Rolling Stone

Greed, debt and Matt Taibbi

September 4, 2012: 4:19 PM ET

What Rolling Stone got right, and wrong, about Bain Capital.

FORTUNE --  Very few of my friends understand private equity, let alone care about it. But some of them wrote me this past weekend, after reading Matt Taibbi's new cover story for Rolling Stone about Mitt Romney's time with Bain Capital. For example, this was from my former college housemate Andrew:

I read the Taibbi article in Rolling Stone. Reading it you can obviously see that the guy has a fairly biased opinion on private equity and Wall Street dealings in general. What's the industry's defense of PE? I assume the truth is somewhere between Mitt's verision of Bain as a massive jobs creator and Gordon Gekko-esque corporate raiders.

Andrew has good instincts. Taibbi took out the long knives for this one, which means he sacrificed a bit of accuracy for potency.

His overall thesis is correct: There is a fundamental hypocrisy in a former leveraged buyout investor railing against America's ballooning debt. Leveraged buyouts, by definition, add debt to a company's balance sheet -- weighing it down in the short-term so that it can (hopefully) thrive in the long-term. Romney defenders point out that America is not the same as a private equity-backed company, a truism that only goes to underscore the flimsiness of using Romney's Bain Capital experience as a singular qualification for the Oval Office.

Unfortunately, Taibbi also takes a lot of wild swings at the broader private equity market that don't ring true. So many, in fact, that his valid critique of Romney's candidacy gets lost.

Here is an accounting:

Four years ago, the Mitt Romneys of the world nearly destroyed the global economy with their greed, shortsightedness and – most notably – wildly irresponsible use of debt in pursuit of personal profit. 

Taibbi is using Romney here as a stand-in for Wall Street, but it's unfair. Private equity firms played virtually no role in the global financial crisis. Remember, private equity neither underwrote home mortgages nor securitized them. Private equity firms did not require federal bailouts under TARP or any other program. In fact, the one big concern about private equity's pre-crisis activities -- the so-called debt maturity wall -- has proven unfounded.

Now your troubled firm – let's say you make tricycles in Alabama – has been taken over by a bunch of slick Wall Street dudes who kicked in as little as five percent as a down payment. 

While perhaps there have been certain leveraged buyouts that involve just 5% equity, the typical contribution is significantly higher. For example, S&P Leveraged Commentary & Data reports that average LBO equity contributions since 1997 have come in between 28% and 45%. Still a debt game, but not quite so severe.

So Tricycle Inc. now has two gigantic new burdens it never had before Bain Capital stepped into the picture: tens of millions in annual debt service, and millions more in "management fees." Since the initial acquisition of Tricycle Inc. was probably greased by promising the company's upper management lucrative bonuses, all that pain inevitably comes out of just one place: the benefits and payroll of the hourly workforce.

Or perhaps the company has enough cash flow to cover both in the short-term, while future growth (based on changes enacted by the PE firms) helps bump up profit. There are no hard and fast rules. Even when a PE firm does lay off portfolio company employees post-acquisition -- not an uncommon occurrence -- it isn't always for financial reasons. Sometimes it's because the new strategy is to de-emphasize or shut down a non-core part of the business, or a unit with declining growth (albeit one that is still profitable). Taibbi makes it sound like buy-then-fry is private equity's modus operandi. It is not. And, in the long-term, private equity ownership does not have a significant impact on a company's payroll.

The private equity business in the early Nineties was dominated by a handful of takeover firms, from the spooky and politically connected Carlyle Group (a favorite subject of conspiracy-theory lit, with its connections to right-wingers like Donald Rumsfeld and George H.W. Bush) to the equally spooky Democrat-leaning assholes at the Blackstone Group.

Blackstone Group co-founders Steve Schwarzman and Pete Peterson would be very surprised to be described as "Democrat-leaning," given their long-standing support for Republican candidates and causes. They probably also disagree with the "assholes" part, although at least they've heard that one before.

The only ones who profited in a big way from all the job-killing debt that Romney leveraged were Mitt and his buddies at Bain, along with Wall Street firms like Goldman and Citigroup. 

Well, plus all of the limited partners in Bain Capital funds. You know, the university endowments, corporate pension funds, teachers unions, etc. Taibbi makes a case that Bain's returns weren't terribly good, but the fact is that LPs re-invested in fund after fund. Even if it was just for the sake of reducing risk via diversification, it's not fair to say that the only people making millions off of Bain Capital were those who worked for Bain Capital. Taibbi addressed this criticism in a follow-up post.

In the Bain model, the actual turnaround isn't necessary. It's just a cover story. It's nice for the private equity firm if it happens, because it makes the acquired company more attractive for resale or an IPO. But it's mostly irrelevant to the success of the takeover model, where huge cash returns are extracted whether the captured firm thrives or not.

This just isn't true. The reference here is to dividend recaps, a noxious private equity practice through which firms can actually generate profits off of investments in portfolio companies that later go bankrupt. But the reality is that, for the most part, dividend recaps alone do not generate the types of returns that bring limited partners back for follow-on funds. Moreover, too many post-recap failures and banks are unlikely to make new loans to fund a private equity firm's future deals (original LBOs or recaps). In other words, the more legitimate wins matter, so long as the private equity firm wants to stick around.

After Milken and his junk bond scheme crashed in the late Eighties, Romney and other takeover artists moved on to Wall Street's next get-rich-quick scheme: the tech-Internet stock bubble. 

Huh? There simply weren't leveraged buyouts of dotcom companies in the late 1990s. These were young companies, most of which weren't generating significant cash-flow. Is this where Taibbi confuses venture capital with private equity? Or is he saying that the tech boom helped indirectly finance private equity, by swelling the paper values of endowment and pension fund coffers (many of which direct 8-10% of their assets to PE)? I'm really not sure.

The new owners of American industry are the polar opposites of the Milton Hersheys and Andrew Carnegies who built this country, commercial titans who longed to leave visible legacies of their accomplishments, erecting hospitals and schools and libraries, sometimes leaving behind thriving towns that bore their names. 

"We try to hide religiously," explained Steven Feinberg, the CEO of a takeover firm called Cerberus Capital Management that recently drove one of its targets into bankruptcy after saddling it with $2.3 billion in debt. "If anyone at Cerberus has his picture in the paper and a picture of his apartment, we will do more than fire that person," Feinberg told shareholders in 2007. "We will kill him. The jail sentence will be worth it."

Steven Feinberg is the closest thing private equity has to J.D. Salinger, so it's hardly a fair representation. Steve Schwarzman has his name on the New York Public Library. Henry Kravis juast put his name on a new building at Columbia Business School. The nonprofit organization City Year has named its headquarters for Bain Capital's Josh Beckenstein. And many private equity executives appear regularly at financial conferences and on financial television networks like CNBC. If they're hiding, they're doing so in plain sight.

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