[Vision2020] Companies’ Ills Did Not Harm Romney’s Firm

[Art Deco]

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June 22, 2012
Companies’ Ills Did Not Harm Romney’s Firm By MICHAEL
LUO<http://topics.nytimes.com/top/reference/timestopics/people/l/michael_luo/index.html>and
JULIE
CRESWELL<http://topics.nytimes.com/top/reference/timestopics/people/c/julie_creswell/index.html>

Cambridge Industries, an automotive plastics supplier whose losses had been
building for three consecutive years, finally filed for bankruptcy in May
2000 under a mountain of debt that had ballooned to more than $300 million.

Yet Bain Capital <http://www.baincapital.com>, the private
equity<http://topics.nytimes.com/top/reference/timestopics/subjects/p/private_equity/index.html?inline=nyt-classifier>firm
that controlled the Michigan-based company, continued to religiously
collect its $950,000-a-year “advisory fee” in quarterly installments, even
to the very end, according to court documents.

In all, Bain garnered more than $10 million in fees from Cambridge over
five years, including a $2.25 million payment just for buying the company,
according to bankruptcy records and filings with the Securities and
Exchange Commission. Meanwhile, Bain’s investors saw their $16 million
investment in Cambridge wiped out.

That Bain was able to reap revenue from Cambridge, even as it foundered,
was hardly unusual.

The private equity firm, co-founded and run by Mitt
Romney<http://elections.nytimes.com/2012/primaries/candidates/mitt-romney?inline=nyt-per>,
held a majority stake in more than 40 United States-based companies from
its inception in 1984 to early 1999, when Mr. Romney left Bain to lead the
Salt Lake City Olympics. Of those companies, at least seven eventually
filed for bankruptcy while Bain remained involved, or shortly afterward,
according to a review by The New York Times. In some instances, hundreds of
employees lost their jobs. In most of those cases, however, records and
interviews suggest that Bain and its executives still found a way to make
money.

Mr. Romney’s experience at Bain is at the heart of his case for the
presidency. He has repeatedly promoted his years working in the “real
economy,” arguing that his success turning around troubled companies and
helping to start new ones, producing jobs in the process, has prepared him
to revive the country’s economy. He has fended off attacks about job losses
at companies Bain owned, saying, “Sometimes investments don’t work and
you’re not successful.” But an examination of what happened when companies
Bain controlled wound up in bankruptcy highlights just how different Bain
and other private equity firms are from typical denizens of the real
economy, from mom-and-pop stores to bootstrapping entrepreneurial ventures.

Bain structured deals so that it was difficult for the firm and its
executives to ever really lose, even if practically everyone else involved
with the company that Bain owned did, including its employees, creditors
and even, at times, investors in Bain’s funds.

Bain officials vigorously disputed any notion that the firm had profited
when its investors lost, arguing that a full accounting of their costs
across their business would show otherwise. They also pointed out that Bain
employees put their own money at risk in all of the firm’s deals.

“Bain Capital does not make money on investments when our investors lose
money,” the company said in a
statement.<http://www.nytimes.com/2012/06/23/us/politics/response-from-bain-capital.html>“Any
suggestion to the contrary is based on a misleading analysis that
examines the income of a business without taking account of expenses.”

To a large extent, however, this is simply the way private equity works,
offering its practitioners myriad ways to extract income and limit their
risk. Mr. Romney’s candidacy has helped cast a spotlight on an often-opaque
industry.

In four of the seven Bain-owned companies that went bankrupt, Bain
investors also profited, amassing more than $400 million in gains before
the companies ran aground, The Times found. All four, however, later became
mired in debt incurred, at least in part, to repay Bain investors or to
carry out a Bain-led acquisition strategy.

Perhaps most revealing are the few occasions, like with Cambridge
Industries, when Bain’s investors lost. Lucrative fees helped insulate Bain
and its executives, records and interviews showed.

*Piling On Debt*

Having spun off from a management consulting firm, Bain has always been
known for its data-driven, analytical approach. Under Mr. Romney, the firm
scored some remarkable successes, enabling its investors — wealthy
individuals and institutions like pension funds — to collect stellar
returns.

The companies that fell into bankruptcy were clearly the exception, and the
causes were also often multilayered. Some companies proved too troubled to
rescue, and others were hit by broader economic or industrywide downturns.

In at least three of the seven bankruptcies, however, companies appear to
have been made more vulnerable by debt taken on to return money to Bain and
its investors in the form of dividends or share redemptions.

That was arguably the case with GS Industries, a troubled Midwest steel
manufacturer that Bain acquired in 1993, investing $8.3 million. The
private equity firm took steps to modernize the steelmaker. A year later,
the company issued $125 million in debt, some of which was used to pay a
$33.9 million dividend to Bain, securities filings show.

The private equity firm plowed an additional $16.2 million into the
steelmaker, but when the industry experienced a downturn in the late 1990s,
the company could not manage its heavy debt. It filed for bankruptcy in
2001, but Bain’s investors still earned at least $9 million.

Debt from acquisitions, usually part of a “roll-up” strategy of buying
competitors, played a role in at least five of the seven bankruptcies The
Times examined. In most of these cases, Bain investors garnered some
initial gains before the companies faltered.

For example, after Bain acquired Ampad, a paper products company, in 1992,
the company grew through a series of acquisitions. Sales jumped, but its
debt climbed to nearly $400 million, and it found itself squeezed by “big
box” office retailers. It filed for bankruptcy in 2000. Bain and its
investors walked away with a profit of more than $100 million on their $5
million investment, on top of at least $17 million in fees for Bain itself,
according to securities filings and investor prospectuses.

A similar phenomenon unfolded with DDi, a Bain-owned circuit board maker
that expanded aggressively in the late 1990s. Sales soared, but so did its
debt. The bursting of the tech bubble forced it to scale back. It filed for
bankruptcy in 2003. The gains for Bain’s investors easily exceeded $100
million. Bain also collected more than $10 million in fees.

*Substantial Fees*

The numerous fees collected by private equity firms have been a frequent
lightning rod for the industry. First, the firms charge their investors a
percentage of the fund as a management fee, meant to cover its overhead.
During Mr. Romney’s tenure, this was initially 2.5 percent and then dropped
to 2 percent. Private equity firms also collect transaction or deal fees,
ostensibly for advisory work, from companies they buy. These fees are
generally collected for major transactions, like the purchase of another
company, a public stock offering or even the initial acquisition of the
company. A third fee stream comes from annual monitoring or advisory fees
that portfolio companies typically pay to their owners, the buyout firms.

These fees can be substantial. In the case of Dade International, a medical
supply company in which Bain acquired a stake in 1994, Bain and other
investment firms piled up nearly $90 million in fees over seven years. The
company filed for bankruptcy in 2003 but not before it had borrowed heavily
to pay $420 million to Bain and other investors several years earlier.

In 1998 alone, Mr. Romney’s final full year at Bain, The Times was able to
identify roughly $90 million in fees collected by the firm across its
various funds, a figure that is probably low because most companies in
Bain’s portfolio did not have to file financial disclosures.

These fees covered Bain’s expenses — like rent, salaries and lawyers — and
the bulk of the remaining money was awarded to Bain employees as annual
bonuses.

Bonuses were relatively small some years, like from 1989 to 1991, when
the savings
and loan<http://topics.nytimes.com/top/reference/timestopics/subjects/s/savings_and_loan_associations/index.html?inline=nyt-classifier>crisis
and other events slowed business. In that period, Bain managing
directors made roughly $300,000 to $400,000 a year, mainly from their
salaries, excluding gains from investments, according to an executive
familiar with Bain’s compensation. By the mid-1990s, as Bain grew, managing
directors’ annual incomes, again excluding investment returns, had swollen
to $3 million to $5 million, mainly thanks to bonuses derived from fees.

Bonuses were not the main drivers of the immense wealth accumulated by Mr.
Romney and other Bain executives. That came from their share of Bain’s
“carried interest,” the firm’s cut of its funds’ investment profits, as
well as the returns from personal investments in Bain deals.

Bain officials insist that fees were never a way for the company to garner
much in the way of profits and pointed out fee structures for every fund
are agreed-upon in advance by investors. They said fees supported the
firm’s staff-intensive approach to managing companies. Totaling up the
hours Bain employees put into deals at standard consulting rates, they
said, would far exceed what the firm actually collected. They said fees
also covered the costs of hundreds of deals researched every year and not
pursued or completed.

Investors have succeeded in the past decade in pressing private equity
firms for a greater share of these fees. In 2009, a trade group
representing institutional investors issued
guidelines<http://ilpa.org/ilpa-private-equity-principles/>it believed
firms should follow, including turning over all advisory and
deal fees to investors, also known as limited partners. “The battle over
fees is right now going in the limited partners’ direction,” said Steven N.
Kaplan, a University of Chicago finance professor.

Bain began splitting some fees with its investors in 2000. In the firm’s
newest fund, Bain officials said they would funnel all deal fees to their
limited partners.

Bain prides itself on the personal money its employees put into deals,
saying its co-investment rate is among the highest in the industry. The
percentage during Mr. Romney’s tenure sometimes ran to nearly 30 percent
but was usually less, according to records and interviews.

“We are collectively the single largest investor in every portfolio company
and every fund,” the company’s statement said. “When our portfolio
companies grow and perform, investors and Bain Capital do well. In rare
instances when a business fails, Bain Capital employees share in the
negative economic consequences of those losses.”

*Offsetting Losses*

When deals sour, however, fees can provide a hedge.

Toward the end of Mr. Romney’s tenure, Bain bought Anthony Crane, a crane
rental company, which then acquired a slew of smaller competitors, financed
by debt. But a building slowdown hit the company hard, and it filed for
bankruptcy in 2004, wiping out $25.6 million from Bain’s investors, along
with $9.5 million from Bain employees. The firm, however, collected $12
million in fees over the life of the deal.

Bain officials maintained they still lost money on Crane because it also
cost them $5.1 million in carried interest that they otherwise would have
garnered from gains in the rest of the fund.

When Bain bought a troubled chain of maternity stores called Mothercare in
1991, its investors put $1.24 million into the deal. Bain repositioned the
company and upgraded its merchandise, but the stores still struggled. Bain
offloaded the chain in 1993 at a total loss, and the new owners put it into
bankruptcy. Bain still collected $1.5 million in fees while it owned the
company, bankruptcy records show.

In the case of Cambridge Industries, Bain first acquired a stake in the
manufacturer of plastic automotive parts in 1995. Bain employees personally
invested $2.2 million, according to bankruptcy records, alongside $15.7
million from outside investors.

Bain immediately collected $2.25 million from Cambridge as a transaction
fee for investing in the company. Cambridge then acquired several companies
in rapid succession, and each time, Bain earned 0.75 percent of the
purchase price as a transaction fee. The rest of Bain’s $10 million in fees
came through advisory fees and payments for a debt refinancing completed by
Cambridge in 1997.

By then, interest payments from the company’s expansion were outstripping
operating income. As part of the refinancing, aimed at lowering interest
payments, Cambridge repaid $17 million it owed to a debt fund run by Bain.
This involved paying it a $2 million prepayment penalty.

Cambridge was finally forced into bankruptcy in 2000, when Bain declined to
provide the company with an infusion of capital needed to fulfill a major
new order, according to former company officials. During bankruptcy
proceedings, lawyers for some of Cambridge’s creditors leveled scathing
criticism at Bain, zeroing in on the fees extracted while they said
Cambridge was insolvent, as well as the prepayment to Bain’s debt fund.

Eventually, Bain settled the dispute by paying $1.5 million to the
bankruptcy trustee.

“We have been unable to identify what, if any, ‘reasonably equivalent
value’ the Company received in exchanges for these exorbitant fees,”
Michael Stamer, a lawyer for the unsecured creditors committee, wrote to
Bain’s lawyers. “It appears, instead, these fees were nothing more than a
device used by Bain to provide a return on its equity.”

Mike McIntire contributed reporting.


-- 
Art Deco (Wayne A. Fox)
art.deco.studios at gmail.com
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