Reuters has a great look today at how Mitt Romney’s Bain Capital loaded up a steel company with debt, mismanaged it, drove it into bankruptcy, dumped tens of millions of dollars of pension obligations on the federal government after underfunding them for years, cost workers up to a quarter of their pensions—and walked away with a big profit.
The Republicans are about to nominate a former private-equity kingpin to run for president in the most anti-Wall Street environment in eighty years, so you’ll be reading lots of stories like these. We’ve already had several good ones, including this New York cover story on Romney as emblem of the 1 percent economy (more like 0.001 percent). This Los Angeles Times piece reported that four of Romney’s top ten acquisitions went bankrupt within a few years. At the same time, Bain Capital made an 88 percent annual return on investment over fifteen years, according to Reuters, surely one of the great investor runs of all time.
How does an investment firm make money while its companies go bust? This is a good time to explain briefly what’s perverse about the private-equity business. Bain, and this is typical, would borrow scads of money to buy a company, putting in very little of its own cash. Oftentimes, Bain then borrowed another plug of money to pay itself a dividend that guaranteed a big profit on its sliver of investment. All this debt didn’t go to Bain itself. It loaded it onto the companies it acquired, shielding itself from consequences in case of default. The more you lever up a company with debt, the higher the interest rates you have to pay investors to get them to buy your bonds. So not only were these companies leveraged to the gills by their new private-equity owners, but they were paying junk-bond rates too. The companies targeted by private-equity firms are typically out of favor because they’re already in some trouble either because their individual business or their sector is in trouble.
That’s a broad-brush description of how private-equity financializes a physical company, and it parallels what Reuters reports here on Bain’s acquisition of Worldwide Grinding Systems in Kansas City.
Bain, with partners, bought the steel mill, which already had been shedding jobs for years, for $75 million and then loaded $125 million on it, cashing out a special dividend that gave it an immediate 350 percent profit, though it would later invest about half of that in a failed merger with another plant. By the time that merger was complete and more debt added on, the company’s debt was more than ten times its operating income. Unfortunately, Reuters doesn’t tell us how much the steel company was paying in interest. I’m guessing that interest alone consumed all or almost all of the company’s operating profit. That would have been a good detail to have.
But the rest of the story is excellent, and particularly the lede, which actually sets the scene from the perspective of the workers rather than management—something you rarely see in business-press stories. The fellas at the steel plant in Kansas City weren’t too partial to the money men from back East, as you might imagine:
It was funny at first.
The young men in business suits, gingerly picking their way among the millwrights, machinists and pipefitters at Kansas City’s Worldwide Grinding Systems steel mill. Gaping up at the cranes that swung 10-foot cast iron buckets through the air. Jumping at the thunder from the melt shop’s electric-arc furnace as it turned scrap metal into lava.
“They looked like a bunch of high school kids to me. A bunch of Wall Street preppies,” says Jim Linson, an electronics repairman who worked at the plant for 40 years. “They came in, they were in awe.”
That fits neatly with this good reporting from workers on how life in the shop changed for the worse as new management messed things up:
Paperwork proliferated. Cost-cutting efforts backfired. Managers skimped on purchases of everything from earplugs to spare motors and scaled back routine maintenance. Machines began to break down more often, and with parts no longer in stock a replacement could take days to arrive.
Labor costs spiked as managers revamped work schedules with little understanding of how the plant actually operated. Linson says he picked up an entire shift of overtime each week because his managers didn’t realize that a furnace needed a full eight hours to heat up to operating temperature.
The steel mill went bankrupt in 2001 amid a flurry of other steel-company bankruptcies. But it’s clear that the hundreds of millions of dollars of leverage Bain placed on the company played a big role in its failure. Debt constrains a company’s ability to survive a downturn—period. And the more you have, the less likely it is that you’ll survive.
The story ends, appropriately, with the human wreckage of the buyout, with new jobs hard to find, health care lost, and meager pensions slashed. Romney’s company, which pushed the steel mill into massive debt, made a 150 percent profit.
Excellent work by Reuters.
Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR’s business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.