May 9th Prediction: Obama or Romney?

[garbon]

We need more Hansy around here.  I miss "socialist idiots" and "ignorant claptrap". 

Yeah, but it does throw things a bit off balance, what with all the respectful terms you use for those on the right.

  Here, have a whore pill.  Give it to someone you love.

[jimmy olsen]

Maybe Romney will buy Europe, wreck it, flip it, and use the profits to pay off the national debt.

Hmm...your ideas are intriguing to me and I wish to subscribe to your newsletter.

[derspiess]

We need more Hansy around here.  I miss "socialist idiots" and "ignorant claptrap". 

Yeah, but it does throw things a bit off balance, what with all the respectful terms you use for those on the right.

  Here, have a whore pill.  Give it to someone you love.

That is a non-partisan term

[The Minsky Moment]

And of course the whole point of companies such as Bain is to buy up distressed companies, try to turn them around and seel them if you can do so successfully.  Of course that doesn't work all the time.  Socialist idiots of course don't understand that, but ignorant claptrap is the norm on the left.

The original Bain strategy was to focus on small, potentially promising, capital constrained businesses.  It was during this phase, which Romney's people sometimes incorrectly characterize as "venture" financing, that Bain did many of the investments touted by the campaign, like Staples and Gartner Group.

While Bain made nice returns on these investments, the scale was small and hence the total profit was limited.  Staples is not even among the 10 most profitable investments made by Bain during Romney's watch.  These deals were basically just a test run using a relatively small amount of capital -- $37 million in the first fund , which is pretty small potatoes in the PE world.

Once Bain got its footing doing these local, small company deals, they transformed into a pretty standard model leverage shop.  The focus transitioned to larger, typically more mature companies that had established business and steady cash flows.  While typically these buisiness suffered from operational difficulties of one type or another, they usually were not "distressed" -- on the contrary, the targets were deliberately selected on the basis of being relatively under-leveraged.  The whole business model revolves around loading the company up with debt to gear up potential returns on equity.  The beauty of the strategy is that even if the company fails, the PE firm still can win, because dividends exceeding the total amount of equity can be paid out from bond proceeds.  This explains why it could be the case that 4 of the 10 most profitable Bain investments were companies that went bankrupt.

GS Steel is a decent illustration of the model.  It was a steel mill that faced big strategic challenges and needed an infusion of investment to upgrade its facilities and equipment.  Bain acquired control with an $8 million equity investment.  Within a year, they sold $125 million in bonds and had the company pay them a $36 million dividend.  So right away, they made four times the investment in a year, regardless of whether the company succeeded.   I do think they tried their best to make the company work - but they also used their controlling position to extract out gains including a distribution in a later merger, and a nice contract with Bain's management consulting arm for consulting services.  Ultimately the company failed under the weight of debt that Bain had layered on, and the PBGC had to pick up an eight figure tab for unfunded pension liabilities.

My own view is that this is not really Schumpeterian creative destruction in action; in fact, given the Austrian view about debt-fueled speculative financial investment, I doubt the this leveraged investment model would win awards from von Mises & Co.  That said, it is a legit business model.  As CEO of Bain Capital, Romney's job was to maximize Bain's return on its PE investments.  No one forced his counterparties to sell and no one forced lenders and investors to buy the junk bonds Bain used to finance its returns on capital.  Romney did his job and he did it very well - no one died and no laws were broken.

Given that - I would be inclined to give Romney a total pass on whatever fallout could be ascribed from any deals Bain did on his watch - except for the fact that Romney has decided to affirmatively tout his Bain experience as the principal piece of evidence proving why more American jobs will be created if he is elected President.  I assume that he has done this because the one item on his resume that actually does tend to show his competence as a potential President -- his experience as Massachusette governor -- was primary poison.  But it is a ludicruous claim and by making it, he has opened the door to legitimate critiques of the leveraged PE investment model, whose overall social utility can be questioned, and of the job impacts of the actual investments made during his time as CEO.

[DGuller]

How can you pay a dividend from bond proceeds that's four times the amount of equity?  Isn't that embezzlement? 

I used to do that in Railroad Tycoon 3:  at the start of the game, start one company, have it take out loans, then buy back my shares for an inflated price, and have it go poof.  I take the proceeds from that, start a bigger company, have it take out a bigger loan, buy back a lot more shares from me at an inflated prices, and shockingly have it go poof again.  After those two times, my reputation would be ruined, but then I would have enough of my own funds to get started without needing other equity partners.  I always thought that this was a gamey tactic that wouldn't work in the real world.

[The Minsky Moment]

I used to do that in Railroad Tycoon 3:  at the start of the game, start one company, have it take out loans, then buy back my shares for an inflated price, and have it go poof.  I take the proceeds from that, start a bigger company, have it take out a bigger loan, buy back a lot more shares from me at an inflated prices, and shockingly have it go poof again.  After those two times, my reputation would be ruined, but then I would have enough of my own funds to get started without needing other equity partners.  I always thought that this was a gamey tactic that wouldn't work in the real world.

That would never happen in the real world.
In the real world, your reputation would improve.   

[HVC]

I used to do that in Railroad Tycoon 3:  at the start of the game, start one company, have it take out loans, then buy back my shares for an inflated price, and have it go poof.  I take the proceeds from that, start a bigger company, have it take out a bigger loan, buy back a lot more shares from me at an inflated prices, and shockingly have it go poof again.  After those two times, my reputation would be ruined, but then I would have enough of my own funds to get started without needing other equity partners.  I always thought that this was a gamey tactic that wouldn't work in the real world.

That would never happen in the real world.
In the real world, your reputation would improve.   

apparently you could even become president

[The Minsky Moment]

How can you pay a dividend from bond proceeds that's four times the amount of equity?  Isn't that embezzlement? 

more seriously: its hard to figure out what happened exactly because these deals are 20 years old and many of the transactions were private.

Bain got a big co-investment from GE Capital, but they (Bain) gained control.  So probably there was some dual share structure put in place or a shareholder's agreement that gave Bain operational control.  Which means they didn't pocket the whole dividend (GE Cap and other co-investors got some), and that the dividend was "only" about 50% of equity not 4X.

Still according to an FT article, Bain doubled their money before the company went under.  Not their best investment but still a decent outcome for them.

[DGuller]

How can you pay a dividend from bond proceeds that's four times the amount of equity?  Isn't that embezzlement? 

more seriously: its hard to figure out what happened exactly because these deals are 20 years old and many of the transactions were private.

Bain got a big co-investment from GE Capital, but they (Bain) gained control.  So probably there was some dual share structure put in place or a shareholder's agreement that gave Bain operational control.  Which means they didn't pocket the whole dividend (GE Cap and other co-investors got some), and that the dividend was "only" about 50% of equity not 4X.

Still according to an FT article, Bain doubled their money before the company went under.  Not their best investment but still a decent outcome for them.

Even still, paying excessive dividends out of bond proceeds seems to be such a clear and obvious scam that there must be plenty of laws against that, or it would be happening constantly.  You're essentially defrauding those who bought the bonds (and I would say that it is fraud, and not lack of due diligence by the bond investors, since they invested before the company's equity was raided and effective credit rating gutted).

[Admiral Yi]

I think Joan is talking about 4 X Bain's equity investment, not GS's total equity.

The question I've got Joan, is why would the ownership of a Bain target be interested in a deal that gives them a 40% chance of going under?  Possibly more to the story? 

[DGuller]

I think Joan is talking about 4 X Bain's equity investment, not GS's total equity.

The question I've got Joan, is why would the ownership of a Bain target be interested in a deal that gives them a 40% chance of going under?  Possibly more to the story?

In another post, Joan said it may have been closer to 50%.  That's still embezzlement territory.  You basically bait and switch the bond market:  you pretend that there is equity there to back up fixed income instruments, but then you take that equity away once you complete the issue.

[Admiral Yi]

In another post, Joan said it may have been closer to 50%.  That's still embezzlement territory.  You basically bait and switch the bond market:  you pretend that there is equity there to back up fixed income instruments, but then you take that equity away once you complete the issue.

You're not paying attention.  Bain got a monster dividend that was 4 X their initial investment.  But that didn't wipe out GS' entire paid in capital.

If it had, the company would have had negative net worth and it's banca rota time.

[DGuller]

You're not paying attention.  Bain got a monster dividend that was 4 X their initial investment.  But that didn't wipe out GS' entire paid in capital.

I am paying attention, and drawing conclusions to the best of my ability.  Your interpretation seems to imply one of three things:

1)  Bain got a ridiculous discount on their initial investment, and got at least 36 million worth of equity for $8 million.
2)  Bain got a dividend out of proportion to their equity share.
3)  GS was able to grow more than fourfold in the space of time between Bain's investment and bond issue.

The first two conclusions imply that other equity stakeholders were the victims of embezzlement, and the third one is just improbable.  And, regardless of what was actually the case, paying a huge dividend after making a big bond issue doesn't look kosher under any circumstance.  At best, you're changing the capital structure of the company shortly after pitching the current capital structure to the bond market.  At worst, you're using bond principal to pay yourself.

[grumbler]

Do a quote search on Google for Hansie's Obama quote, but, before you hit the search button, just guess how many hits you will get.

Try it; it's funny as hell, and while it leaves Hans with zero cred, it costs him no cred at all.

Okay.  Here's the first result:

http://abcnews.go.com/blogs/politics/2009/01/i-won-president/

Looks like the actual quote was:

"I won. So I think on that one, I trump you."

HANS, YOU MONSTER!!!!

  Did you hear a loud "whoosh!" as my point went right over your head?

If you don't read for comprehension, you don't get the joke.  Since you can't follow directions, you don't get to laugh.  Too bad for you. 

[Admiral Yi]

I am paying attention, and drawing conclusions to the best of my ability.  Your interpretation seems to imply one of three things:

1)  Bain got a ridiculous discount on their initial investment, and got at least 36 million worth of equity for $8 million.
2)  Bain got a dividend out of proportion to their equity share.
3)  GS was able to grow more than fourfold in the space of time between Bain's investment and bond issue.

The first two conclusions imply that other equity stakeholders were the victims of embezzlement, and the third one is just improbable.  And, regardless of what was actually the case, paying a huge dividend after making a big bond issue doesn't look kosher under any circumstance.  At best, you're changing the capital structure of the company shortly after pitching the current capital structure to the bond market.  At worst, you're using bond principal to pay yourself.

#2 has to be correct.  It's metaphysically impossible to pay all shareholders a dividend that is orders of magnitude larger than their equity stake.

I assume they way they worked it was Bain got paid an extraordinary dividend for the management work the did.  Remember, the Bain model is not to be passive investors and wait to see what happened.  They are all about using their big gigantic brains to improve company performance.  Management consultants who take all their pay in back end points.