May 9th Prediction: Obama or Romney?

[DGuller]

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.

Then it's not a dividend, but a payment for services.  Even then, it is again iffy.  I can't start a $1 million company with 10% invested out of my pocket and 90% from everyone else, and then pay myself a $500,000 salary, without being convicted of embezzlement.  I hope.

[Admiral Yi]

Then it's not a dividend, but a payment for services.  Even then, it is again iffy.  I can't start a $1 million company with 10% invested out of my pocket and 90% from everyone else, and then pay myself a $500,000 salary, without being convicted of embezzlement.  I hope.

Of course you can, if the shareholders approve it.  Or grant you authority to determine your own salary.

[HVC]

Then it's not a dividend, but a payment for services.  Even then, it is again iffy.  I can't start a $1 million company with 10% invested out of my pocket and 90% from everyone else, and then pay myself a $500,000 salary, without being convicted of embezzlement.  I hope.

Of course you can, if the shareholders approve it.  Or grant you authority to determine your own salary.

would you like to invest in a company i'm starting?

[CountDeMoney]

"By the way, when I get rid of Obamacare and I get rid of Dodd-Frank and I get rid of Sarbanes-Oxley, it doesn't mean I don't want to have any law or any regulation.  It means I want to make sure it's modern, it's updated, it goes after the bad guys, but it also encourages the good guys."
—Mitt Romney, CEO candidate

Wonder how he's going to do that when he's CEO-in-Chief.  Fire the Legal Department?

[Caliga]

and I get rid of Sarbanes-Oxley

I know who to vote for now.

[The Minsky Moment]

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?

They get bought out in cash funded in part by bond proceeds.

[The Minsky Moment]

#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.

Sure it is.
10 kids each put $1 into a lemonade stand business.
One of the kids is Richie Rich.  Richie convinces Daddy to lend Acme Lemonade another $90.
The kids then use $20 of the $90 to buy lemonade mix, sugar, ice and cups.  They use the rest to pay themselves each $7 in cash. 7-to-1 cash return on equity before a single glass is served.

No laws of metaphysics broken. 

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. 

I see the tongue is in cheek but will elaborate anyway.  All that is needed to pay an extraordianry dividend is board resolution to do it.  No great management acumen required.  In this particular case, the first big dividend was paid out within a year, well before the full impact from any management work could reasonably have been felt.  Historically it is true that LBO shops claim to add value with special management expertise.   Sometimes this is actually true - although usually it involves parachuting in talented outsiders they have relationships with.  But more typically in this model, the business is simply run to generate cash to service huge debt loads, the profitability model is based on leverage, not innovation and investment (which siphons off precious cash), and the mangagement acumen involves putting in managers who may lack industry experience but know how to read an expense line and make cuts.

[DGuller]

Sure it is.
10 kids each put $1 into a lemonade stand business.
One of the kids is Richie Rich.  Richie convinces Daddy to lend Acme Lemonade another $90.
The kids then use $20 of the $90 to buy lemonade mix, sugar, ice and cups.  They use the rest to pay themselves each $7 in cash. 7-to-1 cash return on equity before a single glass is served.

No laws of metaphysics broken. 

I guess Yi's point was that this lemonade stand would become insolvent, since the value of its equity would be -$60.  Therefore, it would not be done.

My point would be that if this did indeed happen, then Daddy got had.  Surely he did not expect to lend money to an entity with negative equity.

[The Minsky Moment]

I guess Yi's point was that this lemonade stand would become insolvent, since the value of its equity would be -$60. 

It depends how much they charge for lemonade and how much they sell.  If there is a hot summer and tourists come into town, they might be able to generate sufficient cash to pay off the debt.  OTOH if weather is poor or if the kids from the neighboring block start a competing stand, their lender stands to lose quite a bit.  Either way the kiddy investors have septupled their allowance money.

[DGuller]

There has to be something missing in this picture.  If you can do what the kids did, then why would any company not fleece the bondholders the first chance it gets?  As long as you have significantly more cash than equity outstanding, just use it all to pay the shareholders (I'm sure they'll vote for it), and leave the creditors with the empty shell of a company.

[The Minsky Moment]

There has to be something missing in this picture.  If you can do what the kids did, then why would any company not fleece the bondholders the first chance it gets? 

1. Bond covenants, if they exist.
2.  Risk of fraudulent conveyance lawsuits if company later goes bankrupt.

[DGuller]

There has to be something missing in this picture.  If you can do what the kids did, then why would any company not fleece the bondholders the first chance it gets? 

1. Bond covenants, if they exist.
2.  Risk of fraudulent conveyance lawsuits if company later goes bankrupt.

Why does the second point not apply to the Bain example?

[CountDeMoney]

Sure it is.
10 kids each put $1 into a lemonade stand business.
One of the kids is Richie Rich.  Richie convinces Daddy to lend Acme Lemonade another $90.
The kids then use $20 of the $90 to buy lemonade mix, sugar, ice and cups.  They use the rest to pay themselves each $7 in cash. 7-to-1 cash return on equity before a single glass is served.

No laws of metaphysics broken. 

Wouldn't Daddy then proceed to break up the stand under the pretext of high labor costs, and ship lemonade production overseas to Chinese kids?

[PDH]

Wouldn't Daddy then proceed to break up the stand under the pretext of high labor costs, and ship lemonade production overseas to Chinese kids?

Where, instead of using lemon products, the Chinese would use some sort of toxic protein mixed with fetal parts to make lemonade.

[DGuller]

Wouldn't Daddy then proceed to break up the stand under the pretext of high labor costs, and ship lemonade production overseas to Chinese kids?

Where, instead of using lemon products, the Chinese would use some sort of toxic protein mixed with fetal parts to make lemonade.

You're being far too cynical.  Daddy would just ship the mix, sugar, ice, and cups to China, have them assemble a lemonade there, and then ship the cup with the lemonade back to US.