What Do Private Equity Firms Actually Do? : Planet Money The story of one company purchased by Bain Capital, the private-equity firm co-founded by Mitt Romney.
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What Do Private Equity Firms Actually Do?

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What Do Private Equity Firms Actually Do?

What Do Private Equity Firms Actually Do?

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MITT ROMNEY: Do I believe that free enterprise works and that private equity and the various features of our economy work to actually improve our economy, to make America more productive, with higher incomes and a brighter future? Absolutely.



Hello, and Welcome to PLANET MONEY. I'm Zoe Chace.


And I'm David Kestenbaum. Today is Tuesday, February 21, and that was presidential candidate Mitt Romney you heard at the top, talking during a debate in South Carolina. He was talking about his time running a large private equity firm called Bain Capital.

CHACE: Private equity has come up over and over in the debates. Depending on who was talking, private equity is either a job-destroying monster or a knight in shining armor that rides in and makes companies more efficient, makes the economy work better. We're going to tell you a story and let you decide.

KESTENBAUM: But first, the Indicator from Jacob Goldstein.

JACOB GOLDSTEIN, BYLINE: Today's PLANET MONEY Indicator - 160. Greece's debt-to-GDP ratio in the year 2020 could be 160. This is according to a confidential memo that just came out in the past day, just as, yes, Europe was agreeing to this next bailout for Greece. And let's just be clear. This idea that Greece may have a debt-to-GDP ratio of 160 eight years from now is incredibly bad. It's a terrifying prospect.

KESTENBAUM: Let me just jump in and give a quick refresher. Debt-to-GDP ratio - we talk about that on the podcast a lot. Basically, you compare the government's debt to the overall size of the country's economy. And you can argue about the details. Some economists say you don't want this ratio to get over 90 percent. Some people say it depends. But 160 percent - that is crazy town. It is really, unambiguously bad.

GOLDSTEIN: It's really bad. And David, this memo making this estimate - it's not, like, some random analyst. This is an internal European memo written for eurozone finance ministers, making this really scary prediction, basically.

KESTENBAUM: And even with the bailout - this assumes they get the bailout we're talking about. Now, it says, in eight years, the situation is still going to be really crappy.

GOLDSTEIN: Yeah, and essentially - you know, Greece's economy is shrinking, so that alone makes it harder to pay off your debt. And then on top of that, the country has to keep borrowing money just to keep the government running. But of course, nobody wants to lend Greece money right now, so it's just this endless death spiral of debt, and this latest bailout is not going to end this.

KESTENBAUM: Thanks very much.


CHACE: OK, onto the podcast. Here is Newt Gingrich at the South Carolina debate with one view of what his rival Mitt Romney used to do for a living.


NEWT GINGRICH: I think there are specific cases where Bain Capital's model - which was to take over a company and dramatically leverage it, leave it with a great deal of debt - made it less likely to survive.

CHACE: That's one view of the private equity business. Mitt Romney sees it differently.


ROMNEY: I find it kind of strange, on a stage like this with Republicans, having to describe how private equity and venture capital work, and how they're successful and how they create jobs, but let me tell you that answer. I'm very proud of the fact that throughout my career, I have worked to try and build enterprises, hopefully to return money to investors. There's nothing wrong with profit, by the way. That profit...


ROMNEY: And by the way, as enterprises become more profitable, they can hire more people. I'm someone who believes in free enterprise.

KESTENBAUM: Well, PLANET MONEY listeners, we're going to cut through the rhetoric and look in detail at what private equity firms actually do. Zoe, you spent a month researching this. Today, we're going to describe a deal Mitt Romney's firm did that went bad. In another podcast, we'll take you through a deal that turned out differently.

CHACE: But today - the deal that did not end well. And it starts with this.


KESTENBAUM: Zoe, you just put down the most mundane thing imaginable - a legal pad - lined yellow paper.

CHACE: Before Bain Capital, before Mitt Romney, before private equity, this was invented - the legal pad, 1884. Paper was made from cotton rags back then, and any rags that had spots or wrinkles were pulled off the line and piled up. So this paper factory worker, Thomas Holley, would pick them up and bind them together into scratchpads. They caught on, and he started a pad company in Holyoke, Mass. - American Pad & Paper - for our purposes, Ampad. And for almost a century, Ampad chugs along making its signature yellow legal pads and office supplies until in 1992, it gets bought.

KESTENBAUM: By Bain Capital.

CHACE: Yes, Mitt Romney's firm.

KESTENBAUM: So you can think of private equity - basically, what their role is - they buy fixer-upper companies. They try to make them better. You know how people buy houses, try and fix them up and flip them, sell them for more money? That's basically what private equity firms do with companies. That's what Bain hoped to do with Ampad.

CHACE: Exactly. It was for sale. It was pretty cheap, and Bain saw a lot of value there. They declined to talk to us for this story, but I did find the guy that Bain Capital brought in to run the company - this guy, Russell Gard. And he says if, you were in the market for legal pads, Ampad made the Cadillac.

RUSSELL GARD: Ampad had the premier reputation in the marketplace. They always did - excellent product.

CHACE: They just had good pads of paper, is what you're saying.

GARD: Yeah. I mean, when you had a legal pad from Ampad and you tore across the perforation, it tore across the perforation. You get another manufacturer, you tear across perforation, and that legal pad may leave half the paper on the header. So they always had quality merchandise.

KESTENBAUM: You want perforations that work? You go with Ampad.

CHACE: Exactly, the best perforations in the world. And Bain wanted to buy Ampad because they had a vision. Bain's vision was to make Ampad the center of a paper empire. So here we are in 1992, and it's just when all these office superstores are opening up, like Staples, Office Depot, OfficeMax, Walmart, things like that. These superstores are popping up, and Bain's idea is that it will become a one-stop supplier for these places. They have this vision for an entirely new company. It will do pads, also envelopes, printer paper, whatever paper products Office Depot is going to need.

KESTENBAUM: Now, if you were fixing up a house to resell it, you'd put down a bit of your own money and take out a big loan to buy the house. That is what Bain does.

CHACE: Ampad cost about $40 million to buy. Bain puts in about $5 million, and the rest of it, they borrow. They take on $35 million in bank debt, and this kind of figure is typical in private equity deals.

KESTENBAUM: We should point out - and this is going to sound a little weird - this debt is not debt that Bain is directly responsible for. It's actually on the books of Ampad. So Ampad, as a new company now, it takes out a loan, putting itself down as collateral, basically saying, give us a loan; we're going to try something; if it doesn't work, you own us; you can take us back.

CHACE: And so this company that was slightly profitable when Bain bought it - now it has all these interest payments on $35 million in debt.

KESTENBAUM: But the hope is they're going to build this giant, successful, new paper empire. Russell Gard, the guy who's going to run this company, he is psyched about the plan. He invests his own money in this new company. He actually used his house and retirement account as collateral. It was exciting and a little scary.

GARD: We were highly leveraged as a company - like, squeaky leverage. I mean, we were tight, to say the least.

CHACE: At one point, it looked like they had actually run out of money before they'd even begun.

GARD: We were back in Boston on a board meeting one time, and our CFO said, we're out of money - the night before the board meeting - because if you're out of money, you're going bankrupt, and everything I had was gone.

CHACE: They didn't sleep all night. The next day, it turns out the CFO had made a mistake. They still had $500,000 worth of cash left, and today, the smell of that hotel - that particular Marriott where he spent that sleepless night - it haunts him.

GARD: In fact, if I go into a Marriott that has a certain smell these days, I change hotels because that's - there was a smell that night that, like, I've never gotten out of my head.

KESTENBAUM: So as part of its plan, Bain wants to make Ampad more efficient. Bain Capital is the owner. Gard has been hired to help run this new company.

CHACE: Right off the bat, they do a few things. They move the corporate headquarters to Dallas because the housing is affordable and the airport's central. You can get to everywhere in the country. Gard says they negotiate with the paper mills, and instead of 30 cents a pound, they get it for cheaper - 27 cents.

KESTENBAUM: And they start to build this paper empire. Remember, their vision is to become OfficeMax's biggest supplier, so Bain buys another company. This one makes hanging file folders.

CHACE: Right, a place for your notes that you've written on your legal pads. This hanging file folder company is called SCM. It's in Marion, Ind.

KESTENBAUM: So the people who describe private equity and Mitt Romney as job-destroying monsters - a lot of it comes from what happens next.

CHACE: Jerry Rayburn worked on the factory floor at SCM, and he remembers the day when Bain took over.

JERRY RAYBURN: We knew something was going on when we saw - toward the end of the day, we saw all the security guards starting to surround the plant.

CHACE: Rayburn says they gathered everyone in a warehouse in the back. The chairs were all set up, and they were told, you're no longer employed with SCM. Ampad is the new owner, and you've all been fired, but you're welcome to reapply for your own jobs.

RAYBURN: Here's the applications if you want to reapply for a job with Ampad. You could hear a pin drop. I mean, it was like - everybody was in shock.

CHACE: Rayburn says most people reapplied, but they found out things were going to be different now that they work for Ampad. First of all, they weren't going to be in a union. The union was over.

RAYBURN: Of course, they rehired me, and then they showed me what the pay scales was and the benefits. And I was just, like, shocked.

CHACE: Rayburn says the pay was cut. Gard, who was running the company at the time, disputes that, but they both agree on the other changes. Employees no longer got all their benefits covered. You had to pay in. And the rules on the shop floor - they changed a lot about breaks, shift hours, stuff the union had negotiated. Those were all out the window. You had to work longer. You weren't allowed to leave as often.

RAYBURN: I'm telling you, it was unbelievable, their plant rules. It was like you were working in a - over in another country somewhere.

CHACE: So the workers went on strike. And this is where the story comes back to include Mitt Romney. Romney was on a leave from Bain Capital at this point. He was still the president, but he wasn't involved in the day-to-day operations of the company. He had something else going on.

KESTENBAUM: He was running for Senate in Massachusetts against Ted Kennedy. Running against a Kennedy in Massachusetts - that'll keep you busy.

CHACE: And the race was actually pretty competitive until the strike at the SCM plant in Indiana happened. Ted Kennedy's campaign had a field day.


UNIDENTIFIED PERSON: Mitt Romney's ads claim he created jobs, but what's the record? His firm bought a company in Holyoke and moved its headquarters to Dallas, Texas. Romney's firm bought a company called SCM, fired all 350 workers, told some they could reapply at a 25 percent pay cut.

KESTENBAUM: Zoe, some Romney opponent could run this ad from 1994 today. It is the exact same issues coming up in the campaign.

CHACE: And in 1994, this worked. Romney loses the election. According to Gard, the ads were so effective that Romney called him personally and told him to end the strike. Romney was emphatic, but Gard told him no, because, remember, this is part of their strategy. They have to become really efficient, really lean. They need to become the supplier for OfficeMax and Staples, and they've got some debt to pay off, also. They want to bring labor costs down to make this whole thing work.

KESTENBAUM: In the end, the workers lose their jobs. Bain eventually moves the hanging folder machines out of the Marion plant to another one of the Ampad plants. That's 300-plus jobs gone.

CHACE: When people say Mitt Romney destroyed jobs, this is what they're talking about. And the workers, like Jerry Rayburn - they hate Romney for it. But Rayburn will also tell you there's been plenty of job loss in this town that had nothing to do with Mitt Romney or Bain Capital because a lot of plants have closed in Marion, Ind., not just the one that Bain Capital owned.

RAYBURN: I'll tell you, Marion's had some really tough times here in the last 17, 20 years - real tough times because of all the plants closing. We had GenCorp. They're gone now. We had RCA. They're gone now. Dell Fiber (ph) - they're gone now. It was like we started the ball - we got the ball rolling. We were the first one.

CHACE: So the workers at that plant lost their jobs, but Bain has this bigger vision in mind. And it's now 1995. Bain continues to build its paper empire. Each time, they buy a company with more borrowed money. So we have legal pads. We've got folders. The next step is envelopes. Bain buys Williamhouse-Regency, an envelope manufacturer. And I tracked down John Grimes (ph), who was president at the time.

JOHN GRIMES: We had the vanilla ice cream - the basic product of envelope - but we also had the high-end envelope, and that made us profitable at the time.

CHACE: Very profitable, which is another reason Bain was interested. And David, I will tell you, a profitable envelope company does not come cheap.

KESTENBAUM: Hit me. How much was it?

CHACE: 300 million dollars.

KESTENBAUM: Which, of course, they borrowed, right? So now they're a much larger company, also with much larger debt.

CHACE: Right. They're borrowing a lot, and they're still not profitable. But I talked to a lot of the people involved, and at this point, nobody seemed worried about the debt load. In fact, people are pretty psyched. The plan is happening. The paper empire is growing. They now have these great envelopes, and the guys at the envelope company - they feel like they're going to be part of a bigger, more valuable company. I put it to another one of the executives at the envelope company they acquired, Tim Needham. You're not worried? Nope. Bain's plan seemed reasonable, though his new bosses - the Bain guys - they weren't the cuddliest guys you'd ever met, but he liked their strategy.

TIM NEEDHAM: I would say they were aggressive, smart, and arrogant. When you have a - when you had a meeting with them, they were not interested in the answers. They already had the answers themselves.

KESTENBAUM: But now's the part in the story where something controversial happens. When they go to the bank to borrow money to buy the envelope company, they also borrow money for something else, and it's not to buy another company.

CHACE: Right. Bain borrows an extra $70 million, and it uses that money to pay its investors. Remember, the investors contributed $5 million at the very beginning to buy a legal pad company, and now they get paid back - much more than getting paid back, actually. They put in 5 million, and they get back close to 70 million just three years later. And that's a very, very, very nice return on your investment.

KESTENBAUM: Now, critics of private equity are shocked by this. You know, you put together a company that's not even profitable, you saddle it with a bunch of debt, and then you use that company to borrow money to pay yourself and your investors.

CHACE: But this exact thing is totally typical in private equity deals. And if the company is a huge success, this normally would just be, like, a footnote in an SEC filing. No one even really would pay attention, because at this point in the story of the paper empire it looks like payday is coming - the IPO. The IPO is the day you take your fixed-up company, put it on the market and see how much it's worth.

KESTENBAUM: In our house-flipping analogy, it's where you finished fixing up your house and you resell it.

CHACE: They're so optimistic about the upcoming sale that, actually, right around this time, one of the executives at the company in Dallas builds a replica of the White House to live in out of redbrick. It's a huge estate. And what I'm trying to say is these are heady times, heading into the IPO. Russell Gard and the other guys running the company, along with a couple of Bain executives and lawyers, hop on private jets and fly all over the country telling people the story of their master plan - the paper empire - and asking people to buy stock when the company goes public.

GARD: You get no sleep. You meet with five, six, seven people or firms a day.

CHACE: I'm picturing meetings, like, with, you know, bloody marys in a boardroom kind of situation.

GARD: (Laughter) Well, you would get some boardrooms. You'd never get the bloody marys or a glass of wine. You have your best shirt and tie on and best suit that gives you the best look, and you stick to the script that the lawyers have given you.

CHACE: The script works. They convince a lot of people. In 1996, the company goes public, and people buy the shares. So about 13 million shares sell at about $15 a share. Bain uses the money to pay off a chunk of the debt, and lo and behold, the American Pad & Paper Company is finally profitable, and it's a major supplier to Staples, OfficeMax, Office Depot, and Walmart.

KESTENBAUM: Bain, at this point, is close to cashing out, close to selling all its shares, being done with this company, letting it fly on its own. But the dream of building the paper empire - to dominate the office superstores - it is not quite finished. They can't walk away just yet. There are just a few more purchases - just like, you know, when you fix up a house, there are a couple of more renovations you want to get done before it's exactly right.

CHACE: Here is where Bain makes some decisions that don't go very well, and Tim Needham, the envelope executive - he remembers exactly the day he thinks things took a turn for the worse.

NEEDHAM: Well, I was sitting at the airport - an airport hotel in London, getting ready to fly back.

CHACE: Needham had flown to Europe on a mission to find more envelope companies. Staples, Walmart - they were expanding to Europe. American Pad & Paper wanted to be their supplier. And he was coming back with what he thought was good news. He'd found a company he thought they should buy.

NEEDHAM: And Russ Gard called me up and said, Tim, it doesn't look like we're going to do this. Greg Benson at Bain has acquired a company called Shade/Allied. I was - to be honest with you, I was stunned because I knew that company. I had looked at that company several years before, and I decided that company was an Edsel. It was an Edsel. You know what an Edsel is?


NEEDHAM: It's a dog.

KESTENBAUM: Let me just be precise here. Edsel was actually a car famous for being the wrong car at the wrong time - a total commercial failure.

CHACE: The reason he thought it was an Edsel was Shade/Allied, the company Ampad was about to buy - they made continuous form printer paper for dot matrix printers.

KESTENBAUM: I remember that paper well. It had these holes running up and down the side so the printer could pull the paper through, and after, you'd have to tear off the side parts with the holes. It was perforated.

CHACE: Yeah. Those little strips of paper would get everywhere. And Ampad bought the company that made this in 1997. Tim Needham says it wasn't a product they knew much about, and it meant borrowing another $49 million, To him, it didn't seem like the right move.

NEEDHAM: Everybody in the industry was stunned. I must have had 10 other computer company - computer paper companies call me and said, hey, Tim, if you want some more capacity, I'll be happy to sell you my company right now.

CHACE: (Laughter)

KESTENBAUM: Shortly after this acquisition, things start to go bad. The paper empire business - it turns out to be very competitive. These paper companies in Asia come onto the scene with cheaper products. Also, the price of pulp to make paper from - it shoots up.

CHACE: So in 1997, one year after the IPO, the revenues of American Pad & Paper - they flatten and start to decline, and by the end of 1999, Office Depot stopped buying Ampad's stuff.

KESTENBAUM: Now, this kind of volatility - it's the reason people keep cash on hand - to weather economic storms that come up. American Pad & Paper's problem at the end was that they didn't have a lot of cash. They had all this debt.

CHACE: Executives fled the company. Russ Gard, the guy I talked to - he left in '98. And by 2000, four years after the IPO, American Pad & Paper files for bankruptcy.

KESTENBAUM: Let's just add up the pain here, Zoe. The stockholders who owned shares of the company - they were wiped out. Bain itself still owned 35 percent of the shares. Those were now worth nothing.

CHACE: And all the banks and people who'd lent the company money - they got back a fraction of what was owed to them. And some of these companies they had bought - the envelope company, Williamhouse, Ampad itself way back in the beginning - some of them had been pretty healthy on their own, and now they were in bankruptcy court. I asked Russ Gard what he makes of how things turned out.

When you look back at your legacy there, at the company that you helped to build, what is the value added, since the company did end up going bankrupt and breaking off into pieces? What - is there a lasting value to what happened? And what is it?

GARD: No. In my opinion, no, there's no lasting value. It was - no - no, no lasting value. Could've been, but - you can't continue to leverage companies up because at some point, there's going to be a breaking point - something in the market changes, the economy changes, you have ups and downs in the GDP. So you can't continue to leverage companies. You have to get them stable and fund from within.

CHACE: That's the thing about debt. On the one hand, it helps you grow. But if you have a lot of it and then things turn against you, you can get stuck. And this is the criticism people make of private equity firms. They come in, they take over a company, they pile on the debt, they squeeze out the profits, they pay themselves back and then leave the company to die.

KESTENBAUM: Clearly this, though, does not happen all the time, right? If it did, the banks and the other people who lent private equity companies massive amounts of money - they would never do it again, right? They lost a lot of money in this case. If every time Bain did this, the companies it took over ended up in bankruptcy, people would say no, Bain, thank you very much; I'm not going to loan you money for your next paper empire.

CHACE: The Wall Street Journal took a look at how the Bain projects have turned out over the years - like, how often what was good for Bain was also good for the company it had acquired. And they looked at the 10 biggest deals during the time that Romney was there, the deals where Bain made the most money for itself and its investors. And of those 10 deals, four of them ended up like Ampad did, in Chapter 11.

KESTENBAUM: So, you know, bankruptcy - it's not necessarily fun, but it's also not always the end of the world. I mean, Ampad is still around, right? You have that pad of paper right there.

CHACE: Right. That's an Ampad pad.

KESTENBAUM: And here's one final piece of information to complicate what you might be feeling now about private equity and the role it plays in our economy. When American Pad & Paper went through bankruptcy, the pieces of the company were put up for sale. If nobody bought the pieces, those factories would be shut down. Everyone would lose their jobs. But in the American Pad & Paper case, there were buyers. Who were they? They were other private equity firms who saw an undervalued company at a good price.


MOTOPONY: (Singing) Hanging on to the roots of a broken tree. And I said can't you control your shiver now? Because whatever that...

KESTENBAUM: As we said, Bain Capital declined to comment for this story, but Mitt Romney's campaign did send us a statement, which we will post on our blog. That's npr.org/money. As always, we want to hear what you think. Send us email - planetmoney@npr.org. You can also find us on Facebook and Twitter.

CHACE: And I want to give a special thanks today to all the people who helped with the research for this podcast. The 10Ks, the financial documents - they are not the easiest things to read, and I had some help. So the Holyoke Public Library, Steve Kaplan (ph) David Kedmi (ph) Josh Kosman, Andrew Lowe (ph), thank you. I'm Zoe Chace,

KESTENBAUM: And I'm David Kestenbaum. Thanks for listening.


MOTOPONY: (Singing) You'll never get high if you're afraid of comin' down. Are you afraid of comin' down? Staring t that cold river - all right - hanging on to the roots of a broken tree.

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