Private Equity, Romney’s Bain in the Neck
I spent a good portion of my career planning and executing business turnarounds in a large corporation. Almost all the businesses I worked on were formally profitable businesses that enjoyed leadership positions in their industry. Why were these once shining stars in need of a turnaround you ask. Because someone that was entrusted to lead the business decided to make themself look good and cut costs to improve earnings at the expense of the long term viability of the business. Sometimes this would be the President or General Manager, other times it would be someone farther up the chain of command like a Group VP or CEO that would force the issue.
Years later, I or some other ruthless bastard would be sent out to fix the mess. This is not to say that there is no place for cost cutting. Businesses must react to changing economic and competitive conditions. The problems come when someone simply cuts spending to increase the bottom line and make themselves look good. Taking 2% of sales out of R&D isn’t going to cause immediate problems. Planned product introductions will be pushed out a couple of months as the remaining resources are focused on those projects at the expense of future projects. Over a period of years, the company will slowly, but surely fall behind the competition. Earnings and market share will fall into a downward spiral that is hard to overcome.
The people responsible will be long gone. Enjoying the benefits of moving up the ladder as a result of the short-term earnings pop they achieved. Publicly traded companies have a decided short-term focus. Not by choice, that is what the market demands and we are the market. Capitalist don’t enjoy laying people off, that’s what they are expected to do and if they don’t, the market will find someone that can and will.
So what does this have to do with private equity? I got to thinking about that terrible Mitt Romney and his cruel private equity ways and wanted to put some perspective on it. The goal in capitalism is to create value. That is done by fullfilling or creating a need and satisfying it at a profit. When this happens, jobs and wealth are created.
This is usually the antithesis of value creation. Sometimes their are economic necessities. I would place the Wall Street bailouts in this bucket. The economic health of the entire nation was at stake. More questionable would be the Detroit bailouts. A regionally focused industry with a huge employment base was at stake. For me the problem was not so much that it was done, but how it was done. Loan guarantee giveaways to green energy companies and state-sponsored health insurers called CO-OPs have been nothing short of a disaster.
Publicly Traded Companies
As I described above, it’s not perfect. Too much emphasis on the short term. Well managed companies do strike an effective balance a create significant value for its shareholders. All in all, the best system yet for running an economy.
Comparitively speaking, I think private equity drives the most value creation. The investors are most tuned in to value creation. Their ultimate end game to either leverage the company to take cash out or sell it involves equally sophisticated investors that aren’t going to be taken-in by clever cost cutting. Any fool can cut cost. Managing a business to optimize profitability and create long-term value takes some real talent.
Private equity companies execute turnarounds with a passion because each one is a unique investment. Not a small part of a corporate enterprise that can be swept under the rug.
You can’t run an economy off of private equity, but you can recognize it as a very effective value creation enterprise. Given the value lost through government loan guarantees versus value created by Bain Capital, if I was the President, I’d take Bain off the table as a political issue.