What’s
Wrong Today:
If there
is one thing everyone seems to agree on, it’s that Bain Capital under Mitt
Romney was one of the most amazingly profitable and successful investment
companies in history. He was “coolly brilliant,” agreed his biographers,
Kranish and Helman. How brilliant? Published reports cite fantastic
performance figures:
- Some
media reports say the firm earned “50%
to 80% a year” for investors over fifteen years. - The Real Romney cites reports that
put the figure at 88% a year. - The
American Enterprise Institute went even further than that. In a glowing
profile
of Mitt Romney published in 2006 in its magazine, The American, they claimed:
“During the 14 years Romney headed Bain Capital, the firm’s average annual
internal rate of return on realized investments was a amazing 113 %. The magazine added:
“At that growth
rate, a hypothetical $1,000 investment would grow to $39.6 million before fees.
Few, if any, VC firms have ever matched Bain Capital’s performance under Mitt Romney.”
These are
amazing numbers. Alas,
they are Wrong.
So,
What’s Wrong?
Bain/Romney did not return 113%
per year. In fact, their investment performance, according to their own data,
was borderline unremarkable.
Thanks to two Wall Street Journal
reporters, the full
Romney/Bain 
investment record is available. Patrick O’Connor and Mark Maremont
of the Journal completed a comprehensive assessment of Bain Capital,
including all 77 businesses Bain invested in while Mr. Romney led the firm from its 1984 start until early 1999,
when he says he left the firm. On August 5, Brett Arends released the eBook, The Romney Files, which includes extensive reviews of
Bain Capital.
The Journal sourced
its data from a private placement document Deutsche Bank AG used to raise capital
for a new Bain fund in 2000; 77 Bain investments covering 1984 through 1998 are
included in that placement memorandum. Deutsche Bank cites Bain as a source for
the deal history; these deals accounted for about 90% of the money Bain
invested during that period. (The Journal obtained updated information from a
similar 2004 prospectus). This
is the main source relied on by the Wall Street Journal, the Los
Angeles Times, the Boston Globe, and other publications. It’s the one cited by the Romney campaign itself when discussing his
record.
Among the key
findings in the WSJ article:
• $.9
billion invested generated $2.4 billion in gains for its investors
over 16 years.
• 22% of the companies either filed for bankruptcy reorganization or closed
their doors.
• An additional 8% ran into so much trouble that Bain lost 100% of client money
invested in each deal.
• Ten Bain/Romney deals produced more than 70% of the total dollar gains; 4 of
these businesses later ended up in bankruptcy court.
• Several of Bain’s largest successes were retail firms: Staples, Domino’s
Pizza Inc. and Sports Authority, creators
of many low-paying jobs.
But if you
invested $900 million in steady amounts over fifteen years and earned “80%” a
year, you would have about $900
billion.
If you
earned “113%” a year, you would end up
with about $9 trillion – or nearly three quarters of the U.S. annual
GDP. Bain Capital is a successful company, but if Bain now owns three quarters of the nation’s annual economic
output, I’m sure we would know.
Such are
the miracles of compound interest and the ways that Private Equity firms count
investment gains when they are talking about their investment prowess.
Take this example:
In 1996, Bain Capital bought Experian for about $80 million and then sold it for
about $250 million.
To you and
me, this would count as a 212% gain: Bain Capital made 3x its original
investment. But, according to the Deutsche Bank prospectus, the Experian deal
has an “implied annualized internal
rate of return” of 6,636%.
Why? They flipped the company in seven weeks.
On an
annualized basis, it’s an awesome return. But it’s only relevant to investors if Bain Capital were able to come up with
a string of identical deals for a full year. That’s what “annualized
return” means.
So, it’s
in the context of a 7 week investment and using that computational methodology that
Bain/Romney claims these outsized returns.
Yet, any investor could
have achieved net returns of ~20% per year during that same period, 1984-1998, just
by buying the S&P 500 index and holding it while reinvesting the dividends.
Any investor using leverage the way Bain did could have returned more than 30%.
As Mitt
Romney would later admit (according to The Real Romney), “I was in the
investment business during the most robust years in the history of
investments.” Stock prices soared. The Dow Jones Industrial Average rose more than sevenfold. When you
include dividends, the market rose twelve-fold.
So Bain’s clients
could have just picked stocks out of the newspaper, gone fishing, and earned
about 20% a year. No Harvard MBAs. No Mitt Romney. A broker, a dart board, a copy of the
stock prices page of the Wall Street Journal and a fishing rod. No fees to
Bain, just a steady 20% a year.
But that’s
not all. As everyone in finance knows, what really matters isn’t just your absolute
level of return, but your returns when
adjusted for the risk you took.
Bain
Capital didn’t just buy stocks, the way your mutual fund does. It bought its
companies with debt, lots of it. Leverage, as Mitt Romney has said, was
absolutely key to the business model. LBO firms like Bain Capital bought
companies with a few dollars down and huge loans.
In some cases the leverage used was very large. Bain Capital made
spectacular “internal rates of return” of 1,100% on one of its earliest deals
under Mitt Romney, Accuride, which it bought in 1986 and sold a few years
later. How do you earn returns like that? According to newspaper reports at the
time, Bain Capital put down just 3% of
the purchase price. Most of the remaining $200 million it borrowed.
The
Experian deal described above, involved just 10% down. Bain Capital’s use
of leverage was perfectly legitimate. It was a gamble that paid off. But it
matters a lot when it comes to measuring the investment returns.
Stock
prices boomed during the eighties and nineties. Meanwhile the cost of debt,
like the cost of mortgages for the real estate investor, plummeted. Prime
lending rates fell from 12% to about 8%, according to the Federal Reserve. The
interest rate on corporate bonds halved.
So for
fifteen years, it got cheaper and cheaper to borrow money to buy stocks that
just went up and up and up. There was,
in short, never a better moment in human history to borrow money and use it to
buy U.S. companies. Good timing, Mr. Romney.What
have we learned?
- Mitt
Romney’s investment returns were nowhere near as high as some of the fantastic
numbers you’ve read. - And
the lion’s share of those returns came from playing in a great bull market: The
returns came from leverage and market growth, not from “vulture capitalism” or
from “brilliance”. - They
were not the result of finding underperforming companies and making their
operations better, nor ruthlessly stripping assets and laying people off. - They
came from betting on U.S. firms with borrowed money.
Good for
him. But PLEASE, call it what it is.
And
there’s one more thing. His reported investment
figures are gross, that is, before Bain’s fees.
Nobody see’s
investment returns before fees as indicative of their returns. After all, all
mutual funds quote their figures net. So does every hedge fund. It’s when you are campaigning that you want
to make the returns seem as large as possible.
Bain
Capital charged investors between 1.5% to 2% of their money each year just for
managing it. They also took another
20% of any profits. Simple math tells us that over the course of
fifteen years, based on the information we have regarding the size of Bain’s investment
funds, Bain Capital must have pocketed
at least $500 million in fees and quite possibly, more.
Once you
deduct these fees, you realize that during a fifteen year period Mitt Romney’s
investors put in about $900 million and got back about $2.4 billion. In other
words, Bain Capital under Romney made a dollar-over-dollar gain of about 170%.
Not annualized: In total.
If their
average dollar was invested for five to seven years, it means that Romney’s
investors earned, net, between 17% and 25% a year. You could have too.
Brett
Arends, author of the book The Romney Files,
asked Vanguard, the low-cost
mutual fund company, how much investors would have made if they had just
dollar-cost averaged $900 million into a basic U.S. stock index fund over the
same period, 1984 to 1998.
Vanguard’s
response? The investor would have made
more than $3.5 billion in gains.
$3.5 billion with
Vanguard vs. $2.4 billion with Bain.
Brilliant record? Adequate record? You
decide…
