Private-equity industry: A bad rep, but is it deserved?
Three days after a private equity firm bought the San Diego Union-Tribune in mid-2009, it did what private equity firms frequently do: It cut a lot of jobs.
The cost savings from the 192 layoffs announced that day, and 150 or so others over the next year, helped Beverly Hills-based Platinum Equity more than triple its money when it sold the newspaper in November. It wasn’t nearly so rosy for people thrown out of work in a punishing economy.
That’s life in the private equity world, where layoffs are part of the playbook that elite investment firms use to squeeze cash out of struggling companies. And it is exactly what Republican presidential primary candidates are zeroing in on against front-runner Mitt Romney.
The former Massachusetts governor has been portrayed by rivals such as Newt Gingrich as a “vulture capitalist” while he was leader of private equity shop Bain Capital. Romney says he was a job creator.
The truth lurks somewhere between those extremes.
“There is a lot of misinformation being spread, purely for political purposes and on both sides of the aisle,” Steve Judge, interim chief executive of the Private Equity Growth Capital Council, said in a statement.
The private equity industry has historically made money through a formula of buying troubled companies, restructuring them through layoffs and other cost-saving moves, then reselling them.
The most famous example is the $25-billion buyout of RJR Nabisco in 1988. The saga of that ill-fated deal was chronicled in a bestselling book, “Barbarians at the Gate,” and an HBO movie depicting pinstriped titans battling for the company with little regard for the rank and file.
Private equity’s roots lie in the leveraged-buyout craze of the 1980s junk bond era. LBO firms gobbled up their prey using massive amounts of debt — a burden that strapped many companies and later led to their collapse. Other firms engaged in controversial financial practices, such as paying themselves special dividends, in which they reaped big profits as workers got the boot.
Beyond the job issue, the industry is embroiled in a high-profile dispute over taxes. The earnings of private equity firms are often taxed at the 15% rate that applies to capital gains. But critics, including President Obama, say profits should be categorized as ordinary income, for which the top rate is 35%.
“The industry just has had a bad reputation, sometimes deservedly,” said Mario Giannini, chief executive of Hamilton Lane, which manages private equity investments for institutional clients.
“In its early days in the ‘80s and ‘90s, there was an element of loading up a bunch of debt on a company and cutting costs,” Giannini said. “That was an easy way to make money, and a lot of people did it. That perception has really never changed, and private equity did very little to change it for literally 15 years until it became criticized.”
On the campaign trail, Romney regularly touts his record running Bain Capital as proof that he has the experience and know-how to create jobs in a sputtering economy. He says the firm helped generate a net 100,000 jobs in his 15-year career there.
However, the buyout industry is far better known for job losses than gains, and Romney’s rivals have portrayed him as a rapacious predator who dumped workers and strip-mined companies.
Gingrich has been particularly vocal, accusing Romney this week of being “enamored of a Wall Street model where you can flip companies, you can go in and have leveraged buyouts, you can basically take out all the money, leaving behind the workers.” Similar comments were made by Texas Gov. Rick Perry and former Utah Gov. Jon Huntsman.
The private equity issue has struck a particular chord in South Carolina, where many jobs have been lost to corporate downsizing and overseas outsourcing. The state holds its presidential primary Jan. 21.
A “super PAC” supporting Gingrich said it would spend almost $3.5 million on ads spotlighting South Carolina companies it says Bain acquired but later closed. The group is also expected to release a nearly half-hour video in which people who lost their jobs at Bain-owned companies are interviewed.
The furor has prompted a private equity trade group to defend the industry, saying it adds jobs over time by rescuing companies that “are often underperforming or on the brink of failure.”
The broadsides from Romney’s Republican rivals follow similar attacks from left-leaning activist groups.
An organization called Americans United for Change, financed by labor unions and undisclosed donors, started a website called RomneyGekko.com. It touts fictional Wall Street villain Gordon Gekko — Michael Douglas’ character in the two “Wall Street” movies — as Romney’s potential running mate.
All of this comes at a time of elevated public antipathy toward Wall Street, manifested in the “Occupy” protests around the country — a fact that isn’t lost on private equity managers.
“I don’t put ‘private equity’ on the side of my car when I’m driving around, that’s for sure,” said one fund manager who spoke on condition of anonymity because he didn’t want to draw the attention of critics.
Some say the negative reputation is undeserved. Layoffs are often necessary, they say, to make troubled companies more efficient or to prevent them from collapsing into bankruptcy.
The image “is totally unfair. It’s totally false,” said Peter Rose, a spokesman for private equity titan Blackstone Group. “Private equity creates value by growing companies and improving them and selling them for more than they paid. The flip-and-strip is a myth.”
Private equity firms say they have evolved and today focus as much on expanding promising companies as on downsizing troubled ones.
“That’s what happened in those times,” Judge said. “That’s not what happens today.”
The industry has tried to buff its image over the last decade, including an upgrade of its name. They’re no longer LBO firms; they now use the more benign “private equity” moniker.
“Being known as a leveraged-buyout-deal shop wasn’t the most attractive label out there,” said Colin Blaydon, director of the Center for Private Equity and Entrepreneurship at Dartmouth’s Tuck School of Business. “Private equity has a much nicer ring to it.”
Private equity executives agree that the industry’s goal is to turn a profit, but they say job creation is a natural byproduct.
“You may need to initially retrench, but if you’re going to actually create value over the long term you have to grow, and growing means adding employees,” said John Danhakl, managing partner at Leonard Green & Partners, a large private equity firm in Los Angeles.
Private equity giant Carlyle Group runs a website, carlylegroupcreatesvalue.com, touting companies it says added jobs during its ownership. Manufacturer AxleTech International, for example, doubled its head count to 900 in the three years Carlyle owned it.
A comprehensive study of 3,200 private equity deals over a 25-year period found that private equity is neither a big job creator nor a big job destroyer.
In the first five years of private equity ownership, job losses at existing facilities of private equity-owned companies were 6% higher than at comparable companies. But private equity companies created more jobs at new facilities. The overall result was net job losses of less than 1%.
“Essentially, claims on both sides don’t seem to bear out,” said Josh Lerner, a Harvard Business School professor who co-wrote the study.
The end result, said Dartmouth’s Blaydon, is that troubled companies undergo wrenching changes regardless of who owns them.
“There will be some people who are better off, but there will inevitably be some who will not be better off,” Blaydon said. “That is what goes on with any firm, whether it’s financed by private equity or a company adapting to changing competitive conditions all on its own.”
Alana Semuels in South Carolina contributed to this report.
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