Bain Capital’s ‘Leveraged Gambling’

by Will Ashworth | October 19, 2012 10:17 am

Mitt Romney ran Bain Capital from 1984 through 1999. As a result of that experience, the Republican presidential candidate believes he’s the person to fix what ails American business. David Stockman[1], Ronald Reagan’s budget director, thinks otherwise, and he suggests as much in his new book, The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy.

With information gathered by The Wall Street Journal, Stockman portrays Bain Capital during the Romney era as “… a dangerous form of leveraged gambling…”

Fast forward to 2012.

Has Bain changed in the 13 years since Romney left to organize the 2002 Salt Lake City Olympics? Not so much. Some recent Bain IPOs show how the private equity firm profits while the businesses it acquires become measurably weaker. It isn’t a pretty picture.

Six people were arrested at an Illinois plant Wednesday for protesting the transfer of 170 jobs to China[2] by year-end. The plant’s owner: Sensata Technologies’ (NYSE:ST[3]), the former sensors and controls division of Texas Instruments (NASDAQ:TXN[4]). Bain acquired it in April 2006 for $3 billion and took it public in March 2010 at $18 a share.

According to Steve Bills of Reuters[5], Bain invested $770 million in equity, financing the remaining $2.23 billion with debt. Bain still owns 89.6 million shares (51%) valued at $2.6 billion as of Oct. 17. With $1.2 billion in its pockets from the IPO, two secondary offerings and a private sale, Bain’s realized profits sit at $430 million with the lion’s share still to come. That’s a 400% return. Good for it, but not so good for Sensata.

At the end of 2005, according to Texas Instrument’s 10-K, its former business had total liabilities of $134 million, revenue of $1.17 billion and operating profits of $266 million. Not included in the deal was TI’s radio frequency ID tag operations, which explains why the 2010 prospectus shows 2005 revenues of $1.06 billion and operating profits of $225.8 million.

Either way, this wasn’t a business in distress. Yet by the end of 2007, it had $3 billion in total liabilities.

Its EBITDA at the end of 2005 was $256 million; by 2011, it was $480 million, an annual growth rate of 11.1%. Meanwhile, revenues grew 9.5% annually. Debt, on the other hand, has been reduced by $700 million to $1.8 billion since its high in 2007.

Sensata’s debt-to-capitalization ratio in 2005 was 8.1%. Today, it’s 62%. Its interest expense last year was $100 million, quite high to be sure, but down from $198 million in 2008. Yet the only reason it made money in 2011 was because it didn’t have IPO expenses from the year before.

At the end of the day, Bain took advantage of the fact Texas Instruments no longer wanted the business. Is Sensata a better company today as a result of Bain’s involvement? The employees at its plant in Illinois would tell you emphatically no. I most definitely agree.

A second example is Bloomin’ Brands (NASDAQ:BLMN[6]), parent company of Outback Steakhouse and four other restaurant concepts. Bloomin’ Brands went public Aug. 8 at $11 a share, made 12.8% on its first day of trading and is up 19% since. It’s first-day return is slightly lower than the 2012 IPO average of 14%, but it’s off to a good start nonetheless.

Whether it keeps going is another matter. That’s because its history with Bain is very similar, with the difference being Sensata Technologies is a “carve-out” while Bloomin’ Brands was a public company taken private and then public again. Fool me once, shame on you. Fool me twice … well, you know the rest.

Bloomin’ Brands was formerly known as OSI Restaurant Partners and traded on the NYSE under the symbol OSI until it was acquired by Bain Capital and Catterton Partners in June 2007 for $3.18 billion and the assumption of $185 million in debt. Bain paid $41.15 a share, a 27% premium over its share price on November 4, 2006, the day before the announcement of the deal.

Although Outback’s parent was experiencing a deterioration in its business, it was still making money. In its final quarter (March 2007) as a public company, OSI generated $45.5 million in operating profits on $1.07 billion in revenue. In its final fiscal year (2006) as a public company, its operating profit was $152.3 million, a decline of 33%, but still profitable.

Then the wheels fell off.

In 2008, revenues declined by 5% to $3.96 billion, and Bain was forced to take a non-cash goodwill impairment charge of $726 million, an indication that it had seriously overpaid for Outback and the rest of OSI’s restaurant concepts.

Prior to the acquisition, OSI’s debt was less than $200 million, and its annual interest expense was just under $15 million. After the takeover, debt was $2.6 billion with $136 million in interest, topping out in 2008 at $197 million. By its IPO in August, Bloomin’ Brands had managed to reduce its debt to $1.8 billion and an annual interest bill of $83 million. Most important, its pretax profit was $131 million.

What’s so wrong with this picture?

Bloomin’ Brands enterprise value today is $3.3 billion. Bain paid slightly less than that in June 2007. In the course of five years, the firm took a restaurant operator with a debt-to-capitalization ratio of 14% and amped it up to 64%, all in the name of an additional $60 million in operating income. Bain uses financial smoke and mirrors, a tweaking of profits and outsized levels of debt to persuade IPO investors that it did a masterful job rebuilding businesses.

Debt, as we’ve learned the past five years, is a scourge. It’s ruined many a country’s economy — U.S. itself teeters on a fiscal cliff, thanks to its enormous debt — yet Bain has no compunction about using it. David Stockman comes to the right verdict about Bain Capital.

As of this writing, Will Ashworth didn’t own any securities mentioned here. 

The opinions contained in this column are solely those of the writer.

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  1. David Stockman:
  2. 170 jobs to China:
  3. ST:
  4. TXN:
  5. Steve Bills of Reuters:
  6. BLMN:

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