I recently posted this article
about Mitt Romney to my Facebook Status, along with the following editorial comment:
“Behold, a campaign in disarray. It couldn't happen to a
nicer investment banker.”
In response, my friend, Matt
Kinley posted the following comment…..
“I know I'll be sorry I asked. But what's
with you and investment bankers? Is it impossible to be one and be a decent
person?”
The following response is too long for a
facebook comment, so I’ve included it in a note here.
Matt, you are correct for calling
me out on the snark I occasionally direct at investment bankers….and yes, you’ll
be sorry you asked. I certainly am. It is, quite frankly, a little bit of a blind
spot for me. I spent over a decade of my life working in that world and the
experience has left me jaded. This being said, I met a number of investment bankers who were decent people. I just don't think that what they do for a living necessarily qualifies them for the highest office in the land. In fact, I think, for reasons articulated below, that it tends to disqualify them.
In understanding the depth of my snark,
it is important first to understand exactly what an investment banker is and
what it is that they do. The game plan
for private equity investors (an “investment bank”) is to buy companies and increase
their values by increasing revenues and lowering costs, all the while
collecting huge transaction and “management fees” from the investment target. If everything works well (and sometimes it
does) after about (on average) five years, the investment banker sells the now
higher valued company for much more money, pays off the debt and splits the
profits among the firm's limited partners and keeps a nice chunk for themselves.
Leverage is the secret sauce
here, and an example is helpful to see just how getting the leverage equation
right can result in insane returns to private equity investors. Take a company that I have bought for $
1,000, and let’s say that to pay the price to the former owner I leverage the
purchase by securing $ 900 in debt, requiring me to only put in $ 100 of my own
money in order for me to own the company.
Let’s assume that the company does well (I’ve successfully grown
revenues and cut costs) and in five years, I am able to sell the company for $
3,000. I get $ 3000 from the buyer and
with these proceeds, I pay off the debt of $900 (I’m assuming we haven’t paid
any of the debt in the five years to keep the example simple, although this can
happen in real life with the help of “high yield” or so called “junk bonds”),
leaving me with $ 2,100 profit. In other
words, I’ve invested $ 100 of my own money, and when all the pieces stop
moving, there’s $2,100 left over for me to enjoy; a pretty unbelievable return
on $ 100 invested capital. Now you may
say, “Well Bob, you’ve manipulated the example by setting the purchase price
too high.” First off, my example isn’t
all that unrealistic in light of expectations that most investment bankers have
when engaging on a deal, but as my point is to demonstrate the effect of
leverage, let me temper the rhetoric by ratcheting down the exit price. Assume instead that I only increase the value
from $ 1,000 to $ 1,100, or 10% over five years. Using the same math as above, I would take
the $1,100 I get from selling the company, pay off the debt of $ 900, leaving $
200 for me. In other words, leverage has
allowed me double my money over five years for a company whose value has only
increased in absolute terms over the same period by 10%.
It’s kind of a neat trick, and if
when works….oh man…..is there high fiving and chest bumping when the cash is
distributed. While the cash clearly is a
big deal, it’s important to understand that that for those who have engineered
this financial wizardry, it’s also a rush to pull it off. It’s like any win at craps you’ve ever had in
Vegas multiplied by a million, only better because instead of the win being the
result of a random roll of the dice, it’s the result of decisions, actions and
yes, hard work, that you (the investment banker) have contributed that have
created the win. It is an intoxicating
and utterly gratifying feeling. Don’t
get me wrong, the money is awesome too, but it’s not the money that gets these
guys out of bed every morning. Really,
it’s not. The money is a symbol, a totem
or a trophy signifying competence, power and skill.
We’ve all seen the picture of a
very young Mitt Romney standing among his very young Bain Capital partners all mugging for
the camera with cash stuffed in their pockets.
To the uninitiated and in light of Romney’s political ambitions, the picture looks obscene. However, if you mentally adjust the picture, take the bankers out of their black suits, put them in shorts and T-shirts and imagine that instead of them being a group of young Wall Street robber barons that they’re a group of regular young men at a Vegas bachelor party who have just run a craps table and won big, the picture would be more likely to make you smile than to scowl. While I don’t suggest that the activities necessary for an investment banker to enjoy the win are within the same moral sphere as a bunch of drunks in Vegas who have won a bet, I do submit that the grins you see on these young faces comes from the same place and is stirred by the same pool of semi-irrational endorphins as the Vegas gambler. It’s a jolt to win - these guys have obviously won, and are digging it.
To the uninitiated and in light of Romney’s political ambitions, the picture looks obscene. However, if you mentally adjust the picture, take the bankers out of their black suits, put them in shorts and T-shirts and imagine that instead of them being a group of young Wall Street robber barons that they’re a group of regular young men at a Vegas bachelor party who have just run a craps table and won big, the picture would be more likely to make you smile than to scowl. While I don’t suggest that the activities necessary for an investment banker to enjoy the win are within the same moral sphere as a bunch of drunks in Vegas who have won a bet, I do submit that the grins you see on these young faces comes from the same place and is stirred by the same pool of semi-irrational endorphins as the Vegas gambler. It’s a jolt to win - these guys have obviously won, and are digging it.
Everyone admires a risk taker,
but the difference between an investment banker and a Vegas drunk is that when
the drunk has a bad run, he just loses his paycheck – when an investment banker
has a bad run, companies go bankrupt and lots of people who used to work for healthy,
prosperous businesses lose their jobs. All
of a sudden, the comparison of Bain executives standing around with big grins
and cash falling from their pockets to a bunch of guys in Vegas for a weekend
of cigars, titty bars and black jack becomes....well....strained.
You essentially asked me why I have
a bone up my ass about investment bankers.
With all of this as preface, there are basically two reasons.
First, more often than can be
reasonably justified (the return on Bain investments from 1984 to 1999 is only
marginally better than if you had put the same money in a large cap fund and
let it ride), the risks investment bankers take with other peoples’ money destroys
otherwise healthy businesses with real consequences to real people who need and have earned their
jobs. According to a study by the Wall Street Journal,
in the period from 1984 to 1999 during which Romney ran Bain Capital his firm
invested in 77 separate deals. The $ 1,100
billion of invested capital over that period returned $ 2,400 billion in profits
to investors. Now on the face of it,
that looks pretty good. But when you dig
a little deeper you learn that Bain had to kiss a lot of frogs to find a few
princes. Fully 70 % of the profits they earned
over this time period were secured by only 10 of their 77 investments. On the down side, 22% of the companies they
invested in went bankrupt and another 8% performed so poorly relative to their
capitalization that Bain wound up losing all of their invested capital. That’s right!
In almost a third of their investments, Bain’s Masters of the Universe
failed. By the way, of the 10
super-successful investments they did have, four of them went bankrupt after Bain
sold them. (Bain and Romney argue that
they should not be held accountable for businesses failing after their period
of ownership ends, but the reality is that what this suggests to me is not that
Bain necessarily sold to bad managers (although this is certainly possible),
but rather that Bain was lucky enough to find a sucker to buy these companies
for big bucks before the wheels came off the wagon on Bain’s watch). Although I haven’t seen any numbers on the
consequences of these “fails”, I think it’s safe to assume that literally hundreds
(if not thousands) of people lost their jobs as a result of Bain’s various gambles.
While I have certainly moved
several steps to the left over the course of my lifetime, I am not so far over
the edge as to believe that anyone owes anyone else a job. However, for someone to lose a legitimate job
as a result of an investment banker’s inclination to put a wad of cash on the
come line and willingness to sometimes lose that bet for the sake of a five
year blended private equity fund return is simply monstrous. Leverage is fine, but businesses occasionally
hit bumps in the road and so, need to be capitalized in a manner that allows
them to suffer the vicissitudes of market cycles. By levering up businesses the way they tend
to do, they reduce the margin of error necessary for businesses to succeed. If I was a bettin' man, I'd say that they did this in at least 22% of the platforms they invested in. Add to
that the fact that investment bankers are the consummate short-term
investors. Remember, their goal is to “increase
value” by increasing revenues and reducing costs over the period of their
ownership. All too often, their brief
investment horizon does not accommodate the years (and costs) necessary to
achieve sustainable cost savings through true efficiencies. All too often, cost savings are not the
product of forward thinking investments in technology or dedication to new and
innovative manufacturing practices, or the introduction of innovative goods and
services, but instead, result from indiscriminate headcount reduction demands
that are coerced from management by guys who mistake educational pedigree and
arrogance for actual business acumen.
This leads me to my second point
of disgust. Investment bankers just aren’t
necessarily great business people, but they are utterly convinced that they
are. They are, as a dear friend once told me, like people who are convinced that they are experts on education because as kids they went to a public school. I once worked with a woman who, as
a veteran plant manager, was what I think of as a true business person. She understood revenue volumes, margins,
manufacturing efficiencies and the like, but had also mastered the fuzzy
art/science of transferring these
theoretical concepts to the shop floor and customer negotiating table. Running a business is tough….it’s an exquisite
balancing act in which soft variables not covered in B-school text books play a
decisive role. Disgusted at a series of
nonsensical orders delivered from the board room, she allowed as how those guys
from [insert investment bank name here] didn’t have the business acumen
necessary to run a taco stand, much less a manufacturing business. This, of course, is unfair. I’m sure Mitt Romney could run a very nice
business stand. Running two taco stands
at the same time, however, would be tough.
Investment bankers are typically America’s
elite students recruited and hired from America’s elite universities. It is rare that you find a “dumb” investment
banker….in fact, I say it’s “rare” in order to allow myself the possibility
that there might actually be one. If
there is, I haven’t met him or her. Being
smart, however, is not a sure-fire antidote for being wrong - indeed, smart and
wrong is perhaps the most deadly combination of attributes possible in a human
being. As Bain’s investment records
suggest, investment bankers are wrong a lot!
Here’s the deal; human
capabilities and competencies are functions of both intellect AND
experience. The structure of investment
banking firms and the perceived quality of those who work in them cause
investment bankers to have an odd career path.
They exit college and immediately leap frog from their roles as students
into roles as board members. In so doing
they completely bypass what real businesspeople like to call "operational
experience" which would lead them to, as real business people like to say, "know what the fuck they're doing". Their knowledge, while
formidable, is almost entirely theoretical or, because they often sit on
multiple boards, anecdotal. They see many businesses in their careers, but
actually run none of them. Of course,
this doesn’t stop them from trying.
Every investment banker I’ve ever met is a frustrated operator who just
knows that he or she could do it better.
Who knows? Maybe with the
requisite experience, they might even be right.
Without that experience, however, the inclination to act on the impulse to
actually take control is pretentious, arrogant and fool hardy….if it wasn’t for
the human misery in terms of lost jobs this inclination provokes, it’d also be funny. The bottom line is that when synergies (a
polite word for firing lots of people) are merely scribbles on a conference
room whiteboard, it’s ridiculous how easy it is to "cost cut" a business in
amounts sufficient to finance excessive debt and high quarterly “management
fees”. The reality of actually running a
business after you’ve made those cuts is another matter entirely. While it’s
certainly true that over time businesses have a tendency to take on additional
headcount fat, the slap-happy pursuit of “synergies” has a magical way of
eliminating bone and mission critical organs along with the fat. Of
course, there’s also the human element. I’ll
tell you a secret about business….having to walk into a plant employing fifty
people and tell them they’re all being fired is only really tough the second
time you have to do it. These are
realities completely lost on most (if not all) investment bankers…..it’s not
that they’re bad human beings, because they’re not….it’s that their version of “business
life” is centered around maximizing five year returns (“Do you want to back up
that bet, sir?”….”Why yes, I think I do”) and that they lack the breadth of
true business experience to competently judge the consequences of their
delightfully cogent textbook knowledge.
Frankly Matt, when the Republican
Party talking heads gush about the fact that Mitt Romney is a “businessman” it
makes me giggle. Mitt Romney is not a
business man…..he just plays one on Wall Street. While as an achievement, I appreciate and
respect the degree to which Romney and Bain have successfully driven above-market
blended multi-year returns, it is not lost on me (nor should it be lost on the
American people) that along the way they took huge risks for the benefit of a
small number of wealthy individuals and organizations and at the cost of
countless American jobs.
Mitt Romney
is not the guy I want in charge of the country.
If
he wants, however, he's more than welcome to put a lime or two on my taco! Oh wait….maybe not!
