Understanding Capitalism

Who is Main Street and Who is Wall Street and what is Bain Capital?

There are things that a country needs that are too big to be done by one persion using just the wealth they can accumulate in their life – and it’s not good for the country if you can accumulate that much wealth if it all dissipates when you die.   Building a nuclear power plant, building a steel factory, making electric cars, building a skyscraper constructing an oil pipeline, etc…

So there are different ways these “big things” are created.

Main Street  Capitalism

Not really capitalism at all – more like Free Enterprise.     Mom & Pop borrow $100 from their brother in law, open a store to sell widgets, make money, open more stores selling more widgets – not really on any “capital” beyond what they earn from the business.   When Mom & Pop die, the business dies with them – or maybe lasts until the 3 generation rule kicks in.

Private Capitalism

Usually because of special favors or protective government regulation in combination with intelligence and cunning, and sometimes just being in the right place at the right time, a private person is able to accumulate massive wealth during their lifetime, often using funding from banks.   JP Morgan,  Andrew Carnegie, Andrew Mellon, John Rockefeller, Jay Gould, James Duke (NC), Cornelius Vanderbilt, Charles Schwab….    What they do with their business is private and nobody has a right to know what they’re doing with or how they run their company.    With enough wealth and power, the Government becames their tool to increase their power.

Democratic Capitalism

Starting in the late 1800s, the public started to demand limits and controls be placed on Private Capitalism.    The Sherman Antitrust Act was passed in 1890 to try to break up the power of the so-called “Robber Barons” of America.  The law was written by a Republican Senator from Ohio and passed unanimously by the US House.

With the arrival of Progressive Republican President Theodore Roosevelt, the government started to assert itself in the regulation of large corporations, then passing the Clayton Antitrust Act in 1914 under Woodrow Wilson  adding other types of business practices that were illegal in interstate commerce.

But the watershed in American Capitalism was the Securities and Exchange Act of 1933 under FDR.   The country having rejected Private Capitalism and Wall Street collapsing in 1929, the Federal Government decided the answer was Democratic Capitalism.   This is probably the closest to what most of us were taught growing up and what we think Capitalism is today.

Someone starts a company.   They have a great idea or product, but don’t have a $billion to make a factory.   They decide to “Go Public” – offering stock in their company to anyone that is willing to share in the risk.   A proposal is put together by an investment bank and an Initial Public Offering (IPO) is launched.  Stock is sold, money is raised, the factory is built, the profits are paid out to the stockholders.   Along the way, the company may sell bonds to the public and institutional investors (insurance companies, banks, pensiobn funds) to borrow money, but without the lenders owning the company or sharing in the profits.

Once the company is launched, people start to buy and sell the stock on a public stock exchange.    If the company needs more money and the existing stock holders agree, more stock is sold in a secondary offering.

The price to be paid of having a publicly traded company is exhaustive disclosure.   You have to have a board of directors, and their meetings are open to the stock owners.   Financial data must be reported every 3 months and reported to the government and made available to anyone who wants to know.  Who owns how much stock is public information if they own a signficant amount.   Keeping big secrets is very hard.

So with the public fully informed about the various companies they choose to invest in – who owns them, how much money they make, who runs them – investors (the public) can “vote” for which companies should get more money to build new plants by buying the stock in that company.   

The more the public believes in your company, the easier it is to attract more capital and make more stuff.

Private Equity Capitalism

Bain Capital didn’t invent it, but they were an early player.

The basic concept of the Private Equity company is they identify a company that -could- be making more money than it is.   Often using the target company’s own cash against them, the PE firm makes an offer to buy up all of the stock of the company and “take it private”.   The PE firm uses the cash on hand and the ability to sell bonds against the future earnings (if any) to raise the money to buy out the existing stockholders.

Once the PE firm is in charge, they can do the things they identified as why the company was not as profitable as it could be – shutting down unprofitable business lines, closes stores, firing people who are not contributing to the company, declaring bankruptcy to break union contracts and pension obligations, etc…  

Being back to a Private Corporation, the company has no disclosure requirements to the investing public about who owns the stock, who is making the decisions – the only insight the government has is their IRS tax form, which is not a public document – and the transaction can be so convoluted that literally nobody can understand it.   As a general rule, Private Equity firms don’t start companies, they acquiring existing companies.

Domino’s Pizza (an example floated by Romney) had 6,000 stores in operation when Bain capital purchased the company from its found Tom Monaghan in 1998.   12 years later, the company had “grown” to 9,000 stores.

Sports Authority was an idea started in Florida.   Six or more private equity firms put money in the pot in 1997.  Bain was not the lead syndicator and played no role that I can find in advising the company    In 2000, Sports Authority had 10 stores and was sold to KMart.    The Sports Authority you know was built with by K-Mart, not Bain or their VC friends.   It was nothing but an investment.

Staples was founded by a man named Tom Stemberg.  According to the history on the .uk web site, Mr Stemberg got angry that he was unable to buy a printer ribbon on a holiday.   He was the man who recognized the opportunity and ran the company for 16 years until to left to go work for a Venture Capital firm – Highland Capital.

http://www.forbes.com/2005/03/11/0311autofacescan07.html

Bill Bain rounded up $650k to build the first store in Boston.   The Harvard Endowment fund and Bain Capital have many close relationships.   I don’t know for a fact that Harvard put up the money, but it is logical – they probably figured they would save enough on their own office supplies to make the store profitable.

The Private Equity End Game

Once a Private Equity firm “fixes” a company, the goal is that usually within 5 years, the fixed company will be relaunched as a new IPO and the PE firm cashes out and the reborn corporation goes back into the public stock market, making its way to a prosperous future – however the trend lately is graduates of PE makeovers fail miserably.   Burger King is another Bain Capital Graduate (a joint venture with Goldman Sachs).   After going back through an IPO, the new Burger King failed miserably in the burger wars, in 2010 the company sold itself to a PE firm from Brazil that will take its turn at fixing it.  [Start by selling real milk, not reconstituted powdered milk]

Top 100 chain restaurants

In 2010, Burger King had a sales drop of 2.4% while Subway and McDonalds were increasing U.S. Sales.    McDonald’s is still publicly owned and traded on the NYSE and one of the best examples of Democratic Capitalism still at work.

The Sarbanes-Oxley law passed about 10 years ago has greatly sped up the process of companies “going private”.   Holding the officers and the accountant of a Publicly Traded corporation legally (financially and criminally) responsible for the actions of publicly traded corporations is a huge disincentive to being a publicly traded corporation.

So now we have come full circle.  Private Equity companies have taken us back to the 1890s, when nothing a company does is public, and the American public is locked out of investing in the companies they use every day.   The big difference from the 1890s is now those big “robber barons” are just piles of money with no trail of who actually owns the wealth or is running the company.