No Alpha: Bain Capital’s Investment Results

The political season is in full throat. While everyone is focusing on Mitt Romney’s VEEP selection of Paul Ryan, perhaps it is time to refocus our views elsewhere.

During the primaries, there were all manner of attacks on Bain Capital as a proxy for Mitt Romney. The criticism for outsourcing and layoffs, for the fortune he earned (estimated at $190 – $250 million). Bain saddled some companies with huge debt, using the proceeds to extract large fees. It was a very sharp elbowed form of capitalism. Surprisingly, the criticism came not from the left, but from Romney’s primary challengers on his right. Strange.

This morning, we are going to review how Bain Capital actually performed as investors. No, they did not (as claimed) return 113% per year. In fact, their investment performance, according to their own data, was rather unremarkable.

Let’s start with the WSJ article. Among its key findings:

• $1.1 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;
• Bain’s returns came from just a small number of investments. Ten deals produced more than 70% of the total dollar gains. (4 of the 10 of these businesses later ended up in bankruptcy court).
• Several of Bain’s biggest successes became household names: Staples, Domino’s Pizza Inc. and Sports Authority.

The Journal analysis shows that in total, Bain produced about $2.4 billion in gains for its investors in the 77 deals, on about $1.1 billion invested. This is before fees, which typically run in the range of 2% annually plus 20% of profits (widely known as “2+20”); Some newer Bain funds run 1 & 30, while some older funds ran 1.5 + 20.
That sounds like a great deal – but it is a far less attractive when you do the math and compare to other alternatives.

The Journal sourced its analysis from a list of 77 Bain investments covering 1984 through 1998 that were included in a document Deutsche Bank AG used to raise capital for a new Bain fund in 2000. The Deutsche Bank doc cites Bain as a source; these deals accounted for about 90% of the money Bain invested during that period. (The Journal days it obtained “updated information from a similar 2004 prospectus.”)

That January 2012 analysis looked at the specific deals Bain did. How did they actually perform as a fund over that same time period?

For that, we need to go to Brett Arends’ new ebook: The Romney Files: From Bain to Boston to White House Bid.  (excerpt here).

Let’s start with that silly 113% per year: Thats a more than doubling each year, and it would have turned $1.1 billion into $9 trillion over the same time period. So please ignore that absurd silliness. As Arends explains, it derives from the way Private Equity calculates internal rates of return. You can use it to compare private equity investments to each other, but not for anything else.

Arends calculates that

“Bain Capital, as we’ve seen, produced real dollar-on-dollar investment returns that were, at best guess, somewhere between 20% and 40% a year. If we figure the money was typically tied up for five to seven years, it was below 30%.

From 1984 through the end of 1998, the stock market overall produced gains of nearly 20% a year. If you had leveraged each dollar with $2 in debt at corporate interest rates, your returns would have ballooned to nearly 30% a year. If you’d been able to borrow $3 at corporate interest rates, you’d be up towards 35% a year. That’s how much money you could have made by issuing company bonds and then spending the money picking stocks out of the paper at random.

If they look pretty similar to the returns Bain Capital earned under Mitt Romney, maybe that’s not a complete coincidence.”

In other words, Bain produced all Beta, no Alpha. They used high leverage and took big risk for what was essentially market level rates of return. Any investor who listened to Vanguard’s John Bogle would have done about the same during 1984-1998 – just buy the S&P500 index, and hold it, reinvesting the dividends. The net returns would be ~20% per year — without giant fees or excessive risks necessary.

~~~

In my opinion, the whining (from the right!) about Bain’s outsourcing, layoffs, and the fortunes produced for insiders are misguided. That’s not why Bain should be criticized. Their fundamental flaw, at least according to the math, is that they took lots of risk, use immense leverage, and charged enormous fees, for performance that was more or less the same as indexing.

Said differently: Bain’s sins are the same sins most of Wall Street committed: Too high leverage, too much risk, excessive fees for too little performance.

Bain is worth criticizing not because they are so different, but rather, because they are pretty much just like the rest of Wall Street. And THAT’S nothing to brag about . . .

Sources:
Romney at Bain: Big Gains, Some Busts
Mark Maremont
WSJ, January 9, 2012
http://online.wsj.com/article/SB10001424052970204331304577140850713493694.html

The Romney Files: From Bain to Boston to White House Bid, Brett Arends (August 5, 2012)