Private equity’s toxic image — and the recurring reality that creates it — are illuminated in this national emergency.
A big example is how PE firms led leveraged buyouts of J.Crew and venerable Neiman Marcus, saddling them with billions in debt and collecting management fees that the retailers had to repay to their new private equity owners. Both have now sought bankruptcy protection, sick from COVID-19 and the buyout debt.
Nursing homes owned by private equity are struggling to provide care because of the profit demands of their investors. It’s part of a broader move by the industry into health care, including buying medical practices and pressuring physicians to cut costs and improve profits.
Even before the pandemic, 10 out of 14 bankruptcies of major retail chains since 2012 involved private equity, according to a report last year from the advocacy group the Center for Popular Democracy.
The report stated, “In the last 10 years, a staggering 597,000 people working at retail companies owned by private equity firms and hedge funds have lost their jobs. An estimated additional 728,000 indirect jobs have been lost at suppliers and local businesses, meaning Wall Street’s gamble on retail has led to more than 1.3 million job losses in total.”
Private equity has also been infamous for buying newspapers and savaging them with cutbacks, especially the hedge fund Alden Global Capital.
And this week came a New York Times story about how the wealthiest hospital chains received billions in federal aid while struggling institutions got scraps. Among them was Seattle’s Providence Health System, which “invests in hedge funds, runs a pair of venture capital funds and works with elite private equity firms like the Carlyle Group.”
To be sure, private equity shops aren’t always winners in the game of “financial engineering” musical chairs. Carlyle and its co-investors lost $1.4 billion in December’s bankruptcy filing of food broker Acosta.
But more often than not, the reputation of PE is that of looters.
As Sen. Elizabeth Warren wrote, “Private equity firms raise money from investors, kick in a little of their own, and then borrow tons more to buy other companies. Sometimes the companies do well. But far too often, the private equity firms are like vampires — bleeding the company dry and walking away enriched even as the company succumbs.”
She calls private equity at its worst “legalized looting” and proposed legislation to stop it.
PE wasn’t supposed to turn out this way. Or given the tendency of humans in almost any endeavor, perhaps a good idea going bad was inevitable.
It’s not quite Eric Hoffer’s “every great cause begins as a movement, becomes a business, and eventually degenerates into a racket,” but it’s close.
In 1946, American Research and Development Corporation (ARDC) and J.H. Whitney & Co. were founded as the first modern private equity firms. The mission was straightforward: Buy distressed or promising companies, fix or nurture them and then sell them. These were typically companies that couldn’t raise money through stock offerings or bank loans.
For example, in 1957 ARDC invested $70,000 in Digital Equipment. When the company went public in 1968, ARDC’s investment was worth $355 million, a spectacular return to the investors.
Private equity is for wealthy people, so-called accredited investors or qualified purchasers. They take big risks and expect superior returns. That contrasts with publicly traded companies, in which many more people can buy stock.
Private equity grew exponentially in the laissez-faire Reagan years, notably with Kohlberg Kravis Roberts, notorious for the 1988 leveraged buyout of RJR Nabisco. KKR used only $15 million of its own money in the $25 billion takeover. Thousands of jobs were cut. Other famous companies were ravaged by private equity and raiders during these years. (This was also when Bain Capital was co-founded by Mitt Romney, 2012 GOP presidential nominee and now senator from Utah.)
The 2010s was “the golden age” of the private equity industry, according to disgraced junk-bond king Michael Milken. He told Bloomberg, “You can leverage, you can borrow without covenants, and so for equity holders it affords you very unusual rates of return.” And before the pandemic, he expected it to continue.
In 2006, private equity backed 4,000 U.S. companies. By 2017, that figure had doubled. The number of publicly owned firms fell by 16% to 4,300 over the same time period — and down 46% since 1996.
According to McKinsey, private assets under management grew by $4 trillion over the decade that ended this past year. The number of active private equity outfits more than doubled.
In the September 2007 Harvard Business Review, Felix Barber and Michael Goold wrote, “the fundamental reason behind private equity’s growth and high rates of return is something that has received little attention, perhaps because it’s so obvious: the firms’ standard practice of buying businesses and then, after steering them through a transition of rapid performance improvement, selling them.
“That strategy, which embodies a combination of business and investment-portfolio management, is at the core of private equity’s success.”
That’s the way it’s supposed to work, and often has in such cases as KKR saving Dollar General and Blackstone’s turnaround of Hilton.
But the darker examples cited earlier, and so many more, show that private equity is often a destructive force, playing a big role in the losses of jobs and companies that were the heartbeat of hundreds of American cities. Private equity has also helped raise inequality.
In today’s low-tax environment, private equity gets big breaks, especially with the much-criticized carried-interest loophole. Through it all, private equity is unregulated — and if trillions of dollars under management isn’t a systemic risk, I don’t know what is.
All of which raises the question: Is today’s private equity healthy for the economy or in the national interest? Its track record and pernicious method of operating with no watchdog says no.