Newt Gingrich’s comeback victory against Mitt Romney in South Carolina can be attributed to many things — Newt’s debate performances, Mitt’s tax returns, etc. But it all started when Newt Gingrich and Rick Perry tore into Mitt Romney’s involvement in Bain Capital. Romney’s main response to the Gingrich-Perry critique has been that it’s “kind of strange” to have to defend his private-sector record to Republican competitors. If Romney is to recover from his loss in the Palmetto State, however, he’s going to have to do a lot better than that. He’s going to have to defend his record as a private-equity investor specifically and substantively.
There is no better place to start than with Bain Capital’s investments in South Carolina. It was there, after all, that Romney’s opponents portrayed him as a “vulture capitalist” who “looted” working-class livelihoods in a greedy quest for profit. Indeed, two Bain Capital–owned plants in South Carolina, a steel mill in Georgetown and a photo-album factory in Gaffney, ultimately closed down, resulting in several hundred layoffs. “If you’re a victim of Bain Capital’s downsizing,” said Rick Perry last week, “it’s the ultimate insult for Mitt Romney to come to South Carolina and tell you he feels your pain, because he caused it.”
#ad#But a review of what actually happened in South Carolina tells a different story. And that different story is quite representative of how private-equity investors helped bring global competitiveness to much of American industry.
Let’s start with Georgetown Steel, Bain’s South Carolina foray into the steel industry. The story of steel starts over a century ago. Steel production had been one of the great engines of American industrial growth in the late 19th and early 20th centuries. U.S. Steel, founded in 1901 as a consolidation of several mid-sized manufacturers, quickly became the largest producer of steel in the world, and was the first corporation in history with a market capitalization of more than $1 billion.
In the aftermath of the New Deal, however, labor unions began to flex their muscles. In 1959, the United Steelworkers of America launched a devastating nationwide strike that shut down 85 percent of all U.S. steel production for four months. As a result of the effects that the strike was having on the national economy, and even on the nation’s military capabilities, President Eisenhower invoked the Taft-Hartley Act, and forced the union to end the strike.
While Eisenhower’s move appeared to be a setback for union power, unions were able to extract significant concessions from the steel industry, such as automatic annual wage increases and new pension and health benefits. This outcome was to have long-term consequences for steel manufacturing in the United States.
Beginning in 1959, American consumers of steel, such as the automakers, resolved to become less vulnerable to future disruptions in their supply of raw materials. For the first time, they began importing steel from abroad in significant quantities. They found that steel from emerging economies like Japan and South Korea was just as good as American steel, but much cheaper.
By the 1970s, the American steel industry was hemorrhaging business to foreign competitors. Manufacturers compensated by laying off workers, but this created a new problem. Experiencing the same dynamic that federal entitlements do today, manufacturers were faced with a growing number of retirees’ bloated pension costs and benefits, which they were funding with output from a shrinking number of active workers.
The Carter administration, aiming to prop up the industry, gave $300 million in loan guarantees to five steel companies. (Ironically, the largest recipient of Carter bailout funds, Wisconsin Steel, went bankrupt soon after due to a labor strike at one of their main customers.)
Successive presidents also tried, and failed, to prop up the steel industry. Ronald Reagan imposed quotas on imported steel. Bill Clinton provided $1 billion in loan guarantees to the industry. George W. Bush enacted tariffs on foreign steel. None of it worked. Over a seven-year period in the 1990s, more than 40 U.S. steel manufacturers went belly-up. Nearly all were union shops.
It was in this context that Bain Capital, in the early 1990s, bought Kansas City–based Worldwide Grinding Systems — including a mill that had been in operation since 1888 — from Armco Steel, for $75 million, and renamed it GS Technologies. In 1995, Bain bought another company, South Carolina–based Georgetown Steel, and combined it with Worldwide to form GS Industries, one of the largest “mini-mill” steel producers in the U.S, with annual revenues of around $1 billion, according to Reuters. (Mini-mill producers, as Patrick Brennan notes in this insightful NRO piece, use more cost-effective technologies to better compete with other low-cost manufacturers.)
Like most businesses, the steel industry benefits from economies of scale, and Bain was doubtless seeking to achieve enough size to ensure that its production costs were competitive with those of foreign producers.
#ad#One of the big challenges for GS was its debt load. Bain had borrowed tens of millions of dollars to buy GS Technologies. It then borrowed an additional $125 million, $98 million of which went into modernizing the company’s equipment, the remainder being used to pay a dividend to Bain and its investors. The company then borrowed an additional $125 million to buy Georgetown Steel; after the merger, Bain plowed $17 million of its $36 million dividend back into the company. However, by 1995, GS Industries had accumulated $376 million in debt: a significant sum, given that the company was generating operating income of less than a tenth of that.
According to a report by Andy Sullivan and Greg Rumeliotis of Reuters, GS CEO Roger Regelbrugge wasn’t sanguine about the company’s ability to shoulder that debt load, and Regelbrugge arranged to retire from the company a few years later. GS’s workforce went on strike in 1997 — its first walkout since taking part in the great strike of 1959 — resisting Bain’s efforts to rework its benefit packages.
The continuing onslaught of Asian competition drove GS’s revenues downward, while interest on the company’s debt consumed what operating income it could generate. Finally, in 2001, the company declared bankruptcy, wiping out Bain’s equity investment, along with its reinvested dividend.
The South Carolina plant continued to operate while the company underwent bankruptcy proceedings. In 2002, Daniel Thorne of Midcoast Industries bought the Georgetown mill from GS’s creditors for $53 million. Fifteen months later, Georgetown Steel itself filed for bankruptcy, and the plant’s 465 employees were laid off.
But that’s not the end of the story. In June 2004, another steel company, International Steel Group, bought the Georgetown plant for $20 million, putting 276 people to work. In 2005, Indian entrepreneur Lakshmi Mittal bought ISG; in mid-2006, Mittal Steel merged with European steel giant Arcelor SA to become the largest steelmaker in the world. By that time, the Georgetown plant was employing 320 workers.
Romney and Bain Capital have come under fire from Newt Gingrich for “looting” GS Industries. According to Gingrich, Bain enriched itself and its investors by drawing dividends and fees out of the company, directly causing its collapse. But this isn’t exactly right. According to Reuters, Bain earned $12 million in dividends and $4.5 million in consulting fees from its investment in GS: a tidy sum, but one that amounts to only 4 percent of GS’s 1995 debt load. Furthermore, the Reuters report doesn’t appear to account for Bain’s loss of its sizeable (but unknown) equity investment in GS.
Did Bain make mistakes in the way it tried to run GS? Sure — hindsight, after all, is 20/20. The firm overestimated the attractiveness of the U.S. steel industry, and overestimated its abilities to persuade GS’s workers to reduce their wages and benefits to competitive levels. But it’s factually wrong, and indeed dishonest, to claim that Bain “looted” GS, that Bain sucked the blood out of GS in order to enrich itself. Bain stood to make far more money, and generate far greater returns for its investors, if GS had regained its past prosperity.
The case of Holson Burnes is also illuminating. The Holson Company was founded in 1942 by Abraham Holson, an immigrant who invented the modern photo album. Though Holson was the largest manufacturer of photo albums in the U.S., by the 1980s, the company was suffering due to competition from cheap foreign imports. Bain bought the company in 1986 with hopes of turning it around.
An intriguing opportunity surfaced the following year, when Hallmark, the greeting-card company, put its photo-frames unit, Charles D. Burnes, up for sale. Bain bought Burnes; executives at Burnes and at Holson immediately recognized the possibility of putting the two companies together, and lobbied Bain Capital to merge them. Bain agreed, creating Holson Burnes in 1989.
Bain saw opportunity for photo-album growth in the South, and officials in South Carolina successfully convinced the company to locate a new plant in Gaffney, S.C. Unfortunately, despite a number of related acquisitions and investments in the business, Holson Burnes couldn’t compensate for the onslaught of cheaper foreign imports, particularly in the photo-album business, and the company was ultimately forced to declare bankruptcy in 1992, laying off 150 South Carolinians.
As with Georgetown Steel, however, the joblessness didn’t last. In 1993, the Gaffney plant was bought by Société Bic, the pen manufacturer, and has been in continuous operation since. In other words, the lasting legacy of Bain’s involvement in Holson Burnes — from the standpoint of South Carolina — was the construction of a new factory, one that still runs today.
#page#The Nineties Economy
In the wake of the Gingrich broadside against Bain’s South Carolina investments, John Roberts of Fox News spoke to Jim Cook, executive director of the economic-development board of Cherokee County, South Carolina, where the Gaffney plant is located. “The overall impact to Cherokee County [from the bankruptcy of Holson Burnes] was minimal,” said Cook. “I’ve looked at the unemployment records for that time . . . We ended the year about the same as we started the year. And in fact, the records show we created an additional 300 manufacturing jobs.” Cody Sossamon, publisher of the Gaffney Ledger, told the New York Times that the Ledger never wrote about the plant closure, because it wasn’t newsworthy. “Nobody here really cares about that. It wasn’t a big deal. We’re looking for a new school superintendent. That and the economy are what people really care about right now.”
Similarly, Tommy Howard of the Georgetown Times interviewed David Harper, a veteran of Georgetown Steel’s heyday, who once served as treasurer of the local branch of the United Steelworkers of America. While the endless series of bankruptcies and acquisitions “was like a roller-coaster” for Georgetown steelworkers, “I don’t remember any comments about Bain Capital,” said Harper. While Harper expressed some dissatisfaction in the way that ArcelorMittal was treating today’s workers, “a lot of the [labor] cutbacks are due to automation.”
#ad#What can we learn from all of this? A few things. First, Bain Capital did not “loot” Georgetown Steel or Holson Burnes. At worst, Bain did not manage its acquisitions optimally, leading to bankruptcies that would almost certainly have happened anyway. Second, Rick Perry’s description of Bain’s actions in South Carolina as “vulture capitalism” has no supporting evidence to date. Third, the impact of these two temporary factory closures, while significant to the workers who lost their jobs, was small in relation to the overall size of the South Carolina work force. Both factories are still in operation today.
Fourth, the challenges facing American manufacturing are sometimes beyond the reach of the nation’s ablest business managers. Labor unions repeatedly block needed reforms. Emerging economies can produce many goods at a fraction of the price that American workers do. Global free trade increases American prosperity by making more goods cheaper for American consumers, but it also disrupts the lives of those who worked for once-prosperous American manufacturers.
Some of the candidates have proposals for improving the competitiveness of American manufacturing. Rick Santorum — who has defended Romney’s record at Bain Capital — has made the decline of manufacturing jobs in America a centerpiece of his campaign, and has proposed eliminating the corporate income tax on manufacturers. It’s worth noting, as Patrick Brennan does, that Bain Capital bears significant responsibility for the lone American corporation, Steel Dynamics, that “has independently begun to produce steel on a large scale.”
For whatever reason, Mitt Romney hasn’t wanted to publicly get into the weeds of his work at Bain Capital. And it’s certainly hard to make these points in presidential debates or campaign ads. But what the Romney campaign is forgetting is the influence of opinion-makers in the media. Most editors and pundits aren’t fluent on the ins and outs of leveraged buyouts; without a substantive rebuttal from Romney, they assume that there must be something to the criticisms, even if they support free enterprise in principle. If Romney can persuade these opinion-makers of the value of Bain Capital’s work, he’ll be on his way to persuading the broader public.
If Romney is to recapture his momentum in the GOP race, he has no choice but to confront these questions head-on. He knows that Barack Obama will put capitalism on trial, and Republicans need to know that Romney has the means and the will to fight back.
— Avik Roy is author of The Apothecary, a blog on health-care and entitlement reform. He worked at Bain Capital from 2001 to 2004. You can follow him on Twitter at @aviksaroy.