The Corner

An Example of ‘Vulture Capitalism’?

I finally read the New York Times article Newt keeps recommending. Actually it’s a Reuters article. I am not an expert in this area in the least. But here are some general impressions drawn from the piece, which seems fair and is not quite the damning portrayal of the “looting” of a company as advertised. That doesn’t mean it’s a great picture, either. It will strike a lot of people as grossly unfair that Bain failed to run this steel company, G. S. Industries, successfully, yet still made money. A few key points from the piece.

It was a risky proposition from the beginning:

Soon after, in October 1993, Bain Capital, co-founded by Mitt Romney, became majority shareholder in a steel mill that had been operating since 1888.

It was a gamble. The old mill, renamed GS Technologies, needed expensive updating, and demand for its products was susceptible to cycles in the mining industry and commodities markets. . . .

Some analysts say Bain should not be blamed for the company’s failure, noting that a wave of cheap imports forced nearly half of the U.S. steel industry into bankruptcy during that period. Another company set up around the same time, in which Bain took a minority stake, Steel Dynamics in Fort Wayne, Indiana, thrived.

“GS and Steel Dynamics were about as different as it gets,” industry analyst Michelle Applebaum said. GS’s core products were vulnerable to competition while Steel Dynamics became “one of the country’s lowest-cost manufacturers of steel sheet,” a product with more staying power. Steel Dynamics was also a non-union shop.

Bain invested and got an immediate pay-off:

Nevertheless, Bain and its partners decided to buy the mill for $75 million. Bain put up about $8 million to gain majority control of the company, renamed GS Technologies Inc. GE Capital, former Armco executives [Armco was the former owner] and Leggett & Platt, a major customer for the mill’s wire rods, chipped in the rest of the equity. . . .

Bain got its money back quickly. The new company issued $125 million in bonds and paid Bain a $36.1 million dividend in 1994.

“Paying distributions with debt is not uncommon,” said Campbell Harvey, a finance professor at Duke University. “The only thing that strikes me as a bit unusual is the size of the dividend. There would be logic in them saving some cash for a downturn.”

Looking back on the dividend payout, [ Armco manager Jack] Stutz and another former GS Technologies officer, Mario Concha, believe it weakened the mill’s financial position.

“At the time they paid that dividend, they felt that the financials justified it,” Stutz said.

This made Bain a winner at the end of the day:

Overall, Bain made at least $12 million on the steel company it created by merging the Kansas City mill with another in South Carolina before the new entity declared bankruptcy in 2001. Bain also collected an additional $900,000 a year through 1999 for management consulting services, public filings show.

But Bain was trying to grow the company:

In 1995 Bain merged GS with another wire rod maker in Georgetown, South Carolina, to form one of the largest mini-mill steel producers in the U.S. The new company issued another $125 million in bonds to pay for the merger. Bain doubled down, reinvesting $16.5 million of its earlier dividend.

The new company, dubbed GS Industries Inc., would have annual revenues of $1 billion and employ 3,800 people.

The company was buffeted by tensions with its union:

In 1997, with Armco’s pension guarantees set to expire in one year, the United Steelworkers local at the Kansas City plant was worried that GS was not setting aside enough money to cover pension obligations and other benefits in the event of a shutdown.

David Foster, the negotiator for the union, said labor talks were typically more tense at companies owned by private equity firms because the high level of debt left managers with less flexibility.

Contract talks foundered and the union went on strike in April 1997. The first standoff since 1959 quickly turned nasty. Workers shot bottle rockets at security guards, tossed nails in the roadways to flatten the tires of nonunion trucks and pounded on the windows of vehicles as they left the plant.

After 10 weeks, the two sides reached a deal that boosted pensions and ensured that workers would get health and life insurance in the event of a shutdown.

The company was run poorly:

Paperwork proliferated. Cost-cutting efforts backfired. Managers skimped on purchases of everything from earplugs to spare motors and scaled back routine maintenance. Machines began to break down more often, and with parts no longer in stock a replacement could take days to arrive.

Labor costs spiked as managers revamped work schedules with little understanding of how the plant actually operated.

It got hammered by foreign competition:

Meanwhile, a wave of cheap imports from Asia drove steel prices down sharply, while costs for natural gas and electricity rose. The Asian financial crisis lowered demand for mined metals, which hit the company’s grinding-ball business.

The company’s failure had a number of possible causes:

Charles Bradford, an analyst at Bradford Research, blames the union, in part, for the failure of GS Industries to survive in the new global marketplace.

“If you look at the steel companies that went under at the time, all of them were unionized,” he said. “I’m not saying this was the only factor — these firms faced other headwinds such as cheap labor and a strong dollar … but the unions held them back.”

Union officials blame the Bain managers for saddling the company with too much debt for a capital-intensive, cyclical industry such as steel.

The upshot is that the company went bust. The workers were laid off and didn’t get the pensions they were promised. The U.S Pension Benefit Guaranty Corp. had to cover the company’s basic pension costs. The stories of the struggles of the former workers related at the end of the piece are truly heart-rending. They felt the impact of the failure much more acutely than anyone at Bain. But this wasn’t “vulture capitalism.” Bain wanted GS to succeed and failed to pull it off.


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