Calling Out The Private Equity Vultures

For a stunning look at the heart of the dysfunction of our Wall Street-centric economy, consider today’s article in The New York Times on the impending Chapter 11 bankruptcy of the Simmons mattress company.

Simmons, as the article explains, is not bankrupt because it makes a bad product that no one wants. It has made a marketplace misstep or two in recent years, but not so grave a misstep as to overwhelm a good reputation for quality built over decades.

Instead, Simmons is a victim of a succession of leveraged buyout deals in which the firms making the deals used the company’s assets to generate huge profits for themselves while loading the company with so much debt the company could not possibly pay it off.

The current owner of the company is Thomas H. Lee Partners of Boston. The Times reports that THL will sell the company once it is in bankruptcy. But not to worry: THL has already made at least $77 million off of Simmons, not counting millions more in fees it collects for running the business into the ground. And that’s just a fraction of the $750 million in profits a succession of private equity dealers have gotten off of Simmons—not from making good mattresses, but from making Wall Street deals.

The workers, on the other hand, have a different story to tell. About 1,000 workers have been laid off from Simmons in the past year. Its Atlanta factory closed last fall. Other investors also are poised to lose about $575 million. And now the company has a crippling $1.3 billion debt.

This is the type of rapaciousness that inspired the Service Employees International Union in 2007 to launch a campaign warning of the dangers of the private equity phenomenon. The SEIU’s 2007 report, “Behind the Buyouts: Inside the World of Private Equity,” outlined the dangers of the private equity industry for the overall economy. While that report preceded the Wall Street financial meltdown, and the drying up of the credit market that fed the private equity deals, its recommendations are still valuable.

THL shows up prominently in that report because of its buyout of Warner Music in 2004. It was a famously disastrous deal—it initially laid off 20 percent of its workforce, hemorrhaged money at the rate of $100 million a year and its stock price languished when the company was once again traded on the stock market. Still, THL and its partners managed to make $3.2 billion in one year on a $1.3 billion investment.

As the Times notes in its article, from 2003 to 2007, 188 companies controlled by private equity firms issued more than $75 billion in debt that was used to pay dividends to the buyout firms.

The SEIU report called for increased transparency in buyout deals and for giving workers and the community a greater voice in how deals are structured and in who shares the benefits. The report also raised questions about the tax treatment of private equity deals, noting that the current corporate tax structure actually provides an incentive to load a company with debt, taxes “carried interest” earned from the debt on these deals at a lower rate than ordinary income, and allows a firm owned by a private equity firm that decides to go public to escape taxes that it would otherwise have to pay.

The report concludes:

The private equity industry’s profits come during a period of historic income inequality in America. There is no doubt that the income being accumulated in the buyout business is a major contributor to the concentration of wealth among the top 1 percent of Americans. Yet questions about the role the private equity industry could play in addressing this national challenge remain—until now—unasked, and unanswered.

There is more than enough wealth in the private equity industry for the buyout firms to continue to prosper while also adapting their business model to expand opportunities to benefit workers, communities, and the nation.

The future of the private equity industry cannot be overlooked as Congress debates a host of needed financial reforms in the common weeks. Ultimately, what is needed is a cleansing of Wall Street’s soul. That may be too much to ask. But, at least, eliminating the incentives in the tax code that make it more profitable for private equity firms to flip companies, as if they were houses in a gentrifying neighborhood, than to actually run the businesses as going concerns that make good products would be a start.


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