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Is it leveraged buyout or sellout of America?

Insight

The principal rationale for current day Wall Street-style corporate dealmaking, notably private equity investing, leveraged financial buyouts and friendly or hostile takeovers, followed by restructuring and re-sale of target companies, is that these practices, although risky, stimulate the economy, reward enterprise and create jobs. But do they?

It used to be that way. Back in the postwar days when I worked in mergers and acquisitions for Citibank in Manhattan, we sought to match up quality corporate partners whose product lines and operations “fit.” Citibank made straightforward corporate loans and then helped clients arrange additional financing and investment opportunities. The roles of commercial retail banks like Citibank and investment finance banks like Goldman Sachs were kept separate, but they were mutually supportive. Result: Risks were controlled. America’s economy boomed. Jobs were created. Products were proudly “Made in America.”

Today, however, it appears there is nothing that cannot be gamed or risked. The players are largely middlemen who often know remarkably little about banking or industry, but just enough to play the game. They often parasitize the institutions they run, work for, or deal with — at the expense of shareholders, employees, customers and taxpayers alike.

How is the game played? Here’s one way: A few moderately wealthy individuals get together and pool some money to form an investment firm, partnership or capital management group, eager to make money off the system by exploiting vulnerable companies. They use contacts to raise additional funds from other investors, such as super-wealthy individuals, university endowments and pension funds, anxious for higher rates of return than they think they can find on the normal equity and bond markets.

Next, the group uses these funds to secure multiples of these amounts in loans from major Wall Street firms and other banking institutions, in order to buy out targeted production or service companies, dismember or restructure them, sell off pieces, recombine them and “streamline” (a rather polite word for what actually happens) operations — usually by laying off hundreds, even thousands, of employees. Often, streamlining includes shutting down U.S. operations and exporting them abroad to countries where labor comes cheaper.

The final step, before the middlemen take their cut and bail out, is to overload the surviving corporate entity with a heavy debt burden, the proceeds of which are used to pay back the buyout group in dividends, taxed, if at all, at the favorable low rate of 15 percent. This is approximately what the Kravis group did to Nabisco, the biscuit company, with the result that the diminished little enterprise has had to struggle for survival ever since. It’s what Sun Capital is doing right now to Friendly’s, the family restaurant and ice cream chain, which is saddled with such unsupportable debt that it is likely to go belly up.

To put some numbers on the practice, let’s look at what Bain Capital did for KB Toys Inc., one of America’s leading toy manufacturers. A small partnership put up $18 million and targeted KB Toys. Then, they borrowed 16 times that amount to the tune of $284 million to make up the purchase price of $302 million to raid the company. They forced KB Toys to restructure and to go further into debt in order to promptly pay $85 million in dividends back to the Bain investors who thus “earned,” after expenses, a nice 370 percent return on investment. Result: KB Toys had to start shutting down outlet stores. They lost market share, laid off 3,400 workers and eventually filed for bankruptcy.

This kind of toy story repeats itself all over America. It is largely a myth that these leveraged buyouts are strengthening American industry or creating jobs in America. That’s a thing of the past. Middlemen have learned techniques to prey on U.S. industry and the economy, and avoid paying their fair share of taxes. They are actually selling out America. What Wall Street and the financial industry need is a good dose of regulation and restructuring — if capitalism is going to survive in this country.

Sharon resident Anthony Piel is a former Citibanker and general legal counsel of the World Health Organization.