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Commentary By Avik Roy

Romney Derangement Syndrome

His GOP adversaries are criticizing private-sector success.

A number of commentators have been remarking on how rarely Mitt Romney gets attacked by his opponents in the GOP debates. What’s even more remarkable is what the other candidates are attacking Romney for. Instead of calling Romney to account for his health-policy mistakes, they’re going after him for his . . . successful business career?

Romneycare, by far the largest problem with Romney’s record, was barely discussed in the last two debates. Perhaps this is because both Rick Santorum and Newt Gingrich have previously supported the individual mandate — Santorum in the 1990s, and Gingrich as recently as May 2011 — neutralizing their effectiveness as anti-Romneycare crusaders. But this problem has led Santorum and Gingrich to attack Romney for the things conservatives should most appreciate about him.

First, Santorum and Gingrich knocked Romney for his “pious baloney” about having a career in the private sector. Romney declined to run for reelection as governor of Massachusetts in 2006, clearly because his poll numbers were bad. He was, after all, a pro-life, budget-cutting Republican governor in one of the country’s most liberal states, in a terrible year for Republicans. (Before you shout, “But Romneycare!” remember that Romneycare was Romney’s most popular achievement in Massachusetts. It’s the rest of his record that liberal Bay Staters didn’t like.)

Santorum makes the point that he himself ran for reelection despite poor poll numbers. But what else was Santorum going to do, given that he was a career politician? And let’s not forget that, if Santorum had won reelection, Democrats would not have controlled 60 Senate seats in 2009, and would not have been able to pass Obamacare. It’s not as significant a contribution to Obamacare as Romney’s signature health-care legislation, but it certainly was a factor.

Santorum and Gingrich then went on to attack Romney for his record at Bain Capital. Various conservative commentators have expressed glee at these criticisms. We might even call it Romney derangement syndrome: conservatives disliking Romney so much that they delight in Republican attacks upon free enterprise.

Saturday night, Santorum accused Romney of being a “manager,” pointing out that political leaders can lead only by persuasion, because “you can’t direct, you know, members of Congress and members of the Senate as to how you do things.”

However, as Romney pointed out, anybody who has had to try to persuade an investor to support a startup business, or a customer to use his product, or a star employee to stick around — even if that employee has a better offer somewhere else — has had to master the arts of persuasion and leadership. Santorum served only to reinforce Romney’s argument: that Santorum and other career politicians don’t understand how the private sector works.

Then, in the coup de grâce, Newt Gingrich spoke of the imminent “27-and-a-half-minute movie” coming from a pro-Newt PAC regarding Bain Capital’s economic crimes, sourced from “establishment newspapers, like the Washington Post, the Wall Street Journal, the New York Times, Barron’s, [and] Bloomberg News.”

Bain Capital has grown accustomed to these critiques, as they have been going on since 1994, when Ted Kennedy waged war on the firm in an effort to regain the lead against Romney in their battle for Kennedy’s Senate seat. The most recent, from today’s Wall Street Journal, notes that Bain’s investments had a higher rate of failure, but also a higher rate of spectacular success, than those of Bain’s peers.

So let’s review what it is that leveraged-buyout firms actually do. (In the interests of disclosure, I must point out that I worked for Bain Capital from 2001 to 2004, though not in the leveraged-buyout division.)

The idea behind leveraged-buyout (LBO) investing, sometimes called “private equity” investing, is to buy a struggling company — typically, one that the stock market thinks very poorly of — and restructure the company in order to make it profitable again. (Think GM, before it was bailed out by the government, or Research in Motion, the downtrodden maker of Blackberrys, today.)

Usually, these companies suffer from one of three problems: (1) high labor costs, often because of over-generous union contracts; (2) mismanagement at the CEO level, such as wasting precious resources on flawed product lines; or (3) a new competitor that threatens the old company’s core business model (e.g., Borders trying to compete against the onslaught of Amazon). In some cases Bain may have made mistakes in its turnaround efforts, or misjudged an original business opportunity. That’s, again, what happens in the private sector. Success is not guaranteed. On the other hand, it’s fair to say that private-equity firms such as Bain Capital were responsible for many of the productivity gains, and the retreat of sclerotic labor unions, that the American economy generated in the 1990s. Rest assured that Bain would have not generated those spectacular returns for its investors, nor attracted those investors in the first place, if the majority of its investments failed.

It is true that the money that LBO firms draw out of an acquired company — in the form of dividends and management fees — will always look bad in a situation where the turnaround fails. It will be up to Romney to defend this practice. But it’s important to remember that LBO firms have every incentive to avoid letting their investments fail: After all, they stand to make far more money if their turnarounds succeed.

It’s been discouraging to read that many conservatives see Romney’s record at Bain Capital as a liability. For the truth is the opposite: Romney is a candidate uniquely suited to defending the role of free enterprise in the American economy. When liberal politicians and journalists argue that layoffs are cruel, and that capitalism is unfair, Mitt Romney can speak to how dealing frontally with a business’s problems can lead to better and more numerous jobs over the long term. He can speak not merely in abstract philosophical terms, but using the real-world examples from his successes and his failures.

Romney’s health-care legacy will, and should, continue to be a matter of controversy among Republican voters. However, should Romney end up as the nominee, he will provide conservatives with a singular opportunity: a chance to forthrightly and skillfully extol the Duane Reade economy over the Solyndra economy. If conservatives truly believe in free enterprise, it is an opportunity they should relish.

The LBO firm, often in concert with other similar firms, raises capital to buy the struggling business and turn it around. Most of this capital is borrowed from banks, hence the term “leverage,” but a significant amount comes from the LBO firms and their investors. The target company is usually “taken private” — that is, its shares no longer trade on a public exchange such as the New York Stock Exchange. If these investors succeed in turning around the company, resulting in an increased stock price when the company’s shares are publicly re-listed, the investors stand to reap financial rewards. If they fail, they stand to lose their investment in the company. It is a high-risk, high-reward line of work.

Well before a company like Bain decides to get involved with an LBO candidate, teams of analysts get to work trying to figure out if the idea makes sense. Are there obvious, fixable problems with the company, such as bloated labor contracts? Does the company have assets that the stock market isn’t noticing, such as valuable patents or real-estate holdings? Is the company involved in a viable business that has plausible avenues for growth? Can the company generate enough revenues to pay off the interest and principal from the loans Bain received to buy the company?

If Bain then decides to try to purchase the company, they don’t always succeed. A competing LBO firm may swoop in with a higher bid. The targeted company’s board of directors can refuse a deal if the board thinks it’s not in the interests of shareholders to accept.

If the deal goes through, the real hard work begins. The LBO firm must execute on its turnaround plan, either by working with the company’s existing management or by installing new managers. Managers are often tasked with the difficult work of enacting layoffs, or renegotiating contracts, that the previous regime could or would not. Sometimes the company sells off a non-core asset or product line in order to focus on what it does best. Sometimes, as with Bain’s buyout of New York pharmacy chain Duane Reade, the turnaround involves getting deep into the guts of a business and reorganizing how it does everything from locating its storefronts to buying its toothpaste.

Frequently, these turnarounds initially involve layoffs — when they work, the layoffs act as a kind of pruning that allows a tree to grow again. When the turnarounds fail, however, the layoffs don’t work, and the company goes bankrupt. More often than not, these bankruptcies would have happened anyway: In the case of Bain’s investments in the steel industry, for example, cheap steel imports from abroad made it difficult for most American firms to survive.

Bain Capital succeeded far more often than it failed in these endeavors, averaging somewhere between 50 and 80 percent annual returns from 1984 to 1999. These returns not only made Mitt Romney and his colleagues wealthy, but also rewarded Bain Capital’s investors, which included the endowments of prominent universities and foundations, such as Yale and Stanford, and also well-known entrepreneurs such as Scott McNealy of Sun Microsystems and Michael Dell of Dell Computers.

This piece originally appeared in National Review Online

This piece originally appeared in National Review Online