People in favor of private equity will say that the firms serve a crucial function, making troubled businesses more robust and efficient. The authors of these books allow that this does happen, but they counter that the industry has grown so enormous, with so much money chasing the same deals, that many private equity firms will acquire healthy companies and essentially make them sick, forcing them to pay off the money that was borrowed to buy them. The business model isn’t so much investment, Ballou says, but extraction. “Roughly one in five large companies acquired through leveraged buyouts go bankrupt in a decade,” he writes.
Toys “R” Us is such a sad and vivid example of private equity’s predations that it appears in both books — a storied company that was bought by KKR, Bain and Vornado Realty Trust in 2005. By 2017, after years of layoffs, crushing debt and being charged regular management fees by the private equity firms “for the privilege to be owned by them,” Ballou writes, Toys “R” Us was bankrupt. (It has recently emerged from bankruptcy.) Ballou adds that the rise of online retail wasn’t as much to blame as people said it was. Toys “R” Us had steady sales and decent market share. But almost all of its operating income was going to service the interest payments on its debt (to say nothing of those preposterous management fees). The company went from having $2 billion in cash when it was acquired to having no money to maintain its stores.
If the results are bad when the product is toys, they can turn deadly when the product is care. Private equity firms have acquired nursing homes, provided staffing for hospitals and services for prisons. Morgenson and Rosner quote David Rubenstein, a co-founder of the Carlyle Group, whose acquisition of HCR ManorCare, a chain of nursing homes, ended with bankruptcy after years of cascading health-code violations.
“While we’re not perhaps guardian angels,” Rubenstein said, “we are providing a social service, and that social service is making companies more efficient.” The authors highlight the essential problem with this fetish for “efficiency.” Industries that serve a social function require excess capacity, so that they can continue to provide care when demand surges or an employee calls in sick; nursing homes have to be properly and conscientiously staffed. Cut everything derided as “fat” and you will eventually cut to the bone.
So how does private equity continue to attract money? Pension funds are still among the biggest investors in private equity — a phenomenon that Morgenson and Rosner call “puzzling” and a “mystery,” considering that the firms levy exorbitant fees on the pension funds while increasingly delivering middling or even subpar returns. And, of course, the cost-cutting measures typically imposed on acquired companies often include slashed wages and abandoned pension obligations. Ballou notes the irony of middle-class pension holders providing the financial fuel that strips other people of their own pensions.