Plenty of 'pitting' preceded Romney's profits

Published: Tuesday, July 3 2007 12:00 a.m. MDT

Intrigued by the concept, and how it spoke to his inherent frugality, Romney called lawyers, accountants and other professionals to gauge office supply spending, only to conclude Stemberg had overestimated the size of the market.

"Look," Stemberg told Romney, "your mistake is that the guys you called think they know what they spend, but they don't."

Romney and Bain Capital went back to the businesses and tallied up invoices. Stemberg's assessment of the market seemed right after all.

On May 1, 1986, backed by an initial Bain Capital investment of $650,000, the first Staples opened in Brighton. Explosive growth followed. Today, Staples is an $18 billion company.

Bain Capital, meanwhile, enjoyed a nearly sevenfold return when it sold its stake a few years later, reaping more than $13 million from a total of about $2 million invested.

Although Romney would later point to Staples as a key example of the kind of job-creating, forward-looking enterprise he made his living in, venture capital deals like Staples soon became only a small part of his firm's business, in favor of leveraged buyouts.

Venture deals invest in start-ups in the hope they hit it big. Leveraged buyouts combine small amounts of investors' money with large amounts of borrowed money to buy established companies.

Leveraged buyouts played to Bain Capital's analytical strengths and Romney's caution. If venture investing requires vision, leveraged buyouts demand precision. To determine how much to pay, and hence to borrow, buyout firms must figure out how much cash their targets can generate. Overestimate cash flow by just a few percentage points, and the company misses debt payments and plunges into bankruptcy.

Despite the success of Staples, the venture capital world had too many unknowns for Romney's taste. So he steered the firm to focus squarely on leveraged buyouts. "I didn't want to invest in start-ups where the success of the enterprise depended upon something that was out of our control," Romney recalled recently, "such as 'Could Dr. X make the technology work.'"

Bain Capital applied the "Bain way" to increase the value of the firms it acquired.

In 1986, it bought Firestone Co.'s wheel-making division, renamed Accuride. Bain Capital revamped production, restructured executive pay, and offered discounts to customers that gave Accuride all their business, instead of splitting it among competitors, according to the book The Loyalty Effect, a collection of business case studies written by a Bain & Company director.

Accuride's earnings rose 25 percent. Eighteen months later, Bain Capital sold Accuride to mining conglomerate Phelps Dodge Corp. Bain's $5 million investment had ballooned to more than $120 million.

"Bain Capital is the model of how to leverage brain power to make money," said Howard Anderson, a professor at MIT's Sloan School of Management. "They are real first-rate financial engineers."

But, he says, "They will do everything they can to increase the value. The promise (to investors) is to make as much money as possible. You don't say we're going to make as much money as possible without going offshore and laying off people."

Not that Anderson has a problem with this approach. In addition to being a business school professor, he has also been a Bain Capital investor.

Despite being in charge, Romney usually didn't put together the firm's deals. Instead, he was the careful manager, testing assumptions and keeping his talented, aggressive group of partners together.

Romney opened meetings with corny jokes. At Stanford, Rehnert had been inducted into the honor society, called Order of the Coif. Romney would wonder aloud why he hired someone who went to barber school.

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