Private Equity Investors: Ignorant About Lean – and Destructive

The core principle of lean production is to focus on creating value for customers – because creating value for customers is essential to success. A cautionary tale appearing in The New York Times this week describes how large numbers of companies have been damaged or destroyed by private equity investors who have no understanding of that principle.

The article, by Julie Creswell, focuses on the Simmons mattress company, a 133-year-old firm with a well-known brand. Simmons is set to file for bankruptcy and will be sold – for the seventh time in two decades. Stockholders and bondholders of Simmons will lose most of their money, and hundreds of employees have lost their jobs.

But the private equity firms buying and selling Simmons have done just fine.

Thomas H. Lee Partners of Boston has not only escaped unscathed, it has made a profit. The investment firm, which bought Simmons in 2003, has pocketed around $77 million in profit, even as the company’s fortunes have declined. THL collected hundreds of millions of dollars from the company in the form of special dividends. It also paid itself millions more in fees, first for buying the company, then for helping run it. Last year, the firm even gave itself a small raise.

Wall Street investment banks also cashed in. They collected millions for helping to arrange the takeovers and for selling the bonds that made those deals possible. All told, the various private equity owners have made around $750 million in profits from Simmons over the years…

Every step along the way, the buyers put Simmons deeper into debt. The financiers borrowed more and more money to pay ever higher prices for the company, enabling each previous owner to cash out profitably.

But the load weighed down an otherwise healthy company. Today, Simmons owes $1.3 billion, compared with just $164 million in 1991.

Simmons is not an isolated case.

Simmons is one of hundreds of companies swept up by private equity firms in the early part of this decade, during the greatest burst of corporate takeovers the world has ever seen. Many of these deals, cut in good times, left little or no margin for error — let alone for the Great Recession.

A disproportionate number of the companies that were acquired during that frenzy are now struggling with the enormous debts. More than half the roughly 220 companies that have defaulted on their debt in some form this year were either owned at one time or are still controlled by private equity firms, according to analysts at Standard & Poor’s. Among them are household names like Harrah’s Entertainment and Six Flags, the theme park operator.

The private equity folks are quoted in the story as saying Simmons was destroyed by the recession, not by its debt.

Yeah, right.

Private equity firms have no customers. Their sole reason for existence is to enrich their investors. It seems that many of them pursue that with little or no regard to what it really takes to sustain a business, undermining the company’s ability to serve customers.

I’m sure there are good private equity firms – “good” meaning they actually do try to help the businesses they buy create value for customers, without overloading them with debt. I’ve even heard of private equity firms hiring lean experts to help analyze and work with their purchased companies.

But that requires people who can transition from the pure-profit mindset of an equity firm to the customer-service orientation of a manufacturer, and I suspect those people are few and far between.

Too many of them are the kinds of people who run the firms that bought and sold Simmons – predators who ultimately don’t care whether their acquisitions succeed or fail.

I have nothing but contempt for these people. And I am confident that in the long run, they will be seen for who they are, and will fail. It is unfortunate they cause so much damage along the way.