Jag Venugopal's Blog

January 13, 2012

Birthers, Tea Partiers and now… Socialists. Where’s the GOP headed?

Filed under: Business — Jag @ 6:17 am

The Republican primary season is now becoming a theater of the absurd. First it was people demanding to see Obama’s birth certificate. Then it was the Tea Partiers, who prized supposed ideological purity over all else, including electability. Now, is it socialism?

The newspapers are filled with accounts of how Newt Gingrich, Rick Perry, and their SuperPAC minions are attacking Mitt Romney for his time at Bain. Supposedly, Romney’s company fired a lot of people after taking over perfectly good companies, thereby pocketing the profits. One ad, quoted in the Wall Street Journal, states thus: “The company was Bain Capital, more ruthless than Wall Street.”

Republicans attacking a market economy? Well I guess pigs can fly.

The job of a company in any free economy is not to generate jobs. Instead, it is to deploy capital most efficiently to generate profits for its shareholders. And in doing this well, employment is generated and dollars are put to good use. For what happens when the sole purpose of employment is to generate jobs, look no further than two companies in India that I have blogged about in the past: Hindustan Cables and Haldia Fertilizers. The former does not produce an inch of cable, and the latter, not an ounce of fertilizer. Yet they provide employment to thousands (literally), wasting precious capital that could be put to use elswhere in India’s economy.

When evaluating a company, we were taught in MBA class to see it as a series of cash flows. And there are rather simple mathematical formulae to calculate the value of all future cash flows in today’s dollars. Its called the Net Present Value or NPV. Now, if you’re the owner of a company that is offered a buyout by Bain Capital, you look at your NPV. If Bain offers you more cash today than your NPV, you’re better off taking the money and investing it elsewhere. And in return, Bain either makes your company more efficient, or sells it for its parts. Perhaps they know a thing or two about running your company more efficiently, and therefore their cash flow projections are better than yours. And based on these better cash flows, they’re able to offer you a better price than your own future cash flows.

How can the situation be improved? Certainly not by railing agaist capitalism (how ironic that Republicans have started doing it). Its simply by allowing the owner to realize a better series of cash flows, thus preventing him from selling or breaking up the company. And how’s that done? There are many ways… allow him to sell more; reduce his expenses through reduced regulation, keeping interest rates low by keeping government borrowing low, keeping taxes low, keeping the NLRB in check, preventing ADA misuse… the list is endless.

But I guess, regardless of political affiliation, a good politician does not let truth and facts get in the way.

Update: there’s a great article from WSJ describing what private equity does. While I argue above as to why any owner would want to sell their business to private equity, the WSJ article talks more about what private equity companies do once they buy a firm.


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