Bain (and their horrible ilk) put up a tiny amount of capital to secure huge loans. They used those loans to buy the company, taking it private. Once it is private they can do whatever they like with it; they pay themselves back for the loans by loading the company up with debt (and then some to ensure an immediate profit). They cut everything to the bone, fire as many people as possible, then spin the husk back out as a public company (or offload it to some other sucker).

Bain effectively risked nothing to make a killing and ensure Toys-R-Us would eventually file for bankruptcy due to an unsustainable debt load. Banks are happy to loan Bain money for these schemes because Bain makes a killing on them and private equity almost always finds a sucker dumb enough to buy the zombie company off them. (Every once in a while the zombie goes south so fast private equity is left holding the bag).

For loans to the zombie company the terms are punishing enough the bank only needs the zombie to survive for a limited amount of time.

The part I don't understand yet is who is the dumb money buying shares in these hollowed-out debt-laden husks from the private capital vultures? It almost always ends up badly. Even when it doesn't the upside isn't great.

FWIW Guitar Center is almost certainly headed for the same end and for the same reason.

>The part I don't understand yet is who is the dumb money buying shares in these hollowed-out debt-laden husks from the private capital vultures? It almost always ends up badly.

Is this based on reliable statistics or on highly visible anecdotes? Perhaps the "dumb money" isn't as dumb as you think.

Whoever took it private needed money to buy out the shareholders. They borrow that money using the business itself as collateral. They buy the stock and the company is now private, with all that debt on the books.

Fairly typical large cap PE strategy. Load the company up with debt then sell it off and let the company figure it out after.

Note - not all PE firms do this (big or small) but it is a common strategy that does earn them money.

How is this not fraud?

It's possible there was fraud, if the investors were given false statements. But most likely, they made an educated bet and lost.

The people who issued the debt (made loans to the company to buy back its outstanding shares) are sophisticated investors who saw the balance sheets of the company and thought they were likely to get paid back. If things had worked out, they'd have made an above-market interest rate. They also knew what would happen if things didn't work out (the present situation is a typical downside for LBO capital). They didn't lose all their money -- they made 7.375% interest for 15 years. If they get 50% of the capital back through bankruptcy, that's a total return of 160%. Not the worst investment over the last 15 years, though obviously Apple would have been better.

What's fraudulent about it?

I'll give you one thing: the assets of the company are pledged to the senior bond holders, but then after the bonds are sold the PE company generally disposes of the assets, leaving nothing backing the senior debt.

The junior debt, of course, has nothing pledged to back it at all. Junior debt in leveraged buyouts is pure gambling.

This is in the territory of not even wrong

The part where they skim millions in "management fees" to take it private, and then leave it floundering under so much debt that it dies?

To make the private equity people rich. They stiff the suppliers, employees and other creditors.

This is a variant of the 80s era stuff in the movie Wall St. When WalMart was expanding regional players like Ames, Jamesway, etc would do this. You could tell when it was happening because the stores would be stuffed to the brim with stuff before the bankruptcy.

They borrowed money to buy their shares back.

They could have taken out financing to buy back their shares.