Why Products You Buy Don’t Last

Remington, one the oldest names in the outdoor industry is going bankrupt. This might seem odd because gun makers sold a ton of guns and ammo during the Obama presidency and stocks in that industry did exceptionally well.

Some of you know I write articles for outdoor magazines as a hobby, so I have some good connections there. What I’m hearing is that Remington is going under because over the last couple decades it kept lowering the quality of its product.

One of the things that drives me nuts is that coffee makers and lawn trimmers and such seem to have a life that is continually getting shorter. Our Keurig has to be “spanked” after not very long or it gets gunked up and pours small cups. Our SS electric can opener broke after a year because the critical part was plastic. My power landscaping tools lasted a few years, but I have learned which brands to buy. You feel like when you get 5 years out of a product you did well. That’s sad.

You and I have seen this movie before. It was called Wall Street.

The business of Wall St. that buys out companies it feels are making too little profit and “turns them around” falls under private equity and it is prospering today like never before. Gordon Gecko lives.

The way it typically works is that a private equity firm like Cerberus, KKR, Apollo or Blackstone raises a lot of money by promising investors big returns. The sooner they can realize those profits, the more money the buyout fund general partner can raise and the more fees it can earn.

Here’s how they do that on companies that are already trading on the stock exchanges.

First, they buy enough of the company’s stock to get control. Quickly, they pay themselves back by having the company take on debt, often a lot of debt. So, they love to buy companies that have been reluctant to take on debt before. Since debt payments increase the company’s expenses and lowers profit, they next execute their plan to cut costs,” make the company lean,” i.e. efficient.

That means selling off “underperforming” divisions that don’t generate much cash, which may be the ones in which management has been investing for future growth. Then they cut costs by laying off employees, by moving production overseas, by lowering the cost of the products in any other way they can, like making the candy bar smaller, replacing metal with plastic, maybe by raising machining tolerances to reject fewer parts. If they cut costs enough, they may even lower prices to get more sales.

The consumer, not knowing what is going on behind the scenes, loves it. “Man, you mean I get can get a Remington for that price? I’m buying. What a deal!”

Because the company has taken on debt, called “leveraging up,” when costs start going down because of these “greater efficiencies” the reported quarterly profits soar and start beating expectations, the value of the company in Wall Street’s eyes goes up because of how fast profits are increasing. “They really turned that old company around.” The private equity firm then sells the shares they bought for a large profit, having “improved” the company. A lot of the profits go to the partners in the buyout fund and they do it all over again. They have cost people their jobs, given us all lower quality products, saddled a low-debt company with a lot of debt, started “monetizing” the company’s reputation (essentially selling it as they lower product quality to get more sales at lower prices before consumers adjust their perception of the brand’s falling quality). All for short term profits.

That’s the worst case. In other cases, they may actually improve truly mismanaged companies. And a big part of private equity ($700 billion out of $1.7 trillion) is still to buy companies that have not yet issued publicly traded stock, including young, innovative tech firms that may become the tech giants of tomorrow, e.g. Google and Facebook. I’m talking about when the firms buy out already publicly traded companies.

Here’s what most people don’t know and what concerns me – how much of America they own. Amazon is the 2nd biggest employer in the U.S. with 540,000 employees worldwide. But, buyout firm KKR currently owns companies with total employment of 650,000. The only company with more is WalMart, the retailer of many of these cheaper products.

Buying out companies is now a $1 trillion industry and has become the majority of what private equity firms do as opposed to taking promising companies public. And because it is so profitable, the money keeps pouring in. Apollo just raised the largest pool of money for doing buyouts ever – $25 billion in just one partnership.

So, expect more products with lowered costs. As a whole, America has turned from how it built its dominance in industry, by innovation and high quality and for the most part narrowed that to one area – technology. I might make exceptions for aircraft, vehicles and medical products, including pharmaceuticals. Much of the rest of what we buy is becoming junk. That’s why the majority of individual stocks I buy for clients are in tech and health care.

What companies can you name that are unflinching in their commitment to quality? What companies do you know that are making exceptional products and are not aggressively raising prices?

Leave a Reply

Your email address will not be published. Required fields are marked *