Wieffering: Buffets Inc.: Revisiting a deal gone wrong

When Old Country Buffet tumbled into bankruptcy last week for the second time in four years, top executives of Buffets Inc. were quick to blame the restaurant chain's woes on weak spending by consumers.

But that's only part of the story.

In truth, Eagan-based Buffets is a casualty of the ruinous financial engineering undertaken by the private equity investors who bought the chain in 2000.

In classic fashion, they loaded their plates with debt and gorged themselves on management fees and special dividends, only to lead Buffets into bankruptcy in 2008.

And they made a profit in the process.

You read that right. The New York City private equity firm that bought Buffets, Caxton-Iseman, made about $100 million on its investment in the chain.

Meanwhile, thousands of Buffets' employees lost their jobs. Unsecured creditors got a fraction of what they were owed, and Buffets emerged from that first bankruptcy stuck with six times the debt it had prior to its sale.

If that doesn't sound fair, take comfort. A bankruptcy court trustee thought the same thing and decided to do something about it. More on that later.

Buffets' hobbled condition explains its second bankruptcy, which comes as the private equity industry finds itself facing unprecedented scrutiny and controversy. For that it can thank Republican presidential candidate Mitt Romney, who made his fortune directing investments for the private equity firm Bain Capital.

Some of those deals turned out spectacularly well. And some turned out awful for everyone but Mitt Romney and Bain Capital.

Political foes, including many from his own party, have seized on the latter as illustrative of the perverse incentives that allow private equity investors to reap outsized rewards even as the companies they invest in fail.

That, in a nutshell, is what happened with Buffets.

Buffets was growing and profitable in all but one of the five years before Caxton-Iseman bought it. In 1999, its last year as a publicly traded company, Buffets earned more than $42 million on sales of $937 million. Its long-term debt totaled a measly $42 million.

The Caxton-Iseman investment group chipped in $130 million toward the $643 million purchase price. The remaining proceeds came mostly from asset sales, such as the sale of Buffets headquarters building, and heavy borrowings that are typical of most private equity purchases.

So marked the beginning of Buffets' slide. Its net income never again reached pre-buyout levels, thanks in no small part to the $22 million in investment banking fees and estimated $200 million in dividends Caxton-Iseman collected over the years. And even though Buffets had an executive team in place, Caxton-Iseman also negotiated an annual services fee that entitled it to 2 percent of Buffets' earnings before taxes, depreciation, amortization or the mounting interest payments on its debt.

Much of these details are found in filings with the Securities and Exchange Commission, or in the 2010 lawsuit filed by the trustee in Buffets' bankruptcy case, New York-based JLL Holdings. The suit accused Caxton-Iseman of, among other things, unjust enrichment.

The firm, since renamed CI Capital Partners, dismissed the charges as having no merit. But in September 2010, it and other investors settled the case for more than $23 million.

The settlement prohibited the trustee or anyone associated with the case from talking about it. Indeed, the details were tucked away as an attachment to one of the 3,000-plus documents in Buffets' first bankruptcy filing.

Officially, it's a settlement that includes no admission of wrongdoing or fault. But maybe it also serves as a small warning to other private equity investors.

I don't want to leave the impression that most private equity deals end up in bankruptcy. Indeed, some studies suggest little or no difference in bankruptcy rates between businesses owned by private equity investors and those that are not.

For that matter, there's also little evidence to support the contention by some private equity investors that they are heroic engines of job creation.

Still, Americans are by nature a generous lot. They admire, rather than begrudge, people who take risks that pay off big.

But exploiting the system to ensure a profit when everyone else loses isn't investing.

It's looting.

ericw@startribune.com • 612-673-1736