The first leg of Mitt Romney’s journey to a private equity fortune ran between Nellis Air Force Base in Las Vegas and the Tonopah Test Range, deep in the Nevada desert.
In the mid-1980s Tonopah, also known as Area 52, was home to the newly developed, top secret F-117A stealth fighter. Pilots and support personnel lived in Las Vegas and spent their working week in the desert.
A $10 million-a-year contract to shuttle them back and forth was the prize asset of a small charter company called Key Airlines, which became a formative deal for Bain Capital, the private equity firm that Mr Romney co-founded, and where he built the career that is his main credential for the White House.
Little is known about most of Bain Capital’s investments because private companies do not have to publish accounts in the US, but using court and other public records, the Financial Times has built a detailed picture of one of the deals that established the firm.
The tale of Key Airlines spans the creation of Bain Capital in 1984 – spun out from the Bain & Company management consultancy – and provides a glimpse of its methods and results. Key grew during its Bain years. Sales roughly doubled from 1983 to 1985 and employment more than doubled to about 200 jobs. Bain bought the company on the cheap, rode a turn in the industry cycle and then sold for a remarkable price.
A start-up pilots union was unlawfully suppressed, according to a federal court ruling. Some other methods foreshadowed the later success of Bain Capital: Key Airlines was an early example of a leveraged buyout. The initial deal was 100 per cent debt financed with no capital from the investors.
Bain also reshaped Key Airlines, turning it from a profitable, taxpaying company with a $13m balance sheet and its own aircraft, into an operating company with a $2m balance sheet and a holding company from which it sold assets separately.
These accounts were set out in filings with the US Securities and Exchange Commission when Key Airlines was sold to a public company in 1986. Details of the financing structure come from the archives of the now defunct Civil Aeronautics Board. Documents filed there in 1983 include an internal Bain & Company memo that describes the Key deal. Findings by the National Mediation Board in 1986 and a 1992 judgment in the US District Court of Nevada describe Bain’s union problems at Key.
The man who led Bain’s involvement at Key Airlines was T. Coleman Andrews III, a former White House official, whom Mr Romney helped recruit to Bain & Company. He was "very active in the day-to-day affairs of Key", according to the court ruling, and chaired its board of directors.
Mr Andrews – who now runs an asset management company – could not be reached for comment.
In 2008 Mr Andrews helped to run Mr Romney's campaign for president in the state of Wyoming – a bid that ended when John McCain triumphed in the Republican primaries – and he spoke then of the start of a 30-year relationship. "I had pretty much decided to go join another company, and then this guy I’d never heard of named Mitt Romney from this company I’d never heard of called Bain & Company walked into my business school and started talking to me,” Mr Andrews told a Wyoming newspaper.
An airline for sale
By 1982, Mr Andrews was a partner. Although Bain & Company was a consultancy, its partners sometimes invested in deals together as well. According to CAB documents, in April 1983 a small group of them – including Mr Romney and Mr Andrews – heard from an employee that his father-in-law in Utah was arranging arranging the buyout of a company called Key Airlines.
The partners sent a team of Bain employees, including Meg Whitman, then in her mid-20s and today the chief executive of Hewlett-Packard, to check it out. Key was small but generated stable cash flows. In addition to the Tonopah contract, it serviced aircraft that passed through Salt Lake City, operated an air ambulance and ran a Cessna dealership.
Bain also learnt something else: the sellers were desperate. Mr Andrews testified to regulators in 1983 that he knew Key’s parent company was "under severe financial pressure” and that its management "had a fixed date by which they intended to sell this business”.
Stable cash flows, solid assets on the balance sheet and a distressed seller allowed Bain and its local allies to craft a lucrative deal: an ultra-leveraged buyout through which they bought Key with a minimum of risk and without putting in a dollar of their own.
"This represents the first deal resulting from 18 months of work in the area of leveraged buyouts,” says the Bain & Company memo describing the Key Airlines purchase. The financing structure is instructive as it shows Bain Capital was involved in leveraged deals from its birth. In the US presidential campaign, discussion of Mr Romney’s early business career has concentrated on his risk-taking with venture capital investments such as the office retailer Staples.
The purchase price was $5m. The Bain consortium had Key borrow $5m so that, in essence, the company paid for its own acquisition. The Bain partners guaranteed $2m of the debt but it was secured on aircraft worth $2.5m and Key’s contracts generated a lot of cash. The only real danger was if an economic cataclysm wiped the company out before the end of 1983.
Mr Romney personally bought 5 per cent of Bain's share in Key Airlines, guaranteeing 5 per cent of the debt, or $100,000, in return for a stake that would later be worth many times that. Bain offered stakes to a couple of favoured contacts.
The deal churned out money from the start. By the end of 1983, Key Airlines had secured a valuable extension to its air force contract, and in 1984 operating profit was more than $4 million, net profit was $1.7 million and sales were more than $25 million. Acquisition debt was rapidly paid down.
On the strength of the air force contract and Bain’s wealthy investors, Key was able to buy four Boeing 727 jets, using only internal cash flow and more debt finance. The banks, Mr Andrews testified, "satisfied themselves as to the personal financial capabilities of the various partners”. Key bought the aircraft through its holding company and then leased them to the operating airline.
It was in 1984 that Mr Romney and Mr Andrews founded Bain Capital in an office next door to Bain & Company in Boston. Key Airlines went with them. Towards the end of 1984 their new firm made one of its first investments: a $2 million injection into Key. Regulatory filings indicate that Bain Capital's stake was 24 per cent. SEC records show that Mr Romney was a director of Key Airlines when the company was finally sold. Mr Romney’s campaign declined to comment on this or other financial questions about the Key investment. State of the union Using the new 727 jets, Bain’s plan was to expand in commercial and military charters, but 1985 was not such a good year. Operating profit fell to $1.1 million on sales of $30.5 million and there was a net loss of $736,000. But a serious issue arose when a majority of Key’s pilots tried to form a union. Accounts differ as to why Key’s pilots, at the end of 1985, wanted to organise: the pilots cited safety concerns; management said that the pilots were unhappy because of their low pay. Either way, Bain’s management team at Key recognised that a union would be a problem – particularly because Bain was ready to sell Key, adopting a plan of liquidation for its holding company at the end of 1985.
"Any knowledgeable person familiar with investment in airlines will tell you that it is far easier for non-union airlines to raise capital than it is for a unionised airline,” wrote James Bridges, chief executive, in a letter sent to the pilots in December 1985. Mr Bridges did not return messages left with his office.
There followed an unlawful attempt by Mr Andrews and Key management, in the words of District Court judge Roger Foley, "to stamp out any cockpit crew members’ union before it could come into being”.
In January 1986, Mr Andrews and Olen Rae Goodwin, interim president of the union, met in the Key Airlines trailer at Nellis. The court ruled that Mr Andrews had then "threatened [Mr] Goodwin’s job and he threatened to leave Key, and that the management team would also leave. He threatened to sell Key”.
Mr Goodwin told the court Mr Andrews had compared a pilots’ union to an unfaithful wife. "He said that he wouldn’t be able to stay around if the union was voted in because he’d feel betrayed. And said that if his wife came to him and said that she’d like to stay around but she’d kind of like to sleep around a little bit, that he wouldn’t be able to live with that either,” Mr Goodwin testified.
Mr Andrews denied making those remarks. "I don’t think in those terms. And I don’t speak in those terms,” he said, according to a transcript of the proceeding. But the judge ruled that Mr Andrewshad "never offered a different version of the meeting”.
National Mediation Board investigators said in a report that on March 5 1986, Mr Goodwin and Lawrence Schlang – then chairman of the union’s negotiating committee – had been summoned by management.
Both were presented with prepared letters of resignation, which they signed.
Later that year Mr Goodwin and Mr Schlang sued their former employer for violation of labour laws; in 1992 the court found Key management at fault and awarded the pilots $500,000 of punitive damages.
Those damages – but not the rest of the judgment – were set aside in 1994 when the parties agreed to resolve appeals with a separate financial settlement. In part of the settlement, it appears Mr Schlang and Mr Goodwin acknowledged that "Mr Andrews was not actively involved in Key Airlines’ conduct in connection with the union organising campaign” – despite the earlier judgment and their testimony.
When asked about the case, Mr Romney’s campaign pointed to the candidate’s stance that workers have a right to join a union or not, and criticised President Barack Obama.
"President Obama continues to put the interests of labour bosses ahead of the interests of Americans looking for work. By contrast, Governor Romney has grown companies and created jobs, in the private sector and as governor of Massachusetts, and will get America working again,” said Michele Davis, a spokeswoman.
Bain Capital did not provide a statement.
Bain Capital sold Key Airlines in July 1986, after the union threat was over, to another company it had invested in on the basis of airline deregulation. That buyer was Presidential Airways. The price was $18 million.
One of the early low-cost carriers, Presidential raised $34 million, built what is now Terminal C/D at Washington’s Dulles airport, and started scheduled service. Bain Capital invested $2 million in Presidentialbefore its initial public offering in July 1985 and Mr Andrews joined the Presidential board.
Presidential was struggling to compete after United made Dulles one of its hubs and so diversification into charter services was attractive. Still, the price it paid for Key is hard to understand: $18 million for a company that lost money in 1958, was to lose money again in 1986, and had only $2 million in tangible assets.
Bain only sold the operating company to Presidential. It separately sold the Salt Lake City refuelling arm for about $3 million and sold the 727 aircraft in the holding company for a further profit. There was some debt to pay down, but based on the SEC filings and a list of Bain Capital deals in a Deutsche Bank prospectus from 2000, overall cash flow from the investment seems to have been about $20 million. That suggests a big return for the Bain partners, including Mr Romney, who acquired their stake for nothing.
In the final analysis, it is hard to say whether Bain Capital was good or bad for Key Airlines.
The operating company had higher sales, was more focused, more efficient and employed more people by the time that Bain sold out.
On the other hand, it was also more fragile, with only one line of business, net losses and a weak balance sheet.
There is no doubt, however, that Key Airlines was good for Bain Capital. The young private equity firm had demonstrated what it could do. Bain Capital was on its way.