Deadly Rampage at Newtown Elementary School

12.18.12

Cerberus to Sell Stake in Gunmaker Freedom Group

It’s not just rich corporate guys in New York who’ll take a hit when the private-equity giant pulls out of gunmaker Freedom Group. Dan Gross on how the win for gun regulation advocates hurts some civil servants.

It took a while, but the owner of Freedom Group, the weapons conglomerate that makes the Bushmaster weapon used in last Friday’s assault in Newtown, Connecticut, finally said something.

At 1 a.m. on Tuesday morning, more than 80 hours after the event, Cerberus Capital, the high-profile private-equity firm that owns Freedom Group, issued a statement. Cerberus expressed sadness and attempted to distance itself from the assault, noting that Freedom Group “does not sell weapons or ammunition directly to consumers, through gun shows or otherwise.” It continued: “We do not believe that Freedom Group or any single company or individual can prevent senseless violence or the illegal use or procurement of firearms and ammunition.”

But you don’t need a weatherman to know which way the wind blows. Cerberus recognizes that the Sandy Hook even was a “watershed event that has raised the national debate on gun control to an unprecedented level.” And this higher level of public debate is making Cerberus uncomfortable. “As a Firm, we are investors, not statesmen or policy makers.” So rather than get involved in a messy debate, it is cutting Freedom Group loose.

“We have determined to immediately engage in a formal process to sell our investment in Freedom Group.” That way, Cerberus can give the money back to its investors, and go about its business “without being drawn into the national debate that is more properly pursued by those with the formal charter and public responsibility to do so.”

While welcome, the statement is troubling. And while it is tempting, even satisfying, to lash out at a secretive private-equity firm that profits from the sale of automatic weapons, a deeper look should cause us to pose questions to others, and to ourselves. The rich guys in New York weren’t the only beneficiaries of Freedom Group’s growth. In fact, many of the indirect beneficiaries are people of much more humble means.

Let’s start with the obvious.  Cerberus claims that “as a firm, we are investors, not statesmen or policy makers.” But of course, Cerberus’s small leadership team includes statesmen and former policymakers like Dan Quayle, a former vice president of the United States, and John Snow, a former Treasury secretary. In recent years, Cerberus has purposely become involved with companies that benefit from, and rely on, public policy. One of its more successful investments has been in Air Canada, for example.

Private-equity executives, including the folks at Cerberus, have very strong opinions on matters of public policy when it comes to tax rates, the treatment of carried interest, and entitlement spending. Cerberus executives, including its founder, Stephen Feinberg, have given heavily to political campaigns (virtually all of it to Republicans). For people who chose to operate in regulated industries, who choose to invest in government contractors, and who participate in the political process at a high level to suddenly plead a lack of interest and competency in such areas now that there’s a national debate on gun control is highly convenient.

Cerberus is now going to have to dump Freedom Group at a fire-sale price. Who will buy a company that is the target of public opprobrium and likely new regulation—especially one that is now laboring under a higher debt load? At the end of the third quarter, Freedom Group had $646.8 million in debt, up from $487 million the year before. That’s a manageable load for a company whose sales are clocking upwards at a 20 percent annual rate. But the interest payments can quickly become problematic if the business suffers some setbacks, or if it is exposed to expensive litigation.

Of course, Cerberus has already extracted a few hundred million dollars on behalf of its investors from Freedom Group, by having the company issue debt and buy back shares. And this brings up a larger issue.

The dirty little secret of private equity is that many billionaires owe their fortunes and ability to conduct swashbuckling takeovers to civil servants. From its inception, the industry has raised money from public-employee pension funds—taxpayer-funded retirement-savings programs for teachers, DMV clerks, bureaucrats, sanitation workers, and police officers. Huge institutional investors like the New York State Common Retirement Fund, CALPERS (the California Public Employees Retirement System), and CALSTRS, which invests on behalf of California teachers, possess hundreds of billions of dollars in assets and are mainstays of the private-equity business. When Cerberus, and the Blackstone Group, or Bain Capital use debt to boost returns, and use the bankruptcy code to shuck obligations, a big chunk of the benefit goes to civil servants.

In its statement, Cerberus noted that “Our role is to make investments on behalf of our clients who are comprised of the pension plans of firemen, teachers, policemen and other municipal workers and unions, endowments, and other institutions and individuals.” Many of these funds are in turn controlled by publicly elected officials. And events like Newtown put them in a tough spot. The Financial Times reported that CALSTRS had expressed concern with Cerberus about the investment. Private-equity firms are much more responsive to questions from their investors than they are to questions from the public. If Cerberus, or other private-equity firms, invest in toxic companies that embarrass them, the big institutional investors may be less likely to participate in the next fund. Until recently, these large public funds were looking the other way, too.

The bottom line is that we are much more implicated in the search for profits than we like to think. Andrew Ross Sorkin reports in the New York Times on other gun companies that are owned by private-equity firms, which in turn invest on behalf of such pension funds. Other companies, like Smith & Wesson and Ruger Sturm, are publicly held, which means they may reside in index funds, ETFs, or mutual funds. If we were all to do a deep archeological dive into our portfolios, many of us would find some connection to a gun company.