Vulture Culture?

By Ian Fraser

Published: Sunday Herald

Date: May 8th, 2005

DEPERI_VULTURE_1_1105551fMuch to the annoyance of the City, private equity firms have amassed billions buying and selling vulnerable companies, but is this process a necessary part of the ecology of modern business?

THEY control one-in-five private sector jobs in the UK; yet their activities are cloaked in secrecy. They often make hundreds of lay- offs and sell off the “family silver” within weeks of taking control of a company; yet they have lately been making annual returns of around 30 per cent. They are eager to sanitise their image as a positive force for corporate change but many commentators question what value they bring to the overall economy.

The conundrums at the heart of the UK private equity industry – which is dominated by the big London-based buyout firms Apax, BC, Candover, Cinven, CVC Capital and Permira – may explain why it has not been enjoying a particularly good press of late.

These multi-billion pound organisations have, thanks to a seemingly inexhaustible supply of cheap credit since 2003 been able to dramatically raise their game within the past couple of years.

As banks have been falling over each other to lend them billions of pounds, private equity firms have found themselves capable of raising £1 billion to £7bn for mammoth takeovers much more easily than before.

This means giants of the UK high street are no longer immune to their advances. The likes of WH Smith, B&Q and Woolworths have this year all been targeted by private equity firms. Debenhams, Halfords and Homebase have either recently been, or are currently, in private equity hands.

But suspicions of their business model appear to be rising on both sides of the English Channel.

In Germany, private equity firms were recently branded as “locusts” by the chairman of Germany’s ruling Social Democratic Party, Franz Munterfering.

Last week he issued a “locust list” of 12 figureheads of capitalism which he believes are tearing Germany’s economy apart. The list included four UK-based private equity firms – Apax, BC, CVC Capital and Permira – as well as the US groups Advent, Blackstone, Carlyle, Goldman Sachs, Kohlberg Kravis Roberts and Saban Capital. German players WCM and Deutsche Bank also made it onto the roll of dishonour.

Munterfering, a close ally of chancellor Gerhard Schroder, is struggling to revive his party’s fortunes ahead of regional elections on May 22. He said:

“They remain anonymous, they have no face and descend like a swarm of locusts on a company, devour it and then fly on.”

In the UK, too, private equity firms have been accused of a range of misdemeanours including “mugging” stock market investors and trying it on with a “strip and flip” approach to companies they acquire. Effectively, this means buying on the cheap, selling off a company’s prized assets, and yet still somehow selling the firm at a massive profit within 18 months to two years.

Justin Urquhart Stewart, a director of Seven Investment Management, questions whether private equity ownership of UK business has any beneficial effect on overall economic growth. He also suggests they should be known as “vulture capitalists”. He says:

“On the one hand, you have a lot of venture capitalists around, many of whom are awash with cash having sold off many of their previous businesses. On the other, there are plenty of discounted but cash generative companies that have assets to flog. But I don’t see how any of this will make any difference to economic growth.”

Yet, unlike in Germany — and despite the fact private equity group Phoenix Venture Holdings was blamed for the recent collapse of MG Rover with the loss of 5,500 jobs — private equity firms did not become a bogeyman during the 2005 general election campaign.

This probably has a lot to do with the fact that Schroder’s SPD leans further to the left than most UK parties and that the German economic backdrop is very different to the UK’s. Unemployment there stands at 12 per cent, compared to 4.8 per cent here.

Even though private equity houses have not, yet, become a whipping boy for the Left in this country it is a form of ownership that has clear disadvantages. It lacks transparency, it is arguably less favourable to employees than other forms of ownership, and it is often adopted to bypass the increasingly strict reporting requirements required of stock market listed firms. There have also been suggestions that firms in private equity hands spend less on R&D and have less regard for the environment or corporate social responsibility than their listed peers.

The biggest immediate worry, however, is the tidal wave of cheap borrowings that has washed over the private equity sector since 2003.

Almeida Capital, the private equity research group, predicts that 2005 will be another blockbuster year for the sector in Europe, with an estimated €32bn (£21.7bn) devoted to buyout funds, compared to the previous peak of £20bn recorded in 2000. The danger is that these sums are being “leveraged” with ever-growing quantities of debt, with major banks including The Royal Bank of Scotland competing fiercely to lend to buyout funds.

Such indebtedness has few pitfalls for private equity players in a low interest-rate environment. However should rates rise sharply, or should the economy deteriorate, it would be an altogether different story.

Many UK economic indicators may remain positive, but there is no escaping that the consumer boom is tailing off and that interest rates have already risen from 3.5 per cent to 4.75 per cent. If they were to rise substantially higher or were the economy to take a turn for the worse, some private equity-backed businesses would struggle to repay their loans. Others might even collapse.

The Financial Times last week warned that the recent surge in private equity investment could be a “bubble caused by ultra-lax monetary policy which will turn sour as long-term interest rates rise”.

The same paper earlier indicated that some lenders are beginning to get cold feet about increasing their exposure to the sector. It said the investment banks that are financing the $11.3bn purchase of the US data storage group SunGard — the largest leveraged buyout since KKR’s controversial acquisition of Nabisco in 1989- – are struggling to find buyers for the debt. Ahead of a formal “roadshow”, the early indications of interest were lukewarm, said the FT.

But SunGard CEO Jim Simmons says that — even if there is any lack of appetite for debt in the deal — it would be a minor hurdle. He insists the deal is with the private equity consortium, led by Silver Lake Partners, not their lenders, and it is “on track to complete in the third quarter”. Simmons says: “These are a very intelligent set of investors who only invest in technology companies and know their market very well.”

He says that comparisons with KKR’s purchase of Nabisco — detailed in the best-selling business book Barbarians At The Gate — were ill-founded. “In the Nabisco deal there was $1bn of equity and $27bn of debt. With SunGard there is $3bn of equity and $8bn of debt.”

Yet Jonny Maxwell, chief executive of private equity at Standard Life Investments, admits that escalating levels of debt could be a problem for the sector in future. He says:

“From my perspective, the biggest discipline that is needed in this industry is not to lose sight of a sense of gearing [borrowing] levels. That has happened in the past. It happened with Isoceles.”

He was referring to failed private equity vehicle Iscoceles which, having learned its tricks from America’s KKR, bought out the UK supermarkets group Gateway Foodmarkets for £2bn in 1989. Maxwell says the deal was doomed because “levels of gearing got out of control”. Isosceles struggled to repay its debt and collapsed. After a difficult few years Gateway eventually resurfaced as Somerfield.

But what about the other aspects of private equity? Are the so-called “new Kings of Capitalism” so preoccupied with lining their own and their investors’ pockets to preclude any real interest in the needs of other stakeholders?

Ross Marshall, chief executive of Edinburgh-based Dunedin Capital Partners believes not and argues strongly that private equity can be a force for good. He refers to Millets, the outdoor equipment retailer which his smaller buyout firm acquired from retail giant Sears in 1996.

“At that time Millets was selling a lot of poor quality goods and not making much profit. In the three years we owned it we improved the quality of the product offering, significantly increased the number of stores and created additional employment.”

Millets was sold to Black’s Leisure for around £10 million in 1999, enabling Dunedin Enterprise Trust to treble its money. But Marshall insists others also benefited. “We brought clear benefits to the company and the community.”

Stephan Breban, who recently set up private equity consultancy City Capital Partners, disagrees with the suggestion that private equity-ownership means less is spent on research.

“There are many companies that are totally dependent on research, in the life sciences sector for example, that are private equity-backed.”

Another charge levelled against the sector is that it is too secretive. The big private equity groups jealously guard their privacy, partly because they can.

Some commentators are aggrieved that private equity houses don’t disclose the results of their investments (except to their own clients) and never release details of their indebtedness levels.

But industry experts argue that the ability to carry out delicate restructuring work away from the public gaze can have benefits. Breban says:

“When a company gets into difficulty, it’s much easier to get the problem sorted if it is private equity-owned. With a quoted company the emphasis will be on shareholder activism and engagement. There will be between 200 and 2000 shareholders each telling the management what should be done, each pushing in different directions. This means the company often does the easiest thing: Nothing.”

Breban says that, by contrast, a private equity manager can push through changes much more effectively because “there’s only one person pushing for change”.

He also argues that private equity managers generally have a much more profound knowledge and understanding of the sector in which they’re investing than traditional fund managers.

“They will have more contacts in the sector and know more people who operate there. They can help bring in additional management resources to assist a company that is suffering.”

Maxwell says:

“It’s perfectly appropriate that certain people decide they can grow a business more successfully without microscopic attention being brought to bear on them and deliver a better performance without being exposed to the vagaries and short-termism of the stock market.

“But the ultimate ownership is actually not so very different, as many of the institutions that invest in the stock markets, are also investing in private equity. It’s just another form of ownership which allows greater flexibility and a more long-term approach.

“The whole notion that a cadre of sinister investors is somehow stealing value from the public markets is absurd.”


Automobile Association: The ex-mutual was sold by utilities group Centrica to CVC and Permira for £1.75bn in July 2004. Three months later, the AA said it was axing 900 jobs and pulling the plug on its car repair centres. CEO Tim Parker believes the AA can float and join the FTSE100 (implying a market value of circa £2.5bn) within five years.

Debenhams: The previously-listed department store group was bought by Baroness Retail (Texas Pacific, CVC Capital and Merrill Lynch) for £1.7bn in December 2003. In February Baroness sold the retailer’s “crown jewels”, its 23 freehold properties to British Land, in a £495m sale and leaseback deal. Already looking to return to the stock market.

Halfords: Acquired from Boots by CVC Capital for £410m in July 2002. CVC cut 400 jobs and demanded a 10% price reduction from suppliers while making them wait an extra 60 days to be paid. The retailer was floated on the stock market, with a £593m value last June. CVC retains a 45.6% stake in the business.

Homebase: Homebase was bought from J Sainsbury by Permira for an effective price of £437m in 2000. Permira cut its original outlay by selling land and stores to B&Q, netting £273m, and received £259m from the sale-and-leaseback of sites to Sainsbury. The DIY chain was sold to GUS for £900m in November 2002.

IPC: The UK’s leading consumer magazine publisher was bought from Reed Elsevier for £860m by Cinven in 1998. Cinven cut costs “with gusto” and axed 10% of its 2200 staff before selling the publisher – where titles include Loaded and Woman’s Own – to Time Inc for £1.15bn in July 2001.

Kwik-Fit: The car repair business was acquired from Ford by CVC for £330m in August 2002. CVC closed 200 outlets, axed the Roseburn headquarters and cut prices by 10%. Expected to be sold, either to another buyout group or a trade buyer with a target price of 800m by August.

Odeon & UCI Multiplex: The Odeon and UCI cinema chains were bought by Guy Hands’s Terra Firma for £580m in August 2004. This gave Terra Firma a 35%-38% share of UK box office takings. Terra Firma is looking to cut costs by pooling head office and other functions. The Office of Fair Trading has threatened a full competition inquiry unless “behavioural undertakings” are made.

S&N Retail: Brewer Scottish & Newcastle sold its UK managed estate in October 2003 after deciding to focus on global beer. Spirit Group (Texas Pacific, CVC Capital and Merrill Lynch) paid £2.5bn for the business, whose pub chains include Chef & Brewer and Bar 38. Last year Spirit sold Premier Lodge budget hotels to Whitbread for £536m.

United Biscuits: Finalrealm (which includes PAI, Cinven and DB Capital Partners) bought United Biscuits for £1.8bn in 2000. Costs were slashed by 70m between 2000 and 2002, and the business refocused on priority brands (such as McVitie’s, Hula Hoops and Penguin) and marketing spend stepped up. UB, originally built up by ex-chairman Sir Hector Laing, may be floated or sold to rival business Kraft (which has a 25% stake in Finalrealm).

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1 Comment for “Vulture Culture?”

  1. […] in the mean time to get a good return and make the College saleable? Ian Fraser has pointed out the dysfunctional tendencies of some venture capital deals on his excellent blog (http://www.ianfraser.org/) as has Alex […]

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