EquityFC Blog

Fewer LBOs: good for the mid market? | 31 July 2007

I don't have the answer to that question. But with debt markets tightening and an absence of worthwhile targets, the big LBO players do look like they're on borrowed time (wouldn't you just love the market to correct the big financial engineering plays before the politicians and regulators grind into action?). The latest round of PE jitters hit the Virgin Media sale, which now may go to a trade buyer.
And if investors do want the higher returns affording by PE but can't do it through massive take-privates, perhaps that's an opportunity for them to refocus their funds in the mid market. True, it's not a big enough home for the $560bn-odd of uncommitted "dry powder" in global PE funds. But for smart investors looking for interesting opportunities, MBOs and turnarounds could be just the thing.
Better yet, if (as some economists are predicting) we're entering a downward phase of the business cycle, more mid-market assets could come on the market as corporates divest and companies with flaccid management drop into the turnaround category. For finance directors and controllers, this is a double opportunity. First, there may be greater options for finding work in a PE-backed business. And second, in tighter times the traditional skills of the FD come to the fore. It might be time to wave goodbye to the MBA types and welcome back to the smart strategists with a strong grasp of cost, productivity and the bottom line.

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Babies and bathwater | 31 July 2007

I'm writing a feature for the global magazine of a magic circle law firm at the moment, and gathering views from the great and the good on how the next decade might pan out for private equity. So yesterday I had a chat with Michael Meacher MP, a vigorous critic in the recent debate on PE (his particular bugbear being The Tax Thing).
One of his points is that the tax treatment of PE was engineered as a way of supporting investors in growing companies - genuine wealth and jobs creation, in other words. He says the current crop of LBO players has turned that on its head. Reading the wires today, there seem to be plenty of people backing his calls for reform.
MPs have called for a much broader enquiry into the sector. Commons Treasury Committee chair John McFall spelled it out: "The scale and significance of the industry is now huge. It is absolutely crucial that we ensure transparency and accountability. There is a great deal still to be looked at in relation to rewards in this industry, and to what extent they are generated by financial engineering, or by value creation." [My italics]

In fact, for many MBOs, turnarounds and some take-privates, it is all about value creation. The management need guts, creativity, empathy, leadership skills and hard work to arrive at a successful outcome, and both they and their backers - who face significant risks - ought to have rewards available to them. So it would be a shame if any broad attack on PE were to hamper this critical part of the sector.

I'm less sympathetic to the "financial engineers". When there is no risk - because you pay yourself up front out of increased debt - why should there be preferential treatment? Interestingly, however, the MPs and their long, in-depth enquiry might be proved redundant. Debt costs are increasing, and lenders are getting more suspicious of PE borrowers. They're now stiffening the terms of their loans, apparently. That alone could make the huge buy-outs harder to execute and level the playing field for the multi-billion pound assets between private and public equity. Interesting times...

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TTT - the tax thing | 27 July 2007

Tax - or lack of it - seems to be one of the defining issues in society's relationship with private equity right now. Two obvious things off the bat: first, general partners at PE firms getting mega-bucks without getting taxed like the rest of us is just silly. That's personal remuneration for very little personal risk. Sadly, we're getting bogged down in one of those "if you don't make a special case in order to allow us to be impractically wealthy, we'll run off to Dubai" arguments, when that's not the point at all. It's income tax, duh! Any PE manager who makes that case risks becoming the noughties equivalent of Leona Helmsley.

The real point (my second point) is that investment in enterprise and genuine risk-taking certainly should be incentivised with tax breaks. That's an entirely different proposition, and in fields such as Venture Capital Trusts and genuine VC investments for growth or product development, there is usually a clear public good that can and should be rewarded by the public purse.
Why am I writing about this today? Well, I saw a blog posting about Steve Forbes (he of the flat-rate tax schemes on the 1990s) defending the tax positions for PE firms in the US. Maybe I just haven't been paying attention, but it's interesting that they're having similar discussions about tax over there to our ones here. And the blogger's point is well made: tax breaks for big LBO shops doesn't reward them for investing in business; they just penalise all the other organisations that also invest in businesses which don't get the same treatment. Which kind of makes a compelling, capitalist, market-based argument for the tax position to be rectified.

Remember, most investee companies in leveraged deals are paying very little tax anyway as a result of the debt interest payments. So maybe it is time to cut HMRC some slack? I would be delighted if FCs and FDs wanted to add a comment to this post and bring some much needed finance acumen to this debate...

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Turning values on their head | 24 July 2007

Namedrop time: I've been lucky enough to interview some of the most important figures in UK financial management over the years. For example, I profiled Jon Moulton, managing partner of Alchemy Partners. Far from being an impatient, bullet-headed butcher (which seemed to me to be his professional reputation), I thought he was a terrific guy. Supremely logical, very balanced and perfectly nice. The model of a smart accountant turned businessman and investor, in fact, making him a role model for PE-backed financial controllers and directors...

Terry Smith, maverick investment guru, CEO of Collins Stewart and author of the then-scandalous Accounting for Growth, was another delight to interview - although he did nothing in our 90 minutes together to challenge his rather-more-deserved reputation for pugnaciousness. During our chat he laid into private equity, arguing, among other things, that it was a cheapskate. Trade buyers pay the most, he said, because they'd always find synergies and market share-based value. The public market, with all its safeguards to cover downside risks, pays second highest for assets. But PE needs cheap prices to make the financials work - "so never sell to PE".

Imagine my suprise, then, when I read this week that sandwich chain Pret a Manger was considering ditching its IPO in favour of a possible private equity bid. Even discounting Smith's rants, this seems odd. Sure, PE ought to be able to offer the shareholders of an out-of-favour listed business a healthy premium on their shares to take it private. But outbidding the public markets for a go-go company before it's even floated? That's saying something - about the amount of cash in PE funds, about the public markets and about how executives want to be able to run their companies.

Oh, and one other thing. I've obviously no way of knowing this, but could the sheer cost of floating a business be a factor here? The City's closed shop of banks and advisers extracts a pretty hefty wedge for that kind of transaction - whereas a PE deal could be done relatively quickly, quietly and cheaply. If PE pushes the agencies of the public markets to finally reduce their costs (to make healthy, rather than mega, profits), that'll be another feather in its cap.

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