UK plc is the target of a private equity buying spree. Private equity firms have announced 124 deals for UK companies (both takeovers and minority stakes) with a combined value of £41.5bn so far in 2021, according to data company Dealogic. That was the highest value of deals by this point in the year since it started tracking transactions in 2005.
The latest target is Morrisons. A supermarket that traces its roots back to an eggs and butter stall in Bradford is the subject of a three-way private equity bidding war between American buyout investors.
If the deal for Morrisons goes through it will mean that more than 1 million British workers – including 118,000 at the supermarket group – will be employed by companies with private equity shareholders, equivalent to about 3% of the UK’s total workforce. Other British household names that have been snapped up by private equity since the start of the pandemic include the supermarket Asda, the roadside assistance company AA, the infrastructure firm John Laing and the insurer LV, among many others.
Q&ABritain's most controversial private equity buyouts
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Boots
The British chemist, which traces its roots to the 1830s in Nottingham, was the first FTSE 100 firm to go private when it was snapped up for £11bn in 2007.
The deal, which still holds the record as the UK’s largest private equity buyout, was backed by Kohlberg Kravis Roberts (KKR), and led by billionaire Stefano Pessina, now the pharmacy chain’s executive chairman.
Boots was saddled with £9bn of debt as part of the leveraged buyout, in which KKR and Pessina put in £2.5bn of their own cash and borrowed the rest from investment banks. Just days after deal closed, Alliance Boots paid a £1.55bn dividend to a holding company, though a spokesperson at the time said the money remained within the company and had not been paid out to the new owners. The costs of servicing its debt pile in those first few months were estimated at £65m a month.
The deal also led to the group shifting the headquarters of its holding company, Alliance Boots, to Switzerland, a decision which has been criticised for costing the UK million of pounds in tax revenue, but which the company has denied was motivated by tax savings. Boots’ headquarters remain in Nottingham.
The firm was eventually sold off to America’s largest pharmacy chain, Walgreens, headquartered in Delaware, in a $15bn (£10.8bn) deal that was completed in 2014. Pessina, who invested an estimated £1.25bn of his own capital in the 2007 deal, was previously estimated to have gained 214m shares in Walgreens, worth an estimated £11.5bn, as part of the sale.
Debenhams
Debenhams was taken over by a consortium of private equity funds – TPG, CVC Capital and Merrill Lynch – for £1.7bn in 2003.
Executives installed to overhaul Debenhams were tasked with slashing costs while increasing sales and profit margins. It meant remortgaging some of the stores to save on borrowing costs, and selling 23 shops to British Land in 2005 for £495m, which were then leased back on expensive rent deals up to 35 years long. The proceeds were paid to the private equity investors.
The chain also started regularly discounting items to shift stock that did not sell, a move which has been blamed for dragging the brand downmarket.
The trio made huge returns on their £600m investment, having borrowed most of the money used to clinch the deal.
They collected £1.2bn in dividends despite owning the company for less than three years, and critics say they profited from what is known as a “quick flip”: buying a listed business cheaply, loading it with debt and then refloating it at a big profit. The company, which owed just £100m when it was taken private, saw its debts surge to £1bn by the time it was returned to the stock market in a £3bn float in 2006.
Analysts have said that in its weakened state, Debenhams failed to generate enough revenue to reinvest in the business, a problem which eventually led the company to close its doors earlier this year.
EMI
EMI was the fourth largest record label and largest music publisher in the world by the time Guy Hands’ private equity vehicle Terra Firma bought the company in a £4.2bn deal in 2007. Terra Firma put in £2bn of its own capital, while Citigroup, which advised on the deal, committed to taking on the debt.
The private equity house described EMI – which owned Abbey Road studios and was then home to artists such as Kylie Minogue, Norah Jones, Iron Maiden and Coldplay – as an “asset rich business” that needed to “substantially” cut costs and shift its focus from producing music hits to managing music rights. It went on to make major changes to senior management and by early 2008 announced it was making 2,000 of EMI’s 5,600 staff redundant.
Meanwhile, Hands’ firm was finding it harder to meet loan conditions set by Citigroup, which Terra Firma says became more “onerous” during the 2008 banking crash. The company’s financial troubles escalated and in November 2009 EMI was in a standoff with the UK pensions regulator, which eventually ordered it to pay £200m in to the staff retirement scheme.
A month later, Terra Firma filed a lawsuit against Citigroup, alleging it had driven up EMI’s sale price by suggesting there was another party interested in the company before the sale. But the jury ruled against Hands, saying he wasn’t fooled into paying an inflated price for the business. Hands launched and abandoned a second £1.5bn lawsuit against Citigroup six years later, claiming he personally lost €200m through the deal.
Hands surrendered control of EMI to bankers at Citigroup in 2011, after failing to keep up with its debts. EMI was eventually split up, with its recorded music unit sold to Universal for £1.2bn in 2011, and its music publishing division to Sony for $2.3bn (£1.7bn) in 2018.
Globally, private equity companies controlled companies worth $5tn (£3.6tn) in September 2020, according to Preqin, a data company. By comparison the value of all companies listed on the FTSE 100 is only about £2tn.
There are signs that more UK companies could go the same way. Bridgepoint, a firm that aims for targets valued at about the £500m to £1bn mark, said last week that it will list its own shares in London to raise £300m that is – at least in part – for making more deals. US investment house KKR, whose founders were famously termed “barbarians at the gate” during the hostile takeover of conglomerate RJR Nabisco in 1989, on Tuesday said it would step up its focus on the UK.
Here is a guide to the private equity industry and how it works.
What is private equity?
Anyone who invests in company shares that are not listed on stock markets could be termed a private equity investor. In practice it tends to be used to describe investors who raise money from others to invest in or buy companies. Often they use borrowed money, which has made buyouts easier during the past decade as borrowing costs have fallen.
Targets can range from deals worth tens of billions of dollars to smaller listed businesses such as British aerospace company Senior and promising contenders who are looking for investment. Unlisted companies whose original owners – founders or families – want to cash out are also prime targets.
Who invests in private equity?
Private equity firms generally use other people’s money, raising cash from investors such as pension funds and sovereign wealth funds and then investing it. The industry first came to attention in the 1980s with a wave of leveraged buyouts (borrowing money to take bigger companies private) by companies who were seen as relative outsiders. Since then, however, the industry has moved ever closer to the mainstream.
That has meant that pension funds have increasingly allocated money towards them. A 2014 study of US pension funds found they doubled their exposure to private equity between 2007 and 2013. An allocation of 8.5% of their portfolios is likely to have increased further since then.
The attraction for pension funds is that private equity investments appear to offer higher returns on investment – a key concern when trying to sustain enough cash to pay out to retirees now and in the future.
How do private equity firms make money?
The core business is buying undervalued private companies, improving their financial performance, and selling them on for a profit. Private equity firms in the UK spend 5.9 years on average invested in each company, according to a January study of private equity-owned businesses by EY, an accountancy firm.
Private equity companies make money in a few different ways. First, the firms charge pension funds and other clients a percentage of the money they want invested, plus a larger percentage of any returns beyond a baseline. Traditionally those percentages were “2 and 20” respectively, a setup that can generate enormous amounts of money.
Why is this controversial?
The key element for private equity investors is boosting the returns – and taking their 20%. A key element in boosting returns is debt. Private equity investors often make their purchases using borrowed money, meaning they can pull off bigger, leveraged deals with smaller piles of cash.
Debt often ends up on the target company’s balance sheet, meaning that interest payments reduce the company’s earnings – and its tax bill.
There are other ways of boosting company earnings in the short term that may not be good for it in the longer term. One obvious way is cutting costs, often by reducing the number of employees, which earns opposition from trade unions and many politicians.
Another method of pumping returns is selling assets that the company has previously built up. That can be property (such as Morrisons’ shops) that they can sell and lease back, or subsidiary companies that are not a core part of the business. That frees up capital in the short term, but may be more expensive in the long run or even destroy historic businesses. Prem Sikka, emeritus professor of accounting at the University of Essex and a member of the House of Lords, says private equity firms often deploy “complex corporate structures” using tax havens that are difficult to scrutinise.
What do supporters of private equity deals say?
Supporters of the industry argue that private equity outfits fund the growth of innovative companies and can hold investments for longer than a stock market fund manager, who must follow the fortunes of listed companies quarter-by-quarter.
“Private equity creates ‘public value’ – a combination of social and economic benefits – through the long-term partnerships it fosters with businesses across the UK,” said a spokesperson for the British Private Equity & Venture Capital Association, a lobby group.
Blackstone, one of the biggest US private equity investors, told American regulators last year that private equity is more active in managing companies and is more patient than stock market money.
Is there any sign of a backlash against private equity?
Some academics question whether private equity firms are worth the money. Ludovic Phalippou, professor of financial economics at the University of Oxford’s Saïd Business School, calculated that US pension funds who invested in private equity tended to make only 1.5 times their original investment, a similar level of return to investment in smaller and mid-sized publicly traded companies.
Political pressure appears to be the more likely avenue to clip private equity’s wings. Sikka suggested reforms that could make a difference would be cutting tax relief on interest payments, and changing bankruptcy rules to give protection to employees and unsecured creditors if a private equity-owned business goes under. Another tweak would be taxing private executives’ carried interest – the 20% of the “2 and 20”- as income rather than a lower-tax capital gain.
However, the vast sums raised by private equity firms in the pandemic years suggest that institutional investors such as pension funds are growing increasingly comfortable with the industry, whatever the fees.
