Yahoo Finance Inside private equity's race to buy up Britain
2021 is a record breaking year for private equity deals in the UK, as 'corporate raiders' target cheap British companies on the stock market.
Private equity (PE) refers to finance firms that invest in private businesses or do deals to take public companies private. PE firms typically target underperforming companies, with a view to turning them around and selling for a profit. But the industry is also associated with asset stripping and job losses.
Low interest rates have created a dream environment for private equity, which typically relies on borrowing to fund its deals. The global buyout industry has raised a record $1.6tn (£1.15tn) to spend, according to data from Preqin. Funds are now under pressure to spend that cash.
The UK is an attractive place to go shopping. The legacy of Brexit and the FTSE's over reliance on 'dull' industrial and heavy industry stocks has largely put off international investors in recent years. As a result, many UK listed companies look cheap compared with international competitors.
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“The FTSE 100 is the worst performing major equity index since the UK Brexit vote in June 2016,” says Russ Mould, investment director at AJ Bell. "Unpopular equals unloved and unloved equals potentially undervalued."
There have been 401 private equity deals so far this year in the UK worth more than $49.8bn, according to data from Refinitiv. That’s the highest number in the first half of a year since data began being collected in 1996. The second highest was in 2018, when 297 companies went private.
British companies that have fallen to private equity include: supermarket Asda; mechanics AA; infrastructure firm John Laing; St Modwen Properties; fund administrators Sanne Equiniti; private jet firm Signature Aviation; insurer LV; aerospace company Senior; and pan-Asian takeaway chain Itsu.
The most recent UK deal to grab headlines is the ongoing battle for grocery chain Morrisons (MRW.L). A consortium led by Fortress Investment Group in advanced talks to buy the business and on Friday upped its offer to £6.7bn ($9.3bn). Apollo, a fellow buyout firm, is considering joining the takeover. Clayton, Dubilier & Rice (CD&R) — a rival US firm — is reportedly mulling a counter-bid.
If the Morrisons is taken private, 1 million British workers will be employed by companies owned by private equity. This equates to about 3% of the UK’s total workforce.
The deal spree is provoking anxiety in some quarters, as old questions about the merits and pitfalls of private equity resurface. Politicians and unions worry that takeovers could mean the breakup of crucial businesses and job losses. Investors, meanwhile, grumble that private equity is cherry-picking UK businesses too cheaply.
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Darren Jones, chair of the House of Commons Business, Energy and Industrial Strategy Committee, worries about potential "job losses and pension fund shortfalls" at Morrisons. He raised concerns about the high levels of debt used to fund these types of takeovers in a letter to the Competition and Markets Authority.
Private equity firms borrow to fund takeovers but the way deals are structured means the debt ends up on the balance sheet of target companies. Data from Refinitiv shows that private equity deals typically involve debt worth around six times a company's earnings. That's much higher than typical debt levels for listed companies. Huge debt piles leave firms more vulnerable to changing economic winds.
“Our main concerns are about job security, while maintaining and improving our members’ terms and conditions of employment,” said Joanne McGuinness, Union of Shop, Distributive and Allied Workers national officer.
Morrisons employs 118,000 people in the UK and there are fears that this number could fall after any deal. Cutting headcount to reduce costs and squeeze efficiency gains is a typical private equity strategy. A recent Harvard Business School study found that employment at target firms shrinks on average by 13% in the two years after private equity takeovers.
McGuinness said his union had a "constructive working relationship" with Morrisons' bidders but was "seeking greater engagement and further assurances for staff on the future of the business."
Private equity interest also raises concerns about asset stripping. A company can sometimes be valued lower than the sum of its parts, known as book value. Buying a business then selling off the crown jewels — property, factories, equipment — can be a quick way for private equity firms to make money.
Andrew Koch, a senior fund manager at Legal & General Investment Management, a top 10 Morrisons shareholder, said last month bidders appeared to be interested in Morrisons for the "wrong reasons".
"If an acquirer makes strong returns this should come from making the company a better business," Koch said last month. "It should not come from buying its property portfolio too cheaply, levering the company up with debt, and potentially reducing the tax paid to the exchequer."
Analysts at Bernstein said they “struggle to see” how assets wouldn’t be stripped at Morrisons if the deal price was raised. Assets that could be sold off could include petrol stations, factories, warehouses and stores.
The Morrisons bidders have tried to put shareholders' minds at rest, saying the supermarket's large real estate portfolio — part of what makes it an attractive target — wouldn’t be put on the line. But that promise is not legally binding.
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The EU has implemented a directive to stop asset stripping after a PE acquisition and the ECB requires stringent internal reviews of “all types of loan or credit exposures where the borrower is owned by one or more financial sponsors.” But similar rules don't exist in the UK.
A lackadaisical attitude toward takeovers partly explains why private equity companies are so fond of the UK. In France, for example, labour laws are stricter and the government takes a hard-line approach to foreign acquirers.
“Given previous highly leveraged purchases of high street brands, which have ultimately resulted in administration, job losses and pension fund shortfalls, there is concern that regulatory bodies have insufficient oversight or powers to intervene when new owners act irresponsibly,” Labour's Jones wrote to the CMA.
It's not just those on the political left who are worried about the private equity deal spree. Many investors are concerned that boards are pushing the deals through too cheaply. Data compiled by AJ Bell shows average bid premium of 36% by these private equity firms.
Morrisons' largest investor recently said it was "not inclined to accept" the Fortress offer, forcing bidders to sweeten their offer.
With the UK economy on unsure footing, many will worry that the latest wave of deals could end badly for millions of workers and investors.
Whatever happens, the people behind the deals almost always win. Private equity firms charge a 2% management fee on the money raised from investors and a 20% performance fee on the money made from exiting investments.
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Private equity firms argue this structure incentivises them to make sure their investments are actually successful. It has also helped make PE execs among the richest financiers in the world, with many fund managers earning millions of pounds a year from their investments.
Notable names in who have amassed fortunes off the back of private equity include Stephen Schwarzman, chairman and CEO of Blackstone, who is reportedly worth a cool $15.4bn. John Grayken, founder and chairman of Lone Star Funds, was worth $7.4bn at last count. Tom Gores, founder of Platinum Equity, has a net worth of $5.7bn, according to Forbes.
“Cheap money is a huge bonus for operators like private equity firms so the current record low interest rates are fuelling their spending power," said Susannah Streeter, senior investment analyst at Hargreaves Lansdown. "If they can fund acquisitions cheaply then the potential gains for them are all the higher.”
Disclosure: Apollo Global Management has agreed a deal to buy Yahoo Finance UK as part of a broader transaction with current owners Verizon. The deal has yet to close.
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