Sainsbury, Boots and madness
Most private equity firms claim that they contribute more to the businesses they buy than the injection of relatively cheap debt – although, as I explained here on 15 February, much of the super-normal returns they’ve generated over the past few years has come from little more than loading up their investments with borrowings at a time when markets are rising.
Thus it has emerged from Blackstone’s recent filing with the SEC, prior to the imminent flotation of its management company, that it has probably borrowed in the order of $80bn for its portfolio of companies over the past three years or so. That’s on a par with what even Gordon Brown has been borrowing recently.
This process of “leveraging up” balance sheets isn’t rocket science. Listed companies could do it without selling themselves to private equity investors – but on the whole choose not to do so, because their conventional institutional shareholders generally don’t like the risks that come with the increase in borrowing.
There’s something unsettling about the contrasting appetites for risks of the institutional shareholders on the one hand and the debt-providers, which are often the same institutional shareholders wearing a different hat (as well as hedge funds and investment banks). The debt-providers lend on repayment terms and at rates of interest that imply that they are blind to the risks perceived by equity providers.
The recent trend for some loans to private equity to be so-called “covenant-lite,” giving only limited rights to the lenders to demand repayment when the going gets tough, may be the manifestation of the acute phase of market madness.
It’s a mania induced by excessive global liquidity. Or to put it another way, there is so much cash sloshing around the system looking for a home that much of it has been and will be lent or invested stupidly.
Another manifestation of this madness may be the attempts by private equity to buy Alliance Boots and Sainsbury. In both these cases, if the bids are successful, the current senior executives and their respective operational strategies are expected to be retained. The only big changes will be to their balance sheets: property will be stripped out, debt will be piled on.
There’s something intrinsically fatuous about deals that appear to be driven by simple financial engineering. It’s not as if either of these companies is in dire straits or in need of a structural overhaul, as shown by trading statements and have issued today.
The corollary won’t please the critics of private equity: it’s that if private equity bids a bit more than Sainsbury’s and Boots’s respective current share prices (say 575p for Sainsbury and £10.25 for Alliance Boots), it would be rational for their shareholders to sell. If these are deals driven by the under-pricing of risk, then it’s a fool who doesn’t sell that risk when given the opportunity to do so.
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If there is so much cash slopping around the system why is it that finding funding for high growth start-ups and spin-outs in the UK remains so incredibly difficult?
Dear Mr Peston,
At last a comment from you that reflects the situation at hand.
Corporate restructurings occur in waves and history has demonstrated that they coincide with rising stockmarkets and credit expansion and unsurprosingly collapse with stockmarket declines.
In a revealing study by Renneboog and Martynova these waves occur in two stages with the latter stage domintaed by value destruction. I would suggest that despite all the hyperbole about private equity we may be in the latter stage of the wave that started in 2003 (which coincided with stockmarket lows).
It is also impprtant to bear in nmind that the returns to private equity are unsurprisingly positively correlated with stockmarkets as they are long equity and as a consequence offer little diversification benefits.
I also note that all the justfication is based on EBITDA/interest cover ratios which again highlights the short-termism of these deals as little account is taken of the the costs involved in maninatining the asset base of the businesses being targeted.
Yes, this is all part of the spending alacrity in this great boom we're enjoying. However, in the months and years ahead we will look back at adventures such as these with disdain at these huge sums.
Come the recession, I'm sure Sainsbury's and boots could be bought for a snip...
Exactly, strip the property and load up on debt, who wins from these deals, they are ruining good companies for short term gains.
What we need is a long-term focus on the financial position of plcs and some way of preventing raiders from coming in with deals that are just about enough to force a sale and then making a quick buck leaving the firms in poor repair afterwards with very little in the way of an asset base with which to get back on track.
People will realise as MUFC fans have that Plc. simply means "open-house" its an open door inviting all manner of unwelcome guests in to help themselves to your jewels.
There seems to be something wrong with the way the ' symbol appears in your text on my computer screen. I get a combination of symbols similar to aEtm. Very odd and it makes your text very distracting to read...