Activist stakes for private equity

As the private equity world continues to focus on the public markets, with both hedge funds and private equity funds battling it out to make the highest returns from the best public companies, their strategies are continuing to evolve and converge.

This week saw the announcement that Highbridge Capital Management, the giant hedge fund majority owned by JPMorgan Chase, has hired former Goldman Sachs executive Scott Kapnick to run a new private equity business.

Meanwhile, 3i has begun the listing of its £400m vehicle investing in European small and mid-cap PLCs to acquire influential or controlling stakes, no doubt taking its lead from its activist hedge fund counterparts.

There are, however, many reasons why private equity is being pushed towards taking stakes in public companies. The most obvious is the need to deploy the vast amounts of cash swilling around the private equity coffers. Another is the massive multiples now being mooted for private companies, pushing private equity to look at cheaper options in the public markets.

But other reasons have more to do with the lessons the industry has learned from the activist hedge fund community and the growing resistance of public company boards to give in to financial sponsors’ attempts to take them private.

The latter point was highlighted in a recent report by Close Brothers Corporate Finance, which surveyed chief executives and financial officers at companies in the FTSE 350.

Some 39% of senior executives interviewed said that they would take their companies private provided the price and opportunity was right, while 95% of those surveyed believed that the current volume of public companies going private would be maintained or increased over the next year and 59% said that a continuation of current levels or an escalation was “very likely”.

However, private equity is not a preferred acquirer, with 27% favouring a bid from another quoted company. This reality combined with the current strength of activist hedge funds and their success – such as that of Polygon in the recent Countrywide transaction – has shown private equity that a lot of influence can be gained by taking relatively small positions.

Often, the management of companies that private equity houses feel are undervalued – or could perform much better with management or strategy changes, is reluctant to agree to a buyout. This means that a bidder would have to go hostile which often is not a preferred route, particularly in small to mid-cap sectors.

By taking smaller positions they are diversifying the risk and can effectively spread that risk while at the same time putting “tanks on the front lawn” of the listed companies and putting pressure on their boards. From this position, provided they keep their stakes below 30%, there is nothing to stop them launching or agreeing a bid for the entire company if they wish to do so at very short notice.

Or they can simply use their private equity techniques to turn the company around from the sidelines and make a hefty profit from an eventual sale of the newly improved and valuable company to trade or private equity without initially having to pay a significant premium to the market price.

Sandrine Bradley