It was in the wee hours of a Friday morning in late May last year when executives from Hicks, Muse, Tate & Furst and Apax Partners marched into the London law offices of Allen & Overy and delivered an ultimatum. Tired of six months of haggling over the Yell directories business, they said: “If we don’t sign now, we walk.”
Lyndon Lea, partner at Hicks Muse, and Stephen Grabiner, a director at Apax, delivered the pronouncement to a junior staffer of Yell’s parent, British Telecommunications. Normally, this would have been directed to a big shot, like John McElligot. But McElligot, the corporate development director in charge of negotiating the deal for Yell had been fired the week before – an example of the twists and turns that distinguished this deal.
Over the past few years, directories have become one of the most prized takeover assets in Europe as private equity buyers and media companies struggle to establish pan-European directories powerhouses. Thus, it’s not surprising that Hicks/Apax fought tenaciously to acquire Yell from BT. The roughly $3.5 billion (GBP2.4 billion sterling) transaction, in which the two firms are equal partners, emerged as the largest LBO in European history and the largest LBO of 2001. The debt structure broke down as GBP950 million of senior debt, GBP500 million of high yield, GBP100 million of that was discount notes, and GBP100 million of vendor notes.
Bitter Battle
Internal politicking at BT put Hicks Muse and Apax in fierce competition against the only rival consortium trying to obtain Yell: Kohlberg Kravis Roberts & Co. and Texas Pacific Group. While Sir Christopher Bland, the chairman of BT, insisted on selling Yell to Hicks Muse/Apax, BT finance director Philip Hampton the brains behind the company’s earlier restructuring and debt-repayment efforts wanted KKR/TPG to buy it.
Hampton, sources say, was away in the U.S. on a road show for a BT equity issue when Sir Christopher decided that BT would proceed with Hicks Muse/Apax. Because of a miscommunication within BT, however, informed sources say Hampton learned about Sir Christopher’s decision just 24 hours before the contract was to be signed. Hampton was alleged to have said, “This deal is not happening.”
But it did happen.
However, even with Sir Christopher’s go-ahead, the deal nearly hit a fatal snag. While Hicks Muse/Apax were discussing Yell with BT, the Office of Fair Trading (OFT), a U.K. regulator, asked BT to cap its annual advertising fees for the next four years at the retail price index (RPI) minus 6%. That meant Yell’s prices could only rise at a rate 6% below inflation. Low inflation meant prices would have to be reduced. That announcement shaved about GBP1 billion off Yell’s value, as analysts speculated whether Hicks Muse /Apax might pull out of the deal altogether.
Lea of Hicks Muse says that while “growth prospects were unquestionably diminished” due to OFT revisions, “Yell in the U.K. is an extraordinary cash generative business that is balanced by a U.S. division that is growing at 20% per annum organically. Most commentators on the deal ignored the growing U.S. business and didn’t think about the strong cash-flow nature of the U.K. business.”
Analysts also predicted the OFT’s move would cut Yell’s profits by about 10%. Lea admits that profits were cut, but says the transaction price reflected the prospective profitability of the business, not the historic profits.
OFT’s ruling changed more than just Yell’s price. It caused Deutsche Bank Private Equity, which Hicks Muse/Apax had brought in as a minority investor, to defect since the regulatory changes would have substantially diminished Deutsche Bank’s total investment.
Although Deutsche Bank denied it in a published report, a source close to the deal confirmed that Deutsche decamped to KKR/TPG, taking its knowledge of the Hicks Muse/Apax valuation and extensive due diligence with it. KKR/TPG did change its bid that May week, offering GBP400 million more than it originally was prepared to pay. The BT board told Hicks/Apax it would be willing to give them exclusivity again, if they got the deal done in three days.
Despite the difficulties with the deal, Hicks Muse/Apax felt the directories industry was simply too valuable to give up on. What’s more, Hicks Muse/Apax had already spent a “substantial amount” of money during the two-week exclusivity contract it secured after the first round of bidding. “During that period of exclusivity we chose to spend real money and work like hell, which is unusual in private equity, to take that risk,” says Lea. “We actually incurred substantial costs in that two weeks, to get to the point where, at the end of it, we gave them a fully financed unconditional offer for the business.”
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