The backlash has begun. Public shareholders have finally had enough of seeing companies delisted at one price and then sold back to them for a higher valuation a couple of years later. This year has seen a series of private equity bids rebuffed by the boards of listed businesses, the case of Signet just being the latest example.
This year has seen a significant drop-off in the number of public-to-private deals in the UK. CMBOR puts the completed deal figure at £1.5bn for the first half of this year, a 72% decrease from the £5.2bn in the same period last year.
The board of Signet, the UK jewellery maker, has explicitly stated it opposes a private equity bid, following reports that Apax and KKR had teamed up and were mulling over a £2.3bn offer. Seen in the context of similar high-profile rejections, the idea of a backlash against private equity seems plausible.
Permira has been a particular victim of this new found robustness, if one can assign victimhood to a firm that is on course to close an €11bn fund. This year it has been turned down three times, from HMV, for which it offered £842m, from Kesa Electicals, for which it offered £1.72bn along with KKR and Blackstone, and from De Vere, which chose instead to sell to the Alternative Hotel Group.
Apax has also been on the receiving end of rejection, with bids for ITV, in conjunction with Blackstone, and House of Fraser both knocked back. Robert Tchenguiz also found his bid dismissed by the shareholders of Mitchells & Butler. GUS, the owner of Argos and Experian, rejected private equity approaches for the two business in July despite interest from Permira (again), Bain Capital, Thomas H Lee, and CVC. GUS said it felt its shareholders would be better served by a demerger of the two businesses.
Rejecting a private equity bid has had a negative impact on the share prices of most of these companies, with shares not only priced well below the offer price but some even below their price in the months before a bid was mooted, resulting in some observers questioning whether the boards of these businesses had made a mistake. James Stewart at ECI says: “Quite often after a failed bid, share prices decrease. There is nothing unusual about this, whether the anticipated bid was from a private equity firm or any other type of buyer. The issue is to what extent a public company reflects on a failed bid and the extent to which, and how, it re-orientates its strategy or builds a more direct dialogue with its institutional investors.”
This dialogue is important as it will establish in the minds of the investors that the management team in charge can exploit the opportunity the private equity bidder saw. Stewart continues: “A bid approach was prompted by something. The business was either under-valued or there was a potential for re-engineering the business activities of the company to create value.” The problem for the boardroom comes if the share price continues to fall, as this demonstrates that the management has failed, either in successfully repositioning the company or in achieving the potential value that prompted the initial bid.
On this front, Signet can look to Marks & Spencer. Although not strictly private equity, Philip Green’s bid was private equity in all but name. In the short-term the share price dipped dramatically, but since then it has performed very well (the share price is a third higher now than Green’s 400p bid), helped in no part by a change in management, which is generally how private equity funds seek to create value on deals.
The notion that a company can perform just as well on the stock market as it can in the hands of a private equity firm was spelled out by Alistair Mundy, an executive at Investec Asset Management, in a letter to the Financial Times. In it he said: “The benefits that accrued from the asset sales and working capital improvements following the Debenhams deal can be easily replicated by the sale or securitisation of Signet’s loan book and a reduction in inventory.”
Some investors are now trying to encourage company managers to use private equity like strategies. Stewart says: “Institutional investors are keen for public companies to look at some of the techniques used by private equity, such as creation value, and there is a greater trend among investors to judge for public companies along the same parameters as private equity firms, in particular in regards to efficiency and cost control.”
Another trick that has been picked up is that of recapitalising to take on more debt and return cash to investors. ITV is a good example of this, returning a total of £500m to investors following the failed approach of Apax et al despite falling advertising revenues for the opening half of the year. Rating agency Fitch showed its displeasure by downgrading ITV to BBB-, its lowest investment grade ever, from BBB.
The pressure to adopt private equity tactics only exists among certain investors. However, the inherent conservatism of public company boards means that the use of such tools, which includes the private equity trick of releveraging and using the money made to return some cash to investors will remain rare for the short term, especially given the current concerns over potential interest rate rises. Public companies will struggle to match private equity in terms of returns because it lacks private equity’s flexibility and privacy. Andrew Roberts, partner and national head of private equity at Travers Smith, says: “There is a question as to why any company would want to remain public. In the private world regulation is much lower, and you are not in the public spotlight for annual general meetings and so forth. A lot of directors are now saying ‘why should I operate in the public glare when I can go private and into the hands of private equity firm’.”
Whether there really is a reaction against private equity among public market investors remains a limited argument, but it is one which the industry at large is taking seriously and has been mulling over for the past 12 to 18 months at the various conferences around Europe. Shareholder resistance has even led to new ways of enticing them. Private equity is well aware of its reputation of going in, buying a company, performing some restructuring magic and offering it back to the public markets at a higher price than they bought it for, and some do attribute the recent spate of rejected bids to this perception. As a result, private equity firms have attempted to offer existing shareholders certain sweeteners. The Apax consortium’s original offer for ITV would have it buy 48% of the company for £1.3bn, paying existing shareholders, left with 52% of the business, a special dividend worth 86p per share. When this was rejected the new proposal was for the entire share capital of ITV, allowing the shareholders not only the opportunity for an 86p per share dividend but also to buy a share in the new company set-up to acquire ITV. If they didn’t want to do this, the shareholders would have been offered 44p a share in cash. Despite all this, the bid was rejected again.
Stewart says: “Each bid is evaluated on its own merits. There’s no trend against private equity, no real agenda by public investors to reject private equity bids, because after all the money is coming from the same pot. Investors are not going to be driven into a sale process unless they can achieve value from the sale.”
If there is a less willing attitude surfacing on the boards of the UK’s public companies, it is based not on any vague anti-private equity hostility but instead on a desire to reproduce private equity’s results, and a self-belief that it can. If the deal is right, shareholders will generally sell. It is reckoned that for a private equity fund to make an IRR of 20% it would not be able to pay more than 125p per share for Signet. The FT quoted one shareholder saying that a fair value for the business would have to be well above 130p. The fear among company managers is that they may be selling out too cheaply, and that if a private equity firm can see a potential goldmine, it might as well be exploited by the existing shareholders, an attitude no doubt reinforced by M&S post-Green bid. In short, managers are afraid shareholders will accuse them of selling too cheaply.
This is an accusation which has some justification, particularly in these times of the mega-fund. Private equity is constantly in the news and private shareholders, not just the institutional investors, are well aware of the sort of money now lying in private equity’s war chest. This puts the balance of power in the hands of the public markets, and has dangerous implications for the private equity industry.
Buyout funds are aiming to raise US$82bn in new funds worldwide. Just under US$300bn is estimated to be uncalled in existing buyout funds with US$283bn in aggregate commitments raised in 2005. With such enormous assets, the mega-funds are forced to go for the biggest deals, and the biggest companies are, by their very nature, almost always public ones. Public companies know this.
Corporates have become much more shareholder conscious as a result, leading to boards of directors waiting for the interested firm to up its bid, only for the deal to fall through. As Tom Lamb, co-head of Barclays Private Equity said recently: “Nothing is being consumated – it’s all foreplay and no finish.”