Private Equity in the Dock

The UK private equity industry has taken a bruising over the past few weeks. The BVCA and a clutch of heavyweight private equity managers – Robert Easton, managing director of the Carlyle Group, Philip Yea, chief executive of 3i, Dominic Murphy, partner at KKR and Damon Buffini, managing partner of Permira – were called to testify in a public meeting of the Treasury Select Committee, an arm of the UK Parliament. David Blitzer, senior managing partner of Blackstone was also summoned but was a no-show due to Blackstone’s upcoming IPO. He will be expected to provide testimony at a later date.

The BVCA was given such a grilling that in the media frenzy and mudslinging that surrounded the meeting, Peter Linthwaite resigned his post as chief executive ‘effective immediately’. Linthwaite attempted to explain to the Committee that the private equity and thus the BVCA’s membership covered such a vast industry from venture investors to mega buyout houses that he could not possibly speak specifically for LBO houses but for the industry as a whole.

So the big boys were summoned to be questioned themselves by the Treasury Select Committee Chairman John McFall, a Labour MP from West Dunbartonshire, a Scottish constituency, and thirteen other members of parliament in a three and a half hour marathon hearing.

“Since the last meeting with us we have had the resignation of the chief executive of the BVCA and people calling others in the industry the enemy within. It seems that you are fighting like ferrets in a sack. When is the private equity industry going to get its act together?” asked McFall. “I think it is getting its act together,” answered 3i’s Philip Yea. “But there is no unified voice coming from private equity, is there? It is not helping itself,” the Chairman fired back. Dominic Murphy of KKR weighed in and said: “Ask whether everybody in the FTSE has the same opinion. The private equity community is very broad-based [from venture to buyouts]. To expect everyone to have an identical perspective would be unusual.”


Besides telling the industry to get its act together, the MPs quizzed the Private Equity Four on every topic from employee treatment and pensions to their personal tax breaks on carried interest but some of the witnesses’ most heated debating came when Chairman McFall opened up the panel to Brooks Newmark, a Conservative MP from Braintree and a former partner of private equity firm Apollo Management. “Compared with the days when I was in the industry, now there seems to be a great deal of leverage. Do you share the concern that leverage is high and that the problem is exacerbated by very covenant-light loans?”

KKR’s Dominic Murphy replied: “I do not think it is in the interest of any private equity firm to over-leverage. We do lots of due diligence to find out where that business sits within the industry and what unexploited potential the business has. We then design a capital structure around it which can withstand a full economic cycle.”

“We can all reverse engineer financial models,” interrupted Newmark, “but the fact is that debt-to-cash flow multiples are at a historic high. Given that it is you who are responding to this, part of the accusation is that you guys buy up businesses and asset strip them. I think you guys are involved in Boots. Why do you sell off assets? Is it simply to pay down the debt?”

“The Alliance Boots story is all about growth. We will open a substantial number of pharmacies in the UK and Europe – if deregulation takes place,” said Murphy. To displace the heat on Murphy, Permira’s Buffini said: “We buy a business for the long term and then we want to sell it for more than we bought it for. That is how we make returns for the pensioners who are in our funds.”

“I am not here to listen to what a wonderful job you are doing; I am here to try to get an answer to the question of leverage and systemic risk. There is a systemic risk because the loans that you guys get have very weak covenants. Therefore, you are effectively filling your boots with debt with the risk that if things go wrong you will not have the discipline of tight covenants.” Carlyle’s Easton replied that “covenant light loans are good for the company and the equity in it. In the event of a downturn it simply means that the company will ride it out better with respect to its debt.”

With this remark Chairman McFall had heard enough and said: “Mr Easton, the Bank of England has expressed concern about covenant-light loans as have senior US politicians. So what you say does not seem to square with information that we have received either from the Bank or England or US politicians. I think you can cut the nonsense in terms of cov-light loans being good.” And 3i’s Yea bravely faced McFall again and said: “Chairman, prices have risen. I think that the risk of a failure has risen, as we put in our submission. We do not believe there is a systemic risk. We believe that this debt is coming in from CLO and CDO funds, which are widely held. We are concerned that prices are at quite a high level.”


And as this debate began to hot up George Mudie, a Labour MP from Leeds East, accused the Private Equity Four of paying vast sums to consultants to coach them for the hearing. He went on to say: “I see in the audience a very prominent figure who has probably been part of that.” He was referring not very subtly to Peter Viggers, a Conservative MP for Gosport since 1974 and a member of the Treasury Select Committee. “First, do you think it has been worthwhile?” Mudie continued to question, “Second, is it tax deductible? You were doing very well. Peter must be very proud of you. You have moved into the BVCA territory with your bland and prepared answers. Mr Newmark just asked you a straightforward question about leverage. Your predecessors got savaged because they treated us like mugs and would not answer straightforward questions. Mr Newmark has put a straightforward question and you have treated us like mugs. What is the situation on leverage?” 3i’s Yea, again, boldly faced the committee and said: “Mr Mudie, in my answer I said that we…” Mudie interrupted: “You are okay; you are the acceptable face of private equity. It is the other three villains who concern me.” Carlyle’s Murphy offered up a response: “Mr Mudie, from KKR’s perspective if we look at leveraged levels in the 1980s we used to borrow 90% debt and put in 10% equity. The fact is that we are now putting in 30% equity over our 31-year track record. We do not say that leverage levels are excessive.” Mudie was on the hunt again and said: “Did Peter not tell you to answer straightforward questions?” By this point Easton had had enough of Mudie’s wind-up and said: “Perhaps I can confirm that Mr Viggers did not help us with this at all.”


Newmark wasn’t quite finished with his line of questioning and added: “But you are taking on much higher debt.” Easton replied: “But the multiples of whatever cash flow metric you look at have changed and are above historic highs. What is interesting is that default rates are at historic lows.” “Is that because you have covenant-light loans?” asked Newmark. Easton declared that “clearly, there was confusion about covenant-light loans.” So the Chairman asked him to give the Bank of England a tutorial. And Easton retorted: “I think we need to.” Murphy said: “Covenant-light loans have really only come into force in the past six months, so there will not be a default in that respect. They did not exist last year.”

“That is only because you guys are beating them on the head for this debt,” said Newmark. And Murphy admitted that “everyone likes to negotiate.”


Sally Keeble, a Labour MP from Northampton North wanted to touch on the pensions debate that has raged in the UK since the Pensions Regulator offered support to the Boots trustees that asked for a pensions top up of £1bn on top of the £11.1bn buyout offer from KKR. “If we take Boots for example, for a private equity firm to restructure it and pull out after five years looks like a short term investment to most people,” said Keeble. KKR’s Murphy was quick to reply, “The average life-span of our investments is seven years while the average life-span of an institutional investor is probably less than 12 months. Analysts in the public market today are very much focused on quarter-by-quarter results; KKR is interested in long-term performance.” “How long will you stay with Boots, then?” Keeble fished. “Five years,” replied Murphy. The light flickered across her eyes; Keeble thought she’d hooked Murphy when she said: “So you will pull out of the agreement with the pension funds half way through, because the commitment is for 10 years, is it not?” Murphy easily batted her point away when he said: “The relationship with the pension fund will be protected forever or as long as Boots survives. I do not think that the relationship between our ownership period and the 10 year payment plan has any relevance.” Overall the Private Equity Four performed well under pressure but this debate has only just begun.