United against private equity

This summer has seen two iconic British brands sold to foreign corporates. That the private equity vendors of Weetabix and Boots weren't subjected to a public grilling illustrates the strides the industry has made since the summer of 2007. Not only did that time mark the onset of the credit crunch (the run on banks predated Lehman's collapse by more than a year), but it was a time when the world seemed outraged with private equity.

Accusations of cost-cutting and mass-layoffs at the AA in the run-up to a lucrative £4.3bn sale to Saga by backers Permira and Apax spiralled into demands by trade unions and ultimately a grilling by the UK Treasury Select Committee. The immediate outcome was a change of the guard at the BVCA, which saw the ushering in of a chief long on public relations acumen but short on industry knowledge. The longer-term implication of that summer was an industry more in tune with openness across a wider stakeholder base.

"There has been an improvement in the transparency of the private equity industry since the recommendations made by the Walker Report and while there are still weaknesses in the quality of reporting from some private equity portfolio companies, the industry deserves some credit for attempting to address the accusation of secrecy that unions and other commentators had made against it," concedes Brendan Barber, secretary general of the Trades Union Congress (pictured above). His sentiment is meaningful given he spearheaded the charges against the industry in May 2007.

In fact private equity has passed a big test recently: KKR's partial sale of Boots proved not only that one of the largest buyouts of the bubble years - with an equity cushion of less than a third - did not go bust, but also that private equity could be a responsible owner of the UK's most iconic and crucial brand. During the five-year holding period (and counting, with the trade buyer looking at an option to purchase the remaining stake in two years' time), EBITDA increased from £1.25bn to £1.4bn this year on revenues of £20.5bn to £23bn respectively. There were bumps along the way: relocating Britain's beloved Boots to Switzerland for tax reasons was unpopular, just as a debt buyback from distressed lenders two years after the initial buyout (incidentally by some of the same lenders) raised eyebrows.

But for the most part, it was a buyout done well. The staff knew what was up: a visit by your correspondent to her local Boots Opticians in late 2007 generated a wholly unexpected conversation about the deal when she revealed her profession. The optician revealed that shortly after the deal, staff were invited to a meeting with management and a KKR representative to learn about their new ownership structure and plans for this business. This was impressive as it came in the immediate wake of the UK Treasury Select Committee interrogation - indicating KKR may have already had transparency in mind, extending as far down to on-the-ground opticians in Putney.

In fact, such successes may be helping improve the industry's image, rather than merely stoking cynics' fire. "The private equity model has proven to be much more resilient than many of its critics had imagined. We have been through a major economic downturn, indeed the environment remains very challenging, and the industry continues to perform," explains Chris Davison at Permira. Certainly, the industry may be helping as businesses struggle: in 2011, 20 companies experiencing trading difficulties were rescued by BVCA member firms, helping safeguard 7,548 jobs.

Talk the talk
Much of the ill-will was down to a lack of effective communication rather than a destructive business model. New EVCA Chairman Vincenzo Morelli was previously at TPG and part of the EVCA large buyout committee, so possesses an insider as well as bird's-eye view of the pertinent issues. "The thing that absolutely struck me is what a bad job the industry's done to explain its business model. There is an overwhelming abundance of empirical evidence and studies that give private equity a good rap. These figures have helped the asset class to grow. But there is dissonance with this and the public perception of the industry."

Private equity associations across Europe have been hard at work for at least half a decade, initially as a result of the 2005 locust debate in Germany and then in the wake of the 2007 bashing in the UK. "The industry has moved along a very long way in terms of its reputation.

It's down to four years of hard work - and work that went on behind the scenes even before then - by the industry showing what its role in the process of building businesses is," says BVCA head Mark Florman. "The industry is very good at fixing companies and making them stronger and more competitive. We have succeeded in explaining how that is done to our political friends, the regulator and all interested bodies including the TUC - though there is still work to do."

Indeed the pressure on the industry is coming less from London and more from Brussels and even Washington these days. "In Britain, acceptance is growing. We've worked closely with both the current and previous governments, from Downing Street to Westminster. There is around €70bn of dry capital available to invest in Europe, so really governments should seek to attract it," Florman points out.

Lessons learned
If Britain is becoming more tolerant, other countries are becoming less so. A recent event in Stockholm hosted by unquote" saw the national Swedish news station show up, videographer and all, determined to liaise with local deal doers. While the majority of delegates were amenable to their presence, a handful was less willing to cater to their demands, with their reactions reminiscent of the 2007 UK showdown. In fact, your correspondent later received a note stating: "The press was invited without us knowing about it. We felt it was disruptive and that the discussion fell through. Had we known about this from the beginning we would not have participated."

Sweden is admittedly an egalitarian society, with the haves more likely than their British counterparts to drive second-hand Volvos in an effort to mask rather than flaunt their success. However, it seems the widening gap between the have-lots versus have-nots is catalysing a belated backlash in the Nordics. This year has seen some draconian tax changes to the detriment of individuals at private equity firms, with tax hikes flirting with retrospective status.

A similar situation is underway in the US, where Warren Buffett recently suggested he (and by implication other high earners) should pay more tax. Now, Mitt Romney's presidential campaign is attracting some cynical analysis of the private equity issue. Therefore it may be that most private equity markets will have to endure this backlash and the UK was simply the first in line. As such, perhaps other countries can learn from Britain's experience.

A strong take-away from the British experience is the Walker Report and the Guidelines Monitoring Group set up to ensure compliance. In 2011, the fourth year of operation, the number of UK private equity-backed businesses affected grew from 55 to 78, partially on the back of revised guidelines, which reduced the entry EV from £500m to £350m. There are signs the guidelines are effective at improving reporting. According to the latest report: "Companies that had been assessed in 2010 all reported at a level equivalent to, or in advance of, FTSE 350 companies. Whilst the new entrants all met the basic requirements of the guidelines, the reporting of this group was not comparable to FTSE 350."

Bad news bears
It is not all good news. Firstly, the Walker guidelines may yet be superseded by the Alternative Investment Fund Managers Directive (AIFMD). "It is because for some reason, the industry is classed as alternative. One day we will be viewed as mainstream, but the asset class has only been around for 30 or 40 years, so it is still relatively new," Florman points out.

Secondly, reporting may be improved, but the underlying business model of leveraged buyouts is still widely deemed destructive. "The private equity model is still very dependent on leverage and the use of debt to fund its acquisitions. We believe that there are inherent risks in this model, as has indeed been clearly illustrated by events over the last few years. The private equity industry should be more open about the risks inherent in the use of high rates of leverage and debt," stresses Barber of the TUC.

His view is shared by entrepreneurs, whose views of the industry will have been influenced by the myriad negative reports of recent years in the broadsheets. One UK-based telecom entrepreneur told unquote" earlier this year: "I have had a phone call nearly every week in the last year from a private equity firm interested in my business, but I'd heard too many scary stories of them taking control of businesses. I knew I didn't want to partner with vulture capitalists." It was Wayne Martin, CEO of GCI Telecom. In February, Martin agreed terms with the UK's Business Growth Fund to sell a minority stake in his business to the fund set up by five banks to provide private equity-style partnership but with no leverage.

But what are the alternatives? It used to be public markets, but this year has seen growing disillusionment with PLCs as bosses are paid dizzying sums in short periods of time. It is the antithesis of the private equity model, though few outside the industry concede this yet.

"Private equity has been active in buying poorly run listed companies. Companies where board and management end up being remunerated on the wrong principles, which are often too short-termist. It steps in where there is management drift, a lack of strategy and weak leadership. Because the private equity model only compensates the owner and manager if there is long-term, pre-agreed strategic success. As such, they won't make a fortune in just six months," says Florman.

Not only should the model be better suited, but as debt wanes, equity is what is left. "Everyone agrees we have a growth problem. We have to rekindle growth and we do this by financing innovation," begins Morelli. "This won't come out of debt, especially as Basel III means banks will finance less, not more, businesses. So it has to be equity.

IPOs are dwindling, so you're left with private equity. The message is getting across that Europe needs a vibrant private equity market that is not shackled by heavy regulation." In 2011, around £6.5bn was invested in 803 UK companies.

Over the past five years, around £40bn has been injected into 5,025 companies based in the UK. Had the industry set up the Walker guidelines a decade earlier, the AIFMD may not have been born. For now, private equity markets in the public's ire - as well as those just taking off - may do well to heed the steps taken by the British private equity market and the results generated so far.

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• Topics
• UK / Ireland
• Industry
• BVCA
• KKR
• AIFM Directive
• Walker Report