A potential £8-billion bid by a trio of private equity houses for British supermarket group J Sainsbury demonstrates just how bold and brave the fast-growing industry has become.
If the deal succeeds — and there are plenty of obstacles to a takeover by private equity houses CVC, Blackstone and Kohlberg Kravis Roberts — the supermarket chain would follow United Biscuits, Birds Eye and Pizza Express parent Gondola into private hands.
Success would herald a landmark for the industry as it would be the biggest deal yet in Europe. Failure could prove to be the watershed moment for a business that has started to face critics even from within the City of London.
Private equity — and its sister sector venture capital, both of which draw together funds from individuals and corporate investors — shot to prominence in the 1980s when KKR launched a hostile bid for RJR Nabisco — now immortalised in the book The Barbarians at the Gate. In the late 1990s and early 2000s, the business gathered pace, helped by the dotcom boom and bust, but it really flew last year.
About 1,2-million people are employed by private equity firms in the United Kingdom. Data compiled by the BVCA, the British venture capital and private equity association, shows the business represents 7% of the total annual turnover of the UK financial services industry.
Yet the industry is uncomfortable with public scrutiny, despite having lured some high-profile figures.
Private equity and venture capital also attract a wide array of investors — pension funds and university endowments are among the biggest. Precise figures about the scale of the investments can be difficult to come by but the Insead business school believes there could be as much as $300-billion “committed capital” in the hands of private equity and it is growing at 200% a year.
The investors are usually willing to put a small amount of their total funds into investments that are considered high risk but potentially high reward. They are high risk because of the amount of debt employed relative to the amount of equity, but once the debt is paid off, the profits can be huge.
It is the debt — and the idea that private equity firms run businesses for cash to pay that debt off — that is at the root of much of the controversy. But Christoph Zott, associate professor of entrepreneurship at Insead, says venture capitalists can bring financial experience and advice that can help a badly managed company. “Debt can be a very strong disciplining device, while taking a company private can shield it from the short-term pressures of public markets.” Other pressures of being listed on stock markets such as disclosing directors’ pay and controls can be avoided.
Questions about the seemingly unstoppable business are coming not only from trade unions worried about job losses but also from City of London big hitters and even regulators. Michael Gordon, chief investment officer of Fidelity Investments, said: “What is starting to worry me is when talking to our clients — pension fund trustees — they are seeing private equity as some sort of panacea.”
Clients such as pension fund trustees are moving into private equity believing it offers diversification to their investments. Gordon believes they are not. Instead, they are taking on higher risks because of the leverage and receiving less information about their investment than they would from listed stocks. They also pay higher fees.
City of London investors, who fell over themselves to encourage boards to accept bids by private equity firms, are beginning to urge more caution.
Companies that have been listed on the stock market, bought by private equity and then relisted have also done little to win the confidence of investors. Debenhams was taken private in 2003 only to come back to the stock market barely two years later — with a market value greater than it was sold for and laden with debt.
Gordon notes this will be one way to measure the success of any Sainsbury bid. “The Sainsbury bid will succeed if investors sell to them and then buy the asset back when it comes back to the market,” he said.
The UNI global union — which has 15-million members in 150 countries — used the recent Davos economic forum to condemn private equity companies for “corporate greed”. Philip Jennings, UNI general secretary, said: “They are like a global vacuum cleaner hoovering up assets at any price, anywhere, any time and we want to bring them out of the shadows.”
The UK’s Transport and General Workers’ Union warned last week about the potential Sainsbury bid. Brian Revell, T&G national organiser for food and agriculture, said: “Such a takeover would be based on borrowed money followed by extracting as much wealth as possible from the company … Private equity does not create wealth; they extract it for their shareholders.”
Gordon has some sympathy. “Employees are a little further down the pecking order in private equity,” he said.
Concerns have also been raised about the standard of corporate governance at private equity firms. But the industry argues it is transparent and clear.
The BVCA says investors in private equity funds provide “complete and comprehensive” information to their investors and its members also follow a code of conduct.
A senior venture capitalist says investors in private equity funds actually get more information than they would for stock market listed companies.
Private equity firms can know personally all the investors in their funds — a few hundred, say, compared with the millions on the registers of the biggest stock market companies. — Â