Author: Kwaku Dapaah
Morrisons. Vectura. Signature Aviation. Different firms operating in different sectors of the economy but united by fate seeing as they were all acquired by private equity firms.
Like any other year, there are worldwide deals but this year, Reuters calls the purchases of British firms “unprecedented” (Alves, Rao, 2021) “Buyout groups spent $45 billion snapping up companies in Britain in the first half of 2021, Refinitiv data shows, more than double the next best first six months on record and almost 10% of the total $547 billion they spent across the world” (Alves, Rao, 2021)
Management consulting firm Bain predicts global buyout transactions by year end will be worth ‘$1.1 trillion’ Buyout, growth and venture capital funds had the biggest increases from 2020, up 60%, 39% and 36%, respectively (Jacobius, 2021)
What Is Private Equity?
“Private equity funds are pools of capital to be invested in companies that represent an opportunity for a high rate of return” “They come with a fixed investment horizon, typically ranging from four to seven years, at which point the PE firm hopes to profitably exit the investment.” (https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/private-equity-funds/ )
Exit strategies include stock market listings or the sale of the business to another private equity firm or strategic buyer.
Strategies
Many strategies exist. Corporate Finance Institute (https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/private-equity-funds/) divides them in two; Venture Capital and Buyout or Leveraged Buyout. (Cote, 2021) adds a third option type characterized as Growth
A synthesis of issues may be why the UK is looking attractive to these firms. Relatively undervalued companies for instance “While U.S. (.SPX) and European (.STOXX) stock indexes have gained 65% and 25% respectively since August 2018, the FTSE 100 index is down 8% and trading at just 12.6 times forward earnings. That compares to 21 times and 16.3 times respectively for the U.S. and European benchmarks.” (Alves, Rao, 2021). Brexit of course is another issue although not quite still the elephant in the room.
Justin Onuekwusi may be onto something. The Legal & General Investment Management portfolio manager says there are ‘arbitrage opportunities between public and private markets as investors jostle for shares in potential takeover targets. Allocating to the cheaper asset classes will eventually pay off if you’re willing to be patient,’ “he told the Reuters Global Markets forum.” (Alves, Rao, 2021)
Private Equity may have a reputation for impatience but according to data from 2000 to 2014 by www.peiservices.com found via ClearRidge capital, (https://clearridgecapital.com/articles/how-long-does-a-private-equity-group-wait-before-selling-your-company-again/) , “the median holding period has doubled in the last 10 years from around 3 years to almost 6 years. In some respects, this chart is countercyclical, with hold periods being shorter in a booming economy, as PEGs are able to realize an oversized gain in a shorter period of time and want to lock in that profit by selling the company… the PEG marketplace has become more crowded, with more participants…which often leads to higher prices being paid and a longer holding period to make a gain on the invested capital in the business.” (https://clearridgecapital.com/articles/how-long-does-a-private-equity-group-wait-before-selling-your-company-again/)
Stewart (2020) from Vox says private equity’s primary aim is to make money. So? Don’t all companies need to make money? The deal is most if not all private equity leveraged buyouts use extensive amounts of debt. This debt stifles investment needed to keep the company going. Applebaum and Batt (2018) are illuminating in their piece which among other things compared supermarket chains Kroger (conventionally owned) and Albertsons (PE owned). Both operate in 35 US States, have 20+ well known brands and both are majority unionized but “Compared with other grocery chains, Albertsons has more than twice the net debt-to-earnings ratio—4.74, compared with Kroger’s 2.13, Sprouts Farmers Market’s 1.44, and Publix’s 0.35.” (Applebaum, Batt, 2018)
The industry’s 2-20 fee structure ensures their bases are covered both ways; a 2 percent management fee from their investors and then a 20 percent performance fee on the money they make from their deals.
Researchers in California found about 20 percent of large companies acquired via LBO’s go bankrupt within ten years, as compared to a control group’s bankruptcy rate of 2 percent during the same time period. (McElhaney, 2019)
Stewart (2020) cites a University of Chicago study that found “employment shrinks by 4.4 percent two years after companies are bought by private equity, and worker wages fall by 1.7 percent.” For listed companies being taken private, employment shrunk by 13% “but it increases by the same percentage if the company is already private. The researchers found that labor productivity increases by 8 percent over two years.”
Perhaps, company bankruptcies are unintended consequences of leveraged buyouts. How does this affect Morrisons? The purchase employed debt. (Pratley, 2021) For the workers and the company itself, history may be against it. I’m not saying Morrisons will be the next Sears or Toys ‘R’ Us (Critics of LBO’s say the huge debt pile made it tough for these companies to adapt while PE enthusiasts say the online competition from Amazon and Walmart was to blame).
In any case, as of the writing of this piece, the CMA is probing the deal. (Noble, 2021)