Monday, 30 January 2012
Big Boy? Pants.
The Epicurean Dealmaker blog, is a really good blog that's both more literate and articulate than this thing and far more popular. But ……..… from a British perspective at least his latest chat on private equity strikes me as a bit iffy.
Add in a J-curve reference and I reckon his succinct summary of what private equity is and does could grace any finance dictionary. Except, reading it again I reckon there's another thing missing; history, which matters because the Dealmaker’s account is intended to justify as well as explain private equity.
For the Dealmaker private equity “is a valuable part of the financial ecosystem. It is particularly suited to helping businesses which require some sort of transformation, in structure, methods, and/or capital, in order to improve their value …. they are not asset strippers, “vultures,” or liquidators, either. Think of them instead as boot camp drill instructors, whipping out of shape or underperforming laggards into top-flight athletes.”
Hmm, this is the new management with no vested interests taking over and stripping out all capital consuming fat, chopping off any inefficiencies and implementing a new business model view of private equity where making money is almost entirely about adding value then selling on. It’s a lovely view and perfectly in keeping with what any self-respecting member of the British Venture Capital Association (BVCA) – the British private equity trade association - would tell you in public (Jon Moulton being a possible exception here).
Except right from the outset there's some economical with the truth thangs going on. An obvious one is that the bulk of the BVCA’s members aren’t venture capitalists at all just as the bulk of BVCA member deals by value and volume don’t involve venture capital. Rather, they're private equity bods who buy and sell established concerns, an arguably less moral activity than venture capital investments in wholly new businesses (the US equivalent here presumably being the rebranding of leveraged-barbarian-at-the-gate-buyouts as private equity). So yeah, this is a type of finance that tends to hide behind more user friendly labels.
Anyhoo, I reckon the Dealmaker misses a big trick with his chat on “dividend recapitalisations, when he says “dividend recaps … the relatively recent phenomenon of financial sponsors borrowing additional debt through their portfolio companies during the life of their investment, and using the proceeds to pay equity dividends to themselves and their limited partners”.
Now note the immediate qualification – “this is a relatively recent phenomonenon”, then ponder a while the actual nature of M&A activity over the last 100 or so years in Britain which is this - it occurs in waves.
Like according to Leslie Hannah’s Rise of the Corporate Economy you can, somewhat arbitrarily here, identify the peak of previous UK M&A waves occurring in 1881, 1898-1900, 1919/20, 1929, 1959-68 and 1973. Latterly, ONS data shows the number of mergers and acquisitions unsurprisingly peaked in 2007, the total having grown strongly from 20003/04.
So there you are then. Whereas the Dealmaker sets out generic notions as to the benefits of Private Equity, the reality appears somewhat different; actual dealmaking activity has repeatedly clustered around specific points in time. This, of course, is due to the influence of period specific factors, an obvious one latterly being the shifting willingness of banks to lend. I say shifting because well it does as was illustrated by the pre-credit crunch emergence of cov-lite debt i.e. debt sold to private equity investors with few if any of the covenants previously imposed by lenders so they could manage the risk they’d decided to take on. And lets be clear the emergence of cov-lite lending and the associated willingness of banks to lend against ever more aggressive multiples was a product of them competing to lend so they could hit their quarterly/annual sales targets.
What it was not was not a sudden recognition of private equity’s boot camp-like qualities. Rather, in practice bankers were eventually tripping over themselves to throw money at private equity. Now here is where a big boy defence presumably comes into play - bankers are big enough and ugly enough to do the appropriate due diligence and if they weren’t, well tough.
However, a criticism of private equity the Dealmaker seeks to challenge is that it loads up companies with unsustainably high levels of debt that ultimately fucks them in an eventually making lots of people redundant kind of way. Now if I was minded to argue private equity wasn’t to blame for well anything really, I’d argue that if someone offered me mad amounts of debt for hee haw, then of course I'd take it. Heck I could even cite the example of Focus DIY, bought for a couple hundred million and collapsed owing businesses, shareholders and funders around £1bn i.e. the private equity buyers had gone mad for the “dividend recaps” the Dealmaker mentions just in passing. Except with Focus this appeas to have been how the money was REALLY made and as the Dealmaker points out making money is the primary purpose of private equity. Operating efficiencies, new store layouts? I guess, but really it was about borrowing as much as possible then taking as much of that money out the business as possible via dividends (and I'm no even mentioning the sale and leaseback asset stripping other private equity bods did elsewhere in increasing numbers in the run up to 2007).
Except, that’s not quite in keeping with the boot camp instructor account of private equity is it? Rather, its about being able to spot someone dumb, desperate and/or arrogant enough to lend more (and more) cash than was ever paid to buy a business so as to do a "dividend recap" as a key determinant of private equity returns. And if the business fails, as Focus did, and people lose their jobs, then hey ho.
The other thing recent experience shows is that in an M&A wave, you know a fad, a euphoric precursor to a crash during which a disproportionate number of deals get done, being able to identify patsies, ahem, bankers (and in an aggressively competitive environment there will always be a few) becomes increasingly important as all the low hanging fruit gets plucked (a practical example here being the chat about taking Sainsburys private that in reality appeared based on f'all more than the ready availability of cheap debt vs expensive equity). So much so in fact, given the persistently wave-like nature of M&A activity, I reckon its worth taking away any qualified references to "dividend recaps" and emphasising how a key skill (value add even) of private equity is its ability to spot a dumb banker at 100 paces. That and exploit tax arrangements of course.