The growing influence of private equity groups (PEGs) has become a major talking-point in the food industry, as it has in so many other sectors. Chris Brook-Carter asks if the growth in PEG activity represents a return to the excesses of the 1980s, or whether they serve a useful function in helping to revive failing companies and provide a necessary investment vehicle for capital.
Hardly a deal goes by these days in the food industry without reference to private equity.
In the last month alone, companies including retailers Sainsbury, Coles and Ahold, Japan’s Bull Dog Sauce, US meat processor Swift & Co. and confectionery giant Cadbury Schweppes have all been linked to private equity groups (PEGs) in one way or another.
As reported on these pages in May, one top industry analyst went as far as to warn that all of the world’s retail giants are vulnerable to bids from the cash-laden private equity sector.
Andrew Fowler, managing director at Merrill Lynch and a 20-year veteran of the retail sector, said the relative ease of securing borrowed funds cheaply has left private equity groups with around GBP500bn (US$1 trillion) of “firepower looking for a home”. Bigger retailers, with a rich portfolio of property assets, are most attractive to private equity, he added.
And yet, despite the ever-increasing level of private equity involvement in our industry, these companies remain the most mysterious of financial institutions to most outsiders, viewed at best with confusion and at worst with open mistrust. It is argued that private equity, flush with easy access to cheap credit, has been able to snap up companies around the world at will – and make large profits in the process. Moreover, critics bemoan the lack of accountability, claiming jobs and businesses are in danger when owners are not answerable to shareholders.
However, PEGs are nothing new. They have been around for decades in one form or another. Some have even become ‘new conglomerates’ by default with sprawling corporate empires that embrace a wide range of companies with minimal synergies. They exist to make money where others have failed, and they can be spectacularly successful at that. Perhaps the most famous example of this in recent times is the 1994 sale of Snapple Beverage Corp. to Quaker Oats by private equity firm Thomas H. Lee Partners. The business was sold for $1.7bn, earning the private equity group $872m in profit on an equity investment of just $28m.
Profits such as these do little to help the cause of the PEGs outside of financial circles and their perceived modus operandi is undoubtedly controversial. PEGs have become bigger in recent years and are involved in increasingly large mergers and acquisitions or leveraged buyout transactions, funded through mounting levels of debt.
It is estimated that there are now almost 3,000 PEGs and venture capitalist firms in the US alone. What’s behind this boom in private equity? City analysts have said that there is now plenty of money around looking for a home because of a lack of good alternatives in times of historically low interest rates; PEGs offer a relatively low-risk and high return on investment.
However, critics argue that PEGs chase complacent or under-performing companies for takeover and then look to transform them via ruthless cost-cutting and cash generation. Assets – possibly the whole company shorn of cost, or profitable elements – are then sold on for a profit. The PEG model is seen by some as a form of corporate ‘invigoration’, while others view it as ‘asset stripping’, potentially wrecking companies in pursuit of a quick return.
Talk to opponents of the PEGs and you’ll hear lots about lost jobs, murky tax breaks and investment levels in the acquired companies descending to Scrooge-like levels, with no eye on the long-term health of the business.
PEGs counter that they have become more sophisticated in recent years and can bring a number of advantages to running a company over the traditional publicly listed model. Senior staff now include industrialists (like Jack Welch, formerly of General Electric) rather than just financial engineers, they say. And they have a culture that means they keep a close eye on the way their companies are run.
It is a myth, they add, that PEGs are pure asset strippers. Many of the companies they move in on have been through a rigorous cost-cutting process already, which means the balance sheet can only be improved through increased sales by the time the PEGs takeover. And, PEGs don’t benefit from any tax breaks that aren’t available to other individual or business.
Most importantly of all, supporters say, PEGs are in the business of saving companies that are otherwise on a downward path. Tough decisions may have to be taken, but they are done so with an eye on forging a profitable and viable business that has a future. Furthermore, it is the very fact that they are private and de-list their acquisitions that means PEGs can make controversial management decisions, which they claim are in the best interests of the business concerned, without having to worry about shareholder reactions or the need to publicly release information under rules on stock exchange disclosure. PEGs also like to point out that big corporate scandals, such as Enron that send shockwaves through the markets, tend to be associated with publicly held firms rather than private ones.
However, employees still tend to be fearful for their jobs when PEG deals loom large and the issue of whom the PEGs are accountable to – generally small groups of private investors and credit lenders – remains a real concern. Just lately there have been more noises of protest echoing the ‘bad-boy’ image that PEGs had in the 1980s. In the UK, trade unions have begun campaigning for a windfall tax on the funds and private equity bosses have been hauled before Parliamentary committees in an attempt to shed more light on their businesses. And the new Prime Minister Gordon Brown is reported to have said he will review that tax rules for partners in private equity firms.
However, despite their perceived power, there have been signs that the supremacy of private equity may be easing, a trend that has been observed in the food industry.
Last week, the acquisition of Ahold’s US foodservice arm by two private equity groups has been delayed after investors refused to support the debt financing backing the deal. Lenders are said to be demanding stricter financial conditions on such deals, fearing debt financing has become too cheap and putting their investments at risk.
Unease among investors is also believed to be behind the decision from a private equity consortium to cool its interest in troubled Australian retailer Coles Group – which has subsequently agreed a takeover bid from a listed conglomerate. Meanwhile, Bull-Dog Sauce Co., the iconic Japanese sauce manufacturer, has won legal backing for its plans to stave off a hostile bid from a US hedge fund.
Throw in recent the political examination of private equity groups in the UK and one gets the impression that the future for private equity is less certain than it was perhaps even just a few weeks ago. And that is a thought that will cheer certain sections of industry, including the food business.
However, the uncomfortable and unanswered question remains: are PEGs evolving into entities that shape viable long-term businesses, or are they still, at heart, focused on ‘strip and flip’?