Private equity investors – barbarians or saviours?
In the film “Barbarians At The Gate” there is a scene where poker-faced private equity maverick, Henry Kravis, played by Jonathan Pryce, explains how leveraged buyouts work to an anxious Ross Johnson, who is about to launch an audacious takeover bid for a company that he runs in what would escalate into a record-breaking $25.7 billion acquisition.
“We pay off the debt incurred in buying a company with cash from the ongoing operations and selling off pieces of the business,” Kravis explains. To which Johnson, played bythe late James Garner, asks:”Is that French for firing people?”
The movie depicts the real-life story of the 1988 bidding war between the two men to acquire tobacco and food maker RJR Nabisco, the 19th largest US corporation at the time, in a transaction that is today viewed as an ancestor of all private equity transactions, sometimes referred to as leveraged buyouts (LBOs).
While South African private equity is yet to reach the investment levels of 2007, it is still potent with R162.2 billion in funds under management, part of which can be deployed to make sizeable corporate takeovers.
After numerous failed attempts by Johnson to boost the languishing share price of RJR Nabisco, he decides to take matters into his own hands by launching a management buyout (with the help of Salomon Bros and Shearson Lehman Hutton) to acquire the hugely undervalued company for $17 billion and delist it from the New Stock Exchange. But Kravis, the founder of Kohlberg Kravis Roberts (KKR), a prominent Wall Street private equity firm, enters the fray. By the time Kravis wins the bidding war, the price tag of RJR Nabisco has been pushed to $25.7 billion, consequently increasing debt used to finance the transaction.
This film is instructive on how private equity investors work. They are known for their ruthlessness in slashing the workforce in order to boost profit and pay off the debt. Trade unions despise them. But others embrace them.
The big debate
The debate then becomes: are private equity investors job destroyers or job creators?
A survey published last year by South African Venture Capital and Private Equity Association (SAVCA), a mouthpiece for the local private equity industry, puts an interesting spin on the debate. The survey found that private equity investment boosts sales, profits, and employment by 40% in the companies concerned.
In the foreword of the report, Aubrey Shabane, head of equity investments at the Development Bank of Southern Africa, waxes lyrical about the positive impact of private equity on the South African economy. “There are several favourable outcomes from private equity and venture capital investment. Besides providing capital, these investors bring dynamism, a depth of operational experience, huge financial acumen, contacts, strategic partners and foresight,” Shabane explains.
In the run-up to the 2008 global economic crisis, private equity firms were busy, gobbling up blue-chip JSE-listed companies as they borrowed big to take advantage of historically low interest rates and happy-to-borrow capital markets.
The busiest year of the private equity boom, 2007, saw US firm Bain Capital, co-founded by US businessman-turned-politician Mitt Romney, acquiring clothing retailer Edcon for $3.5 billion, South Africa’s largest LBO in history. Then the same year, where a record R26.1 billion of private equity deals were concluded, a consortium led by UK private equity firm Actis Capital purchased financial services firm Alexander Forbes for $1.2 billion.
“There are several favourable outcomes from private equity and venture capital investment. Besides providing capital, these investors bring dynamism, a depth of operational experience, huge financial acumen, contacts, strategic partners and foresight”
After a blip in private equity deals in the wake of the global recession, Blackstar, a little-known private equity firm led by Andrew Bonamour, paid R3 billion in 2012 for listed media and entertainment group Avusa and rebranded it Times Media Group (TMG).
Shaving off fat
But private equity investors bring changes or impose the so-called restructuring to infuse new strategy or shave off fat, causing frustration to executives and staff who are let go.
Soon after buying Alexander Forbes, Actis introduced a controversial management structure that led to Peter Moyo exit as the company’s managing director even though he had sailed Alexander Forbes through a bulking scandal, which resulted in the company being fined R480 million by the Financial Services Board for secretly stealing interest income belonging to pension funds it administered.
An axe also fell on staff at “top-heavy” TMG, where Bonamour rang in changes including doing the classical assets disposals that private equity firms are renowned for. Bonamour sold movie theatre Numetro, book store Exclusive Books, music recording label Gallo Records, and financial data information provider I-Net Bridge, vowing to turn TMG into one of South Africa’s premier media companies following years of mismanagement and under-performance. It was reported that Tokyo Sexwale’s company, Mvelaphanda, watched the value of its 20% stake in TMG dwindle from R1.4 billion to R500 milliondue to the inept management of the company.
While South African private equity is yet to reach the investment levels of 2007, it is still potent with R162.2 billion in funds under management, part of which can be deployed to make sizeable corporate takeovers. Last year, the industry concluded R17.5 billion worth of deals, still a long way from 2007’s R26.1 billion, but way better than the 2009’s investments worth R7.2 billion, concluded at the height of the global recession. The downturn in investment activity was worsened by commercial banks turning off credit taps to heavy borrowers like private equity investors.
Critics of private equity investors lament job losses. They say these investors are known for dismembering companies by selling off assets to pay off mountains of debt borrowed to buy companies, hence they are called “barbarians” in some financial circles for stripping assets of acquired companies to the bone.
Critics say private equity saddles healthy companies with humungous debt that leaves them with a few options but to cut jobsto service debt to avoid liquidation.
On the other hand, proponents counter that they force companies to become lean and mean, making them more competitive and profitable in the long run. In other words, private equity firms acquire companies to make money, unlike corporate-to-corporate takeovers, which are pursued to make companies bigger or to capture greater market share.
It seems the debate on whether private equity investors are good or bad for jobs will continue raging on.
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Article first published by www.getbiz.co.za