https://www.thetimes.co.uk/edition/business/private-equity-is-back-so-are-its-critics-89b5nnjwk
The Sunday Times
Private equity is back – so are its critics
16 August 2020
By Jill Treanor
Animal spirits are stirring among the controversial breed
AA – in numbers
£2.6bn Size of the AA’s debt pile
£240m The company’s market value
$1.5trn Private equity’s war chest
When the AA was created in 1905, its members were concerned about speed traps. Teams of cyclists were organised to help drivers avoid painful penalties using secret signals and salutes.
Some 115 years on, its members should be concerned about another type of trap: debt.
Now a breakdown and insurance business, the AA is saddled with so much borrowing that its brief, six-year stay on the stock market looks likely to come to a premature end. Its £2.6bn debt pile heavily outweighs its £240m market value and it is on the receiving end of takeover offers from private equity investors — the very same species that piled on the debt in the first place.
It is the latest chapter in the 20-year saga since the AA was first sold — and illustrates the merry-go-round nature of many private equity deals. Until 1999, the AA was a mutual owned by 4.4 million members, who each received a £250 payout when it was sold to Centrica for £1bn. In 2004, the owner of British Gas sold the AA to private equity houses CVC Capital and Permira for £1.75bn.
Their ownership was fraught with controversy, with 3,400 jobs axed in months and a merger engineered in 2007 with the over-50s insurance specialist Saga. The enlarged group, called Acromas, had £6bn of debt. It was primed for a stock market float in 2010 — before institutional investors balked at the idea.
It took a further four years, and separation from Saga, for the roadside rescue business to float at 250p a share, with a stock market value of about £1.3bn — and £3bn of debt.
It got off to a shaky start — the shares fell on the first day of trading. They reached highs of more than 400p in 2015 but have since been on a downward trajectory. While the new private equity suitors — Centerbridge Partners, working with TowerBrook Capital Partners; Platinum Equity Advisors; and Warburg Pincus — have put some life into the shares, they closed at just 39.5p last week.
It is little wonder that some seasoned investors are sceptical when private equity bidders come calling, looking to sell shares through a float. Richard Buxton, manager of the Jupiter Growth investment trust, reminds himself to “think twice” before dealing with the buyout barons.
“At one stage we considered having a little black book about which private equity firms were the worst to buy off,” he said.
In the Covid-19 climate, private equity is likely to be doing more buying than selling. City sources reckon firms are waiting to pounce on weakened businesses, with bankers working on a wide range of potential deals that could revive the moribund mergers and acquisitions (M&A) market.
Jonathan Boyers, head of corporate finance at KPMG, said he thought that “private equity investors will probably lead the recovery in the M&A market”.
There is money waiting to be invested, with more so-called dry powder on the sidelines than ever before. At the start of the year, data collector Preqin calculated the global industry was sitting on a $1.5 trillion cash pile primed for investment.
But while the Covid-19 crisis might present an opportunity to go after cut-price targets, it also presents a challenge: many companies are already saddled with debt, making it difficult for private equity buyers — which often rely on loading companies with loans — to make their model work. TheCityUK trade body has estimated that £36bn of emergency loans to small businesses could turn toxic.
Boyers at KPMG said that private equity could adopt a model of buy now, sort out the debt structure later, when the crisis eases.
Veteran deal-maker Daniel Pinto, who runs Stanhope Capital, sees an opportunity: “The cash brought in by private equity will refinance the firms that had received government money.” Stanhope’s Entrepreneurs Fund — which backed Sir Martin Sorrell’s go-it-alone project, S4 Capital, after he left advertising giant WPP — is ready to invest post-pandemic, Pinto added.
“In the context of Covid, you will find a large number [of companies] going through a tough period that will need cash to fall on their feet and to grow. They will find a very good partner in private equity to do that.”
Some, though, are unsure about that.
“Where businesses have got into difficulty [after floating], it’s often because private equity goosed the returns and didn’t invest in the business,” said Buxton.
Not surprisingly, the private equity industry disputes this. Richard Hope, head of Europe, Middle East and Africa at the buyout firm Hamilton Lane, said firms were now holding their investments for longer than many imagined — from two years two decades ago to six. And the proportion of equity to debt has increased from 35% to 52%, he added. “There is no concept of the quick deal — of this fast buck or quick flip.” Hope explained. “The industry is very conscious of its image.”
The AA has told the stock market that its suitors are promising an injection of equity to cut the debt. For now, at least, perhaps.