Even in the heyday of Thatcherism, private equity funds were an exception on the British financial landscape. Although Oliver Stone’s 1986 blockbuster Wall Street, featuring an Oscar-winning Michael Douglas as the amoral mogul Gordon Gekko mouthing one-liners such as “Greed is good” and “Money never sleeps”, highlighted the transformation of the financial sector in the United States, the private equity boom in this country only took off in earnest in the early 1990s with Permira, the largest British-based fund.
Even now, most of the biggest private equity firms are American, including the likes of Kohlberg Kravis Roberts (KKR) – which owns Boots, the pharmacists – Carlyle, and Blackstone, the former owner of embattled care home provider Southern Cross.Private equity funds buy and sell entire companies and try to make a profit, whether through greater efficiency, shutting down loss-making divisions or asset sales. This is capitalism at its most undiluted.
From a purely financial perspective, private equity buyouts have a mixed record. They do not always turn businesses around. The collapse of Southern Cross, whose problems started after 2004 when it was bought by Blackstone, is the latest example of the misery that a buyout with a bad business plan can cause.
As to how and why the private equity boom lasted so long, the answer is straightforward: cheap money and tax regimes that enabled equity bosses to avoid the taxman alongside a sustained increase in stock values. Like much of the British economy, the private equity boom was founded on debt. When acquiring a company, a private equity firm would load as much debt as possible onto it as a means to avoid corporation tax. Meanwhile, the dramatic rise in the FTSE index (which mirrored the house price boom) meant that it wasn’t difficult to make money out of a deal.
The damage that can be caused by private equity buyouts is well documented. Unlike a publicly-listed company that, with its shareholders and various board members, is often difficult to reform, most private equity firms will immediately strip a company down to its roots. It is concerned with questions such as “How can costs be cut without reducing quality?” and “Is a business worth less than the sum of its parts?”
Bluntly, this can translate into getting employees to work harder for the same or reduced wages and asset stripping. A major problem with private equity is the imbalance between risk and reward. The risk of failure is borne almost entirely by the company’s employees, while virtually all the rewards of success and profitability go to the private equity company. With the odd exception, private equity firms are not interested in a company for anything other than its capacity to make a quick profit before being sold off.
In the case of Southern Cross, Blackstone sold the property firm that owned the freeholds of its care homes. This netted Blackstone a small fortune, but crippled the business left behind, which is now in hock to 80 different landlords charging high rents for Southern Cross’ 750 care homes. All are capable of bankrupting the business and making its 43,000 staff redundant.
It is a significant development that private equity bosses have entered the political sphere. In the 1970s, Conservative and Labour politicians were vociferous in their condemnation of asset strippers. Tory premier Edward Heath described Lonrho boss Tiny Rowland as “the unacceptable face of capitalism”.
Britain’s main political parties have had a marked change of heart since those days. John Moulton, who runs the aptly named Alchemy Partners, is one of many private equity donors to the Conservative Party. Moulton also helped pay for Defence Secretary Liam Fox’s private office when the Tories were in opposition. Meanwhile, the king of British private equity, Sir Philip Green, was appointed by the coalition to look at cost-cutting in government departments.
Labour politicians, particularly Gordon Brown and Tony Blair, also had very close links to the industry. In the years before the 2005 election, private equity leaders Ronnie Cohen, Nigel Doughty and William Bollinger donated £4 million between them to the Labour Party. Brown later appointed Paul Myners, a former chief executive of pension fund manager the Gartmore Group, as a Treasury minister. Some commentators said it was a bit like putting the boss of Bupa in charge of the National Health Service.
The close relationship with political parties, as seen with the knighthoods, peerages and ministerial positions, has become dangerously pervasive, particularly in relation to the tax system. When Labour came to power in 1997, capital gains tax was, at 40 per cent, the same as the top-rate of income tax. By 2010 it was a meagre 18 percent. If a private equity boss paid tax on their profits from selling a company, they were paying a lower rate than their cleaners. And that was if they chose to pay capital gains tax. A study in 2006 by accountants Grant Thornton estimated that 54 British-based billionaires were paying income tax of £14.7 million on combined fortunes of 126 billion. The example of Philip Green, who paid his wife a £1.2 billion dividend in 2006 that was tax-free because she resident in Monaco, was arguably most notable because Green made no attempt to hide or deny it.
Labour did not just allow but actively encouraged private equity groups to thrive in the United Kingdom. Partly, this was due to the party’s light-touch approach to financial regulation and its determination to be, in Peter Mandelson’s words “intensely relaxed about people getting filthy rich”. Also it bought into the idea that companies which took a stiff dose of private equity medicine would emerge leaner, stronger and end up paying more tax revenues as a result. Although it had become obvious by 2007-08 that a large number of private equity buyouts were benefiting neither HM Revenue & Customs nor employees, the private equity bubble had become bloated on so much borrowed money that it had effectively taken the Labour Government as an economic hostage.
The immediate future for private equity is likely to be a quiet one. Relatively few funds have gone bust, but the scope for leveraged takeovers built on borrowed money has shrunk dramatically. Without access to bank loans that are large but cheap, the margins for private equity firms are much tighter. The likes of Blackstone, Permira, KKR and Philip Green thrived on their ability to persuade banks to lend them hundreds of millions of pounds. Like everyone else, they have been hit by the collapse in bank lending. Since hardly any private equity vehicles put in substantial capital of their own into a buyout, there have been very few big deals since 2007. Certainly, the days when Philip Green could single-handedly raise in excess of £11 billion in loan promises in his attempt (albeit unsuccessful) to buy Marks and Spencer in 2004 seem unlikely to return.
In this lull, both the coalition and Labour would do well to look at how private equity can be curbed – whether through the tax system or competition policy. Capital gains tax should be at the same rate as income tax, while a public interest test should be introduced to ensure that private equity companies cannot buy firms such as Southern Cross (and, arguably, Boots) that provide a public service. Southern Cross is unlikely to be the last company to suffer the after-effects of a buyout. Selling off property and renting it back was one of the most common methods used by private equity groups to generate quick profits. With the housing market comatose for would-be buyers while rents continue to rise, other firms in Britain could suffer the same fate as Southern Cross.
