Private Equity: a vicious new breed?

Rob Ray looks at the recent manoeuvrings of Private Equity and asks what relevance its growth may have

Submitted by Freedom on May 16, 2007

In scenes reminiscent of the 80s pre-stock market crisis, a major row has blown up over the attempted Private Equity takeovers of high-street giants Sainsbury’s and Boots.

While unions and some sectors of the Labour party have attacked what they see as a rapacious reawakening of asset-stripping for the noughties, Private Equity groups have hailed it as perhaps the next step in providing greater efficiency through competition.

Private Equity takeovers occur when management teams buy out publicly listed companies and take them off the stock market as private entities. The most common use of this system for profit stems from the 70s when business tycoons developed ‘the flip’, where a management team takes over a company, aggressively attacks wages and jobs to ‘cut away fat’, then sells back to the market in a three to five year cycle.

The flip is achieved through what is known as a ‘leveraged buyout’ where the massive funds needed to take over large companies are loaned by banks and investors, and secured with the assets of the company being bought out.

The practice reached its zenith in the 80s when major takeovers were attempted by firms later labelled ‘the asset strippers’, for their practice of taking healthy companies, selling their assets, firing much of the workforce and then selling back a shell to the public markets. The Private Equity market died down in the 90s, as mega-mergers placed many of the big players beyond the reach of even major private equity groups and confidence dimmed in the risks of investing during an economic downturn.

However the rise of the ‘club buyout’ in the last 4-5 years, where several major funds buy in to reach for larger targets, has recently seen some of the biggest companies in the world targeted. Sainsbury’s and Boots are just the tip of a very large iceberg. Other major buyouts in the last few years have included the AA, Debenhams, and the largest yet, TXU for $44.5bn.

The sector has grown at a stunning pace, nearly doubling from $112.5bn invested in 2004 to $215bn invested last year, and an estimated $400bn warchest for further buyouts. One in five workers in the UK are now under the control of some form of private equity.

Unions have launched an attack on the sector following a brutal fight at the AA, where unionists accused the buyers of gutting the business by selling buildings and then leasing them back, outsourcing personnel and where that wasn’t possible, simply cutting staff so roadside coverage was compromised. At Debenhams, the company has posted its third profit warning after being taken public, as the company struggles to shrug off underinvestment and cuts. Unions are accusing Private Equity of continuing the same cycle of the 80s.

Private Equity, and much of the business press, say otherwise. Quoting a report by the Nottingham University centre for buyout research, they point to evidence that while initial cuts do take place, it is a precursor to expansion by the leaner companies that emerge.

However the centre, which was founded by Barclay’s Private Equity Ltd. does not mention where this new employment comes from, or what form it takes. It also fails to say where the initial cuts take place, or to mention the effect of asset sales. It does mention the bankruptcy rate of leveraged buyouts after the flip is finished.

One in eight firms go to the wall.

The union drive looks set to be a flash in the pan, demanding only that private equity be taxed more. But the sector is a clear and present danger to workers, as a model which diverts massive assets away from wages and employment towards the ultra-rich, and produces nothing.