Britain - "Private equity" - old yuppies in new suits

Jul/Aug 2007

Private equity firms have been in the spotlight over the past few months. Probably what everyone knows about them is that one private equity boss, Nicholas Ferguson of SVG Capital, stated in the Financial Times at the beginning of June that the tax relief on capital gains tax allows top private equity firm "employees" to pay taxes at a rate "lower than a cleaner's".

Then the private equity firm KKR, hit the headlines, when it took over Alliance Boots, the high street chemist chain. And it stayed in the news, because it refused to take responsibility for the Boots employees' pension fund, so the pension fund trustees had to take them to court. Shortly after this, another private equity group, Blackstone, was involved in the threatened, but failed, takeover of supermarket giant, Sainsbury. But while this was still on the cards, union representatives expressed their dismay at the prospect of this kind of company taking over.

The message has gotten across that these firms are only interested in a quick buck and are out to asset-strip the companies they take over and wreak havoc with the workforce in terms of job cuts, cuts in conditions and endangering their pensions.

So as soon as there was any suggestion that Ford might sell Jaguar and Land Rover to private equity, Tony Woodley (now of the new merged union, Unite) immediately called for government intervention "if private equity buyers were the only choice".

The new guests at Number 10

If private equity has a very bad reputation this is pretty well-deserved. It was the private equity firm, Texas Pacific, which was pulling the strings behind the scenes at Gate Gourmet - the British Airways' caterer, whose workforce went on strike over severe cuts in their numbers and changes in their terms and conditions in 2005.

And certainly it was the experience of the private equity takeover of the AA in 2004, which has been the main driving force behind the GMB union's very visible campaign against the tax dodges and cowboy style tactics used against workers in the companies that these funds have taken over.

This union campaign has undoubtedly played a role in getting the House of Commons Treasury Select Committee to undertake enquiries into the private equity business.

Thanks to this enquiry, which has featured many comic moments, and which is still, at the time of writing, putting the private equity players through a grilling, each in turn, the whole charade has also been seen on TV. So much so, that its richest "partners" - who have been ironically dubbed the "new masters of the universe" and portrayed as the thuggish face of a "new" and nasty capitalism, may well soon join the ranks of celebrity. After all, as they say, no publicity is bad publicity.

Already Damon Buffini, of Permira, has been appointed as one of Brown's special advisors and given a seat on his new Business Council. Whether this is the reason that Alistair Darling, the new chancellor of the exchequer, has already made a statement to the effect that the tax rules which allow private equity firms to get away with not paying tax will not be changed, is open to question. But it makes sense.

Probably some of the private equity players would have preferred that their identities and the tax dodges (perfectly legal) which they use to make their fast bucks remain secret. But they had no real chance after the media got hold of this on-going story. Jeremy Paxman even interviewed Rod Selkirk, chief executive of Hermes PE and Paul Malone of the GMB on Newsnight. Then after a particularly bad grilling at the Select Committee, the chairman of the British Venture Capital Association (BVCA) decided it would be best for him to resign.

This has all the elements of a soap opera. And things went from bad to worse, after the GMB union used the opportunity of the Glastonbury Festival to parade the photos of the heads of some of the private equity funds - inviting the punters to vote for the worst villain!

Why the AA broke down

The GMB union's preoccupation with private equity was sparked by the situation AA workers found themselves in after the takeover by Permira and CVC in July 2004. This provides a good example of the way that private equity operates, so it is worth giving a brief outline of what has happened, from the point of view of the workers.

The AA - Automobile Association, whose slogan is "the UK's fourth emergency service" - used to be a mutual association, owned by its members, theoretically at least, up until it was sold to Centrica, the parent company of British Gas. In 2004, Permira and CVC Capital Partners bought it for £1.75bn.

The CEO, Tim Parker then set about "restructuring". Out of a workforce of 10,000, over a third - 3,400 - were sacked. Prices for certain categories of motorist were increased by 30%. Obviously response times for motorists in distress increased - with some waiting up to 4 hours for help.

The GMB union, which had been the main recognised union at the AA for ten years, was derecognised by AA bosses in March 2005. A new union called the "AA Democratic Union" was set up by a group of ex-GMB stewards and officials, which was immediately recognised by the company and given full facilities for recruiting. This union now claims over 4,000members out of the 7,000 workforce.

And what happened to the workers' conditions? To quote a GMB press release from December 2005: "AA patrol staff and recovery vehicle drivers are being forced to work up to 11.75 hours per day for five days in a row as overtime is made compulsory. This is due to lack of staff to cover the rosters to provide a service to the public. This comes on the heels of AA management admitting they sacked too many staff and have too few staff to deliver a service.

Patrol staff are currently rostered to work 11 hours per day for a minimum of five days in a row. They can work as many as 8 days in a row, depending on the rostered shift. They also have to take a job that comes in before finishing time so they can regularly work 12 hours per day."

The union goes on to say that staff had also been refused leave between December and April because of the increased breakdowns in the winter period.

Obviously many aspects of the conditions of the AA workers will be familiar to workers employed by supposedly "respectable" companies. The long hours of work - near compulsory overtime - these will strike a chord with BMW workers building the Mini in Oxford. They will also strike a chord with Hamtons workers in the Ford Dagenham Press shop where the scrap metal operation is outsourced to this cowboy company which saves on wages and expects 12 hour shifts and seven days a week working.

These hours of work and conditions are in fact becoming pretty much the norm in many workplaces and are a feature of contracted out operations. As for not being able to cope because too many workers have been sacked - well, Royal Mail workers, and again, the Ford Press shop workers, will be all too familiar with that one! And the job cuts? Well, private equity firms have not been the biggest job slashers by far - in fact it is the government which "wins" this title, hands down, in the public and civil services.

And behind the scenes...

It was what was going on behind the scenes, in the offices of the owners of the AA that was significant, however, and very particular to private equity operations.

They had squeezed out of the company a doubling of profits by December 2006, that is, the sum of £200m. But their original investment, plus the amounts spent on new equipment, was now represented by £1.9bn of debt. As a result the owners had not been liable to pay tax, since all of the interest paid could be offset against this. And apparently they could also take £500m out of the company as a special dividend after a refinancing deal.

By December 2006, Buffini et al were already looking for a buyer and their asking price was £3bn. But in fact what came up instead, was the "perfect deal" - a £6.15bn merger with the insurance company, Saga, which is owned by the private equity firm Charterhouse Capital Partners.

So now the "partners" will be able to take out a total of £2bn in special dividends as part of a special refinancing deal. We are told that everybody is making money out of this deal. Tim Parker the AA chief executive will make £40m out of his original investment of £6m; the Saga chief will make £144m.

But it is a conjuring trick. In fact what the bosses have done is to increase their borrowings to £4.8bn, taking £2bn of this debt as "profits" to be divided among themselves. The new merged company will not pay corporation tax as it will be able to offset the profits it makes as debt interest. As the GMB points out "The scale of the debt will mean that for each of the 11,000 staff of SAGA/AA there are borrowings in excess of £400,000 per person and interest payments per head of £30,000 per year... double the level of wages per person. This is not sustainable and if the company goes belly up under limited liability privileges, those who have taken out £2bn will not be liable for one penny." Too true. And what will happen to the workforce and their pensions? No need to ask.

No, it is not a new kind of capitalism

Private equity is not a new phenomenon at all. And it is certainly not a new kind of capitalism, nor, as the Economist recently called it, "in many ways a superior model of capitalism".

While he Economist was praising private equity, a leading German politician was, at the very same time, calling private equity investors "locusts who were stripping assets and destroying jobs" while Business Week called them the "gluttons at the gate".

Private equity funds can be compared to investment clubs in which a small number of very rich entities (individuals or other investment funds) commit themselves to pool together a minimum investment (a minimum which is usually very large) into a fund. Generally (there are other types, but the mechanism is the same), the resulting fund is used to buy existing businesses with the help of huge amounts of money borrowed from the financial market (up to 70% of the value of these businesses) which are all the easier to raise as the private equity partners are known for their predatory record and success. The businesses purchased would normally be sold within 3-5 years, and the fund wound up in 7-10 years when the club members would have their capital returned with any profits earned.

So how does a private equity fund increase the capital of investors so exponentially? They did this at Debenhams, doubling investors' money within 30 months - apparently a "classic example".

The company was bought in 2003 by private equity firms CVC, Texas Pacific and Merrill Lynch PE using £600m equity to borrow £1.4bn for the purchase.

Soon after this, the property assets were separated from the operating business and remortgaged to "release cash". In 2005, the freehold and long leasehold sites were sold to British Land and leased back in a deal that brought in £495m of spare cash. The business was refinanced twice, so that the debt was increased to £1.9bn. This allowed £1.2bn to be taken out and returned to the private equity firms as a special dividend worth twice their original stake of £600m.

The "extraction of value" in such cases is pure financial engineering (as they call it) - in other words they are moving sums of money around and changing their functions. The business which the private equity investors then sell will have become laden with debt - equal to the amount they have taken out. For instance in the case of Debenhams, the company had only £100m in debt before it was sold to private equity. Now it has £1.9bn debt, so it has significant interest payments and must pay rent on its premises because it no longer owns the freehold sites. In fact its future is really in question as a going concern.

As was said before these operations by private equity funds are not a new phenomenon. The same kind of buy outs and asset stripping by similar funds went on for a period of time in the 1980s, at the time, characterised by LBOs or "leveraged buy-outs", and criticised in the Hollywood film "Wall Street". The boom in LBOs died down after a number of scandals involving junk bond trading and, above all, an increase in interest rates which made such operations far less attractive.

The megadeals and megabucks involved in some of the more notorious deals which have been made actually benefit very few people - and indeed always the same small band of individuals. The British Venture Capital Association has 400 firms registered with it, although it has been in existence for over 24 years.

In Europe, it is the UK private equity business which is most developed, thanks to the leniency of its tax system, which make this type of manoeuvres potentially more profitable than elsewhere. Here the big names are firms like the 3i Group, Permira and CVC. But of course the sector is most developed in the US where the big names are Blackstone, Texas Pacific, Apax, Carlyle and KKR.

These firms do not break the law or even bend it. They merely use the system to their benefit and to the benefit of the investors in their funds. For these rich thugs - as they indeed are, the consequences of their actions on others mean absolutely nothing.

Even the admiring Economist, felt that the reaction among the billionaires to "Mr Ferguson" of SVC Capital's comment about the 10% tax rate of the private equity partners was wrong. The Economist thinks they should pay more tax. And it added "Whether Gordon Brown,... will want to change the tax treatment of private-equity firms is not clear. He has staked much on the bet that Britain's path to prosperity lies in making London the world's centre for financial wheeling and dealing, and will be reluctant to do anything to send its denizen's packing. But nor can he afford to be seen to countenance one set of rules for the rich and another for the rest. As in America, where a bill to tax some private-equity outfits more severely was introduced by the Senate on June 14th, change is in the air. Just how much remains to be seen."

The House of commons Treasury Select Committee still has a few of the masters of the universe to interview before it makes its final deliberations on these matters. But of course, as the Economist says, this is really down to Gordon Brown and he is unlikely to want to rock the boat too much, even if he designed it himself.

They may be different but they scare the same

The current fad for private equity funds illustrates a number of features of capitalism as it is today. It highlights the existence of huge amounts of floating capital looking for a quick investment in such "quick-buck" operation, provided there is a good chance for the "quick buck" to materialise (the name of a private equity fund manager being enough of a guarantee) - but this has been the case since the mid-1980s. It underlines the fact that the capitalist class is more interested in "extracting cash" out of existing facilities than using its capital to develop new facilities - which has been the case overall since the 1970s. In other words, it may be a fad, but what it is based on is not new. Nor is it a sign of "good health" for capitalism, contrary to what economic experts would have us believe.

Underlying the warning heard from union quarters, such as Tony Woodley, that private equity is some form of "unacceptable" or "rogue capitalism", is not just the fact of its attacks against workers, but its "lack of transparency and unregulated nature", as opposed to publicly-quoted companies, which are supposed to be under all sorts of financial checks and bounds and to have a management "ethic" of some sort.

However, capitalists are capitalists. Whether it takes the form of a vampire or a leech, a scrooge or a miser - is not the point. They all extract their profits from the exploitation of the working class - and therefore the objective role they play in society is the same.

Private equity may appear different to those who are at the receiving end of its asset-stripping. For these workers, the aggressive "quick buck" greed of the private equity thugs can have sudden and disastrous consequences, especially if they are not prepared for it.

But the quick buck greed of Peugeot caused it to close down the Ryton plant in the Midlands, and move to Eastern Europe. Peugeot-Citroen is, as far as we know certainly nothing to do with private equity. And the best thing Woodley could think to do against this was to launch a "buy British, don't buy French" dead-end campaign.

No, the one thing that is absolutely common to all capitalists across the board is their capacity to fear the working class. And this is why it does not really matter who owns a company. The best way to impose "transparency" on any boss and control its misdeeds is not be the stock market, nor government-backed regulators - it is the conscious mobilisation of the working class. When these bosses face a determined collective fight back by workers, they will shiver in their shoes in exactly the same way.