The craze in the mid 2000s for private equity barons to take over some of the UK’s best-known business names and load them with debt is coming back to bite.
As the Bank of England warned this week, the legacy of the private equity boom poses a threat to financial stability.
Many private equity deals done in the pre-crisis bubble years were loaded up with enormous debt burdens. High leverage leaves those companies more susceptible to going bust, in turn exposing their lenders to large write-offs – which is bad news for the state-backed banks, as RBS and HBOS, now owned by Lloyds, were in it up to their necks.
Private equity has been at, or near, the scene in a string of high profile disasters. They include Southern Cross, where former private equity owner Blackstone, which sold out several years before its downfall, made handsome profits in just two years of ownership.
The high street is littered with casualties. Peacocks – where a management buyout deal was backed by controversial Payment In Kind or PIK securities – went under when RBS refused to swap debt for an equity stake.
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Camera chain Jessops was cobbled together by private equity then launched on the stock market in 2004 by Dutch financial group ABN Amro; Debenhams, whose shares recently crashed following a profit warning, returned to the stock market in 2006 after its private equity owners extracted large gains in a mere three years.
The argument in favour of private equity is that debt instils discipline on management, which has to work harder and more efficiently to service it. In reality, many private equity deals involved companies being starved of investment and subjected to stringent cost-cutting and job losses.
In the next few years large swathes of private equity debt will be due for re-financing, and the problem here is that credit conditions are likely to be very different from the gung-ho environment in which the loans were granted.
At its high watermark, in 2006-7, banks were falling over themselves to win private equity business, and offered so-called ‘covenant-lite’ loans that dispensed with the normal protections for lenders.
The Bank points to a huge ticking time-bomb, in that the vast majority of the £160billion of leveraged loans maturing from last year onwards involve so called ‘bullet repayment’ where the principal is only paid off when they mature.
Many of these firms, which account for 8 per cent of all corporate debt, will find it very difficult to refinance.
Leveraged deals were highly lucrative for private equity princelings, who put together the deals and benefited from lower rates of tax than their own cleaning ladies on their gains.
The legacy, however, has all too often been corporate collapse, redundancies, denuded pension funds and losses for subsequent stock market investors.
The confidence trick underlying the private equity ethos is that leverage is some kind of magic ingredient that can turn base metal to gold, but the alchemy doesn’t work – it only seems to, when asset prices are bubbling and credit is easy.
Too often, it was licensed rapacity, and there are more victims yet to come. Recovery drive
The negative industrial production figures this week put even more pressure on George Osborne ahead of the Budget to come up with initiatives to boost growth, but as Mervyn King pointed out, it is not all gloom.
One bright spot for the Chancellor is car manufacturing, which has been remarkably resilient throughout the slump.
The former 1970s basket case now supports 700,000 jobs and accounts for 10pc of UK exports as well as being at the forefront of innovation, with £6bn of investment ploughed in over the past 12 months.
The Coalition has been helpful to the industry, not least by supporting the Automotive Council – originally the brainchild of Lord Mandelson – that seeks to back innovation and strengthen supply chains.
It could help further by pressing the banks to support smaller firms in the automotive supply chain with working capital.
If the UK is to sustain inward investment by large car makers, there needs to be the capacity in the supply chain here to meet their needs.
Osborne should also continue with his policy of reducing corporate tax rates, showing genuine long-term foreign investors that he is serious about making Britain an attractive place to be.
Even better, he could start shouting more loudly about the UK’s successes. The renaissance of the car industry shows what can be done.
Ruth Sunderland is Associate City Editor of the Daily Mail