The new breed of “private equity” funds are on the rampage. CVC Asia Pacific has bought half of the company that owns the Nine Network for $4.5 billion, Kohlberg Kravis Roberts has bought half the Seven Network for $4 billion, Newbridge Capital bought Myer for $1.4 billion, and now Texas Pacific, in partnership with the Macquarie Bank wants to spend $11 billion on Qantas.
Worldwide the value of new so-called private equity takeovers is said to double every 12 months.
And yet somehow it all seems familiar...
Back some two decades ago in 1987 when I was working as a reporter at the Sydney Stock Exchange an announcement come over the loudspeaker that seemed to make no financial sense.
An equity consortium headed by the then 26-year old Warwick Fairfax planned to spend what was then an obscene amount of money ($2.25 billion) taking the newspaper-publishing company that bore his name private.
Most of the consortium’s funds were borrowed and after the takeover Fairfax would disappear from the stock market.
The deal would only make financial sense if Fairfax was really worth far more than the stock market had believed it was. In other words, if the market had got it wrong.
It was driven by very easy access to finance (remember this was the newly-deregulated 1980’s), a tax regime that encouraged borrowing, an optimism about how the company could be freed up to make money if it was taken private, and the fees that would be earned by the geniuses that put together the deal.
As it happened it all ended very badly. Much of Fairfax was sold (The Canberra Times, the Seven Network) or closed down (The National Times, the Sydney afternoon Sun); Rothwells, the merchant bank that arranged the finance collapsed bringing down the Western Australian state government; and Warwick Fairfax lost his part of the family fortune.
Right now the new explosion in private equity buyouts feels to me like the debt-fuelled takeovers of the 1980’s did at the start.
After some initial astonishment they are being treated in the press as if they are works of genius. If the Nine Network, the Seven Network and Qantas are suddenly worth twice what they were, it must be because the share market has it wrong. It couldn’t possibly be because the financial engineers behind the deal don’t understand what they are taking on.
The faceless predatory private equity funds of this decade are being driven by similar forces to those that drove Australia’s colorful “entrepreneurs” in the 1980’s.
Our tax regime encourages takeovers fuelled by debt. Back then takeover merchants such as Robert Holmes a Court, John Elliot and Alan Bond could negatively gear – get the taxpayer to fund half their borrowings. Today the capital gains tax paid by foreigners who buy an Australian company and then sell it is extraordinarily low, and set to get lower. Legislation now before the Senate will eliminate the capital gains tax paid by foreigners on non-real estate Australian assets.
The Australian economy is strong and our sharemarket looks set to keep climbing – just as it did back in 1987 (ahead of the crash). It’ll need to keep climbing in order for the private equity funds to double the worth of the Nine network etc and get their money back.
And just as in the 1980’s money is incredibly easy for the funds to get. And not just from lenders. Although, not commonly realised, Australian superannuation funds are big investors in private equity funds.
Among the biggest is Australia’s biggest public sector superannuation manager, named ARIA, the Australian Reward Investment Alliance. If you haven’t heard of it that’s because its only recenly changed its name. It used to be called the CSS/PSS and it runs both of those funds. If you are a Commownealth Public Servant it is highly likely that ARIA is managing your money and pushing it in the direction of pivate equity funds.
ARIA’s Chief Executive Steve Gibbs says he won’t name the private equity funds. He uses about 15 to 20 of them, most of them Australian. All up they hold about 5 per cent of the ARIA’s funds and may soon hold up to 10 per cent per cent.
The way it works is that ARIA commits to give each of the private equity funds it deals with a certain amount of money. But it doesn’t actually hand over the money until the fund needs it to pay for a takeover.
After the takeover ARIA and the other investors in the private equity fund get no return whatsoever from the investment until the equity fund disposes of it at a profit. When that happens ARIA gets its money back and hopefully more.
As Steve Gibbs explains: “So we might say to a particular manager $50 million, and that’s a typical amount, we would say, okay we will commit up to $50 million, and over a five year period they will draw that down as they find good investments, and by the time they make their last investment, investing the last of the $50 million, we have probably got half of it back because of investments that have been realized.”
I suggested to Mr Gibbs that each deal that he put money into though a private equity fund was really a gamble that asset prices were going to continue to increase.
He told me that he never used the word gamble but that “what you are doing here is you are making an investment on the basis that once the investment is in the hands of one or more of these private equity managers they can help the company develop a strategy which will ultimately grow the company. It may be as simple as providing capital, it may be that the company has the strategy but doesn’t have the capital”.
You and I though our super funds are behind the new wave of private equity takeovers.
It’s a new wave fuelled by optimism and the belief that big companies are often the best ones. Lets hope that it turns out better than it did in the 1980’s.
