Bailouts and buyouts

LDC's prolific deal rate has raised questions about the use of bailout cash – and, more broadly, about the merits of private equity, writes Andy Thomson.

“What we are doing fits absolutely with what the bank expects us to do, and presumably also what the government would expect us to do.”  This was the view expressed to PEO yesterday by Peter Brooks, managing director at LDC, the private equity arm of the UK’s Lloyds Banking Group.

And what is it that LDC does? “We simply support UK companies. We put in development capital and we seek to increase the number of employees and the turnover and profits of the company in question. Private equity firms like ours are massive funders of UK industry.”

Andy Thomson

LDC created a stir when recent Dealogic figures showed it had become the most active investor in UK buyouts, with three times more deals completed than any of its rivals in the first nine months. On the face of it, investing strongly in new deals in 2009 looks a good move. Valuations are low, investments made during recessions tend to deliver significant out-performance, and – unlike the vast majority of its rivals – LDC has the resources of a very large balance sheet to call on. And that’s where a big PR problem has arisen.

This is a balance sheet that was, after all, propped up by a £17 billion government bailout in the wake of the financial crisis and which today stands to benefit further from a £21 billion capital raising, which is currently being discussed and is expected to see the government inject a further £6 billion to maintain its current 43.5 percent stake in the bank.

Because of this unusually direct and sensitive link between taxpayer money and the activities of a private equity firm, questions have been raised in press reports and by politicians about the appropriate use of bailout cash.

“Was a private equity unit supposed to benefit from the bailout?” asked the headline of an article in the Times newspaper. In a Sunday Times piece about LDC’s reported talks to buy a minority stake in new Formula One team Manor Motorsport, Liberal Democrat Treasury spokesman Vince Cable was quoted as follows: “Many customers will find it impossible to understand why, when Lloyds is cutting back on lending to thousands of small but sound British companies, they have money to spend on vanity projects of this kind.”

In reality, it seems as though LDC – cognisant of the look-bad factor – has gone out of its way to avoid the glitzier aspects of such a deal. It is understood to be insisting that, if a deal goes ahead, it does not have its name on the Manor car and will not engage in any promotional activity. To LDC, it is likely that this is simply a transaction that makes sense from a commercial perspective. And it arguably deserves to be taken on trust on this: LDC has, according to reports, delivered the best return on risk-weighted capital of any part of its parent organisation.  

This commercial argument perhaps should be good enough in itself to answer the critics. After all, is the end goal not to produce a healthy Lloyds Banking Group and potentially yield taxpayers a decent return on their money? In Brooks’ view, of course, LDC is also a contributor to societal good – notably as a creator of jobs. And there are statistics (provided by organisations such as the BVCA) that support the notion of PE firms making a positive net contribution to the jobs total.          

The problem is that this message still doesn’t seem to be getting across. The mountain of bad LBO debt that could plausibly cause further “systemic” issues for the banks means that private equity is viewed with suspicion by many – and by some as one of the outright bad guys of the crisis. The furore around LDC’s activities shows that this suspicion does not attach solely to the largest end of the market (some who should know better seem incapable of making the distinction between LBO and mid-market strategies).

Take a look at recent press coverage of private equity – putting the rather distinctive case of LDC aside – and much of it creates an impression of an activity perceived to be a little too risky, shadowy and self-serving. The industry may have hoped that the PR battle over taxation was an isolated skirmish that could be fought and laid to rest. Recent evidence hints at new battle lines forming.