Friday Letter: Another Debenhams?

Based on some of the recent press coverage of the industry, it would be easy for the casual observer to get the impression that private equity is the root of all evil.  

But it’s not just disgruntled employees, trade unions and left-wing academics that appear to have decided that private equity embodies all that’s wrong with 21st century capitalism. There are increasingly visible signs that the public markets are viewing the industry with greater suspicion too.

This was evident again this week after Jessop’s, a specialist UK photography retailer, saw its share price plummet by 70 percent in a single day, following a series of profit warnings. As soon as people remembered that this was a business previously owned by private equity – in this case ABN AMRO Capital – the mutterings started about buyout firms taking companies private, stripping them of value, and returning what’s left to the unsuspecting public markets. It’s another Debenhams, commentators said.

It is ironic that one of the most successful private equity deals of recent years seems to be in danger of becoming a byword for the industry’s disdain for the public markets. Debenhams, a UK department store chain that was taken private by CVC, TPG and Merrill Lynch Private Equity in 2003 and re-floated three years later, netting the three firms a huge return, has seen it share price slide following last year’s flotation. As it continues to trade well below its offer price, investors have begun to cite it as a classic example of private equity ‘leaving nothing on the table’ for the public markets.

Now Jessop’s is being tarred with the same brush. It is two and half years since ABN’s private equity arm floated the business. When its share price hit 15 pence this week – 90 percent down from its offer price of 155 pence – one UK broadsheet traced its problems back to the time when ’the business was loaded up with debt and floated off’ by ABN. The buyout firm has publicly kept its counsel, but sources said that it has been shocked by some of the accusations. Jessop’s showed slow but steady growth during the firm’s two-year ownership, and a banking source said that on flotation the company had debts of about £30 million, compared to its market capitalisation of about £160 million. ’Loaded with debt’ it was not.

In truth, Jessop’s problems are not dissimilar to those faced by many smaller retailers. Declining demand for its biggest-selling product (digital cameras), and difficulties in trying to squeeze a better deal from its suppliers, which led to a well-publicised stock shortage before Christmas, are difficulties that can hardly be blamed on its previous owners. Retail is a cyclical sector, and market conditions can change quickly.

But the bigger issue here is the increasing tendency to point the finger at private equity when former portfolio companies under-perform on the public markets. The danger, of course, is that if public market investors become increasingly suspicious about private equity backed flotations, it will become harder for sponsors to use this as a sensible exit route. And that would be bad news for everyone: not only for the firms themselves, but also for public investors, who could end up missing out on companies whose period of private equity ownership has left them better equipped to exist as public entities.

Some kind of hybrid approach may be one answer: today global private equity provider Warburg Pincus floated energy exploration company emgs in Norway, but will keep a 60 percent stake. Yesterday, French group Wendel said it may float business services group Bureau Veritas – but retain a controlling interest. Legrand, the French-listed electrical parts manufacturer, is still 60 percent owned by KKR and Wendel. This way, public market investors get to share in the upside, and buyout firms cannot be accused of taking the money and running.

So far, the evidence in this area seems to be in the industry’s favour. Most research on the matter, notably by Harvard academic Josh Lerner, shows that private equity backed flotations actually outperform the average. This is clearly a message that needs to reach a wider audience. But perception is everything – it only takes a few ’Debenhams’ to create a climate of suspicion that no amount of statistical analysis will be able to dissipate.