Friday Letter: Still on the hook

The collapse of Phones 4u has highlighted – and probably worsened – the industry’s reputational problem

It's hard to escape the feeling that the collapse into administration of UK mobile phone retailer Phones 4u – a portfolio company of London-based BC Partners – has done fresh damage to the public reputation of private equity. That's certainly what a number of people within the industry have been telling us this week.

Whether or not that's fair is a moot point. It partly depends who you blame for the precipitating cause of this collapse, i.e. the withdrawal of supply by two of the big mobile operators. The latter have been trying to link their decision to the debt loaded onto the business by its private equity owner, arguing that it constrained Phones 4u’s ability to offer them a more competitive deal. But this seems rather cynical and self-serving; there's surely at least some truth in the retailer’s contention that Vodafone and EE just wanted to boost their margins by selling more phones direct.

Where BC is vulnerable, however, is over the £200 million dividend recap it extracted from the business barely a year ago – as a result of which it now stands to make money on this deal, regardless of what happens to the company. In their defense, the firm has argued that the business could easily afford it at the time, since it had £400 million of cash in the bank; equally, the debt load of the business after the recap was not particularly excessive, either by private equity standards or even in terms of Phones 4U's recent history. From the outside, it’s impossible to know whether the owners could (or even should) have anticipated the commercial calamity that happened next. But there’s no question that with the wonderful benefit of hindsight, it looks like a bad decision – and with 5,500 jobs on the line, it’s going to be hard to convince anyone otherwise.

On the positive side, lessons have clearly been learned from the shambolic way in which the industry has reacted to this kind of situation in the past. Rather than pulling up the drawbridge, as firms have done all too often in the past, BC issued a joint statement with Phones 4u as soon as the news broke on Sunday night, in which they emphasised their concern for the workforce and pinned the blame squarely on Vodafone et al. Since then they’ve continued to engage with the media, attempting to explain why they did what they did when they did. That’s progress.

On the other hand, as the reaction this week has shown, private equity has clearly made little progress in dispelling the suspicions that have long surrounded its tactics. “We have seen far too many cases of private equity firms borrowing money to take over companies, stripping them of assets and leaving them vulnerable to financial collapse,” Trades Union Congress general secretary Frances O’Grady said this week. “This model of value extraction is bad for business. It is always the workforce that ends up paying the price.” That’s more or less the same thing the unions were saying five years ago. Equally, Vodafone and EE wouldn’t be trying to blame the company's private equity owner unless they thought it would work.

This particular case also highlights a peculiar conflict for private equity firms. In the strictest sense, BC has discharged its fiduciary duty to its investors quite successfully here, since despite the collapse of the company, it is going to deliver a positive return for its LPs. By taking the dividend last year, it de-risked the investment entirely – which you might argue was a cautious and prudent way to protect the interests of its key stakeholders. You’re not likely to hear the firm shouting about this, and it’s not a message that would play well in the mainstream press. But at some point, it will look to communicate that to current and potential investors.

Of course, it feels like sophistry to suggest that the firm has no duty of care to its portfolio companies or their employees. If anything, this just lends weight to the suggestion – as put forward, coincidentally, in a new report this week from the G8 Taskforce on Impact Investing, led by Sir Ronald Cohen – that it’s high time for a broader definition of fiduciary duty, which does a better job of encompassing externalities beyond financial return.

In practice, most firms in this industry have already started to incorporate these additional considerations into their investment process. But Phones4U has shown that despite this progress, the battle for hearts and minds is still a long way from being won.