Friday Letter: The trouble with turnarounds

The high-profile failure of City Link in the UK is a stark reminder of the many risks of private equity in backing faltering businesses

The timing definitely did not help: the fact that City Link, the UK parcel delivery business owned by UK turnaround specialist Better Capital, went into administration on Christmas Day of all days, resulting in 2,356 job losses, is one the reasons why there’s been such a storm of anger and resentment blowing ever since.

Better had acquired the business for £1 in April 2013, despite it having incurred substantial losses over several years, but hadn’t been able to turn it around: “We thought it was a poor market. We were wrong: it was a very poor market,” Better’s founder Jon Moulton told PEI yesterday.

Unsurprisingly, the timing of the announcement was heavily criticised by staff, trade unions and also politicians, with some dubbing Moulton the ‘Grinch’. Better claims it never intended to make the statement on Christmas Day. “The idea was that the announcement would be on Boxing Day or the day after, but the union decided to write to its members on Christmas Eve telling them that the company was already in administration – which it wasn’t.” That gave rise to “very significant pressures on the company”, with suppliers, operators, contractors all getting very concerned, which precipitated an announcement on Christmas Day, Moulton said.

Whether delaying the bad news by a day or two would have made much difference might be a moot point. In any event, a week into the New Year and in Britain at least, City Link’s collapse continues to make headlines.

Because Better structured half of its investment as a secured loan, the firm will be able to get approximately £20 million of its £40 million investment back, and Moulton is adamant that Better will recoup that money. News of this development resulted in another flood of criticism – even from within the private equity industry.

Luke Johnson, like Moulton a high-profile UK private investor, wrote in the Financial Times this week that “Better Capital would be unwise to seek repayment… until staff and partners have been decently treated”. And: “If by his behaviour he [Moulton] demonises private equity, he does the industry that has made him wealthy a great disservice.”

Moulton counters that Better’s conduct should not be criticised by private equity or anyone else. “We have been in the company 18 months, we have lost £20 million. We clearly weren’t doing anything to rip the assets out of the company. And we arguably provided 18 months of employment which otherwise would not have been there.”

What’s more, lenders recouping part of the investment is standard procedure, he insists. “If we had financed this deal with £20 million of equity and £20 million of asset-based lending, which we could have done, we would have lost our £20 million of equity and the bank would have collected their asset-based lending. I don’t think there would be any comments [about that] whatsoever.”

These points are well made – including the last one about private equity’s chances of a fair hearing in the court of public opinion being slim. It usually doesn’t get one, and it certainly won’t on this particular occasion, not with the story having incensed so many people already.

But therein also lies a difficulty for Moulton and his particular blend of rescue investing: when it goes wrong, precisely because it is the kind of private equity approach a lot of people love to hate, they won’t turn around (sic) and say, ‘well done, at least you tried’. What they will do instead is point the finger, and hard.

Moulton is too smart and too experienced an operator not to know this. He may be entirely within his rights to want to minimise his financial loss. But what he should be doing more of also is to explain his reasons for investing in this long-failing business in the first place, i.e. to really make the case as to why he felt it was right to take on the risk that was coming with it, and justify his due diligence process.

Because now that it hasn’t worked out, Luke Johnson is also right that private equity stands to lose more than Better Capital’s £20 million. The industry’s many critics are having a field day and, to make things worse, 2015 is an election year in Britain.

Tim Hames, director general at the British Venture Capital Association, recently wrote that private equity’s biggest challenge in 2015 is political uncertainty. If the Left form the next government, the political backlash to the City Link fiasco could be immense.