Friday Letter: Why Milibands 'empty threat' matters

UK opposition leader Ed Miliband singled out private equity this week as an example of 'bad business'. The argument may have been weak, but the sentiment is significant.  

The speech by Labour leader Ed Miliband at his party conference this week was a success in at least one respect: his attack on private equity as pernicious “asset strippers”, part of his distinction between “good” and “bad” businesses, made headlines in most UK newspapers. At a time when most people are pretty apathetic about political discourse, this certainly had a degree of 'cut-through', as they say in Westminster.

Sadly, this wasn't a reflection of the quality of the argument. Miliband's principal example of a 'bad' business was Southern Cross, the care home operator formerly owned by The Blackstone Group, which recently buckled under the weight of its own debts. “Look at what a private equity firm did to the Southern Cross care homes,” alleged Miliband. “Stripping assets for a quick buck and treating tens of thousands of elderly people like commodities to be bought and sold. They may not have sold their own grandmothers for a fast buck. But they certainly sold yours. They aren’t the values of British business.”

What he failed to mention, of course, was that Blackstone had exited the business via an IPO in July 2006 – and that the operating model he implicitly refers to was in place long before Blackstone got involved. As the BVCA pointed out afterwards: “To hold [Blackstone] responsible for all that has happened there since then is as fair and reasonable as blaming Mr Miliband for everything that has happened to Britain since 2006.”

Miliband's distinction between “producers” and “predators”, or “wealth creators” and “asset-strippers”, may play well to his base. But if Southern Cross is the best example he can come up with, that doesn't bode well for his argument. On the face of it, Southern Cross is just as good an argument for a clamp-down on publicly owned companies.

It would be easy to dismiss Miliband's words as empty political rhetoric. As we pointed out earlier this week, his threatened changes to private equity's regulatory oversight would probably be superseded by EU law anyway, while he'd also struggle to push any radical tax changes through Parliament. An “empty threat” was how one London-based financial services lawyer characterised Miliband’s comments.

It's also hard to see how he'd distinguish between good and bad businesses in practice; presumably the alternative to the market making this choice would be that politicians or civil servants make it instead – prompting a raft of questions about qualifications, motivations and potential conflicts of interest.

There's also, of course, something quite significant Miliband failed to mention. Even if there are examples of companies where private equity ownership has been unsuccessful, what about all the (far more numerous) occasions where private equity ownership has strengthened a company and grown its revenues, products and employment base? Dismissing the entire private equity industry on the basis of a few bad examples is short-sighted at best.

Also notable was his failure to explain where he expects “wealth creators” to come from. Who is going to provide the risk capital that lets entrepreneurs and management teams invest in their business and their staff? The banks? Given global economic turmoil and recent credit market conditions, that seems increasingly unlikely.

Nonetheless, it would be a mistake for the industry to ignore such a speech altogether. Miliband is tapping into an anti-private equity sentiment that once again is cropping up on both sides of the Atlantic – and if former Bain Capital chief Mitt Romney becomes the Republican nominee for the US presidency, chances are that the industry is going to be caught in the cross-fire. His political opponents are already starting to attack his background.

So all told, it's never been more important for private equity to be banging the drum about the value it brings to portfolio companies, the advances it has made in improving its environmental, social and governance practices and, crucially, how its capital can be instrumental for economic recovery. Kudos to Blackstone president Tony James for doing just that on CNBC television last week. More fund managers and investors should follow his lead.

We've said it before, but the point needs to be made again and again: the industry needs to get out ahead of its critics, honestly explaining any missteps and shouting about its successes. That way, misleading and specious arguments like the one advanced by Ed Miliband this week will get the reaction they deserve.