Panel: Debt is a 'red herring'

Jacob Rothschild, Kurt Bjorklund, Arif Naqvi and Simon Cairns gathered to debate the effects of excessive leverage at the launch of LSE’s private equity masters programme.

Regulating the providers of debt rather than the private equity industry would be one way of avoiding the over-use of leverage in buyouts, said Ulf Axelson, the newly appointed reader in finance and private equity at the London School of Economics.

Axelson was speaking at the university’s launch of its finance and private equity masters’ programme, which is supported by MENASA-focused Abraaj Capital.

Axelson delivered an overview of academic research into the asset class, asking whether private equity is a positive or detrimental force to the global economy, a question which formed the basis of a panel discussion.

The only thing that drove leverage levels, was how easy it was to get leverage.

Ulf Axelson

He pointed to his own research, which concluded that the amount of leverage used by private equity firms in the past was driven primarily by the availability of debt, rather than its suitability for different businesses. “The only thing that drove leverage levels, was how easy it was to get leverage,” he said.

Jacob Rothschild, a veteran investor and private equity limited partner, said that incoming banking regulations would go some way to stymie the over-use of leverage. “Basel III will stop the aberration of the last few years,” he said on the following panel discussion.

Limited partners are meant to be limited.

Arif Naqvi

Rothschild went on to warn of an upcoming contraction of the asset class, calling into question whether private equity should even be referred to as an “industry”. “There will be a very significant contraction,” he said. “The idea of it becoming an industry full-scale raises question marks.”

Axelson had also suggested giving LPs the power to veto any highly leveraged transactions as another way to temper the over-use of debt to make acquisitions.

When asked during the panel discussion whether he would be happy to allow his LPs to veto unsuitable capital structures on individual deals, Kurt Björklund, co-managing partner and director at Permira, said that as the financial crisis hit, his firm had been able “to trade out of inappropriate capital structures”. He added that “strategically bad investments” cause more of a problem than over-leveraged ones. The correct capital structure, said Björklund, was “very difficult to judge remotely”.

“Limited partners are meant to be limited,” added Arif Naqvi, founder and group chief executive officer of Abraaj Capital, the sponsors of the LSE programme. Naqvi said such a move would the put the LP’s “limited” status at risk.

Naqvi also reminded delegates that the use of leverage is not uniquely a private equity problem. “As far as I’m aware, Greece is not a private equity firm,” he said. “And Lehman Brothers wasn’t a private equity firm either.”

Also on the panel was Simon Cairns, who among other high-profile financial services positions spent nine years as chairman of emerging markets private equity investor Actis. During the debate, Cairns made the point that throughout his private equity career he never once used debt in a transaction.
The debate chairman, Harvard Business School professor of management practise Felda Hardymon, concluded that leverage could be considered a “red herring” given how little academic study had been conducted on the subject.