Mutual benefits

During 2005, the UK buyout market saw a significant number of public-to-private transactions, with 20 such deals completed at a total value of £7.2 billion (€10.4 billion; $13.2 billion), according to the Centre for Management Buyout Research (CMBOR). Despite a sluggish start to this year in terms of take-private deals, with just four completed in the first quarter, a number of high-profile bids for public companies by private equity firms has attracted substantial media attention.

What this flurry of private equity interest in public companies entails for the industry is as yet unclear, but commentators have begun to speculate about the state of the relationship between the public and private equity markets. Some maintain that the balance of power between public and private ownership is fundamentally shifting, heralding a systemic change in the structure of the UK corporate landscape. Others predict a cyclical blip, the likes of which have been seen before. For instance, in 2000 a total of 42 public-to-private deals were completed at a value of £9.4 billion, signalling the high-point for such deals in the UK market and substantially exceeding last year's total. It could be argued that it is not so much the appetite for public-to-private transactions that has increased, but the column inches dedicated to them.

Some maintain that the balance of power between public and private ownership is fundamentally shifting, heralding a systemic change in the structure of the UK corporate landscape. Others predict a cyclical blip, the likes of which have been seen before

In the midst of this debate, the British Venture Capital Association (BVCA) and the London Stock Exchange have released new independent research that highlights the importance of a vibrant stock market to the health of the private equity industry. The report, The London Markets and Private Equity Backed IPOs, outlines the synergistic relationship between the public and private domains. The strong performance of private equity backed IPOs and the significance of the IPO route as a source of liquidity for the industry's investors and the companies that it backs illustrates the importance of a vibrant stock market.

While much has been made of the movement of listed assets into private equity ownership, this new research highlights the extent of the reverse flow of assets from private equity portfolios into the quoted markets. Private equity backed companies have accounted for around 50 percent of all new UK listings on London's Main Market over the 1998 to 2004 period, with the industry having benefited strongly from increasing stock market liquidity. Private equity houses achieved 43 exits by IPO on the LSE and AIM markets in 2004 and 30 in the first nine months of 2005, according to …unquote”.

PUBLIC EMBRACE
In the context of all new listings on UK stock markets, the level of public-to-private investment activity is not as significant as one would imagine. The total value of public-to-private deals in 2005, at £7.2 billion, represents just 43 percent of the £12.6 billion offer value of all new UK listings during the year. In terms of the volume of such transactions, there were a total of 354 IPOs on the London Stock Exchange and AIM in 2005, compared with just 20 public-to-privates, giving a clear indication of the direction of flow between the public and private domains.

The report also shows that the UK's Main Market liquidity has grown considerably since 1998, with turnover (ratio of shares traded to total market capitalisation) standing at 139 percent in 2005. The AIM market's aggregate turnover stood at 74 percent in 2005, having shown considerable improvement over the past two years.

A company looking to rethink its business concept or requiring substantial investment to support an aggressive growth phase may find the private equity model preferable, combining an alignment of economic interests; a close and direct relationship between managers and owners; and a willingness to forego short-term return for longer-term value enhancement

The fact that companies move fluidly between the public and private domains, in both directions, highlights the vital role that each of these markets play in the broader life cycle of a business. The de-listing and potential re-entry of Debenhams to the stock market is a case in point, with a period of private equity ownership having enabled management to refocus the business, a process that could have been more difficult in a public market context. That said, the performance of Marks & Spencer shows what can also be achieved within a public market environment.

There is now choice available to existing shareholders to take cash out and seek alternative market opportunities, or stay in and see whether incumbent management can release value. The development of the private equity alternative is surely beneficial to all parties and to the general dynamism of our corporate landscape.

EITHER, OR
Whether a company is held within one or the other market very much depends on the individual circumstances of that business at a particular time. For instance, a company with stable earnings per share and dividend growth may be suited to public ownership, where investors are more focused on certainty and predictability. But a company looking to rethink its business concept or requiring substantial investment to support an aggressive growth phase may find the private equity model preferable, combining an alignment of economic interests; a close and direct relationship between managers and owners; and a willingness to forego short-term return for longer-term value enhancement.

When significant changes are required to boost long-term shareholder value, a company's management team needs to have the freedom to make longer-term strategic and operational decisions. In the case of a publicly traded company, any ensuing period of uncertainty would be unwelcome to an investor base which lacks the direct engagement with operational management enjoyed by private equity management.

The success of the private equity model in creating sustainable growth businesses across corporate UK is well documented in the BVCA's Performance Measurement Survey and its Economic Impact Study. In addition, the BVCA's latest research highlights the fact that private equity backed businesses continue to perf o rm strongly post-IPO, contributing to the overall health of the quoted markets. Private equity backed IPOs in the UK outperform other IPOs, generating returns of 15.2 percent (unweighted) and 13.8 percent (weighted), over the course of the year after flotation, compared with 6.1 percent and –1.9 percent for other IPOs.

These findings support the view that private equity backed businesses tend to be robust, well managed and in good operational shape – representing an attractive opportunity for public market investors.

Peter Linthwaite is chief executive of the British Venture Capital Association.