When news of KKR's interest in Alliance Boots, the UK chemist, leaked in March, some commentators promptly pointed out that the firm's timing was awful. KKR, the market learned, had secured the support of Stefano Pessina, AB's deputy chairman and largest shareholder with a 15 percent stake, to take the company private. At a time when the “conflicts of interest” inherent in private equity-backed PTPs is a prominent item on the ever longer list of complaints about the industry, critics argued, surely this cosy arrangement between Pessina and the New York buyout giant would turn investors' stomachs.
The conflict of interest argument is of course well rehearsed. In any buyout situation, managers participating in the proposed bid have an obligation to the existing shareholders to push for a high sales price. At the same time, however, as future owners, their objective is to acquire the company as cheaply as possible. And because management invariably have better information than anybody else involved in the deal, the worry is that they will likely do better as buyers of the company than they will as sellers.
A similar dilemma is facing Pessina with Alliance Boots. His bid for the business, which has since been challenged by Terra Firma and the Wellcome Trust, is contingent upon a recommendation from the board. He does not manage the business, but helped create it only a year ago when the company went public, and so his position as architect, large shareholder and member of the board clearly calls for a considerate approach to handling the situation. Still, the detractors insist the situation simply cannot be handled considerately enough, despite the fact that Pessina said he would not be involved in any further discussions about the KKR approach. They insist Pessina's involvement in any buyout is simply not appropriate.
PTP-savvy private equity firms, naturally, are familiar with this kind of criticism, and their response is well rehearsed as well. In the final analysis, they insist, a public-to-private is a negotiation just like any other, and it is the responsibility of the board – comprising as it should do a group of highly experienced, professional business people – to ensure the business is sold at the best possible price.
More fundamentally, they like to add, PTPs are an important exit route for investors in public companies that are failing to fulfil their potential. Once an offer is on the table, first the board and then the investors must decide whether the proposed valuation is fair and attractive, or whether the business can become even more valuable as a listed entity. If they decide to sell and the new private equity owner ends up making money from the deal afterwards, cries of foul play are simply not appropriate.
This is a powerful argument. However, it would be even more powerful if private equity firms reserved the right to sponsor PTPs on a hostile basis also. Most do not. In fact, most limited partnership agreements explicitly prevent private equity firms from bidding for quoted companies without support from management. Consider for instance the following passage from the placement memorandum of Blackstone's most recent mega-fund: “The Partnership will not pursue the acquisition of a business if such acquisition is opposed by a majority of the members of such business' board of directors (or by stockholders possessing a majority of the voting power of such business' outstanding securities) – provided that this does not include acquisition of a business in connection with bankruptcy or similar restructuring.”
According to fund formation specialists, such language is included in the documents mainly so as to not embarrass limited partners. Large buyout groups continue to source the bulk of their capital from public pension funds, and these do not like to be part of the controversy surrounding unsolicited takeovers.
This is understandable. However, private equity would become an even more effective alternative to public market ownership if bidding against managers and/or the board were allowed. There simply could not be a better way to keep the latter focused on creating value for shareholders than the knowledge that underperformance may lead to private equity intervention on a take-no-prisoners basis.
Given the political climate in which private equity currently operates, hostile action does not seem particularly expedient. But it would make the public markets more efficient, whilst also putting paid to the argument that management-backed PTPs always leave a bad taste in the mouths of sellers. LBO sponsors should bear this in mind next time they draw up an LPA.