Spotlight - 80s revival: The growth of the PEGs
The drinks industry has not been immune from the growing influence of private equity groups (PEGS) in the corporate world. Critics argue that PEGs hark back to the worst excesses of 1980s corporate greed while their proponents believe they help to revive failing companies and provide a necessary investment vehicle for capital as other traditional avenues are looking unattractive. Chris Brook-Carter weighs up the arguments.
Hardly a deal goes by these days in the drinks industry without reference somewhere along the line to private equity. On just-drinks' news pages alone in the last three months, Cadbury Schweppes, Vin & Sprit, Britvic, Threshers, Coca-Cola Amatil, Foster's and Cott Corporation are all reported to have had dealings with private equity groups (PEGs).
And yet, despite the ever-increasing level of private equity involvement in our industry, these companies remain the most mysterious of financial institutions to most outsiders, viewed at best with confusion and at worst with open mistrust.
However, PEGs are nothing new. They have been around for decades in one form or another. Some have even become 'new conglomerates' by default, with sprawling corporate empires that embrace a wide range of companies with minimal synergies. They exist to make money where others have failed, and they certainly seem to be doing that.
In August last year, Tata Tea Ltd acquired a 30% stake in Energy Brands Inc., from TSG Consumer Partners for US$677m. In selling the stake, the PEG saw a $40m equity investment appreciate by nearly 17 times in just three years. But perhaps the most famous such deal in recent times is the 1994 sale of Snapple Beverage Corp. to Quaker Oats by Thomas H. Lee Partners for $1.7bn. The PEG earned an $872m profit on a $28m equity investment with that deal.
Profits such as these do little to help the cause of the PEGs outside of financial circles, and their perceived modus operandi is undoubtedly controversial.
Critics argue that PEGs chase under-performing companies for takeover and then look to transform them via ruthless cost-cutting and cash generation. Assets - possibly the whole company shorn of cost, or profitable elements - are then sold on for a profit. The PEG model is seen by some as a form of corporate 'invigoration', while others view it as 'asset stripping', potentially wrecking companies in pursuit of a quick return.
Talk to opponents of the PEGs and you'll hear lots about lost jobs, murky tax breaks and investment levels in the acquired companies descending to Scrooge-like levels, with no eye on the long-term health of the business.
But PEGs counter that they have become more sophisticated in recent years and can bring a number of advantages to running a company over the traditional publicly listed model. Senior staff now include industrialists (like Jack Welch, formerly of General Electric) rather than just financial engineers, they say. And they have a culture that means they keep a close eye on the way their companies are run.
It is a myth, they add, that PEGs are pure asset strippers. Many of the companies they move in on have been through a rigorous cost-cutting process already, which means the balance sheet can only be improved through increased sales by the time the PEGs takeover. And PEGs don't benefit from any tax breaks that aren't available to other individual or business.
Most importantly of all, supporters say, PEGs are in the business of saving companies that are otherwise on a downward path. Tough decisions may have to be taken, but they are done so with an eye on forging a profitable and viable business that has a future. Furthermore, it is the very fact that they are private and de-list their acquisitions that means PEGs can make controversial management decisions, which they claim are in the best interests of the business concerned, without having to worry about shareholder reactions or the need to publicly release information under stock exchange disclosure rules. The PEGs would also point out that corporate scandals, such as Enron, that send shockwaves through the markets, tend to be associated with publicly held firms rather than private ones.
But employees still tend to be fearful for their jobs when PEG deals loom large, and the issue of whom the PEGs are accountable to - generally small groups of private investors and credit lenders - remains a real concern.
Just lately there have been more noises of protest echoing the 'bad-boy' image that PEGs had in the 1980s, a public perception shaped by the movie Wall Street and the bestselling book, 'Barbarians at the Gate', about the Kohlberg Kravis Roberts (KKR) bid to buy RJR Nabisco. In the UK, trade unions have begun campaigning for a windfall tax on the funds. And the new Prime Minister Gordon Brown is reported to have said he will review tax rules for partners in private equity firms.
The arguments will go on, but PEGs have certainly become bigger in recent years and are involved in increasingly large mergers and acquisitions or leveraged buyout transactions, funded through mounting levels of debt.
A typical buyout involves taking private a company which is trading on a public stock market. A hostile deal to take a firm over might be financed by debt that is a multiple of eight times a deposit paid by the PEG itself. And the big firms are frequently in competition with each other, bidding prices up further.
Hardly a week goes by now without news of a big PEG deal, or PEG interest in a major public company. They're active across the world and in many industrial and retail sectors. According to Standard & Poor's, the total value of private equity buyouts in Europe and the US surged to US$440bn in 2006 from $100bn in 2003.
It is estimated that there are now almost 3,000 PEGs and venture capitalist firms in the US alone. What's behind the boom in private equity? City analysts say that there is now plenty of money around looking for a home because of a lack of good alternatives in times of low interest rates; PEGs offer a relatively low-risk and high return on investment.
Their methods remain controversial but their influence is without doubt growing. Financial institutions and fund managers have flocked to them. PEGs have been able to easily finance buy-outs through huge loans; if a corporate asset is priced at a high value PEGs are increasingly the only ones able to raise sufficient cash. The deals have been getting bigger, the portfolios wider and the debts even larger. And the biggest private equity firms are now immensely powerful forces.
However, the uncomfortable and unanswered question remains: are they evolving into something new, or are they still, at heart, focused on 'strip and flip'?
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