High noon for private equity?

Debenham’s, the high street retailer, was last week on the receiving end of a scathing broker’s research note. The 126-store company, which was recently re-floated controversially after a brief period in the hands of private equity, was ranked bottom in a league table of European clothing retailers by Goldman Sachs. The poor showing has heightened concerns that the business was returned to the public arena in poor shape by its former owners CVC, Merrill Lynch Global and Texas Pacific Group. It comes at a time when the spotlight on private equity, and its role in business and society, has never been greater. Debenham’s is said to epitomise the “quick flip”, whereby businesses are bought, laden with debt, and sold on at a profit. To the distress of trade unions and opposition politicians, J Sainsbury could be next. It has been described as private equity’s high noon. Its role in the eating and drinking-out market perhaps illustrates perfectly the positive and negative impact it can have on enterprise. It has been the favoured funding route for a raft of fast-growing eating-out groups including Individual Restaurant Group, La Tasca, Loch Fyne, Wagamama and YO! Sushi. A Sunday newspaper supplement published yesterday featuring the 100 buyout firms that have the fastest growing profits in the UK, included a smattering of restaurant groups such as Tragus, the operator of Café Rouge. Tragus is scheduled to produce underlying profits in the current year of about £27m. This comes just over four years after the business was bought from Whitbread for £25m. A recent tertiary buyout by Blackstone valued the business at £267m. That is some value creation. Private equity has proved it is just as good at running companies as anyone else. One could argue that the FishWorks chain would not be in such a predicament if it had been in the hands of private equity, given its discipline, control and an uncompromising demand for top management. As Ian Armitage of Hg Capital told one Sunday newspaper: “The discipline of private equity makes companies fitter, leaner and better able to compete.” That may be true in some instances, but it is not always the case. Private equity has exploited the asset-rich nature of pub groups, arguably to the detriment of some of those operating businesses. It has been responsible for some “nuclear” sale-and-leaseback deals that has seen some sites leveraged to the point of extinction. It has re-enforced the cliché of a swarm of locusts descending, taking everything and moving on. Interestingly, the private equity consortium that returned Debenham’s to the stock market is virtually identical to the one that sold Spirit Group to Punch just over a year ago. Spirit is one of the most obvious examples of the quick flip. It received little investment, it was loaded with debt and some of its best sites were sold to property investors, and let back to Spirit at unsustainable rental levels. When asked what the legacy of Spirit was, one senior person within the organisation replied that the three-year exercise had simply been “a project” from which shareholders and management had benefited enormously. But we may not have seen anything yet. There is the prospect of private equity firms using Reits – tax-efficient property trusts – to wave unprecedented levels of cash at public investors in return for their pub companies. Reits could be the catalyst that drives the separation of asset ownership from pub management, and that may naturally drive down capital investment in UK pubs and bars. They may establish a clearer value arbitrage between what a company is worth if it is run for its long-term benefit of shareholders and customers, and what it is worth in a quick, private-equity flip. It is a weighty issue – and not clear-cut. More in the March M&C Report. On the general issue of private equity, the debate will escalate. In this industry it has been both a force for good and bad. It seems that private equity may have to finally answer calls for a “public face”. As Hg’s Armitage puts it: “Private equity has become a useful whipping boy but we should not complain, we should explain. It’s our responsibility – we are not looking for sympathy.”