Simon Walker, BVCA Chief Executive
The Foundation Lunch
3rd December 2008
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I know from your website that one of the aims of The Foundation is to help your clients think differently.
My main job since becoming Chief Executive of the BVCA has been to help people think differently about private equity. And that's what I am going to try to do with you today.
This past week, I've been thinking a bit about the high street. Partly because of the Pre-Budget Report and asking myself whether a 2.5% cut in VAT can possibly boost consumer spending when stores are already cutting prices by a third or a half. That's equivalent to taking something costing ten pound and saying "this year only, yours for £9.79".
I've also been thinking of the fate of poor old Woollies, which collapsed a few months short of its hundredth birthday, with debts of some £385 million ... and 30,000 jobs on the line.
You might remember that one of our members, the private equity firm, Apax, bid for Woolworths less than three years ago.
Ultimately that bid - which valued Woolies at £840 million - fell through. I was wondering what might have happened if it had gone ahead.
I am sure there would have been some tough management decisions. I'm sure that costs - and yes, jobs - would have been cut. Whole bits of the business might have been sold off.
I'm also sure that Apax would have been labelled asset-strippers, locusts, sharks, jackals....you name it, they would have been called it. There would probably have been a union campaign against them - Save our Jobs, Hands off our Woolies, petitions to No 10, supported by MPs up and down the land.
I don't know whether Apax would have succeeded. Maybe not. But it probably would have been Woolies' best chance of survival because you would have had a business owned by people with skin in the game, who had a real incentive to make it profitable again.
And today we might have had a viable business called Woolworths on our high streets.
Those of you whose pensions are with Axa or Legal and General might have preferred it too. You're the ones who are last out as Woollies goes under.
Take Rover. Another of our members, Jon Moulton, at Alchemy, bid for Rover a few years back. It was rejected. Why? Because people thought that if he took it over there would be blood all over the carpet as costs and loss-making activities were cut.
So there might have been.
But those tough decisions were exactly what Rover needed. Instead, without private equity, what did we get?
We've had all the job losses, the whole business has gone, and this time it's you and I, the taxpayer, who poured millions of good money after the bad until the election had passed and the politicians thought that they could quietly put Rover out of its misery.
Take another example - EMI. A basket case for as long as any of us can remember. A byword for excess and waste as a public company.
When Guy Hands and Terra Firma took it over, the critics were falling over themselves to say that he was bound to fail.
I don't know if Guy will pull it off and rescue EMI or not. But I do know this. EMI has got a much better chance of survival now.
And Guy Hands has exploded another myth about private equity - that it just walks away when the going gets tough.
He has done the exact opposite, investing more cash and more time in an effort to fix the problems and salvage a viable, profitable business from the wreck EMI became as a plc.
Just as Cinven, Candover and Permira have done with Gala Coral - pumping hundreds of millions into Gala Coral because it needs cash and they believe it has a future.
That's why it is so important that people think differently about private equity. That we move away from the stereotypes perpetuated by trade unions, President Sarkozy or the Socialist Group in the European Parliament.
We need to see private equity for what it is. It's not perfect. It's certainly not infallible. Like any other business model, it sometimes makes rotten decisions. Some firms are more successful than others. And in the months ahead, companies backed by private equity will fail - just like publicly-owned companies.
But taken as a whole private equity provides many of the things we need to make our business sector and our economy more successful and productive. That is more true than ever when you think about the problems we face today.
Let's just think what we are going to need to get the economy growing again.
• We' re going to need liquidity - cash - to get the wheels of commerce turning again and people prepared to invest
• Long-term attitudes towards investment and an end to the short-termism which has contributed to the current crisis
• The ability to repair broken or languishing businesses
• New business start-ups because they are good at creating jobs
• Clever research being "spun out" of Universities and turned into viable, fast-growing businesses - the growth industries of the future
• Increased productivity and the ability for UK businesses to compete effectively in international markets
and lastly
• We're going to need to rebuild shattered pension pots by generating strong returns for pension funds.
I am sure you can think of others, but that isn't a bad list to be going on with.
So how does private equity and venture capital measure up?
Firstly, it is sitting on cash. Despite the credit crunch, global funds raised more than $320 billion in the first half of 2008.
That money is waiting to be invested - in a world where cash is in desperately short supply and where banks won't lend.
As David Rubenstein, the founder of Carlyle, says this could turn out to be one of private equity's finest hours. Investing at the bottom of the market is something the private equity industry has done through other downturns. It should lead to decent returns for investors in due course.
Secondly, venture capital and private equity are long-term investors. Compare this with investors in public companies, who are constantly looking for short-term returns. Private equity typically stays invested for five or six years and often longer. In other words, private equity offers an antidote to the short-termism which has contributed to the current problem.
Thirdly, I believe private equity will have an important part to play in the recovery because it invests right across the economy, from University start-ups , to growing businesses looking to expand into new markets, through to big household names that have lost their way.
As big corporates focus on their strengths during the recession, we're going to see non-core businesses hived off. Those divestitures are going to need financial backers.
Private equity brings the disciplines that are needed to fix broken businesses - focus, toughness, experience, and alignment of interest. Big rewards for success when cash is actually returned to investors. But no rewards for failure - unlike many public companies.
Fourthly, because private equity has a proven track record at generating superior returns across the economic cycle - pension funds are going to need it more than ever after the savaging they have suffered in recent months.
Those are some of the things that our industry can bring to the party if allowed to do so. I want to say a bit more in a moment about what the government can do to make sure that private equity can play its part.
Let me say something first about market conditions at the moment. How different is it now compared with say 18 months ago when we were seeing the huge deals - like KKR's takeover of Boots - being done?
The short answer is: totally. Those big deals have evaporated with the credit crunch.
A few quick stats prove the point:
- the value of the buy-out market halved from the first half of 2007 to the first half of 2008. Those figures don't capture the dreadful last few months.
- the total number of buy-outs hit a 15 year low in the first first half of 2008
- the top 4 deals ranged from Emap at £2bn to Northgate Information Systems at £0.5billion - all public to private. Adifferent league from KKR's £11bn + for Boots
- the mid-market has also shown a sharp downturn: deals in the £100-£500million range fell dramatically.
Private equity is having to focus back on driving operational efficiency into its portfolio companies.
That is no bad thing. There is some truth in the accusation that in recent years with the availability of easy credit private equity has maybe got a bit lazy. With people falling over themselves to lend and to get a piece of the private equity action, the role of leverage became increasingly important.
That has all changed. People in private equity will prove their worth - or not - by delivering hard-won operational improvements and not clever financial engineering.
I would argue that private equity is already demonstrating that it can adapt to these new conditions. Firms are having to be more creative to get deals done.
For example, the Leeds-based turnaround investor Endless private equity acquired Crown Paints in an all cash takeover saving nearly six hundred jobs in Darwin - a place where jobs aren't easy to find.
Firms do have cash to invest when the time is right and when the banks want to do deals again.
What these tougher times will also reveal is whether private equity really does make a difference by bringing management know-how to the table. Or whether, as its critics claim, it is simply stuffed full of people who have brilliant degrees in maths, know how to do clever financial modelling but don't actually know how to run a business.
That isn't a criticism you could level against Clive Hollick at KKR for example. Before coming in to private equity, he had huge hands-on experience building up United Business Media over a twenty year period. Most of Terra Firma's senior players have come into private equity with a strong background in hands-on management - running businesses like Scottish Power or Stagecoach or Allied Domecq.
Liam Strong at Cerberus ran Sears. Rick Haythornthwaite struggled successfully to restore Invensys to corporate life.
Tim Parker, the so-called Prince of Darkness, has run AA, Kwik-Fit and Clarks - so plenty of hands-on managerial experience.
There's been some interesting research by Viral Acharya into the effectiveness of private equity versus PLC boards which supports the basic contention. 75% (of who) felt that private equity boards were more effective. On a point scale of 1 to 5, private equity boards averaged 4.6 versus plc boards at 3.5.
Clearly the proof of the pudding will be in the eating over the next couple of years for private equity. I don't expect everyone to do equally well. There will be failures. But I do expect private equity to make a huge contribution to fixing the economy and making businesses profitable.
I have one caveat, and let me end on that. The caveat is that Government and regulators mustn't mess things up.
There are two ways in which they could kill the goose that lays the golden egg - or at least make it fly off to Switzerland or Dubai or Dublin.
One is by too much taxation - and I'm afraid that last week's statement in the Pre-Budget Report that the top rate will be going up to 46.5% is bad news for UK competitiveness.
The other is too much regulation. Here everyone in financial services faces a multi-layered threat - from the US, where Barack Obama has come out very clearly as being in favour of more rather than less regulation.
From the EU, where the Socialist Group in the European Parliament in particular is going to be campaigning in next June's elections for more regulation.
And from the UK, where we have the Chairman of the FSA, Adair Turner, saying that he wants to wipe the slate clean on regulation.
I know that some of this is a knee-jerk populist reaction to the global meltdown in banking. And more regulation in the US - a la Sarbanes Oxley - could be good for financial services in the UK.
I hope the British Government does not rush to judgement. Let's not screw up tomorrow's recovery by stopping a repeat of yesterday's problem.
As a believer in free markets, I can't resist pointing out that the real problems came from the most regulated sectors of the economy. That said, I recognise that greater openness is an important theme for private equity. Which is why over the last year we've introduced far greater transparency through the Walker Report, which we will continue to roll out in the months ahead.
But overall, if we avoid these pitfalls, I am clear that the role of private equity in our economy is going to continue to grow. In fact, we are going to need it more than ever. We are going to need its cash, its flexibility, its management, its focus to help get the economy moving again.
Private equity is far from perfect in every respect. There will be failures, some of them big ones.
But when you look at what it is good at - fixing broken businesses and helping businesses to expand and become more profitable - then I am certain that it has an important part in putting us back on the path of growth.
