Last week’s collapse of a private equity bid for J Sainsbury had one illuminating side-effect. The shares fell on the news, as might have been expected. But they still ended the week some 25 per cent higher than before the bid – and that says a lot about public perceptions of private equity’s judgements, notes Tony Jackson in his FT column.
The Sainsbury deal had been blocked by a minority from the Sainsbury family. Unless the family changes its mind, the company looks largely bid-proof. So by implication, investors think Sainsbury is worth more to them simply because the bid was mounted at all.
This might not be thought unusual. Bids have a way of focusing investors’ minds and even failed ones can leave the share price higher for a while. But the tone of the commentary in this case suggested something more. Sainsbury, we were told, must be worth at least as much as the bid price, because a group of big private equity houses said so.
This is a remarkable tribute to private equity’s awesome reputation. Not only can it manage companies differently and apply more leverage. It is also presumed to be better than run-of-the-mill fund managers at valuing companies in the firstplace.
This is equally true in the credit markets. The IMF’s latest Financial Stability Report sounds a mild note of alarm about the leveraged loans that private equity houses take out. Anecdotal evidence suggests, the IMF says, that “in the case of deals sponsored by some of the larger and more established private equity funds, investors in leveraged loans may be relying unduly on the due diligence performed by the sponsor”.
In other words, investors will buy into the deal in a spirit of blind faith rather than independent inquiry: the diligence effect
So what evidence is there that private equity is better at assessing value? One public company veteran who crossed over to private equity some years ago said the first thing that struck him was how much more thoroughly private equity performed due diligence.
In the credit markets, there is also an issue of timing. When a private equity house launches a leveraged loan, it does so after the deal has been announced. Investors do not have time to replicate the groundwork on projected cash flows and so forth. All they can do is study the presentation and make a snap judgement.
So on the face of it, private equity can lay claim to a superior model not only of governance, but of intelligence gathering. The first claim is open to argument, the second perhaps less so. But in ideal terms, the two are interdependent.
This is because the intelligence forms the basis of the operating strategy. That will involve targets on which management’s rewards depend – targets that are only as good as the homework that produced them.
Any public company worth its salt would claim to do something similar. But the process lies beyond the scope of the outside investor.
This does not mean that the public company model is inherently inferior. Its defensive strengths will pay off in the next downturn. And private equity, as the IMF warns, is vulnerable to a change in the more or less perfect conditions it is enjoying at present.
But when that happens, conventional fund managers are going to have to raise their game. Granted, they cannot devote the same resources to intelligence-gathering as private equity. But when the private equity boom ends, they are going to have to try.