In UK private equity’s ‘most wanted’ list of those deals that have become a byword for all that its critics maintain is wrong with the industry, two seem routinely to bag the top spots.
The buyouts of the AA and Debenhams.
While Damon Buffini’s Permira incurred trade union ire over measures imposed at the motoring organisation, the buyout and subsequent re-flotation of Debenhams has exposed a different and arguably more vulnerable flank of private equity. The company just hasn’t done very well.
And in an industry that justifies itself on its performance, and tends to be scathing of poorly managed companies and weak managements, that is probably a more serious and certainly a more embarrassing problem. After all, no one expects the unions to be happy.
On Monday, the FT reports, TPG, one of the buyers of Debenhams, called on investors in the department store chain to be patient with the retailer’s performance. “We have been in for over three years and we can be patient and stay in for a long time. If people came in looking for a quick return they may be disappointed. The question is how patient they are,” Philippe Costeletos, the TPG partner behind the deal said.
But Debenhams’ three private equity backers, TPG, CVC and Merrill Lynch, made more than three times their initial £600m equity investment in less than three years when the company was returned to the public markets. Shares in Debenhams closed at 127.5p on Friday, well below its float price of 195p.
While the exact profits from the deal have never been disclosed, the FT has calculated that TPG invested about £250m and made an estimated return of £675m, excluding the 14 per cent stake it kept after the flotation. CVC put in about £215m and made close to £580m with a 9.7 per cent stake, while Merrill Lynch Private Equity invested £135m to earn about £365m and an 8.5 per cent stake. Staff are thought to have made close to £50m from their 4 per cent stake.
John Lovering, Rob Templeman and Chris Woodhouse, Debenhams‘ top executive team, made estimated profits of £21m, £41m and £41m respectively and retained combined stakes worth about £60m at the time of the float.
The FT retail correspondent Elizabeth Rigby examines in an FT analysis how what is trumpeted by some involved as one of private equity’s foremost successes is now in danger of going down as one its failures.
“We are the whipping boys of private equity,” Rob Templeman, Debenhams’ chief executive, told the FT. He claims bad weather, weak fashion trends and interest rate rises had hurt performance. It was not, he insisted, a fall-out from the actions he took when Debenhams was private — pointing out that the clothing market was tough for many retailers.
But one private equity veteran quoted disagrees. “They tried to present it in the best possible light, that there was sustainability to what was being done [to Debenhams] . . . But that is what the market got wrong.”
The plan at Debenhams was to improve cash management, cut costs, increase sales and expand margins after the 2003 buyout.
Cash flow more than tripled, and was used to pay down net debt. But Debenhams had begun slashing prices on slow-moving goods, which some critics argue did long-term harm by eroding the brand, explains Rigby. Mr Templeton renegotiated contracts with suppliers, and began to implement deep cost-cutting, with head office staff reduced by 12 per cent in the first year. Senior staff started to defect.
Spending on refurbishments was cut by 77 per cent, a lack of investment that analysts say hurt performance, especially as competitors were spending at the time. Mr Templeton also raised £500m in 2005 through the sale of store properties.
These measures meant impressive performance, says Rigby. Then in the summer of 2005 came the big pay day. A £1.9bn refinancing paid its shareholders £900m as net debt soared to £1.87bn.
Next came the exit. The float succeeded – but only just, getting away at the bottom of the range, valuing the business at £1.68bn. Concern was already mounting on the operational outlook, and the subsequent profit warnings and disparity between what was presented in the flotation document and the reality of Debenhams’ performance has been a bitter pill.
The management team, and its backers, are toughing it out, pointing to short-term failures but a more aggressive expansion programme and more efficient supply chain.
But as its critics keep on whipping, there are those who suspect that the Debenhams’ executive team would rather find an early exit through the return of the business to private hands.