All change for private equity
Circumstances have changed and the easy money has all been made. Now private-equity firms will have to learn how to run businesses
It has been a bumper few years for British private-equity firms, with a record level of deal-making. In 2021, the number of companies bought out by the major houses hit an all-time record of 803 for the UK, with a combined value of £46bn. Supermarket chain Morrisons was bought out by Clayton, Dubilier & Rice, as was construction giant John Laing, the telecoms firm Talk Talk, the security company G4S, and car-breakdown service provider the AA, along with plenty of others. With interest rates at record lows during the pandemic, and with British quoted companies cheap compared with other markets globally, private-equity firms snapped up assets wherever they could find them, and often competed with each other to drive up the price rather than let a business fall into the hands of a rival. It seemed like an easy way to make money.
Right now it is looking a lot harder. We learned earlier this month that Morrisons lost £1bn last year, and its new chief executive, Rami Baitiéh, is struggling to turn the chain around. Its rival Asda is in no better shape. Now owned by the Issa brothers and TDR Capital, the chain is losing both money and market share. It is not hard to work out what has gone wrong. At Morrisons, for example, interest costs have soared, with finance costs rising to £735m last year, a huge payment for the chain to meet. The same is almost certainly true for every other major private-equityowned business. By definition, these are no longer quoted companies, and don’t have to report detailed results, but it is likely that many of them are no longer profitable.
The big private-equity funds lectured us for years on how they would deliver sharper, more focused management. Now it looks as if they will have to prove it. They can’t financially engineer their way out of trouble anymore. Debt can’t be sold cheaply, nor can it be refinanced at near-zero rates. The stockmarket is too flat for any but a handful of technology firms to refloat at sky-high premiums. There is only one route left. They will have to trade their way out of trouble, improving the operating performance of the businesses they own, winning new customers and launching new products.
A change of mindset
That should be possible. After all, quoted companies and entrepreneur-led start-ups do it all the time. But it will involve a very different mindset. First, private-equity firms will have to learn how to invest, and not just cut costs. The traditional private-equity playbook was to send in some consultants to cut out all the paper clips, slash the lunch expenses, and move the call centre to India, while selling off the land and buildings and leasing them back. It was a ruthless costcutting exercise, and while every business has some unnecessary expenses that can be slashed, it didn’t usually do much for growth. In a tougher financial climate, they will have to work out how to invest as well, accepting that they may need to spend money for many years before they make any kind of return. That will be a huge change.
Next, they will have to bring in new managers, with far better marketing skills. A hard-headed accountant parachuted in to turn around one company after another might have been perfect a few years ago, but he or she is unlikely to know much about expansion. Baitiéh may well be the first of the new breed. He was a rising star at the French supermarket chain Carrefour, with deep industry knowledge. The private-equity firms will have to hire many more like him to grow the companies they own.
Finally, they will have to be patient, as will their investors. You can cut costs, re-engineer the balance sheet, and sell off a business within four or five years. It is a fairly simple routine. But genuinely growing a business takes time. New products have to be created, marketing strategies developed, and new customers won over. It can take a decade to get real results, often longer. There aren’t any quick wins. Many of the major private-equity houses won’t be up to it. Those that are will have to learn how to manage businesses successfully, and how to get them growing again. And they will have to learn fast – because the companies they own will decline very rapidly otherwise.