The perils of Private Equity
Apparently there’s some big problem with Private Equity these days. So much so that we’re supposed to use capitals when describing the awfulness of the phenomenon.
This is, sadly, all driven by the awfulness of commentators’ knowledge of private equity.
Take this video from Bloomberg. The High Streets of the nation are being colonised by those dastards from those private equity companies. Morrison's is one example used.
At no point at all is it even acknowledged - not even to say well, yes, but that’s different - that both Lidl and Aldi are owned by private capital. They’re capitalist organisations that aren’t on public markets - private equity. No, that isn’t different. Which leaves us only with the claim that “Private Equity” is Americans, not Germans, and that’s not, really, all that much of a difference.
But note that this is Bloomberg. A financial news organisation. They’re betraying their own gross ignorance on something so simple. They do it at least twice more too:
“Imagine, say, you want to buy a little shop for £500,000. You sue £100,000 of your own money to pay for the deposit, but you borrow the remaining £400,000 usually from a bank. You spend another £50,000 sprucing the place up, then sell it three years later for £800,000……you pocket the difference as profit. Now, imagine that rather than you being responsible for repaying the money you borrowed, the shop itself was responsible. Not you, the shop. You can walk off into the sunset with all the proceeds of the sale. The shop’s new owner now has to find a way of repaying the money that you borrowed. That is sort of how leveraged buyouts work.”
Nonsense. Mindgargling nonsense. People able to type think this sort of thing do they?
The shop is always the repayer of the loan - a bank won’t lend you money without you putting up the shop as security, recall?
But yes, it gets worse. We have a very fine economic theory - contributed to a bloke getting a Nobel no less - called Modigliani-Miller. Which says (in a very short version) that in private companies the blend of debt and equity in the capital structure doesn’t change the overall valuation. Whether this is wholly and 100% true is another matter, but it’s broadly and wholly so. What this means is that in that example, the debt stays with the shop, then the price paid for the equity portion will be the overall value - the £800k - minus the debt - the £400k.
No one ever gets to sell the equity for the full enterprise value without the debt burden being taken into account that is. A claim that they do or can is simple nonsense.
Secondly, why is private equity (even, Private Equity) roaring in UK retail? Because it’s a declining industry. Online is 26% of retail sales now. Commercial property values (delayed by upwards only rent reviews but it is still happening) are falling through the floor. The burst of retail bankruptcies is - as I would argue Body Shop was for example - people trying to get out of long lease commitments at rents of a decade ago.
But that’s exactly when private equity has a chance of doing something different from publicly held. By owning most of the debt themselves they then become preferred creditors in the reconstruction of the now bust retailer - and it’s the landlords who get it in the neck.
Sigh. Sure, sure, it’s possible to not like private equity if that’s your bag. But people like Bloomberg are supposed to know these things rather better than to tell us stories of hobgoblins and capitalist d’stards.
Private equity turns up in declining industries because they’re able to sweat the downwards curve of the business better - or differently - than public equity can. British physical retail is a declining industry. And that’s, erm, about it.
Blimey, if financial journalists cannot grasp this sort of thing then what are financial journalists for?
Tim Worstall