Supermarket chain Morrisons is the highest-profile UK-listed company to be targeted by private equity this year. But it’s by no means the first – and it almost certainly won’t be the last. As the Financial Times points out, private-equity firms have now bid for 13 UK-listed businesses since the start of 2021, the highest figure since 1999. If you include private firms in the UK too, the figure rises to 345, the highest on record (going back to 1984).
What’s driving this? On the demand side, private equity has access to lots of very cheap debt, while institutional investors are crying out to invest in private-equity funds, which can’t just sit on all that cash once they’ve raised it. So there’s an appetite for deals. On the supply side, UK assets specifically are seen as relatively good value in a generally expensive world, especially now that Brexit uncertainty is mostly behind us and the vaccine rollout has been better than expected. Foreign buyers have the added attraction of buying sterling assets at a time when the pound is low relative to its history. Moreover, public companies are particularly appealing right now. As Simon Borrows of listed private-equity fund 3i told Ben Martin in The Times last month, private equity is turning to public markets partly because valuations of private companies are so high. “They’re seeing better value in listed markets.”
As we’ve noted on several occasions, this move to take (or keep) companies private is not healthy. When companies move from public to private markets, ownership becomes narrower and thus wealth more concentrated, while accountability and transparency fall. If voters are to support the idea of a free-market shareholder democracy, they have to be able to participate. That’s all aside from the controversial question of whether private equity on balance improves the companies it buys or just hollows them out to flip to “greater fools”.
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City fund managers aren’t too chuffed either. Many reckon that private equity is getting these assets cheap, and it certainly seems that Morrisons will have to attract higher offers before any deal can be done. Yet purely from an investors’ point of view, this is quite exciting. Shareholders in Morrisons haven’t seen the share price at this level since early 2019. If it takes the sniffing around of a predator to draw market attention to the “true” value in these companies, existing shareholders can be forgiven for thinking “so be it”. Rather than worry about exactly which companies may or may not be targeted, the best bet (as we’ve been saying for a while) is simply to get exposure to the UK market. Opt for a cheap UK index fund or exchange-traded fund, or if you’d rather go with an active manager, a UK-focused investment trust such as Law Debenture (LSE: LWDB) should benefit.
I wish I knew what private equity was, but I’m too embarrassed to ask
Private equity simply refers to an ownership stake in a company that is not publicly listed. Private-equity investors (usually backed by big institutions, although there are also listed private-equity funds that small investors can buy easily) either invest in unlisted companies, or buy listed companies – typically ones that are seen to be underperforming – and take them private.
Private-equity managers aim to be very hands-on owners, unlike traditional shareholders in listed companies. By working with unlisted (or de-listed) companies, the private-equity owner escapes the short-term focus of the equity markets. In theory, this gives them the space and time needed to make the companies more efficient (if the company is a “turnaround” play) or to “unlock its true value” by pursuing a longer-term or more radical strategy than public shareholders might be expected to tolerate. Having whipped the company into shape, the private-equity manager will then seek an “exit” – often by relisting the company on public markets.
This is a time-consuming process, so investors should expect to have to lock up their money for several years. Tying up your cash in an asset whose true value is never entirely clear (much like a house, you only know what an unlisted company is really worth when you try to sell it) is risky. The reward investors expect to achieve for taking this extra risk is known as the “illiquidity premium”.
It’s also worth noting that theory and reality do not always match up. Sometimes private-equity owners do improve a company – but often private equity is just about financial engineering. The new owner borrows lots of money against the firm’s assets; slashes investment spending (damaging long-term growth prospects) to pay the interest; and then “flips” the hollowed-out company along with the enlarged debt load, making a handsome return on the thin sliver of equity it initially provided.
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