The speculated $16 billion takeover of Coles by a private equity firm shows how far these very private private businesses have come in this country in the last decade while garnering very little media attention.
The ascent of private equity firms in recent years reminds of the rise of the corporate raider in the mid-1980s. It wouldn’t be unfair to suggest that private equity uses extremely similar methods to the famous corporate raiders, who included Carl Icahn, Victor Posner, Ronald Perelman and James Goldsmith. Those corporate raiders (along with buy-out specialists Kohlberg Kravis Roberts and Co.) would use the leveraged (or management) buy-out (often with a stack of junk bonds arranged by Michael Milken) to takeover undervalued public companies.
The modus operandi of corporate raiders and private equity houses is pretty simple. Buy an underperforming business using minimal equity and a truckload of debt. Immediately sell down non-core assets to reduce the debt to a manageable level while at the same time, cutting off all the fat from the business (bye bye corporate jets). The kicker, as noted by Michael Pascoe in Crikey on Friday, is the tax shield created by the huge debt which means that the vehicle doesn’t actually generate any profits and hence, pays little or no income tax.
While the raiders and private equity houses seem quite similar, private equity houses have by and large, avoided the negative stigma which attached to the raiders. Michael Douglas’ portrayal of Gordon Gekko in Oliver Stone’s Wall Street was an amalgam of several raiders, including arbitrageur Ivan Boesky and raider Carl Icahn. By contrast, it is unlikely that anyone is rushing to make a movie about CHAMP Private Equity executive chairman, and one of the pioneers of private equity in Australia, Bill Ferris.
The effect of leveraged buy outs in the mid-80s was so profound, US Congress even considered bills to restrict takeovers and limit the deductibility of interest. While both failed, they symbolised the growing public distrust of the debt-funded raiders.
There is much to like about private equity buy-outs of public companies. They solve the inevitable problem of agency costs which occur in companies where ownership and management are distinct. Also, private equity buyers are quick to remove inefficiencies and unnecessary corporate excess.
However, the nasty side-effects which led to a chorus criticising the 1980s corporate raiders may also hold true for private equity. Due to the significant debt assumed to complete the buyout, private equity vehicles pay little or no tax. (By contrast, Coles Myer last year paid $266 million in income taxes). In addition, private equity purchases also often lead to the squeezing of suppliers and redundancies.
Until now, private equity firms have been able to generate huge (rightfully earned) profits while avoiding the image problems encountered by the 1980s raiders. However, with companies of the scale of Coles Myer now in play, it is unlikely that they will be able to stay under the radar long.