Boots: Bid details

  • Robert Peston
  • 9 Mar 07, 05:47 PM

I’ve had it confirmed that the institution mulling a Boots bid is KKR, which is the world’s biggest private equity firm and the de facto founder of the private equity industry. It has also been in the private equity consortium mulling a bid for Sainsbury. It’s not yet clear whether its interest in Boots will have implications for the Sainsbury deal.

One thing’s clear: the Treasury’s review of “shareholder debt” hasn’t put off the private equity boys.

Update 18:45 GMT: The disclosure that Stefano Pessina is collaborating with KKR on the bid massively increases the likelihood that this deal will go through. He is the creator of Alliance UniChem, which merged last year with Boots. But the crucial point is that the Monaco-based Italian billionaire controls at least 15 per cent of Boots’s shares.

What’s more, more than half of all Boots’s shares are in the hands of relatively few investment institutions. So KKR/Pessina won’t have to persuade too many holders to nab their prize.

One bunch of brainy people who presumably are feeling a little silly tonight are investment banks’ sell-side analysts, since almost all of them rated Boots’s shares as a “sell”. Their bearishness seems to have given Pessina his opportunity to offer just under £10bn for a business with formidable cash-generating capacity and a great opportunity to expand around the world.

Looks as though another great British business will soon be in overseas hands.

Questions for Ed Balls

  • Robert Peston
  • 9 Mar 07, 11:14 AM

Ed Balls’s speech yesterday on private equity and whether British companies in general invest with a long-enough time horizon was welcome, largely because this is a serious issue of profound importance to our future prosperity – but one that ministers rarely touch even with a mile-long barge pole.

edballspa.jpgIt’s just a bit too huge, serious and daunting for most politicians. And to Balls’s credit, there wasn’t as much of the speaking-clock-style “these are our great achievements” stuff that normally fills such ministerial addresses.

The more significant points he made were that he, as minister for the City, recognises the contribution that private equity can make to UK productivity growth, that there are good and bad private equity firms (wealth-creating long term investors and short-termist, asset-stripping cowboys), and that a mindless crackdown on the industry would deprive the UK of an important source of capital and management expertise.

But there are some big questions that he left unanswered, possibly because to do so might turn him into an hors d’oeuvre either for the City’s sharks or for the predators of the trade unions and the Labour left. So here are those questions, for him to ponder:

1) Does he really think, as he implies, that the three-year investment time horizon of many private equity firms is long enough for an economy wrestling against India and China, where they plan 10 and 20 years ahead?

2) He takes comfort from the fact that private equity-owned businesses are still a smallish proportion of the British economy. But that’s to look at the stock rather than the flow of deals. For years now, money pouring into private equity for purchase of British businesses has far outstripped new money going into UK listed businesses. According to the Financial Services Authority, the UK equity market capitalisation shrank by a net £46.9bn in the first half of 2006 and has not grown since the last quarter of 2004. Does he think this rapid transfer from public to private is healthy and sustainable?

3) There will be no general review by the Treasury of the principle that interest should be deductible from corporate tax. But the debt in private equity deals is on a sharply rising trend, as measured by the ratio of borrowing heaped on private equity-owned businesses to their earnings before interest, tax, depreciation and amortisation (an accounting proxy for cash flow). When you couple that with the increasing volume of private equity deals, it means that there is sharp downward pressure on corporation tax revenues for the Exchequer – because more debt means more interest payable which means lower taxable profits which means less tax. Isn’t that erosion of the British tax base a serious worry?

4) The Chancellor introduced a 10% rate of capital gains tax largely to encourage the creation of new fast-growing businesses in the UK and provide an incentive to entrepreneurs. Does he think that the spirit of that CGT reform is being met in the way that the partners in private equity firms typically benefit from this 10% rate on their “carry” (if they pay tax in the UK at all, they will typically pay 10% on their very substantial share – usually 20% – in the capital gains on any private-equity realisation)? Are the many tens of millions of pounds that private equity partners pocket from these deals really rewards for the kind of risk-taking that the Treasury wanted to encourage with the 10% rate?

5) These days everybody loves transparency. And certainly a sensitively drafted code of disclosure for private equity-owned businesses – of the sort that’s being encouraged by the Treasury and Balls – might see some of the rapacious cowboys driven away. But isn’t there a risk that new disclosure rules will be at best cosmetic and at worst damaging? The point is that private equity houses that engage in bigger deals, such as Permira, already publish a great deal of financial information about the companies they own. They are motivated to do so, in order to create excitement and interest from potential investors or trade buyers for the moment when these businesses are sold. On the other hand, the smaller and younger businesses owned by private equity might find new disclosure requirements both prohibitively expensive and potentially damaging (if the veil were drawn back before they are robust enough to withstand competitive onslaught). So let’s not fool ourselves that transparency is always a public good.

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