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Archives for June 2007

Crunch time?

Robert Peston | 10:29 UK time, Friday, 29 June 2007


The global rise in interest rates is beginning to bite - though not in a wholly predictable or reassuring way.

Whatever the official surveys show, retailing bosses tell me that they have detected quite a pronounced slowdown in trade over the past couple of weeks - manifested in softness in that bellwether, the Marks and Spencer share price.

And adjusting for the propensity of most store bosses to confuse a common cold with bubonic plague, the climate on the high street is likely to be less clement for a while.

More serious, however, is what's happening in credit markets and to hedge funds. All sorts of complicated bonds and financial instruments have seen sharp falls in their price - leading to humungous losses for hedge funds and investors exposed to those hedge funds.

It's a delayed reaction to problems in the US housing market, notably the losses experienced by providers of sub-prime loans, or lenders to lower quality borrowers.

But here's the worry: contagion to all sorts of other loans.

We live in a complicated world where debt is sliced, diced and repackaged in ways that in theory are supposed to provide investors such as hedge funds and investment banks with "pure" solutions for their requirements for specific kinds or risk and return.

In theory this represents a great spreading of the risks of lending to lots of different institutions - which should mean that when things go wrong, a little bit of pain is felt by many firms, rather any single institution going bust.

That's the theory. In practice, all this financial innovation has generated unprecedented speculative activity - so much of the trading in these new financial instruments is basically a bet or punt, whose effect is actually to magnify the financial impact of a market event, like a crunch in the US sub-prime market.

And worse than that, the market in many of these financial products - with confusing names like Collateralised Debt Obligations and Collateralised Loan Obligations - is highly illiquid. So when everyone wants out, the price falls through the floor.

What's more, all credit markets are connected. So when big losses occur in one area, the supply of credit to seemingly unconnected borrowers can be cut very rapidly - as we are seeing in a spate of cancellations of higher risk debt-issues by companies and financial businesses.

To be clear, this is not meltdown, or at least not yet. But there is no sign of credit markets being bailed out by central banks. Quite the opposite, in fact.

Both the Bank of England and the US Federal Reserve are signalling that they are still worried about inflationary pressures - which means that interest rates are likely to rise further still.

We may be in for a hair-raising few weeks and months.

DTI, back from the dead

Robert Peston | 07:30 UK time, Thursday, 28 June 2007


Here’s a funny thing. Years ago Gordon Brown made it clear to me that he would bury the Department of Trade and Industry, as and when he had the power to make or break government departments. But now that he has that power, he has decided to endeavour to redeem it as a proper ministry for business (though it may lose its battered “DTI” moniker).

gordon_brown3.jpgIt’ll lose its responsibilities for science, innovation and skills – which as I wrote here yesterday will be merged with the relevant bits of the Department for Education to create some kind of ministry for improving the qualifications of the workforce and the capacity of British companies to translate research into saleable products and services.

But it will gain the deregulation unit from the Cabinet Office and will retain its pro-competition, trade and pro-consumer mandates. Also, slightly against expectation, it will keep its energy responsibilities.

In the end, the new Prime Minister concluded that creating some kind of climate-change super-ministry – to include energy, transport and chunks of environment – would not be particularly efficient. Environmental campaigners may not agree, although the CBI probably will.

I don’t know who will run either the new business department or the skills/science ministry. There’s been lots of talk of his adviser on business issues, Shriti Vadera, going to the Lords and becoming a minister – though my sense is that she’d prefer to work in international development if given the choice.

Interestingly, however, the Chancellor’s closest adviser, Ed Balls, seems set to become Secretary of State for the slightly remodelled Department of Education – which will be a big job, given that Brown finds it difficult to complete any sentence without saying how important he thinks education is to the future of the UK.

The other Brown priority is health – which is apparently going to Alan Johnson. I’m minded to ask what harm Johnson ever did to Brown, since health is a bit of a graveyard for politicians.

Of the two Miliband wonderboys, one becomes the new “Boy David” as foreign secretary and the other, Ed, will have the daunting challenge of endeavouring to give coherence and shape to all Government policies as a senior minister without portfolio in the Cabinet Office.

The Chancellor, as has been widely expected for weeks, will be Alistair Darling – whose hair actually turned white during his many years of unstinting loyalty to Brown and Blair.

UPDATE 16:15 So now we have a name for the reconstructed DTI: it’ll be called the Department for Business, Enterprise and Regulatory Reform, or DBERR for short. Which is not a moniker that trips off the tongue and leads me to only one conclusion: as and when Gordon Brown moves on from No.10, I won’t be employing him as a brand consultant.

That said, whether by chance or design, DIUS – or the Department of Innovation, Universities and Skills, the other new business-focussed ministry – has a certain faux-classical gravitas.

Brown's grandees

Robert Peston | 11:28 UK time, Wednesday, 27 June 2007


Gordon Brown is creating a special council of business leaders to advise him directly as prime minister.

It will meet two or three times a year and will advice Brown on whether government policy is helping or damaging Britain’s competitiveness.

The members will also be available to Brown to give him advice as and when he needs it.

Brown’s business council members include:

Damon Buffini, managing partner of Permira
Stuart Rose, chief executive of Marks & Spencer
Tony Heywood, chief executive of BP
Sir Terry Leahy, chief executive of Tesco
Arun Sarin, chief executive of Vodafone
Stephen Green, chairman of HSBC
Sir John Rose, chief executive of Rolls-Royce
Mervyn Davies, chairman of Standard Chartered
J-P Garnier, chief executive of Glaxo Smith Kline

A senior member of the government told me that the initiative was part of bold plans by Brown to redefine the government’s relationship with business.

Other parts of those plans may include a slimming-down of the Department of Trade and Industry to focus much more on promoting trade, deregulation and the competitiveness of British companies.

Separately a new department focussed on skills and innovation is expected to be created. It would bring together the science and innovation bits of the DTI, and the training and skills parts of assorted departments.

For me, the most striking member of the business council is Damon Buffini, who runs the UK’s leading private equity firm. It rather implies that the current review of the private-equity industry by the Treasury will NOT increase taxes significantly for the private-equity superstars or in general change the treatment of private equity in a way likely to be perceived by private equity as damaging.

Why would Brown appoint Buffini if he thought there was a risk of Buffini storming off the council in a huff within months?

Brown’s Saudi dilemma

Robert Peston | 08:15 UK time, Tuesday, 26 June 2007


Last night BAE received a subpoena from the US Department of Justice requesting all relevant information on its £40bn contract to supply military equipment to Saudi Arabia.

You would think that would be hugely embarrassing for BAE, given all the allegations that have been made about sleaze and bribes connected to this deal, known as the Al Yamamah contract.

But actually it's a much bigger headache for the Government.

In fact, it will be Gordon Brown's first big diplomatic dilemma as prime minister.

Why? Because the contract was between the British and Saudi governments, not between BAE and Saudi.

BAE was only the contractor.

So it will be a decision for the Ministry of Defence, not BAE, whether to disclose the details of the deal.

The Saudi government has made it clear over many years that it regards the contract - which allegedly involved payments of hundreds of millions of pounds to Prince Bandar, a member of the Saudi Royal family - as highly confidential.

That's why it put pressure on the British government to stop an investigation into it by the Serious Fraud Office last year.

So the Saudis will not be overjoyed that the Department of Justice is apparently taking up where the Serious Fraud Office left off.

Saga plus AA equals ?

Robert Peston | 10:45 UK time, Monday, 25 June 2007


I am hearing that the biggest ever merger in the UK of two private-equity owned firms is about to be announced.

Saga, the financial services and publishing business aimed at people of a certain age, is buying the AA. It will create a business that if it were a public company would certainly be big enough to be in the FTSE 100.

My guess - and it is a guess - is that the enterprise value of the newly merged company would be around £6.15bn, with the AA valued at £3.35bn and Saga at £2.8bn.

It looks like something of a financial triumph for the AA’s owners, the private equity groups Permira and CVC. They bought the AA two and a bit years ago for £1.75bn - but that business now has an enterprise value (the value of the equity plus debt) of £3.35bn.

The reconstruction of the AA carried out by Permira and CVC may have attracted the ire of the trade unions. But it has succeeded in increasing the value of the business very significantly.

UPDATE: This deal is another PR triumph for private equity. Please take that in a spirit of unbridled sarcasm.

The press release issued to announce the merger is a model of waffle. It talks in rosy terms about what these two businesses can learn from each other and how Saga products can be sold to AA customers and vice versa.

But as for the sort of facts and numbers you would expect to see when two public companies merge, almost none are in evidence.

Which is a bit of a slap in the face to the thousands of employees of the AA and Saga, and also to any savers in pension schemes that are invested in the private-equity funds behind these companies.

What is the impact on jobs? No mention of that.

What cost saving could be made? No guidance given.

How about the scale of incremental profits? No clue provided.

Nor was any useful detail or assurance about the impact on jobs given to the AA's staff union when it met the company's management at 9.30 this morning to be told that staff were shortly to have a new employer.

Naturally I contacted executives at the AA and the private equity firms to talk about all this. But I was told only one man was authorised to talk about the deal, the CEO of Saga, Andrew Goodsell.

As and when I get hold of him, I will pass on any further intelligence I can harvest. But don't hold your breath.

UPDATE: The merger of Saga and the AA is triggering a substantial payday for thousands of Saga employees – and a humungous one for the chief executives of the respective businesses.

Some 1500 Saga employees are shareholders in the business. Most of those paid £20 for what is known as sweet equity some two and a half years ago. Those shares will pay out £10,500 when the deal putting together Saga and Permira is completed later this summer.

Of that £10,500, 75 per cent will be paid in cash, with the remaining 25 per cent rolled into new shares in the business.

It's nice profit and is a rare example of private equity firms allowing the spoils of their dealmaking to be shared with hundreds of staff - which many will see as no more than fair. The risks for employees frequently increase in the wake of a private-equity takeover, but typically their rewards are slender.

However the spoils for Saga’s chief executive, Andrew Goodsell, are an altogether different order of magnitude. His shares will be valued at around £150m, of which he will pocket around £110m in cash.

As for the AA’s chief executive, Tim Parker, he is understood to be cashing in his entire stake, which is worth around £50m.

UPDATE: Last word on this for tonight, in response to a number of comments. It is difficult to know precisely how much the owners of the AA, Permira and CVC, have made from this deal. But there is no doubt they have made a mint.

The uncertainty stems from the lack of disclosure about the debt-equity split when they bought AA for £1.7bn two and a half years ago. As I've already said, what we do know is that the £1.75bn enterprise value has become £3.35bn.

However, my understanding is that CVC and Permira invested £500m from their funds in the AA, all of which has already been repaid through a refinancing. So for a zero net cost, they are left with an asset valued by the Saga deal at more than £1.5bn - of which they may well cash in a further £900m. Nice work, as they say.

Tories and the super rich

Robert Peston | 09:13 UK time, Saturday, 23 June 2007


George Osborne, the Tory Shadow Chancellor, has made common cause with the left of the Labour party and trade unionists by saying he is sceptical that the huge earnings of partners in top private equity firms is a proper capital gain, as most of us would understand it.

That has big implications. If it were translated into a reform of the tax system, these private-equity superstars would be liable for the top rate of income tax on all their earnings.

They would no longer benefit from the low 10 per cent capital-gains-tax rate introduced by Gordon Brown to encourage risk-taking entrepreneurialism.

Osborne's concern is that the partners in private equity firms put only a tiny amount of their own equity (their own money) into these deals. Most of the equity in these deals comes from outside investors (pension funds, or wealthy individuals), not from them.

But for a tiny equity investment, they reap 20 per cent of the gains from these deals (known as the carry) but are liable to the tiny 10 per cent capital gains tax rate (if they pay any tax in the UK at all, which many don't).

For Osborne, this carry looks very much like a City bonus, rather than a capital gain for risk taking. Which is why he thinks they should probably pay income tax on these gains.

If all this were taxed at the 40 per cent top-rate of income tax as George Obsorne suggests, they would have to pay millions of pounds in additional tax - except that many of them would immediately take steps to become tax exiles.

Which is why it may make more sense to do what the private-equity veteran, John Moulton, said this morning, which is to overhaul and simplify the entire capital-gains-tax system, rather than penalising the partners of the big private equity firms as a special case.

However what's striking is that the Tory shadow chancellor has been much more explicit that the private-equity superstars are not paying enough tax than the soon-to-be prime minister, Gordon Brown.

Which only goes to show that in these confusing days when the old left-right political divisions are blurred, concern that the super-rich should pay their way exercises many Tories quite as much as Labour supporters.

Sarkozy v Brown

Robert Peston | 10:38 UK time, Friday, 22 June 2007


In the history of attempted coups at European summits, the removal by M Sarkozy of the EU’s commitment to “undistorted competition” from the new draft treaty takes some beating.

So much for Sarkozy “the reformer”.

What he has done will split the EU right down the middle.

French President Nicolas SarkozyIt’s also an explicit attack by the French president on Gordon Brown’s vision for Europe – which doesn’t augur for European harmony in the months ahead.

Apart from anything else, the promotion of competition has brought unmitigated benefits to European consumers, in the form of lower prices for all manner of goods and services.

There would probably be no Ryanair or Easyjet, if it weren’t for EU competition policy.

There would have been less pressure on mobile phone companies to lower their prices for using phones abroad.

And the European Commission’s periodic forays into duffing up huge companies that exploit their enormous market power – such as Microsoft – would probably not have happened.

The pro-competition philosophy, enshrined in all previous treaties, is an example – perhaps a rare one – of the EU being directly in touch with the needs of citizens. So at a time when the EU has something of a credibility problem, it’s slightly odd to weaken that pro-competition approach.

However for the French government – and to an extent the German one too – the triumph of the British liberal-market approach to the stewardship of economies rankles. Many European governments long for the days when they could subsidise business in the putatively strategic interests of their respective economies and not be worried about being prosecuted for distorting competition. And it irks them that most of their biggest companies can no longer be protected from Europe-wide competition.

As for Gordon Brown, what Sarkozy has done attacks the essence of how he thinks Europe should be. He believes that globalisation is the unstoppable economic force of our age – and he believes that European member states will be unfit to prosper in a globalising world unless their economies become leaner and meaner subject to the discipline of competition.

He will not be able to accept a treaty that excludes the historic competition clause.

But Tony Blair and the UK cannot afford to fight for its reinstatement as a lone voice – partly because Blair has too much else on his shopping list, and also because it would be devastating for the cohesion of the EU if this were Britain against the rest on an issue of such moment.

Happily, British officials appear to have wound up the Irish to lead the fight back. The Portuguese and Italians are also likely to join the cause.

Perhaps most significantly of all, the European Commission is up in arms about what M Sarkozy has done: its very legitimacy will be in question, if it can no longer fight the good fight for European consumers.

Private equity's wedge

Robert Peston | 14:02 UK time, Wednesday, 20 June 2007


It is the thin end of a very fat wedge.

As I wrote here last week, the 180 or so partners of the mega private equity firms pay nil or derisory tax on the millions of pounds many of them earn each year on their “carry”, or their share of the capital gains made on the businesses bought by their respective funds.

Given that the majority of these people are non-domiciled or non-resident for tax purposes, a tiny minority pay even the paltry 5% tax that is levied under Gordon Brown’s benign capital-gains-tax rules (the rate is 10%, but what's paid is just 5% thanks to well-established conventions on the calculation of costs).

So if such a small number of people are deriving such a fabulous tax break, why are our elected representatives getting quite so worked up about it?

Well, it’s because their underlying concern is about something much bigger: it is about the consequences of the entrepreneurial economy which most politicians have for years been saying they wanted to see take root in the UK.

In the past few years there has been a golden age of British wealth creation, especially in the City of London. But now that we have it, not everyone is comfortable about it.

An unavoidable consequence of the success of the City and financial services has been a massive enhancement in the ability of talented individuals to generate fortunes for themselves on a scale unseen for perhaps a hundred years.

In private equity, hedge funds and investment banks, there is a culture of big-money rewards which is part-and-parcel of their dynamism and success.

But it’s not just the City. Seriously wealthy people are being born every day as they sell businesses they’ve created.

It all means that the gap between the very richest and the very poorest is widening at a remarkable rate.

And there are implications for social cohesion, especially if the wealthiest are seen to be making the smallest contribution in tax to the state that nurtured them.

What Sir Ronald Cohen – a doyen of the private-equity industry – said to me on Today (which you can listen to by clicking here) about the risk of a violent backlash is worth hearing, for all the sniping from his competitors about how he has already pocketed his own very fat wedge and is therefore blithely unconcerned about spoiling it for the next generation.

To digress for a second, even if Cohen is non-domiciled for tax purposes – which I am told he is, although he does also pay substantial tax here – it seems to me to be just silly to argue (as his rivals do) that he has no credibility when arguing that a more progressive tax regime should apply to private equity.

But to return to the big issue, the British economy has grown considerably faster than it would have otherwise have done, thanks to the flourishing of a new spirit of enterprise.

But the biggest rewards have accrued to a minority - and growth has been disproportionately weighted towards the prosperous south.

So it's time to recognise that the debate about private equity's fat rewards and low tax is really about something much bigger.

It is about waking up to find that we now live in a winner-takes-all society in which the gap between the super-rich and the rest is widening at the speed of a private Gulfstream jet - and whether we are really at ease in that brave new world.

Cadbury's reorganisation

Robert Peston | 08:17 UK time, Tuesday, 19 June 2007


Cadbury Schweppes’s reorganisation and job cuts - which are announced today - show the all-pervading influence of private equity.


Because the sweets and beverage business is doing to itself what a private equity owner would do.

It is making itself more efficient through a 15 per cent reduction in headcount and a similar reduction in the number of places it makes confectionery.

That means around 7,500 jobs will go around the world over four years and ten confectionery sites will close – though Bourneville, as the company’s home-sweet-home, is likely to be largely unaffected.

The reorganisation will cost it around £450m in a one-off charge.

But Cadbury is hoping to reap a very substantial increase in its profit margins, perhaps as much as 40 per cent or 50 per cent.

However Cadbury's story is about more than cost cutting.

It is already the world's biggest confectionery company - and it believes it can become a lot bigger, by investing in developing markets and by manufacturing healthier and ritzier products for richer consumers.

Cadbury, which is dropping the “Schweppes” from its moniker, has also confirmed that a sale of its huge US drinks business - which makes Dr Pepper and Seven Up - is more likely than a stock market listing.

That could raise more than £7bn. And the bidders for the drinks operation are - of course - private equity funds.

So what's the overall message from Cadbury today? It's "do unto thyself before private equity does it to you."

And here's what should cheer up Cadbury's shareholders and the millions of people who have a stake in it through their pension funds: the profits from this sweeping reorganisation should accrue to them, rather going to the partners in private equity firms and the investors in their funds.

UPDATE 1600: In response to those who say that the same pension funds invest in FTSE 100 companies and in private equity, actually that’s not quite right. The vast bulk of cash going into the largest UK-based private equity funds comes from giant overseas pension funds, especially US ones, such as Calpers.

All the statistics show that UK pension funds remain under-invested in private equity – although they are putting more money into these and other alternative assets. So when private equity buys British businesses, that represents a distribution of assets and potential returns away from British pensioners to overseas pensioners.

By the way, if you click here, you can watch an interview I did this morning with Todd Stitzer, the chief executive of Cadbury.

Another struggle for ICI

Robert Peston | 14:14 UK time, Monday, 18 June 2007


In 1991, Margaret Thatcher’s favourite conglomerate, Hanson Trust, bought a 2.8% stake in Imperial Chemical Industries and hinted it might like to buy the whole thing.

The reaction of the media and fustier elements of the City was one of outrage. It was as though the Tower of London was about to be sacked and the crown jewels sold off to Ratners.

icilogo.jpgICI was viewed as a national treasure, a nurturer of scientists, a school of management. The British establishment viewed it as little short of scandalous that a bunch of takeover artists at Hanson – whose primary concern was the Hanson share price – should suggest that ICI could put a bit more emphasis on rewarding its shareholders.

In some ways it was the totemic struggle of age. ICI fought vigorously to undermine Hanson’s reputation and credibility.

But although it saw off that particular aggressor, it lost the battle – because ICI’s executives were forced to recognise, in a way that they never really had before, that their primary responsibility was to the company’s owners, the shareholders.

In other words, ICI became just another British company. And it became the amazing shrinking business, because that’s what it thought shareholders wanted.

It de-merged its pharmaceuticals side, Zeneca, and pulled out of commodity chemicals. New owners became wealthy from the bits of ICI it didn’t want.

What’s left at ICI is a business that sells far more in Asia and the US than in the UK, that employs 26,000 people – fewer than when it was created by a four-way merger in 1926 – and that still has a great name.

But such is the spirit of the times, today the British establishment will not get out of bed to preserve ICI’s independence.

This morning ICI confirmed that it had received an “indicative” takeover offer of 600p a share from its Dutch rival, Akzo Nobel – which it rejected on the grounds that its board believes the business is worth a great deal more.

However, to use that ghastly City expression, ICI is now “in play”. It is now prey, or quarry, a tempting asset for Akzo, or another chemicals giant, or private equity, or even a Middle Eastern plutocrat.

Barring a stock market meltdown, ICI will be swallowed whole and soon.

Does that matter? A bit. Over time, the consequence will probably be a reduction in the number of jobs available in the UK for chemists and technologists and ambitious managers.

So if your child is studying chemistry at school or university, he or she may well be forced to join the great march of British scientists into investment banks, hedge funds and private equity.

Tax and private equity

Robert Peston | 08:43 UK time, Friday, 15 June 2007


There is something about private equity that really irks legislators (which is surely not old-fashioned envy about how much the partners of private equity firms trouser).

In the US, a pair of influential senators – the ranking Democrat and Republican on the Finance Committee, no less – are introducing a bill that would increase the tax paid by Blackstone, the private equity giant, after it floats on the stock market.

And in the UK, MPs on the Treasury select committee are sending out a strong signal that they want private equity firms’ “carry” – their share of the capital gains made on the investments made by their funds – taxed at a higher rate than the prevailing 10%.

The Treasury now feels under irresistible pressure to reform this system in some way, following the admission made by two doyens of the private equity industry – Nick Ferguson and Sir Ronald Cohen – to the effect that it’s hard to justify the tax rate for the really big players in private equity.

In fact, Ferguson may find himself commemorated in the annals of tax law, because any change in the private equity tax rate is being referred to as the Ferguson Premium.

Actually, I should point out that the partners in private equity firms in practice only pay 5% tax on the carry. That’s not because of a tax dodge, but because of age-old agreements with their investors about how the rewards and costs of investments are distributed.

Anyway there is a great deal of emotion around the place about how private equity billionaires pay less tax than cleaners, so it’s worth taking a deep breath and looking at the hard reality.

The big bucks in private equity accrue to the partners of around 18 London-based firms. They have raised around $115bn from investors – on which they personally stand to make hundreds of millions of dollars each.

There are about 180 of these partners in total. But of these, probably two-thirds are not British: they are super-bright foreigners who work in private equity in London, because it’s the European centre of private equity action.

Or to put it another way, 120 of the 180 private-equity partners are non-doms for tax purposes – so they pay ZERO tax in the UK.

The 5% carry-tax probably applies to the remuneration of perhaps 60 British people – except that 30 of these have probably become non-resident, basing themselves in Monaco or a similar tax haven for tax purposes.

On that basis, if the tax law was changed simply to catch the partners of the big private equity firms – which is what Sir Ronald Cohen suggests – it would have an impact on 30 people. And my guess is most of those would immediately take steps to relocate themselves abroad for tax purposes

In other words, a tax increase that was aimed merely at the super-rich end of the private equity market would probably be a complete waste of time, if its purpose were actually to raise revenue for the Exchequer.

Of course, the real point of any tax increase would be to feed the baying dogs of private-equity haters – even if the tax reform were innately fatuous.

However if a tax increase were applied more widely, to the couple of hundred smaller private equity firms whose partners don’t earn enough to relocate themselves abroad to escape tax, well that could – over time – shrink a valuable industry. The entrepreneurial partners in those firms might well go off and do other things, and the supply of investment capital to smaller companies would diminish.

The point is that in a globalised world, there are growing numbers of firms and individuals who can base themselves more or less anywhere for tax purposes – and therefore there is not a great deal that a country like the UK can do to extract much additional tax from them. It’s not fair, but it’s a fact.

Which means that the debate about private equity – which I’ve said with tedious regularity – should be about whether its impact on the British economy is good or bad, in the widest sense. And if it makes sense to drive this large and successful British industry into the sea, then it would also make sense to tax private-equity partners till the pips squeak. But otherwise…

We're all doomed?

Robert Peston | 06:58 UK time, Wednesday, 13 June 2007


One of the great, global, economic forces of our age, which I’ve bored you rigid discussing in this blog, is that it has been possible to borrow long-term money at relatively low interest rates.

For the past few years, the impact of these low long-term interest rates has been visible in a surge in borrowing by individuals and companies together with the related phenomenon of rising prices of almost every kind of asset or commodity. Here are just three important manifestations:

a) UK house prices that keep going up and up – almost regardless of what the Bank of England does to short-term interest rates;

b) share prices, that have increased more-or-less in a straight line since the spring of 2003;

c) a boom in takeovers of companies, financed by borrowing, and a great wave of repurchases of shares by companies, again funded by debt.

Now, a fall in longer term interest rates is simply the corollary of a rise in the price of certain US Government bonds.

And what has kept the price of those bonds high has been two trends.

First, the accumulation of vast foreign exchange reserves by China, Japan and other (largely Asian) exporting nations, which have been invested in US government bonds.

Second, a decision taken some years ago by large insurers and pension funds to become more risk averse, and reduce their exposure to shares while increasing their holdings of bonds.

Now according to analysts, for some years long-term interest rates have been significantly lower than they should have been on the basis of their normal historical relationship with short-term interest rates and the health of the global economy.

Which is why what has been happening over the past few days is important, though largely unreported outside of specialist financial publications: there has been a sharp fall in the price of 10-year US government bonds, known as US Treasuries, and thus a precipitate rise in the benchmark price of borrowing for ten years. Yesterday, the yield on 10-year US Treasuries rose to its highest level for more than five years (to 5.27%).

This is much more important to all of us than what the Bank of England does to short-term interest rates.

For example, the rise in these long-term market interest rates pushes up the price of borrowing for our big banks and building societies and will probably feed through to the interest rates on new fixed-rate mortgages.

Which could prick the housing-market bubble.

If those longer-term rates continued to rise, the frenzy of private-equity fuelled takeovers could fizzle – because the cost of financing takeovers would exceed the cash-flows of the relevant target companies.

So just why have longer-term rates risen? Well, one reason is that the global economy is performing too well – which means that central banks are either pushing up short-term interest rates (as they have just done in the eurozone and New Zealand, and probably will in the UK) or are not cutting them (as is the case in the US).

But that is not the significant reason, because that would not signal a return to the historically normal relationship between short-term interest rates and long-term ones.

No, the more interesting reason for the rise in long-term rates is that the Chinese are switching hundreds of billions of dollars out of bonds and into equity-related investments. And there are also signs that other important global investors are increasing their appetite for risk and equities.

That in turn means share prices are unlikely to collapse in the immediate aftermath of the fall in bond prices. They will probably be sustained by the sheer volume of cash being put into stock markets by the Chinese and others.

But there could in time be a seriously negative impact on the price of shares. Higher longer term interest rates should eventually lead to a squeeze in the profits of companies, which would make shares in those companies less valuable.

The bond-market turmoil and fall of last week may turn out to be the beginning of the end of the current upswing in in shares, property, you name it, the possible end of an all-embracing bull market.

And that would mean, to quote Private Fraser, that "we're all doomed, doomed."

Ford's failed marriage

Robert Peston | 09:02 UK time, Tuesday, 12 June 2007


It is an 18-year marriage that has ended in failure.

Ford bought Jaguar for £1.6bn in 1989, in an attempt to build a big business in European luxury cars.

That was followed by the £1.7bn purchase of Land Rover in 2000.

jag_203getty.jpgBut Jaguar in particular has never prospered under Ford's ownership and the world's third largest motor manufacturer last night told MPs that both it and Land Rover are to be sold.


Well, Ford is in a big mess - it lost more than £6bn last year and wants to get back to basics.

And although Land Rover and Jaguar also lost money last year, there is not expected to be a shortage of bidders for the businesses.

Luxury consumer brands are in demand. And the cash to finance a takeover is likely to come from the usual source - private equity firms (and perhaps Middle Eastern or Russia billionaires) whose pockets are bulging with billions of dollars to invest.

That said, Ford will be lucky to get its money back on the sale of these two marques. Apart from the £3.3bn it paid for the two businesses, it has ploughed in hundreds of millions of pounds of investment and swallowed substantial trading losses.

In the case of Jag, Ford has turned a sleek cat into a groggy moggy. It's all a bit sad.

UPDATE 1700: Land Rover is a much stronger and more profitable business than Jaguar. According to bankers, Ford will have no trouble selling it.

However Jaguar is an altogether different proposition. There are, I am told by those close to Ford, genuine concerns about whether it has a viable long-term future.

So Ford’s bankers are not convinced that Jaguar can be sold as a standalone business, which is why it may be wrapped in with Land Rover as a sort-of Buy-One-Get-One-Free.

But if that did happen, Jag employees would have every right to feel anxious: there could probably be no guarantee that a new owner would not shut down most of Jag’s manufacturing capacity.

Ethics man at BAE

Robert Peston | 07:31 UK time, Monday, 11 June 2007


BAE has an image problem.

The giant defence company says it's never broken the law when selling military equipment.

But it's been embarrassed by the disclosure - made by the BBC's Panorama programme - that it paid hundreds of millions of pounds to a Saudi prince as part of the enormous Al Yamamah deal with Saudi Arabia, together with assorted other allegations about fat commissions being paid on deals.

So the company’s chairman, Dick Olver, and the independent non-executive directors want reassurance that the company does nothing improper in the way that it sells arms.

Their solution is to set up an independent ethics committee, to investigate the way it does business and ascertain whether its practices conform with the highest ethical standards.

And to demonstrate that it will be a serious, impartial enquiry, they are appointing a former Lord Chief Justice of England and Wales, Lord Woolf, to lead it.

To be clear, the Woolf appointment is not a direct response to last week's disclosures. Woolf agreed to do it a few weeks ago, in the wake of a steady stream of allegations over many months about the way BAE has won sales, but the announcement was held up by a delay in signing up other heavyweight members of his committee

However, he will not review BAE's past behaviour for fear of being accused of interfering with a criminal investigation by the Serious Fraud Office into past BAE deals.

The SFO abandoned its probe of BAE’s Saudi deals last December, following pressure from the British Government – which claimed that the investigation was threatening national security. However the SFO is still investigating other BAE sales in Africa, eastern Europe and South America, following allegations that it made illegal payments to win them.

Woolf will report on BAE’s current approach to winning deals. Which has the potential to embarrass a company as big, unwieldy and international as BAE - even if the executives at the top of the company are convinced that it does nothing wrong.

There are a couple of others risks for BAE too. First, shareholders may well question why the chairman and the non-executives need the reassurance of the Woolf review, if they are completely confident about the way the executive team – led by the chief executive, Mike Turner – runs the business. Any hint of a split between non-executives and executives would be destabilising.

Also the decision by the chairman and independent non-executives to appoint Woolf may be seen by some of BAE’s critics as the equivalent of them asking BAE’s executives the old chestnut "so when exactly did you stop beating your wife?"

Green grows the Tesco-o

Robert Peston | 08:51 UK time, Friday, 8 June 2007


The BBC is probably a bit too obsessed with Tesco, so I feel sheepish in drawing to your attention that the great supermarket whale has this morning announced a takeover offer for a Scottish garden centre company (of all things) called Dobbies.

tesco_203pa.jpgBy its standards, Dobbies is just a light snack, a bit of plankton. It is paying £156m for a chain of 21 stores across Scotland and Northern England, which is the equivalent of less than three weeks of its own cash flow.

But it obviously wants this business pretty badly, because it is paying a fairly steep price in relative terms. The offer is the equivalent of more than twice Dobbies’ annual turnover and 17.5 times Dobbies’ earnings before interest, tax, depreciation and amortisation or EBITDA, which – for those not steeped in EBITDA lore – means it is paying 17.5 times this crude measure of operating cash flow.

The point of the deal, according to Sir Terry Leahy, Tesco’s chief executive, is to further reinforce Tesco’s green credentials – not in the sense of “green fingers” but the other more modish “green”.

dobbies_jpg.jpgThis is how Leahy puts it: “The increasing popularity of gardening, and in particular the trend towards environmentally friendly products, makes this an attractive sector for Tesco to invest in. The deal is an important part of our strategy to provide customers with greater access to affordable energy saving and environmental products. Garden centres are ideally placed to support this because for many people gardening is the way they express their desire to be green.”

I’ll be honest, but that’s not how I’ve ever thought of garden centres – but I can see what he means. So to be clear, this is NOT Tesco acquiring a load of freehold sites that might one day be convertible into supermarkets, should the tyrants of British planning allow such a conversion. Nothing could be further from Tesco’s mind: this is diversification.

But I nonetheless think the competition authorities should spend more than a few minutes considering the implications and whether the deal should be allowed. Right now, Tesco is deemed to be far too big to be allowed to buy another supermarket company. It circumvented that restriction a few years ago by buying a big chunk of the convenience store market, running rings around competition watchdogs.

Tesco is now so big in so many different product lines, there is a proper question to be asked about whether it should be allowed to expand at all through takeovers of any kind of retailer in the UK – as opposed to outside Britain, where the same concerns don’t apply.

Dobbies is a fairly small business in an apparently discrete sector. But as part of Tesco, it would be converted into a wholly different kind of economic force, a kind of fertiliser for a whole new form of the Tesco-isation of Britain. Green grows the Tesco-o.

Saudi sandstorm

Robert Peston | 10:48 UK time, Thursday, 7 June 2007


It is challenging to write with certainty about almost anything to do with the vast Al Yamamah defence contract between Britain and Saudi Arabia

The reason is that the original Al Yamamah deal - signed by Margaret Thatcher as British Prime Minister in 1985 - was covered by a stringent confidentiality agreement.

Which means that when allegations of impropriety or funny business surface, as they do regularly, neither the MOD or BAE systems can confirm or deny them - without breaching the terms of the original agreement.

However, this is what I can say with some confidence.

I've been told over many years by those connected to the deal that all payments made under the contract were both written into the contact and known to both governments.

Or to put it another way, any payments made by BAE – to Prince Bandar or anyone else – were officially sanctioned in the contract and by the British Government.

So if, as Panorama and the Guardian allege, hundreds of millions of pounds were paid by BAE to Prince Bandar of Saudi Arabia in connection with these military sales, then both the British and Saudi government approved the payments.

Now it would be pretty embarrassing for the British Government to admit that. But to reiterate, even if it wanted to make a clean breast, it could not. It would be driving a coach and horses through the confidentiality clause of the Al Yamamah contract and the Saudis, with good reason, would probably feel they could never deal in confidence with the UK again.

Now this is where it all gets very murky.

To state the obvious, Panorama would not have alleged that substantial payments went to Prince Bandar if it didn’t have powerful evidence.

However a source close to Prince Bandar is denying that these payments were made in the manner specified by Panorama, that is to a branch of Riggs Bank in Washington.

That’s one denial. A second denial is that Prince Bandar was the beneficiary of any payments made.

So far, so confusing – which, of course, rather suits the British and Saudi Governments.

However, there is no on-the-record denial, as yet, and no denial that commission payments were made to senior Saudis by BAE.

In fact, BAE has consistently said to me that commission payments were made to Saudis in connection with this deal. All that BAE has ever rejected is any suggestion that the commission payments were illegal.

It is also important to be rigorous in recognising what it meant to pay commissions on the Al Yamamah deal: the Saudis paid billions of pounds to BAE for airplanes and military equipment and BAE then recycled hundreds of millions back to… the Saudis.

Friends of Saudi cannot see what could be wrong with that. Others believe that if such payments were made in such a secretive way, there must be something very fishy.

Finally let us not kid ourselves that there would be nothing at risk if the British Government were suddenly to disclose all the gripping detail of the Al Yamamah contract.

This deal has been worth more than £40bn to BAE and other defence companies - it's been a massive source of valuable British exports.

What's more, BAE was hoping to sign a new phase of this deal next week. That would be worth an estimated £20bn and would be for the sale of Typhoon jets.

The Saudis hate the idea that their washing - dirty or otherwise - is being hung out in public. So BAE is nervous that following the allegations made overnight about the original Al Yamamah deal, the Saudis may have second thoughts about the new deal.

So £20bn of new exports to Saudi could be jeopardised. If you are against the arms trade, you are not going to worry about that. But £20bn is proper money.

Who runs Royal Mail?

Robert Peston | 07:50 UK time, Wednesday, 6 June 2007


If Life on Mars were about 1970s industrial relations, the current dispute between Royal Mail and its workforce could be an episode.

There is the odd 2007 twist – such as a workforce taking umbrage that it’s being offered a 2.5 per cent pay rise when the chief executive is pocketing a bonus reported to be £370,000 and total remuneration of around £1m (that’s what has really annoyed the postmen I’ve met recently).

But it’s mostly a trip back in time to an era of struggles between managers and unions over who really ran the place.

Both the company and the postal workers’ trade union, the CWU, appear convinced that the result of a ballot of 127,000 postal workers – to be announced at 11.45am on Thursday – will show a clear majority in favour of strike action.

If so, a strike is probably inevitable at some point within the permissible 21 days. Why? Because of the breadth and depth of the CWU’s concerns, which will be hard for management to allay.

Royal Mail’s directors believe that future success rests on pushing through as yet unpublished plans to improve productivity. They want to change working practices so that they can make the most of new automated sorting kit that they want to buy – which would allow them to reduce headcount. Directors hope that most of the necessary job reductions, which would run to many tens of thousands, could be achieved by natural wastage and voluntary redundancies.

But the CWU wants none of it. Its hope is that such reconstruction of the business could be made superfluous, if all that dreadful competition introduced into the postal market could be rolled back.

Billy Hayes, the CWU general secretary, says in a blog that he thinks ministers see the need to rein in market forces – and that all they need is an extra nudge from the threat of a strike to make it happen.

Hmmm. That’s not what ministers and senior officials tell me. The soon-to-be prime minister, Gordon Brown, would rather put on a frock and become a surprise cross-dressing guest in the Big Brother house than concede that competition is a bad thing.

The weird truth is that Royal Mail’s executives concur that competition has been introduced in an unfair way. They hate that they are forced to subsidise commercial rivals who are creaming off the most profitable business of delivering mail in bulk for commercial customers.

But there is no chance right now of an entente between management and workforce, even though it might be rational for them to jointly lobby the regulator Postcomm to tilt the playing field a little bit in Royal Mail’s favour.

In classic 1970s style this has become a battle about who runs Royal Mail – a trade union with unusual power in a workplace or a management intent on modernising a business. The stakes are too high for a quick and painless resolution.

Private grief

Robert Peston | 08:43 UK time, Monday, 4 June 2007


Nick Ferguson has big boots in the UK private equity industry: he is the creator of the business which mutated into Permira, the London-based private equity giant, and the chairman of SVG capital, the leading subscriber to Permira’s funds.

As such, it is hard for private equity firms to dismiss him as a marginal character or someone with a prejudiced hostile attitude to their industry. So his remarks – as reported in this morning’s Financial Times – will engender anxiety in the pricier rental districts of London’s West End where private equity firms are based.

Ferguson said: “Any common sense person would say that a highly-paid private equity executive paying less tax than a cleaning lady or other low-paid workers... can’t be right.”

He was apparently referring to capital-gains-tax rules introduced by Gordon Brown as Chancellor which allow private equity executives to pay tax at a rate of just 10% on their share of the profits (known as the “carry”) on a corporate buyout. “I have not heard anyone give a clear explanation of why it is justified,” said Mr Ferguson.

Well, one explanation might be that an industry valuable to the UK would emigrate to another financial centre without this tax break, to the detriment of growth and jobs here. But even if you think the presence in London of a substantial private equity industry is great for Britain – and there are plenty of people who don’t think that – it is moot that the industry would up sticks were the tax rate to be increased a bit.

In a world where it is fairly straightforward for highly remunerated executives to work in one place and live for tax purposes in another, there’s a painful rub for Her Majesty’s Revenue and Customs. One of the reasons why the private equity industry probably would not flee is that many of the leading private equity players at London-based firms don’t even pay the 10% tax, because they are not based here in terms of incurring a liability for personal taxation.

The risk for Gordon Brown and the Treasury in increasing tax on private equity is that many more private equity executives – large numbers of which are not British subjects – would find legal ways to avoid paying any tax at all: so even more of them might end up with a lighter tax burden than their office cleaners.

The debate about tax therefore is only half the debate. The central issue – the one being examined by the Treasury Select Committee – is whether private equity makes a positive or negative contribution to this country in a much wider sense.

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