The issue: No one benefits from a company’s destruction
Professor Dr Peter Roosenboom (1973) is Professor of Entrepreneurial Finance and Private Equity at Rotterdam School of Management, Erasmus University (RSM). He is the head of the Finance department and conducts research into corporate finance, private equity, corporate governance and financial accounting. In late April, Roosenboom will be one of the scientists who, together with representatives of various investment firms and interest groups, have been invited to participate in a roundtable discussion in the Dutch House of Representatives about private equity funds. The objective of this discussion (according to Henk Nijboer, financial spokesman for the Dutch Labour Party) is to “put an end to locust-like rapacity in the Netherlands”.
Some people call them locusts. Others say they can nurse a failing company back to health. Are private equity funds a bane or an indispensable part of the investment sector? Professor of Finance Peter Roosenboom: “A turnaround specialist can bring their house in order – with all the associated risks.”
By Geert Maarse Images Unit20
Companies that fall in the hands of a private equity firm don’t seem to fare very well. First HEMA and PCM; and now V&D is in dire straits. What’s going on here?
“In the case of V&D, you could wonder what drove Sun Capital, which has owned the chain since 2010, to let things slide for so long. They didn’t formulate a new strategy. They failed to respond effectively to the changes in consumer behaviour, with consumers increasingly seeking out cheaper alternatives: Action, Primark, H&M. In addition, it took V&D too long to respond to the online shopping trend.”
Is it typical for private equity funds to make such of a mess of things?
“The question is to which extent V&D’s current crisis can be blamed on Sun Capital and previous investors. The department stores were already in trouble when Anton Dreesmann stepped down in the late 1980s. On average, private equity funds actually add value. Take the recent IPO of the eye care chain Pearle, for example, under the name GrandVision. Or Ziggo and Action. All companies that grew under the aegis of private equity, took over other companies, entered new markets and became more efficient and productive. Generally speaking, companies like this are subsequently sold on at a profit.”
What’s so unique about private equity investments?
“Essentially, private equity is about investing liable capital in non-listed companies. To this end, the investors take on debt – or rather: allow the company to take on debt. They collect money from institutional investors: pension funds, insurance companies, banks. The idea is for the acquisition to have increased so much in value within a few years that it can be sold on at a profit. To this end, the company will develop a new, occasionally more aggressive strategy with the aid of the private equity firm.”
What’s the difference between private equity, venture capital and hedge funds?
“Hedge funds tend to have a shorter horizon and invest in listed companies. Venture capital involves taking an interest in new, fast-growing start-up companies. The strange thing is: venture capital works along more or less the same lines as private equity, yet people are wildly enthusiastic about this investment model. A key difference between the two is how debt is financed.”
According to many people, this financing with loan capital is actually part of the problem. How does this work exactly?
“In the case of a private equity investment, a far higher share than usual of the money invested in the company involves loan capital. Companies that make excessive use of debt capital for their financing can take greater advantage of opportunities to deduct interest rates, relatively speaking. But this enormous debt burden also greatly increases their exposure. The problem with the companies in the news right now is that the transactions in question took place before the current crisis, when it was easier to borrow money and prospects were rosier. They ran into trouble due to changing economic circumstances.”
V&D used to own a lot of real estate. According to some, this would have been a good nest egg for the chain. Its 5,000 employees wouldn’t have had to worry about their jobs or – as is presently the case – wage cuts.
“When the private equity firm KKR acquired Vendex KBB in 2004, they decided to sell V&D’s real estate. Their reasoning was: ‘This company is a department store; not a property developer’. The proceeds of these sales ended up in the pockets of the institutional investors. V&D may have been able to hold out for a bit longer with this real estate.”
But in itself, this kind of ‘asset stripping’ isn’t a problem?
“I’m not saying that. But occasionally it’s good – and I don’t want to use the term ‘asset stripping’ in this case – for a company to hive off activities that don’t fit in with the strategy it intends on following. Or activities that can be done better justice by some other company. What’s more: this strategy is only implemented in one out of every three of such cases.”
Things also took quite a bad turn at PCM. First, the publishing group was acquired by the British firm Apax, then it was stripped, and then sold off in parts for even more money.
“Things went wrong indeed in this case – although it’s an exceptional case. The Ondernemingskamer (Enterprise Division of the Amsterdam Court of Appeal) established that the company was severely mismanaged in the 2004-2007 period. Individual interests prevailed over those of the corporation.”
In most cases, does this process leave a healthy company?
“Yes. No one buys a company with the intention of destroying it and selling it on at a loss.”
Why then are investors like this subject to so much criticism?
“They usually don’t pull their punches – particularly in the case of Anglo-Saxon funds. They have an aggressive financing approach, handle larger-scale acquisitions than the Dutch funds, and they aren’t afraid to intervene and throw around their weight. Look at how the unions have been side-lined in V&D’s case, for example. And then there’s this Dutch patriotism: foreign companies are taking over our national heritage. But in many cases, the companies in question were already in heavy weather. A ship drifting rudderless, with poor management. A turnaround specialist can bring their house in order – with all the associated risks. Private equity investors could put more work into explaining this. Tell people what they’re doing, and why. That’s why for years, I’ve been arguing for more transparency.”
Don’t they focus far too much on the short term?
“Generally speaking, the investment term – in other words, the period during which a company is in the hands of a private equity firm – is five to seven years. There are companies that are sold on within the space of a few years, but essentially, there aren’t any major differences with publicly-traded companies. In fact, the stock market can be far more dependent on the issues of the day – with day prices, profit warnings and quarterly reports.”
In your analysis, you focus on both macro- and meso-economic aspects. But aren’t you losing sight of the employees’ interests, who often lose out in transactions like these?
“The laying off of employees inevitably leads to social turbulence. Nevertheless, you should always ask yourself: what would have happened to these companies if they hadn’t been acquired? While it’s nice to be able to avoid a massive round of lay-offs, it isn’t nice if the company goes under in two years’ time due to the further accumulation of labour costs. This can call for some painful decisions. Of course, this is terrible for the people concerned, but this doesn’t mean that private equity contributes to higher unemployment rates at the macro level.”
The House of Representatives’ financial spokesmen have invited you to participate in a roundtable discussion on this subject. Of course, one of the questions they will be asking you is whether the policy needs to be changed. What will you be saying?
“This policy has already been adapted in part. There are already some restrictions as far as financing with loan capital is concerned. And it has been made more difficult to raid the cash till.”
Should the government come down even harder on investment by private equity funds?
“That’s a political decision.”
Could you provide the arguments for us?
“A company that is mainly financed with loan capital is vulnerable. In other words, you could choose to put a check on this development. The government has already done so at the level of individual households – consider the gradual reduction of tax deductible mortgage interests. But this way, you will also be reducing the positive effects of private equity. The turnaround specialist who is working to get a poorly-performing company back on track, possibly with the aid of difficult restructuring processes and a revised strategy. During the roundtable discussion in the House of Representatives, I aim to limit myself to the scientific research. Because you will always have public commotion about excesses, whatever measures you decide to take.”
The issue is a section in Erasmus Magazine, the opinion and information magazine of Erasmus University Rotterdam, in which an EUR-academic responds to a current-social issue.