Private Equity firms ask for UK bailout - a way to make this work

In news that is unsurprising, Private Equity firms have joined the rest of the UK economy in demanding some Government handouts of free cash. It is all the rage after well, even Football clubs like Wigan have been demanding free money to help them survive (in Germany, they have bailed out Schalke 04 and Werder Bremen already, incredibly). 

PE firms have a PR angle that says they employ a lot of people and the firms they maange will go to the wall if they don't get help, so costing a lot of jobs....but why might these firms go to the wall?

A - PE firms took big bets in recent years on retail, see the margins for turning around a struggling industry business could be more than 20%. Covid has ruined this position so now PE firms are saddled with bad investments. 

B - PE firms generally buy companies, load them with debt, pay it off and then sell of float them. OK, they claim to add some management pizzazz and to some extent it is true as occasionally they will invest in new IT or some such to improve operating margins to reduce debt, but not too often if they can help it. Now their investments are saddled with debt that will be hard to even service. A nice Government bail-out will save their equity position will help to keep the companies alive. 

However, the Government is in a bind, it has huge pressure on it not to bail-out companies based in tax havens, so many US PE firms with their Cayman or BVI structures will be challenged. Also, at some point the accountants who advice Mr Sunak are going to have to give him the bad news about running out of our grandchildren's money. 

But if the Government is going to be bribed into going down this route anyway, I can suggest a few tweaks to the investments that will enable them to work in the medium-term:

1 - Wipe out chunks of the PE equity in return for the bailouts, it is only fare the investors take the hit here. The PE firms should be allowed to remain in, but if a business is saved with state money, then it should turn any future profit back to the State relative to its investment level. 

2 - Insist with this debt for equity swap, that there are strong leverage limits for total debt. There is no point lending to companies saddled with so much debt that they are zombies and unlikely ever to be able to repay. Remember too, much of this debt is effectively profit in advance taken by the PE houses anyway.  We don't need more RBS type investments where decades will pass before breakeven. In the Covid era, 100% debt to turnover or more should be a no-no. 

3 - Be tough, change the above criteria dependent on industry sectors, bailing-out retail leisure is high risk and thus should be high reward, bailout of say a bank is less risky in this particular economic crash. 

4 - Size does not matter, just because PE have bought a big bet, does not make it better than a smaller company. Small companies are the bedrock of our economy, they should have access to bailout investments too.  

Homebase goes for £1

That is quite a hit, an Australian outfit called Westfarmers buys the place for £340 million two years ago and has now sold it for £1 to Hilco - a group of retail turn-around experts, who can actually turn things around. The total write-down for Westfarmers on the whole farrago is £454 million, so more than the cost of acquisition. Ouch!


So why did it go so wrong for Westfarmers...


1) Business Rates - these are simply rising too quickly on larger premises for either landlords or tenants to maintain margins . Retail operates at 3-5% margin and |Rates are often increasing over this which is pushing up rents, even as occupancy falls across the UK retail space.


2) Amazon - Continues to eat everything that moves, it has lower rates and higher volumes, it is happily eating the whole high street and out of town sector.


3) Housing - UK disposable income has been very tight and doing up your garden or bathroom is only very occasionally a necessity so DIY has had a hard time of it. For the benefit of the nation , it is a long time since all TV was wall to wall property shows.


4) They sacked the management on acquisition and tried to make it like the Australian Bunnings business which put Homebase - aimed at DIY enthusiasts - into a place where instead they had more limited ranges to compete with Wickes. Thus instead of moving the market, they destroyed their margins and business.


I am pretty confident of a turnaround that will save more than 50% of the business.


The usual Company Voluntary Agreement will paste the landlords and deal with point 1. Point 2 is horrid, Point 3 may turn in due course and is about market dynamics (non-food is declining for now) and Point 4 is where the action is and something can be done.


So Hilco have a shot at recovering the business, but the loss of £20 million a month means there is significant risk of closure to much of the business.