Geared for action
Private equity appears to have become an unstoppable force driving all before it with a business alchemy that few understand and even fewer can resist. As we point out in our cover story, if we all relied solely on popular myth then sensible treasurers would be running for cover as soon as they got a hint that a private equity house was sniffing around their plc.
But perhaps corporates can do something other than react like rabbits caught in the headlights of the private equity juggernaut. There are signs that corporates are beginning to work out strategies to deal with the challenges posed by private equity. As this is mostly a question of financial engineering, it is not surprising that treasurers should be at the heart of the action. As John Grout, the ACT’s Policy and Technical Director, reports from the ACT’s Midlands Regional Group’s Conference and Network event, corporates are beginning to look at techniques such as whole business securitisation as part of a review of balance sheet and funding and are finding that it is cheaper and raises more than conventional bank finance.
The veracity of such methods has been confirmed in a report by accountancy firm KPMG, Private equity versus the corporate, which suggests that the FTSE 350 can give themselves a much needed advantage over the private equity sector by moving faster and more aggressively in competitive situations and by exploiting a capacity for greater leverage.
Private equity players are often said to have the edge in winning the deal due to high leveraging but research shows that for £500m+ deals, the weighted average cost of capital (WACC) of FTSE 350 companies at an average of 10-11% is comparable with the private equity houses’ average of 11-13%.
On average, the net debt to earnings before interest, taxation, depreciation and amortisation of the FTSE 350 is 1.2 times; the figure for a private equity-backed business is a stonking 7.7 times. Corporates may not want to ratchet up to quite that degree but by increasing leverage they may be in a position to compete better.
There has been a long-held sense that leverage is bad, but we are starting to see some evidence that conservative attitudes to debt are beginning to shift. A key risk of leveraging is that the cost of debt suddenly increases. But bearing in mind that FTSE companies are big cash generators at the moment, it can be argued that only a substantial increase in interest rates would outweigh the beneficial impact on WACC of the increased debt levels. Increased leverage has always been seen as risky, but in the current climate it appears that being undergeared is the greater risk. It’s your choice.
PETER WILLIAMS
Editor