Boots v Sainsbury
Any day now Alliance Boots will succumb to a takeover bid from a private-equity fund, probably KKR in partnership with Stefano Pessina, rather than Guy Hands’s Terra Firma with the Wellcome Trust.
When that happens we’ll be able to run a useful experiment about whether private equity is a good or bad thing, because we’ll be able to compare the performance of Boots against the one that recently got away from private equity, J Sainsbury.
The two companies have a great deal in common:
1) They’re both worth about £10bn.
2) They both face intense competition from Tesco and Asda (though obviously in different parts of their respective businesses).
3) They are both about mid-way through a recovery programme having endured years of decline.
4) They are both run by executives from the Mars stable, Justin King at Sainsbury and Richard Baker at Boots.
5) They both have strong brand names and powerful market positions.
However quite soon there will be a couple of big differences between them. Boots will become much less visible than Sainsbury. It will be able to reconfigure and develop its business without the requirement to keep thousands of investors and the media informed of its every move, its every success and its every ailment.
Broadly, the owners and managers will feel liberated to do more or less what they like.
And those managers will be feeling pretty chipper. They will have cashed in for many millions in aggregate their current incentive packages and will be loaded up with even more generous incentive packages.
The contrast with Sainsbury could not be more stark. There the top tier of management have just suffered a double whammy. Unlike their peers at Boots, they’ve had a magnificent windfall on their current performance packages dangled in front of them and then snatched away; and they’ve dreamed of becoming immensely wealthy in partnership with new private-equity owners only to see those new owners gallop off.
In a way, the different plights of the two companies can be put down to two billionaires, each of whom has a strong emotional attachment to one of the businesses: Stefano Pessina, who created the Alliance bit of Alliance Boots, a pan-European network of healthcare retailers and wholesalers; and Lord Sainsbury, who was chairman of Sainsbury till becoming a minister in Blair’s government and who scared off the putative private-equity bidders for Sainsbury by saying he wouldn’t take less than £6 a share for his substantial stake.
Pessina wants to take Boots private because he believes it’ll flourish away from the hurly burly of the public markets; Sainsbury, whose record as a manager of Sainsbury was not superlative and whose trustee sold a load of his stock at prices well below £6, is pledging his faith and a substantial part of his fortune to the status quo.
Which of these two would you back to win? The outcome will have quite an impact on whether the shift from public to private ownership turns out to be a cyclical or a secular phenomenon.
UPDATE 07.00
The board of Boots has recommended a takeover offer from one of the world's largest private equity firms, Kohlberg Kravis Roberts.
The offer is £10.90 per Boots share, which is a bit more than investors had been expecting.
It values the leading healthcare retailer at £10.6bn.
The deal would be by far the largest acquisition ever made in the UK by a private equity firm.
It will be highly controversial, following the recent campaign by trade unions and MPs on the left of the Labour Party claiming that private equity takeovers lead to savage job cuts and excessive rewards for the executives in private equity firms.
Boots's board has said yes, because KKR has improved its offer a fraction from what it originally offered.
The deal would be enormous in terms of its impact on people. Boots employs more than 100,000. Millions of us trust its pharmacies. And its wholesaling operation is a huge supplier to the NHS.
So takeover will reignite the debate about whether ownership by private equity is good or bad for British companies.
Unions are bound to complain that there'll be job insecurity for Boots's staff and fat profits for KKR.
Whereas the company's deputy chairman, Stefano Pessina - who's in partnership with KKR - will probably argue that Alliance Boots's prospect for growth would be better as a private company - sheltered from the interference of shareholders and the media.
UPDATE 11.30
Terra Firma's higher offer is conditional on inspecting Boots's books - and is therefore not a firm offer. For that reason, Boots's board is under no pressure to recommend it.
Terra Firma's motive for making the announcement is to drive up Boots's price in the market. It is prepared to pay an effective £11.15 - viz £11.26 minus the break fee (seminar on this to follow).
This prevents KKR from going into the market to buy stock as under takeover code rules a bidder cannot pay more for stock in the market than the value of its offer.
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Alliance Boots and Sainsburys face acquisitions by Private Equity bids. The companies offer a nice test of the outcomes of Private Equity moves. This assumes that the Alliance Boots bid will succeed, and the Sainsbury one will fail. There are a range of structural and market similarities shared by the two firms. The killer-fact seems to be Lord Sainsbury’s reluctance to sell his shares at an attractive price have beaten off the predators that had been circling Sainsburys.
But there are other considerations which make comparisons trickier.
First, the two billionaires in the game have quite different motives and track record. Pessina is a self-made entrepreneur who created his substantial wealth. Lord Sainsbury inherited his wealth.
Another complication is that Pessina has an unusual, well-nigh unique set of roles, and is on one hand an insider in Alliance Boots, and on the other, the prime-mover of the take-over. I can’t get my head around the conflicts of interest – although the company has stated that there are none relevant to the take-over discussions.
AS David Cameron said recently in another context, there are two tests that have to be satisfied: The delivery of the promised corporate gains post take-over. The second, is demonstration by the new Company that having escaped from the constraints of plc interfence it will maintain the standards of Governance in a post-Enron era.
i know we live on a open world but is not a reason to sacrifice the british industry. What is the point to a private equity company to buy Boots or Sainsbury's. They are needed to create firm not to destroy them by reaching financial results which are so damaging for the firm and for the employees.
I know we must be pragmatic because we connot save all firm but i cannot understand why british politics leaders are not encouraged their industries ( a country like britain) Big names of you industry are now desappearing. What a shame!!!!!! And i will just said that every big country pertically the emerging countries like China and India are protecting and encouraging their industries because they had understood it is vital for them. Why britain is not doing this i want a debate (sorry for my english, is very bad) And remember if britain looses its industries everything in the future will go!!! (R&D, back office, finance, sevices...) They will be no more job and britain with loose his pretige and sovereignty. Now publish this note and lets debate
YOur report is valuable but I suggest that there are points that need more attention. As you may know similar LBOs of Qantas and the huge retail conglomerate Coles have been in the news in Australia, where I was recently, staying with my son in Melbourne. Investigate!!
LBOs are with money borrowed from banks - which banks?.
Size of Company and private debt is worrying the BofE
Profits will largely go in interest payments, which are tax deductible. Thereby reducing corporation tax and ending tax on dividends. Loss to govt income
In times of recession, companies can survive by reducing or cancelling dividends. If they default on interest perhaps on an international scale, it could destabilise the world financial system.
KKR claim huge fees for the transaction. Board members - vice chairman with 15% will pocket vast sums.
Ruthless managers without retail experience will move in; staff get demoralised, because the motivation is not the actual business but money. Ask an employee at ALLDERS, where at least one customer has noticed the change in attitude.
You should tell us the international portfolio that KKR and other US private equity groups now command - and its potential threat to financial stablity.
I really think this will be a smart move for the industry as Boots recovers from its dark decline. But what does it mean to sharholders and more importantly its staff. Im not so sure whether Boots will continue its excellent and examplorary training initiatives. Also, staff shares; what will becomes of these as many staff have locked monies into these?
I work in private equity and am frequently disappointed by the lack of journalistic rigour in investigating our industry. If I may, I would like to higlight a few misconcpetions which are sometimes reported:
Myth One: private equity investors are short termist and opportunist.
Response: in contrast to the public equity markets, nothing could be further from the truth. If the public markets were efficient and long term then the value of the companies would reflect the long term prospects of the business. Why is it that we repeatedly see private equity bids at substantially higher values than the prevailing share price? This is about more than simnply paying a premium for control of the company. It is about private equity investors recognising that long term performance is more important than valuing shares on a quarter to quarter basis based on earnings expectations in the short term, an approach adopted by the majority of public market investors.
Myth Two: High debt burdens lead to greater interest payments, which are in turn tax deductible, and therefore reduce government revenues.
Response: the net tax income received by the government is the same under differing debt structures. If tax is not paid directly by the business - as it goes to pay interest, then the banks lending the debt (and which receive the interest income) will pay the corresponding tax from their own earnings. Either way the same amount of tax will go to the government.
Myth Three: managers of private equity businesses are typically greedy and are paid more than their publicly quoted counterparts.
Response: Whilst I do not contest that the ability to earn greater sums of money exists for managers of private equity businesses than their public counterparts, the equal and opposite is also true. This is risk and reward in its purest form, not greed. Management incentive schemes in the private equity world are strongly linked to the value of the business. Therefore, salary and annual bonuses are almost non-existent as compared to the usual packages given to public managers. Unlike in the public markets, private equity businesses are not lifestyle businesses for managers. Where private equity businesses underperform, the management is replaced swiftly, often with minimal or no pay-offs. Unfortuantely this high level of accountability does not exist in the public markets.
I could go on, but I suspect it would only serve to bore the reader. In closing, I would say that the as the private equity industry grows it needs to increase its level of social accountability, and has been poor at doing so to date. However, it should be noted that private equity investors can and do make a meaningful positive impact on the companies they control.
Private Equity buyouts are just the latest manifestation of Asset Stripping. Find yourself a well established business with a large property portfolio, buy it with borrowed money, saddle the business with all your debts, then sell off the assets and mortgage off the income streams to make as much money as possible. All you then need to do is manage the books for a couple of years by drastic cost cutting and complex accounting to keep the share price up and make the City happy. The Media will laud you as Financial genius and it's time to take the money and run.
Ten years later, who cares?
Re Paul Langston
Myth Four: Private equity investors are asset strippers.
Response: Paul has correctly identified a sale and leaseback of freehold property. Transactions such as this are to enable the business to focus on its core activities to ensure that gains in growth from core areas translate directly into value for the business. The existence of a property portfolio, or other such asset, often leads to a managerial distraction at best, or at worst confuses investors over the true focus of the business and hence its proper valuation.
Who gains from such a sale and leaseback? Of course, the sale proceeds go to the current owner. However, in an efficient market the value of the portfolio should have been fairly reflected in the valuation placed on the business by the previous owners and their advisors before they sold out. Therefore it is difficult to see how private equity can be classed as "asset strippers" when they have paid full value for the asset.
Using Sainsbury's as an example: are investors in Sainsbury's looking to invest in:
(i) a retail chain; or,
(ii) an owner of freehold properties?
I suspect it's strongly the former, a retail chain. At present, Sainsbury's is a c.£8.0bn property company with a c.£2.0bn retailing company attached - this is probably not the business focus an average Sainsbury's shareholder recognises or indeed the focus lent upon in their own annual report. Should investors want to invest in both businesses, then they can diversify by investing in Sainsbury's and a separate property company. I suggest that this investment diversification decision is not best made by Sainsbury's management, and therefore the freehold properties are best held by a specialist property company.
Bernard Keeffe - your comments stack up if you assume that the recipients of the interest deductions are not taxed on receipt - when I last looked UK banks were taxed on income receipts so where is the loss to the treasury exactly?
Which Unions will complain when Boots doesn't recognise them??
I'm an ex-trade union person trying to get my head around private equity and I have to say that (much as I would like to!) I can't find much to argue with in the remarks from the private equity person in post 5. There are a lot of myths and misuderstandings about private equity. One could add the misconception that buyouts equal job losses. In fact the evidence is more mixed, with MBOs tending to result in increased employment but MBIs leading to lost jobs.
However the one issue that I really struggle with is what exactly private equity brings to the party. Let's be clear here - the overwhelming bulk (75% plus) of private equity activity in the UK is buyout, not venture or expansion. What are we actually achieving in broad terms by using our pension funds to finance this? Why can't public companies adopt the same kind of strategies as PE, if they are such a good thing? And why do we need to pay company directors even more than the huge amounts they already get to do something they are already being paid to do (run the company as effectively as possible).
One has to wonder too whether all that debt will come back to haunt us. I know again the argument here is finely balanced. The IMF recently sounded a bit of a warning, but the ECB suggested that everything is peachy. Can anyone tell a dumbkopf like me what the real picture is?
Re TP
There is nothing to be ashamed about in trying to understand PE. It is a complicated industry - but we appreciate you looking at it from a balanced perspective without preconceptions.
If I can address a couple of your comments:
(1) MBI (Management Buy-In) will almost always result in more up front job losses than MBO (Management Buy Outs) by definition.
A MBI brings new management to a business and replaces existing management. This typically happens where a business is underperforming and hence management has underperformed. Therefore the first action of new management is to put the business on an even keen - which inevitably means matching the cost base to the revenue stream in the short term, and often in job losses.
A MBO will back existing management to essentially do more of the same. Therefore drastic actions are less likely to be required, and hence jobs in the short term are more secure.
(2) Private vs Public Equity
There are a number of arguments around why private equity may be more suited as an ownership structure. A few examples:
(i) Longer term investing in the PE world. Athough I recognise this is debatable - 3-5 years is not always seen as long term - but it is longer than quarter on quarter.
(ii) Closer corporate governance in PE companies. PE owners attend monthly board meetings and retain absolute control of the direction of business.
(iii) Stricter shareholder control. E.g. when was the last time a group of directors did not receive the salary and bonuses they were seeking in a public company? This frequently happens in PE investments.
(iv) Diversity of experience of senior executives. A PE house will put 2-3 non-executives onto the board of a company. Each of whom either has significant operational or managerial experience. This fosters a collaborative effort and serves to assist and test the top executives.
(3) Re Directors pay. Apologies if I didn't make myself clear in post 5.
Over 90% of the remuneration to directors in PE investments arises from an increase in the value of the company. Not salary and bonuses. Therefore if the business doesn't perform, the directors receive next to nothing. If the business does perform, then the directors reap the benefits, and rightly so. As I mentioned earlier salaries and bonuses are typically much, much lower for directors of PE investments.
Please also see my other post - number 7.
Mr Peston says this is apparently "a useful experiment about whether private equity is a good or a bad thing".
This is not a theoretical experiment in a vacuum - it will affect the jobs, livelihoods and incomes of hundreds of thousands of Alliance Boots staff across the UK and globally. These people are human beings and their well being should not be put at risk just for the sake of an "experiment" to satisfy the fat cat investors and analysts in the City bubble.
Having worked on several PE transactions, I must say that the level of detail involved in a PE's due diligence of any prospective target is commendable. Moreover, PE's have a very clear vision and focus on how to increase value. One must not forget that PE's also come with sector expertise and its not just financial engineering, its the whole package of clear strategy, commercial expertise and financial engineering that brings the returns.
On the question about debt above, I am quite sure that the top PE houses know exactly what the returns are going to be and would not venture if they knew that the risk of the business going belly up was high. Moreover, a PE has to satisfy their banks with financial models that show how the debt and interest on the debt would be paid and don't forget that they almost always take an interest rate swap.
On the comparison of Boots vs. Sainsbury, one must note a significant difference between the two entities. Boots only owns about £1.5b or so worth of properties but Sainsbury's was a massive £8b worth of properties and therefore the scope for returns from property was huge. In Boot's case it is the operations that are more important.
At the end of the day, I do think that PE is not all doom and gloom and does bring some added value to the economy.
A point on these discussions keeps reaccuring and constantly niggles at me.
Jon B has made the point that there are as much as 100,000 jobs 'on the line' as a result of this takeover and suggests that they have now been put at risk.
As an employee, I don't feel the company I work for is doing me a great favour by keeping me employed. They need me. That is to say, they need someone in my role. If not me, someone else.
If they could do without me, they would, and I can't see how anyone can reasonably hold this against them. If the soon to be new owners of Boots can continue to run a successful business but at the same time cut their wage bill, then this is only good business practice. There is a strong arguement to say that, if this is possible, it should have already been done by the directors, in the interest of the shareholders.
It would not be in the interest of the PE firms to destroy what is currently a well established business with a huge amount of goodwill. Their interest, as it should've have been for the directors, would be to increase the value and profitablity of the business.
Succinctly, the only way I can see it makes sense for a PE firm to start laying off staff is if a business already lacks efficiency. And if the only way this can be rectified is by a private equity takeover, then this only strenghtens the arguement for such a move.
However, I would point out I consider myself a novice in this field and if anyone can point out a flaw in my logic I will happily concede.
As an employee of Sainsbury's, it was obvious the PE consortium were going to bring nothing to the company. Their sole purpose being to get their hands on the property.
The record of PE is shaky. The record of Allders and now Debenhams shows how things go wrong. What did PE do for Debenhams exactly, apart from slash investment ?
The so called PE record of creating jobs, is also is a red herring. The number of jobs may increase in some cases, but how many are low paid/part-time?
PE can be useful for new start-ups, but now it would appear that Asset Stripping, for the generation of short term cash generation is its main aim. The two Lord Sainsbury's were correct, massive debt is bad for business. Let's hope the PE industry withers before its effects irrevocably damage the UK economy.
I think problem lies with the management of Sainsbury and Boots, who made these companies venerable for take over bids,
Perhaps, it is worth looking into Tesco and Vodafone's corporate strategy, who unlike other companies in recent time managed to expand exponentially to the other part of the world.
I both love and hate these comment sections. You get both idiotic comments and some real gems.
Let me focus on the idiotic. e.g. Shashank Garg - Sainsbury's is only subject to private equity bids because of its management? The current management has lead Sainsbury's to great heights compared to the dire situation when it took over from Peter Davis.
Another idiotic argument to my mind is that "At present, Sainsbury's is a c.£8.0bn property company with a c.£2.0bn retailing company attached" - that may be true. But how would "Sainsbury's opco" survive by paying massive rents to "Sainsbury's propco"? It surely wouldn't (lack of capital for investment in new stores, refurbishments, price competitiveness).
In pure economic terms, sure, that is may be the most efficient outcome, a resultant less than efficient supermarket business goes under and a lucrative property portfolio company does very well.
However for both sentimental and competitive reasons surely the Sainsbury family (esp. Lord John) are right that J Sainsbury plc is best left as it is - supermarket and property. That way the company, by exploiting its property assets perhaps more than at present, can both survive as a long term enterprise and challenge its competitors.