Speaker key
LB: Lionel Barber, FT editor
CS: Charles Sherwood, partner of Permira
DB: Damon Buffini, managing partner of Permira
PS: Peter Smith, FT private equity correspondent
Edited transcript
LB: In the space of three months, you’ve turned from golden boys and girls to bad boys. Why do you think this has happened?
DB: It’s quite extreme, but I can understand it when you read all the press that’s out there in the industry...there’s a whole load of issues coming through that kind of go together, so I think there’s the point about people not quite understanding what we do and the benefits that we do bring to the economy, and the positive story that the industry has to tell about job creation, productivity, making the UK economy effective in a global environment.
Those messages have not got through. And that’s all been clouded also by the debate about globalisation, and I think there is political element to it as well, and I think they’ve all come together and I think that’s where we are.
LB: But why now?
DB: I think also there’s no doubt that private equity, it’s a global phenomenon. It’s been driven by the pension funds. So there’s a mystique as to what’s happening. Why is private equity so big? It’s being driven by the pension funds. So last year, over $200bn of equity invested in private equity funds. [At Permira] we’ve got 70 pension funds [and] roughly 30m pension fund beneficiaries.
LB: 30m?
DB: 30m through those pension funds, including 1m local government employees in this country. And they’ve increased their allocation to private equity deliberately. They’ve seen very, very good rates of return, and so they’ve increased their allocation to what we do. And actually, they’ve dramatically increased it, because the returns, compared to other alternatives over the last five years, have been very good.
But there’s a dramatic increase in the amount of money they’re allocated on equity, and therefore the funds have got bigger, and therefore the transactions that are being done have got bigger and when the transactions get bigger, some of the companies are household names, and therefore it’s just much more prominent.
LB: Sainsbury was a typical one.
DB: Exactly. It’s a prominent household name which is a potential leveraged buy-out possibility, and that really brings it home to everybody how big the industry can be. So it’s all those things around put together.
LB: But also, it’s not just Sainsbury being a household name, it’s that Sainsbury also employs thousands of workers.
CS: I think that’s happened before. I think the underlying reason for this is economic. I think we went from no boys to bad boys – no boys, in the sense that I don’t think frankly anyone cared when we were investing in smaller businesses. Now that we are increasingly becoming owners of much larger businesses, absolutely legitimately people have an interest in that.
Now the timing is partly just at some stage that profile has become such that people were going to take a clear interest. I think there is an element of political timing in it too.
PS: Can you explain that? What is that? The [Labour party] deputy leadership campaign?
DB: Oh, we’re not politicians. I think you’ve probably got more insight into that than we have.
PS: But you said there were some politics there.
CS: Well I think if you look at what happened in Germany, the timing of the “locust” debate in Germany was clearly around an election. I think the GMB [trade union] has been making, raising some of these issues for some time. I think the reason they have got particular traction probably at this moment has an element around the political environment.
But that’s not to complain. That is the reality of life, and we accept, we absolutely accept [that], and you and I have talked about this Damon, we absolutely accept that given the size and profile of the businesses that we are now owners of, that there is a responsibility on our part to communicate clearly what’s happening.
LB: But when I met you, Damon, last week, I said to you that I’d had this conversation back in September with a senior City figure and unprompted he said, “I’m telling you, private equity is riding for a fall. They don’t explain what they’re doing, they’re not organised, and it’s going to hit them hard soon.” Why haven’t you been a bit better organised? Why haven’t you thought about this message?
DB: Well I think that we have thought about it. I think Charles’ point is that until quite recently, nobody was really interested in private equity. It was just under the radar screen. Peter was interested, and a few other people were interested, but they weren’t really interested.
PS: It was more in the confines of the business pages.
DB: It really was. And so the fact that we have got a very good story to tell – the fact that we are growing companies’ productivity and creating employment in the companies that we own, which is true – nobody wants to hear that. Now of course there’s so much noise there that actually it’s quite difficult to get that message over.
That message is there. It’s not changed. It’s not changed for our investors. Overnight our investors haven’t all of a sudden said “you’ve not delivered”. They’re saying quite the opposite – “It’s a great asset so we’d like to put some more into it please”. So the positives of the industry haven’t changed, and I think what we have to do now, and I’ve been saying it for quite a long time, that the industry should be more open about what it does and what the companies do. And the companies should communicate more about what they are doing and how they are creating stronger businesses which benefit everybody. And that’s where we are.
PS: Have you had any specific contact with any senior politicians that want you practitioners, to be out there delivering the message about why you might be shutting a factory in Hull? Have you had any direct contact?
DB: As an industry, clearly the BVCA [British Venture Capital Association] works on our behalf, and clearly given the size of the companies, we do know some of the political figures in the situation. And yes, they are encouraging us to do that.
PS: Can we say who they are?
DB: No, I think it’s a pretty general point. I think it’s pretty obvious that the private equity industry is a very successful component to the financial services industry, which is a very successful part of the UK economy. And clearly, the Labour government has been very supportive of financial services in this country, and they want us to be successful.
PS: Can we nail the point, though, about whether you might have had direct chats with some senior Labour figures?
LB: Not just you, but others.
DB: Well, the BVCA is a very good organisation that may have had contacts with senior figures. They do that all the time.
CS: I think the communication has actually been going on. I think if you saw the communication between Permira and the industry as a whole and our investors, there is a governance structure and an answerability, and a level of detail on a portfolio of companies that we provide to our investors which would rival any relationship with public shareholders.
I think if you looked at the communication between private equity companies and their employees, and other stakeholders in those businesses, I think that would also compare very favourably with the public markets, because I think most private equity groups put a considerable premium on the ability to have a strong relationship with the workforce that’s often going through a period of quite considerable change.
Where there has been undoubtedly a gap has been in communication with the broader media. And the reason there has been that gap, I think, is exactly the one that we’ve tried to identify, which is that frankly there wasn’t a demand for it. When the companies were much smaller, there was not an interest in it. There certainly is now. It’s totally legitimate. But it was not one that the industry was well prepared for.
And I think at Permira, we have tried to lead the way in that regard and we have tried to prepare the ground. And one example of that is insisting that with all investors that came into the last fund that they would be prepared to have their names disclosed. But even we have been caught by surprise, we will admit, by the rapidity with which the companies that we are owners of… and our relationship with those companies has risen up the spectrum of public interest. That has been far more rapid than we would have guessed.
DB: But that’s fine. That’s where we are. I think we have to react to that. I think the industry has to be more open, and I think we have to have more openness from the companies which we invest in.
PS: What does that mean in practical terms?
DB: I don’t really know what that means, but I’ll give you an example. Here’s a private company. This is the annual report for the AA last year. Now that’s got much more information in it, financial information, than the AA ever produced as a company when it was owned by Centrica.
CS: And another one is being produced… I’ve cleared the first draft along with the rest of the board for the 2006 annual report about two weeks ago.
DB: That’s an example. I’m not saying that all companies should produce detailed annual reports.
CS: You never did.
DB: But there’s an example of an idea of where openness could go, the direction we could go.
PS: So you might produce similarly bulky annual reports? How do you choose?
DB: I think that what has to happen is that we have to think about where we are in this debate. We have to think about what is the level, the appropriate level of openness and disclosure with our companies. But nevertheless, what I would say now is that it’s clear – and we think it is also right – that there should be some more openness and disclosure from the companies we invest in. We don’t have a problem with that.
LB: So let’s clarify. You are clear in your own mind that you’re going to have to offer more information to the public, and to investors and to the media, about the companies you invest in?
DB: No, let’s be clear on that. I think our investors receive very good information, and they are very happy. They are very happy with what we do. I’m sure we’ll come back to a few questions on that, but they are. So I don’t think it’s a question of investors.
I think, as Charles said, there’s a debate about large companies that were in the public domain which are now private, and what are those companies doing. And I think we have to think about how we address that.
LB: So for a broader audience who are interested in how some of these larger companies – say over 10,000 employees, 5,000 – that you’re intending to give more information about. Is that right?
DB: Well can I just frame that?
LB: If you’re saying “I’d like to be more open, we recognise the audience has changed, therefore we’re going to do it” – OK, fine. What does that mean in practice?
CS: What it means in practice is that we work with the management teams of these companies to encourage the highest level of disclosure that is consistent with sensible commercial practice in the interests of communicating with shareholders. Now it sounds like a hell of a mouthful. It sounds almost mealy-mouthed, and we’ve explained the issue that we have. We are investors. Owners yes, but we are fundamentally investors, and it is the management teams, the chairman, the chief executive and the senior management team who are responsible for managing the businesses. And managing the businesses includes legitimately managing their communication policy with their own stakeholders.
Now I am a non-executive director of the AA. If I pick up the phone and describe to Peter at great length and in great detail what’s happening at the AA, Tim Parker picks up and opens his Financial Times in the morning and sees the innards of his business described to the world by a non-executive director and shareholder without reference to him, he would rightly feel that his role in communicating on behalf of the company had been effectively usurped. And you would not expect Fidelity to do that with British Airways, and you can’t expect Permira or CVC to do that in respect of the AA or Apax and Permira in respect of New Look. It has to be us as investors working through the portfolio in companies, encouraging the management teams to responsibly communicate with all the stakeholders in the business, recognising that those stakeholders are increasingly including a public audience.
That’s the portfolio companies. When it comes to Permira itself, it’s different. That’s our business. And frankly you can have whatever information you want on that business. With one exception, you can have any information you want. The one exception is, there has to come a point, I think, in any business where there is a line between the business and the private lives of the people working in that business.
But as far as Permira is concerned, I mean you’ve got most of it here, but you’ve got the returns. We can give you the names of the investors in the funds. We can give you our investment strategy and what companies we’ve invested in, how much we’ve put in those companies, how we compare against the industry benchmarks, where we are around the world. I don’t know what more we can actually say. We can tell you how our governance structure works. We can tell you how the profits are determined in the business and the principles on which they’re shared.
The only line we do stop at is saying that it is reasonable that there is some degree of privacy with the individuals in the business.
PS: You mean compensation [for individuals]?
CS: Yes, it does. And there is an element… I know there is a lot of interest in that, but there comes a point frankly where that is little more than financial voyeurism.
PS: It is also true that as the industry’s grown so much bigger, that the amounts of money being made by the buy-out groups is very substantial. So if you raise a €1bn fund and you charge a management fee of 1.5 per cent, fine. If you raise €11bn and you also charge 1.5 per cent, then that’s quite a material change in money being generated and it may not cost you 10 times as much to run the business.
DB: Well our investors are some of the most sophisticated investors in the world. They do incredible amounts of due diligence; months and months and months of due diligence. They are often advised by some of the most skilled advisers in the world who have total access to all the market data, so they know what the market is. And in Permira’s case, 90 per cent of our investors have been investors in our last three funds. They know what we’re doing. They like the fact that we are investing in the business, so frankly we’ve invested in all these offices around the world and we’ve been in Tokyo, we’re looking at Asia, we’re in the US, we’re always looking in Europe.
We invest a lot of money in the business. They like that. But they are aware of the economics, and they are satisfied. And the reason they’re satisfied is because of the performance that we generate. They are happy. They think it’s good value. And that’s fair.
CS: And actually, the fees have come down to about half of where they were when Damon and I started in this industry, as a percentage. In absolute terms, they would be substantially higher. We have over 100 investment professionals now.
PS: The reality is that your returns are very good relative to your peer group, and you probably could have raised a lot more than €11bn. But you’re holding all the cards in terms of who you let in or not, because there’s surplus demand to get into your funds, which means that at this point in the cycle, the limited partners don’t have as much power as they might have when the cycle changes. You get to dictate the level of fees.
CS: It’s not a crime if the customers want your product Peter.
LB: Supply and demand.
DB: And at this point in the cycle, we have performed. There’s no parachute for failure in this business. If you don’t perform, you don’t raise any money. The performance is very transparent. The investors know it; they can benchmark it very clearly. So I think they are very happy with the value that they are receiving from us.
LB: I still want to come back to this question of disclosure. Regarding the companies that you invested in, you’re saying you will encourage them to be more open?
DB: Given where we are at this time, so we have companies like the AA that have produced annual reports and companies like New Look which have financial information out there just as a given, because of the financial instruments they have in the company. There are other companies that are totally private. I don’t think we’re quite ready yet to say what does that mean, but I think it is fair to say, from our point of view, and I think from I would guess most people in the industry, that they accept there has to be some more openness. There has to be more. What is that? I can’t answer you at the moment, but do I think that in the foreseeable future it will be a bit clearer? I think it probably will be.
LB: And we can also say that you have taken a first step by revealing the names that were invested in your last fund.
CS: Yes, I think that’s a first step.
DB: Let’s be quite accurate on that. What we’ve insisted on is that anybody who was invested in our funds, their names could be revealed; not that we were going to publish their names.
PS: You’ve got the option. Have you needed to use the option? Have you wanted to use the option?
CS: What we’ve done, exactly what we have done is with responsible journalists – and you and I have had this conversation before Peter – we have shown them a list of our investors on the understanding that the list will not be reproduced. Now the reason for that is not that we are shy about revealing these names, but there are investors here who would feel that it was unreasonable of us to be promoting our business on the back of their brand names.
So I will give you an example which is the [not publicly disclosed] pension fund. Now it is one of 180 investors in Permira IV. And I show it to you, we show it to you upon that understanding that you will not reveal those names. But we are prepared to show it to anybody who has a legitimate interest to demonstrate that these companies are ultimately owned by perfectly worthy and beneficial owners. .
DB: Teachers. And as I said, there are a million UK local government employees.
CS: And 6m teachers.
LB: Can we deal with the question of the level playing field and favourable tax treatment, of debt versus equity? Steve Schwarzman [chief executive of Blackstone] at Davos was talking about how private equity could borrow on more favourable terms and actually they could have debt with no covenants, and then they could use toggles to delay repayment of debt. I mean, the list went on. Do you think that’s a problem in the public mind?
DB: Well our companies aren’t treated any differently to any other company. We don’t have any special treatment. This idea that our companies are getting special treatment from the tax system is not true. All companies can deduct their interest as a legitimate business expense because companies use it to fund capital expenditure, acquisitions and often working capital. So I don’t think that argument is fair.
LB: But equity is taxed twice.
DB: Well the question was is it a level playing field? And it is a level playing field. Our companies are not treated any differently to any other company. They’re not.
CS: I think there’s a general issue, Lionel, about the obsession with this question of the leverage. But the leverage does not create the value. I think that’s a very important point to make, and it’s a simple piece of mathematics. The average cost of the debt in our financial structures is around about 9 per cent pre-tax. It will sound high, but the senior debt costs about 7.5 per cent, the high yields probably 10 per cent, and the mezzanines probably 14 per cent. And if you take a blend, you come out at about 9 per cent pre-tax.
This is before the tax yield that Lionel is focusing on. If you take the full benefit of that tax yield, that 9 per cent costs about 6.5 per cent after tax. If you ask anybody you care to ask, Lombard Street Research, London School of Economics, Schroder’s Investment Management, they will tell you that their expectation for the total return, total return from the UK stock market over the medium term, will be in between 6-7 per cent. I’ve never heard anyone come out with any other number.
Now my point is that if you are buying a company off the public market, you are implicitly buying a business that’s been priced, excluding any premium that you pay, to yield a total return of between 6-7 per cent. Presumably, if you have a premium, it’s going to be less than that. However much you take that income stream, or that value stream generating a return of 6-7 per cent, and you leverage it with this stuff costing 6.5 per cent, you don’t achieve anything. And to the extent that the yield is actually lower than 6-7 per cent because you’ve paid a premium to take it off the market, you will actually have a negative effect of that leverage. It is only by virtue of getting the return on the investment up by what you do with the business itself, that you are able to create the excellent returns that have been seen in some transactions with some private equity groups.
The point being, in summation, that the leverage does not create the value. What the leverage does do is it magnifies the value that has been created by other means, but those other means involve a lot of hard work.
DB: Let’s take a couple of examples of that. In our portfolio, we tend to have household names in the UK. So Travelodge, which we acquired and then sold to Dubai International Capital; a successful transaction for us. It was the leverage to create the value there. We built 100 new hotels by our ownership. We refurbished every single hotel room and changed the pricing policy. That’s what created the value there. And so when Dubai bought the company, rather than have 12,000 hotel rooms, it had 25,000 hotel rooms and another 15,000 to come. That’s why they acquired it.
PS: Did you sell the property?
DB: We sold the property.
PS: So it changed from a property backed business to an operating business.
DB: It was an operating business, yes.
CS: You know, there are almost no property backed hotel businesses now.
DB: Everybody can do that. All hotel businesses are now doing that whether they’re owned by private equity or they’re not. Intercontinental, for example.
CS: I think that really was a case, Peter, in fairness of us effectively bringing Travelodge in line with the rest of pack.
DB: Take New Look, which is another example. So it was a public company, it’s now a private company. It has 1m more square feet of selling space than it had when it was a public company today. It’s much more profitable. It’s growing very nicely. And it [and Travelodge] employs thousands more people. Thousands, thousands more. Not hundreds; thousands more people.
Now that’s not leverage. That’s operational improvement. And that is the message that we and the industry have to get across. It is not the fact that we are very good at capital structures, because frankly I think capital structures are easily transferred; the knowledge about the capital structure. The capital market is a fairly fluid concern.
LB: When you say thousands, can you be a bit more specific?
DB: I can. In New Look there have been over 2,000 new jobs created. Some of those are part-time; some of those are full-time. And in Travelodge, it was over 2,000 new jobs. And they’re quite big numbers.
LB: Again, when one talks about the markets, isn’t this about this extraordinary era of cheap money which you’ve rightly been able to exploit? And the fact that the credit spreads are very tight in historical terms. Is that not the case? Could you imagine in, say, two years time, there will be a completely different debate?
DB: Well, having been in this building for 20 years, we have seen probably at least three cycles in the private equity business. So will the debate change about cheap money? Yes it will. But I don’t think the debate’s going to change about how you create value in private equity companies. We fundamentally believe it’s all about building strong, sustainable competitive businesses. That’s what we have to do. That’s what people are going to buy from you. So for our investors to create… to get the returns that they want from us, the funds are, as you know, 10-year closed life funds. We are actually long-term investors, so on average we’re about five years as our investment period, which is longer than any other component of the capital market. But clearly we do have to sell companies eventually, but they’ve got to be worth more when we left them. So that fundamental isn’t going to be different.
Now, whether there’s as much debt available, or more, time will tell. But our investors pay us to judge these things. That’s why they back us. That’s why they’ve backed us for 20 years.
LB: What about flipping?
DB: Fine, well that again is probably our fault in terms of not being able to communicate properly. Now on average, we are investors for nearly five years in businesses that we invest in. Now that can’t be classed as flipping. It can’t be. That’s the number on average, five years.
LB: Do you think there have been other instances amongst your competitors?
DB: Well we can’t talk for the industry by any means. It’s Permira here, and I think it’s only fair that we just tell you what we have done and what our philosophy is.
CS: But let’s just throw some examples out. In Hogg Robinson, it was reported in one newspaper as a quick flip. We owned that business for six years. Homebase. I still see it sometimes described as a quick flip. Well, our investment in Homebase was only two years, right? But in that two-year period, the profits increased four times on the back of a massive transformation of that business. Completely new product ranges, introduction of mezzanine floors, restructuring of the central functions, IT transformation and SAP implementation. So it may have been a short period of time, but it was a very different business that came out than went in. And as Damon says, on average four and a half years; very nearly five years.
PS: But don’t you all in some respects get tarred with the same brush? If some are doing quick flips?
DB: That’s where you guys come in, isn’t it? Because when we communicate to you and say it is four and a half and five years, and in no way can that be classed as a quick flip, then I think we should be differentiated from anybody who you do think is flipping businesses quickly.
CS: I’m told the average hold for a long-only investor, a traditional long-only investor in the UK stock market is now down to 10 months. Hedge funds, as you all know, it can be 10 days or 10 hours. And the point being, Lionel, that private equity… it is ironic that private equity on the one hand is accused of being a quick flip, but on the other hand, it’s probably actually the longest term for corporate finance in the country.
LB: Do you think the debate is different here than in America?
DB: At the moment, yes, for some of the reasons we talked about right at the beginning of the meeting. I also think that the private equity market is much more mature and I think therefore the debate is probably more informed. So I think it is different.
CS: I think there is a difference in attitude in particular to the types of business actually involved in the industry. So in the US, I think there is a spirit of entrepreneurship and business creation that applauds the successful building of new businesses. Now in this country, it seems strange, because I think people are prepared to… are very happy to accept that if you’ve spent your life building a mobile telephone business, or in a pharmaceutical company to create a business that generates significant profits and is financially rewarding, that that is absolutely fine, but somehow if you do that in our country’s largest industry, which is the financial services industry, there is something somehow reprehensible about that, which I do find difficult. I think that in America they find this almost incomprehensible.
DB: I also think that there clearly is much more exposure in the US at individual pension fund level to private equity. So I think although private equity is now… it’s becoming more prevalent in the UK, so again I’ll say we’ve got 1m UK government employees, investors in our funds through their pension funds. We have 6m teachers, all of whom are in North America. And I think they are just much more aware of the benefits that private equity has brought to them directly; because it has. And therefore I think that makes the debate different.
LB: People are not used in this country to seeing the amounts of money I think which are now being earned. In America, it’s long been true that earning a million is nothing. Do you not think it’s something to do with that here that people feel – even if they don’t know all the numbers – uncomfortable with people earning really, really big sums of money?
CS: Well I’m a Brit and I hate success as much as the next man, but sometimes you have to put up with a bit of it if you want things like a very good economy.
DB: I have to say I’m quite optimistic about the country, and having lived in both places as you know, I actually think this country is pretty meritocratic. And I do believe that if you can get the message out which is clear that private equity… you are invested in it, it’s part of your pension fund, and if it performs, you will be better off. That’s important. And I think when people understand that I think they will understand that, just as our investors then accept, that there is a price of success, and it is good value. So I think that can be achieved. But I think you started Lionel by saying is the debate further on in the US, and I think it is.
LB: I think it is too. What do you hope to achieve with your contact with the GMB? Have you had a response?
DB: Not yet. We think that some of the questions are important. So again I’ll say, we have 30m pensioners invested with us. There are a lot of people that work for our companies. There are lots of unions where we have absolute amicable relationships with. Now look, the GMB’s clearly got some misgivings about what we do, but frankly what I think is the best way to approach this, is more than have a very personalised, aggressive campaign, which when the issues are as big as they are I don’t think is to the benefit of anybody. What I prefer to have is a constructive dialogue. Now whether that will happen or not, I don’t know.
LB: I presume you haven’t had a response yet to your letter?
DB: I’m not sure. Providing we find out I’ll let you know.
LB: It was a bit of a moment for you to have made that overture in public. So do you plan to have a meeting with him one on one?
DB: I’ve said that.
LB: Any time, any place?
DB: We would like to have a private meeting with Mr Kenny and Mr Maloney [Paul Kenny, GMB general secretary, and Paul Maloney, the union’s national organiser], myself and Charles, to talk about some of the issues that he seems to have with the AA.
LB: Do you think it’s more than just the AA?
CS: Well clearly, they have referenced the situation at Birds Eye too.
