Not-so-private equity

Private equity firms are warning that economic growth will be jeopardized if governments do not press state-dependent banks to write off debts owed them by the leveraged buyout industry - so that the industry can start borrowing again. How can private equity be in need of government support?
Peter Johnson
3 December 2009

According to Financial Times, Guy Hands, the head of Terra Firma, a private equity house with offices in London, Frankfurt, and Guernsey, has warned of dire consequences for economic growth if governments did not press the banks they now control to write off large chunks of debt owed them by highly leveraged businesses controlled by private equity funds. Terra Firma has invested around €11 billion in transactions worth some €42 billion, and Mr Hands estimates that all told, leveraged (i.e. very exposed) bank loans of some £4 trillion are outstanding and up for repayment in the next five years.

The causus belli here is Terra Firma’s investment in the music business EMI. Completed in March 2007, it’s one of their largest investments, and as part of the deal, EMI group owes around £2.6 billion to Citigroup, now 34% owned by the US government. EMI has not yet published its 2009 report because of on-going uncertainty, but from the 2008 figures, we might assume the group is not profitable: its 2008 loss of £750 million included finance charges of £500 million. Earnings before interest have increased in 2009, but not by that much. Terra Firma wishes to invest another £1 billion in EMI, presumably because EMI needs the money. But no one will finance this investment until EMI’s borrowings are reduced, in other words, until Citigroup agrees to write down its debt. They have so far not been flexible, unlike, according to Mr Hands, others banks that have not taken public money. He would like the US government to press Citigroup to play the game.

So what is going on here? To be fair to Terra Firma, this is not about getting more of EMI for nothing – they own all of it already. And because the debt raised for leveraged buyouts becomes that of the target group rather than of the investors who initiate the transaction, this is not about stopping Terra Firma from going under. It is about stopping EMI from going under (which would of course be a big loss for its investors). Matters are complicated in this particular case by the fact that Citigroup is a US bank and EMI and Terra Firma are based in the UK. It’s hard to mount a public interest argument with the US government.

We’ll have to see what happens to EMI, but there’s a broader issue. It is being claimed that private equity transactions are a key component of economic growth, and that the state, having rescued the banks, should pump in a bit more money (because that’s what it’ll come to) in order to re-fuel the engine of high-debt, low-asset investment. In fact, there is evidence that governments’ low-interest, easy-money policies have already done this: the high risk debt markets are back.

I say nothing of the morals of the individuals and firms concerned, but private equity funds have long been part of the erotica of naked capitalism. We salivate over their performance. Somewhat like investment banks, they seem to have the gift of conjuring money from nothing. And they inhabit the same world of financial intermediation: if A gives money to B, then C will give money to D to invest in E and so on. The claim that this system is needed to identify and correctly price investment opportunities has become rather threadbare. The only interest the state can have in propping the system up is to keep E in business, supposing it – the state – decides that E is worth keeping in business. And that could be done directly, were governments not desperate to keep to the line that private shareholding markets best make all the important decisions.

It also seems odd to criticise state-owned banks for not being push-overs, particularly when many government departments buying them were push-overs. But if there is now some alignment of interests between taxpayers and the banks’ rump shareholders, who can really complain? So long as there’s gravy on the train, though... it’s almost funny.

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