The mysteries of private equity
By Michael Robinson
BBC Radio 4
Mr Moulton said the private equity business has been transformed in the last seven years
Private equity is the business of dealing in companies: buying them, shaking them up and later selling them on at a profit.
In recent years, private equity profits have boomed and money from institutions like pension funds has poured into the sector.
Jon Moulton, Britain's best known private equity operator, first hit the headlines in 2000 when his company Alchemy Partners tried to take over the then ailing car manufacturer Rover.
Since then, he says, the private equity business has been transformed.
"The institutions have provided the industry with funds of £10bn ($20bn) and if you've got a £10bn fund you do need to go 'elephant hunting'," he says.
"So the guys are out 'elephant hunting' and ever larger targets are being done."
Personal gain
The biggest "elephant hunter" of all in private equity is Kohlberg Kravis Roberts, better known as KKR.
This summer the giant American firm came hunting in Nottingham. Its target: Alliance Boots, the city's most famous business and Britain's biggest pharmacy.
Alliance Boots is the UK's biggest private equity buyout
KKR bought Boots for £12bn after a fierce bidding battle, and a tussle with Boots' pension trustees over a deficit in the fund.
Existing shareholders were delighted - they got a healthy windfall profit.
KKR is happy to point to the above-average returns they have already produced for its current pension fund investors, but is reluctant to talk about how much the firm's elite - the so-called "general partners" - could gain personally if the takeover proves a long-term success.
Given the political storm this year over the how much private equity chiefs earn and how much - or little - tax they pay, this raises two key questions:
What return do KKR's partners stand to make from the Alliance Boots takeover, and how does it compare with what their pension fund investors might get?
This depends on how much KKR's partners have invested in the takeover and what share of their investors' profits they are entitled to when Alliance Boots is eventually sold.
It's a very competitive environment and I need to persuade them to take my money rather than the money of another pension fund round the corner
Chris Hitchen, pension fund manager
KKR declines to answer either question, though using the best information available, the BBC has made its own rough estimate of the potential returns.
The estimate is based on a few assumptions: One, that KKR's partners have invested £80m - a number suggested at a hearing of the Treasury Select Committee.
Two, that they are entitled to a 20% share of the profits - a share common in private equity. And three, that KKR's investment in Alliance Boots would grow at 23% a year - less than the average returns KKR claims to have produced over many years.
Calm investors, concerned workers
The results are startling.
If Boots was sold after five years, KKR's investors would get back two-and-a-half as much as they had put in.
We've seen levels of gearing increase to a level where in some cases we find it irresponsible
Peter Taylor, Duke Street Capital
But, because of the effect of a 20% profit share, KKR's general partners' £80m would have multiplied 11 times.
After 10 years, the gap would be wider still, with the KKR's investors' initial stake having multiplied six and a half times, whilst KKR's general partners' £80m stake would have grown to £3.2bn - 40 times the investment we assumed they started out with.
Having seen the estimates and calculations, KKR declined to comment.
Pension fund managers have been criticised for allowing private equity operators to take such large shares of the profits from their deals.
But Chris Hitchin, who runs the massive Railways pension fund, says asking private equity managers to take less has not been an option.
"It's a very competitive environment", he says, "and I need to persuade them to take my money rather than the money of another pension fund round the corner."
So long as private equity firms make money for his pension fund's members, Mr Hitchin says he is "less concerned if some people are getting very rich."
But the general secretary of the trade unions' body TUC, Brendan Barber, is concerned about the potential level of personal rewards from a deal like Alliance Boots, which he says bear no relation to the money originally staked by the general partners.
It is, Mr Barber says, "part of this sense of ever-increasing inequality of a super-rich elite floating free from the rest of society, somehow divorced from the problems that all the rest of us face in the real world".
30-07-07, 11:19 PM
