Pacific Brands is a classic of the golden era of private equity.
Bought out of the foundering conglomerate Pacific Dunlop for $730 million in 2001, its new private equity owners ripped out $100 million in cash, geared it up with mountains of debt and sold it back to the stock market in early 2004. They banked $1 billion from the public float.
It was a slick operation all round. The privateers from CVC Asia Pacific and Catalyst Investment Managers, and their investment bankers from Macquarie Bank who teed-up the float, slapped together an impressive board of directors. Fat with other peoples' money to spend, the big superfunds bought it with their ears pinned back, even though it had been loaded with debt to the tune of 3.5 times its earnings (before interest, tax and so on).
The success of the deal was not down to paper shuffling alone. The privateers had turned the manufacturer around. They fixed the supply side. They breathed new life into the brands. Blue collar marques such as Chesty Bonds and King Gee turned bogan into chic.
The irony won't be lost on the 1,850 real blue collar types who are losing their jobs to China - in a company which deployed dinkum Aussie multimillionaire Pat Rafter and billionaire Sarah Murdoch to spruik its products.
Golden era
From lawyers to bankers, management consultants to celebrities, private equiteers to company directors, PacBrands executives to independent experts - rich and super-rich alike - fed high on the hog on this old Aussie manufacturer and its employee battlers.
The brutal reality is that it is ten times cheaper to make a singlet or a pair of undies in China than it is in Australia. ''Offshoring'' of jobs is inevitable and PacBrands merely a high-profile case.
The fee-fest, the brand profiles and the magnitude of the job losses has made Pacific Brands a media event.
For the private equiteers, it was a beautiful thing. Almost any business sold in 2004 to 2006 delivered outstanding returns. This was the golden era and PacBrands was the quintessential private equity play - a three-year turnaround and an internal rate of return (IRR) of 141%.
There were plenty of ''three-bangers'' or threefold returns during these years. Think Just Group privatisation and refloat, the float of another Pacific Dunlop business Repco, the float of JB Hi-Fi, the purchase of Bradken from Smorgon Steel followed by its IPO, the privatisation of Ausdoc followed by breakup of the business.
These deals shone thanks to the buoyant economy and multiple expansion, that is, buying an unloved retail business on 4-5x EBITDA, sprucing it up and bringing it back to the share market on a multiple of 8x. As the great bull market progressed, private equity fund IRRs of 65%-plus were won by most of the players.
Insiders say some 40-odd private equity executives are swaggering around Sydney - it is mostly a Sydney game - each on average $20 million richer for the cause.
Just Jeans represented an IRR of 157%. Like JB Hi Fi it was also a winner for shareholders.
Momentum
It is always an interesting exercise to contemplate the economic benefit, or social benefit for that matter, of all this dealing. Now that Eastern suburbs and Palm Beach property prices are coming off the boil, has the money simply gone? The PacBrands jobs have gone, gone to China. The proceeds of the paper shuffling may have gone too, in luxury holidays, renovations and assorted assets now worth less than they once were.
During the golden era, major international private equity firms began to descend on Australia.
KKR and Carlyle Group among others both set up shop. The other trend was a mushrooming of domestic private equity managers. The superannuation industry was a buyer, a big supporter and most super funds have exposure to private equity funds.
Most rushed to allocate more of their funds under management to the sector as the boom was in full swing, and soon to end.
There is a natural tendency also for private equity managers to increase the size of the fund with each consecutive raising - hence the funds raised in 2006 tended to be about double the size of the preceding raisings in, say, 2002. The latter though was the ''vintage'' to enjoy, rather than the former. Anything bought in 2006 is likely to be a failure thanks to the downturn.
It is strange that super funds themselves were, until recently, not permitted to gear their investments at a super fund level, but there were no restrictions on investing in private equity funds whose outstanding IRRs were reliant on extreme levels of gearing.
Past the peak
With so much money sloshing around the private equity space from 2006 onwards, and with asset prices inflated by the bull market, there was no way that 2006 and 2007 vintage funds could ever compete with the returns achieved by the 2002 vintage.
For example, vendors of retail businesses that would have changed hands at 4-5 times EBITDA in 2002 now wanted to be paid 8-9x EBITDA to sell. A quick look at the history of retail IPOs over the past 20 years shows that it is a rare business that can command a valuation of more than 7x EBITDA on IPO.
Private equity funds then which stumped up close to 9x EBITDA to purchase retail businesses in 2006 and 2007, and plenty of them did, were punting on being able to grow earnings fast enough to achieve an acceptable return despite there being little prospect for multiple expansion.
Moreover, they were gambling that multiples would hover at historically high levels for at least long enough for an exit to be achieved - say, three years.
Even then an IRR of more than 20 - 25% would be a hard-ask - a long way short of the stellar returns achieved by the previous generation of private equity assets. It seems reckless in retrospect, but then again the money was flowing into the funds, and the privateers get paid for that too.
Bad bets
We now know that neither of these requirements for investment success has held true. As a consequence, private equity in Australia is littered with assets that appear bent on losing money for their investors. Uncomfortable discussions between the lending banks and private equity managers over covenant breaches (ANZ and the Bank of Scotland were the two biggest lenders to private equity) are the order of the day.
There is also the prospect that most of the private equity managers in Australia are currently managing their last fund as the investors have been so badly burned that they will be loath to invest again.
The carnage in the sector has also left managers sitting on their hands, reluctant to draw down funds even if the funding has technically been committed by the fund investors as they know that investors have lost confidence in private equity. This is resulting in roll-up strategies being left in the lurch at just the time when there is value in the market again.
Which assets are in the worst shape? Anecdotally, it would seem the following rules apply: anything in retail is a dog, anything in NZ too, anything in mining services and anything exposed to the high-end consumer.
Retail - Australian Discount Retail has gone belly up for Catalyst and Champ. Gresham has Witchery and Mimco (no wonder Wesfarmers recently wrote down its stake in Gresham private equity), Ironbridge has BBQ Galore (the US arm of which is in administration) and Super A-mart. Archer Capital has Rebel Sport and Amart Allsports. Affinity has Colorado. TPG has Myer, Goldman has Kathmandu and PEP and CCMP bought Godfreys.
New Zealand - Catalyst has Metro Glasstech, Ironbridge has Envirowaste, Mediaworks and Base Backpackers.
Mining Services: There were a few exits here which suggest the PE investors got out just in time. Emeco for one. It was at least a 3x return for the privateers but its share price today is a fraction of its IPO price.
Getting it wrong
In other cases, private equity was left holding the baby.
In a game of pass the parcel between private equity firms, Catalyst bought Valley Longwall (a provider of specialist underground coal mining equipment) from Crescent Capital in 2007 - delivering Crescent 5.7x its original investment and an IRR of 300%. In the present market Catalyst is no hope of replicating that return, if anything.
High-end consumer - Riviera for Ironbridge is the standout here.
How did the private equity industry get it so wrong? Its practitioners are generally held to be as savvy as any in the finance world.
The industry incentive structures explain a lot. Most mid-cap funds pay 2% of committed capital to the management team as a management fee, together with 20% of any return achieved a benchmark annual return of 8% - a performance fee known in the industry as "carry".
For mid-cap funds of up to $500 million, the management team won't be making more than a good professional wage on the basis of the base fee alone. It is only if they earn "carry" that there are big dollars to be made. This structure encourages the manager (usually a team of about six people for a typical mid-cap fund) to "roll the dice", knowing that the payoff for success can be a carry cheque of tens of millions of dollars to divide among the team. The risk on the downside is that the manager does not get to manage another fund and members of the team find themselves looking a job. Assuming they were about during the golden era, they would hardly be queuing with a token at the local Centrelink.
Besides those privateers who didn't spend their winnings, the other beneficiaries of the boom were shareholders in listed companies which were taken over by private equity at a premium that was never justified.
Then there are the owners of private businesses that were purchased at prices that they could never otherwise have achieved - and of course, professional hangers-on such as investment bankers, lawyers and accountants. The frenzy threw up perhaps a billion in fees.
mwest@fairfax.com.au
