International News

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

New research from Celerant Consulting suggests that over half of UK business leaders find winning the hearts and minds of employees the most difficult aspect of delivering change within companies.

A survey of over 600 senior executives across Europe and the United States, carried out by the Economist Intelligence Unit, suggests that the majority of change programmes - structured approaches to implementing and managing change within a company - fail. 64% of UK leaders questioned said that half or fewer of the change programmes they have undertaken in the past five years have been successful.

The most significant challenges faced by UK companies in executing change programmes include winning the hearts and minds of staff (51%) and overcoming a lack of buy-in from local management (36%). UK bosses recognise that 'effective communications' (25%) and 'employee buy-in' (21%) are the most important factors in successful implementation, compared to global averages of 19% and 17% respectively.

Despite the high possibility of failure, the survey suggests that UK leaders spend more on change initiatives than their counterparts in any other country. The average expenditure by UK leaders in the last year (£5.43m) was 36% higher than the global average. This comes against a background of an estimated UK spend on consultants of £10bn in 2007, according to the Management Consultancies Association.

The survey also reveals that 57% of UK business leaders say their planned change programmes for the coming year are a direct response to the credit crunch. Accordingly, over a third (40%) of UK leaders plan to increase their spending on change initiatives over the next 12 months, while only 12% intend to spend less.

The quest for operational efficiency is driving change programmes. Almost two-thirds (64%) of UK business leaders say that improving their company's operational efficiency is the top issue on their agenda. In a further sign that the credit crunch is impacting on the corporate agenda, reducing costs (58%) is seen to be significantly more important than increasing revenues (43%).

Ian Clarkson, chief executive at Celerant, said: "A slowdown always put the question of 'how do we respond?' on the table - and frequently the answer becomes 'we need to change'. Yet, as leaders themselves admit that the majority of initiatives do not work, what should they do to ensure they successfully manage the process of change? "Our survey shows that companies fail in the execution of change initiatives because they are unable to win the hearts and minds of employees at all levels of their organisation. This happens when people do not trust their managers or understand what values the management team stands for. Too often a change programme is seen as an excuse to make people redundant. In order to successfully deliver change, leaders need to inspire people with a sense of urgency, have a clearly communicated vision and plan and continually motivate staff. As change management becomes part of day-to-day management, only those leaders who can successfully execute it will survive and flourish."

Ralph Hargrow, global chief people officer at Molson Coors Brewing Company, said: "Change for the most part is personal. You have to speak to people personally, to have them understand and embrace the promise of change. That requires a lot of work. Broadly speaking, the easier it is for individuals to understand and embrace the personal benefit of a change for themselves, the easier it is to win their hearts and minds. The more difficult it is to paint a vision, the more difficult it is to effect and embrace such change."

Consulting Times July 2008

Twenty-eight years ago, a brother and sister set up a bus service in Perth that ran two coaches to London. Those two coaches expanded into Stagecoach Group, at one time the biggest bus company in the world and a watchword for Thatcherite capitalism. The next step was international expansion, and that was where the wheels fell off.

Six years on from the company's nadir, where its shares hovered around 10p and rumours it was on the verge of going bust, it has fought back to surpass its peak at the turn of the century. One analyst yesterday called the group the "shining light" of the public transport sector after it announced a strong set of results.

Stagecoach's storming rise in the 1980s was described as "a classic rags-to-riches tale from the frontiers of capitalism" by Christian Wolmar in his book Stagecoach, published in 1998. It was masterminded by Brian Souter, a former bus conductor and accountant, who launched the company in 1980 with his sister Ann Gloag using their father's redundancy money.

Through a strong knowledge of the industry and following the wave of privatisation and subsequent fragmentation of the market after the Transport Act 1980 it build a significant presence in the market. By 1992 it had expanded into rail operations with the shortlived Stagecoach Rail. Its use of the system and aggressive tactics weren't always appreciated. Mr Wolmar said: "Through press coverage of Monopolies and Mergers Commission referrals and reports, Stagecoach became notorious, an emblem of the excesses of Thatcherism."

When the time came to list on the London Stock Exchange in April 1993, investors clamoured to get their hands on the stock, with the float coming in seven times oversubscribed. It listed at 23p per share, valuing the group at e134m, and over the next six years stormed to a peak of 284p in 1998. One sector expert said: "In the late 1990s all the public transport groups thought the UK had gone ex-growth. There had been huge consolidation, and everyone began looking abroad."

National Express, Arriva and Stagecoach all looked to North America. Stagecoach bought Coach USA, the country's biggest operator, in June 1999 for $1.2bn, creating the biggest bus operator in the world. Mike Kinski, who had taken over as Stagecoach's chief executive the previous year (Mr Souter had become chairman), said at the time of the deal: "We see this as a $40bn market potential."

The move proved disastrous, as over the next three years it had to issue four profit warnings, primarily relating to the US business, which sent its shares spiralling to 10p. This sparked speculation that it was in danger of breaching its banking covenants, which was hotly denied at the time by the financial director, Martin Griffiths, and subsequently proved inaccurate.

The transport analyst said: "Coach USA was not a good buy. It was a lower-quality business and had serious problems. They bought the wrong business, and added to that it was just coming into a recession in the US." The business was also smashed by the terrorist attacks of 2001. "In late 2000, the market thought were problems at the company, but no one realised how serious and deep-seated they were. They realised extensive surgery was needed."

Several months prior to the fourth profit warning, it launched a full-scale inquiry into its US operation and Mr Kinski's successor, Keith Cochrane, parted ways with the company. "There was the impression that he had tried everything and it justwasn't working," one source said. The company brought Mr Souter back, and the rebuilding process had the share price peaking at record levels late last year at 291.5p. One company insider said it had adopted a "back-to-basics" strategy to rebuild its business. Mr Griffiths, who remains the financial director, said yesterday: "The company made a poor acquisition in the US, it didn't meet our expectations. I was always confident we could come through it, but it was a painful process."

Under Mr Souter, Stagecoach sold down or restructured 70 per cent of the US operation, keeping only the most profitable businesses. But essentially it was refocusing on the UK. The group also sold down a business in New Zealand and its interests in Hong Kong. Then, two years ago, the Australian investment house Macquarie offered e263.6m for Stagecoach's London Bus division, which signalled the end of its interest in operating buses in the capital.

The analyst said: "They focused on core UK operations and set about working out how to stimulate growth and exit the unprofitable US businesses. The market perceptions are of a very good management team, and of course shareholders are happy because of the huge amounts returned to them."

Last year, rather than targeting another expensive foreign acquisition, Stagecoach returned e700m to shareholders (including Mr Souter and his sister, who still own about 25 per cent of the company between them). This followed a e250m return several years earlier, but the size surprised analysts and investors alike. "The share price has continued to rise as the market can see it is a cash-generative business and it is happy to return money to investors," the analyst said. Over the past five years the company has also halved its almost e1bn of debt on the balance sheet.

The group has been helped by the sector, which is not particularly cyclical; people will always need transport to travel to work, as well as the children using buses for school and pensioners who travel regularly to hospital. Mr Griffiths added: "The macro environment for public transport is good. People are more concerned about the environment and congestion on the roads is increasing. There is also a wave of inward migration from countries in Eastern Europe which are very comfortable with public transport."

Stagecoach's shares yesterday jumped over 7 per cent to 240.5p after it reported that its performance since the end of October had hit the top end of management forecasts.

Its UK rail business stood out, with like-for-like revenue growing 14 per cent in the nine months to 3 February. These numbers also did not include East Midlands Trains, the franchise it took over on 11 November. Elsewhere in its rail portfolio, its operation with Virgin rose 12.4 per cent. The group's UK bus operation rose 7.4 per cent, while passenger volumes on its buses grew 2.5 per cent.

The management believes that the outlook remains positive despite caution over the wider economy, particularly with the impact of rising fuel prices, although much of that is hedged.

Mr Griffiths said: "The numbers are good, and we are reassured by the continued rise in revenues. The strategy has been very clear in the past four years. We are focused, but also opportunistic, and looking at bolt-on acquisitions. As for another multibillion-dollar deal; we never say never, but at the moment we are comfortable."

LAST ORDERS: Australia's Industrial Relations Commission has upheld the sacking of a supermarket manager who drank two beers over lunch.

Employment lawyers are warning staff against too much celebration this Christmas after the Industrial Relations Commission upheld the sacking of a supermarket manager for having two beers at lunchtime.

The commission ruled Tony Selak had breached the conditions of his employment as the manager of a Safeway store in Melbourne by violating the "zero tolerance" policy on drinking in working hours enforced by Woolworths, which owns Safeway.

Mr Selak, 36, admitted having two glasses of beer over lunch in May, but argued that the policy should not apply to managers, who did not operate equipment or machinery. He said he was drinking only to help create a more relaxed environment in which he could convince a valuable employee, who was thinking of resigning, to stay with the company.  But Commissioner Gareth Grainger found Woolworths's decision to sack Mr Selak, who had worked for the company for 18 years, was "not harsh, unjust or unreasonable".

The law firm Fisher Cartwright Berriman said Mr Selak's case had national implications, especially given the looming Christmas season and its traditional festive lunches.  Alistair Salmon, a partner with the firm, said: "This decision makes it clear that an employee who breaches an alcohol policy and is sacked then, prima facie, does not have sufficient grounds for unfair dismissal.  "Employees need to look at their contractual obligations as they move into the party season, where alcohol consumption greatly increases, notwithstanding some of those obligations might be considered unreasonable."

The European Union's highest court struck down a German law that shielded Volkswagen from takeover, paving the way for Porsche to take majority control of Europe's biggest carmaker.  The ruling is a major boost for the European Commission in its crackdown on so-called golden shares, or strategic stakes that give governments special influence over listed companies.

"The Court confirmed that public authorities should not have special rights in private companies. Special rights have become an ever more endangered species on their way to extinction," Commission spokesman Oliver Drewes told a briefing in Brussels.

The law's demise could also end decades of cosy ties between management and labour at VW in a system called co-determination that gives workers a major say in how the company is run.

The court ruled as expected that the Volkswagen Law broke EU rules on the free flow of capital because it capped voting rights at 20 per cent and let VW's home state of Lower Saxony veto strategic decisions with just 20 per cent of the votes.

Porsche welcomed the ruling that lets the maker of 911 sports cars exercise all of its VW voting rights via its nearly 31 per cent stake in Volkswagen ordinary shares.  Porsche has said it has secured enough options to let it "significantly" raise its holding in VW but has declined to say whether this meant it could already gain majority control.  "There is no decision on how we will proceed. We will take the decision to the supervisory board and this will be a decision for the supervisory board," Porsche spokesman Frank Gaube said in Luxembourg.

The next meeting of the sports car maker's supervisory board is set for November 12, he said, adding he could not say whether the VW issue would be on the agenda.  One source familiar with the matter said it was unlikely Porsche would increase its stake before the end of this year. 

Analysts suspect it may await the outcome of Lower Saxony state elections on January 27 before making its next move.  This put an immediate dampener on shares of Volkswagen, which fell 3.3 per cent to 174.52 euros by 1224 GMT after briefly rising as much as 2.5 per cent following the court's decision.  Shares in Porsche were up 4.8 per cent.

VW said it would examine the ruling's impact on its statutes, while the powerful IG Metall engineering workers union called on the Berlin government to ensure labour representatives on VW's board could still block plant closures or transfers.  "The verdict puts the interests of capital markets above those of employees and Lower Saxony," IG Metall local chief Hartmut Meine said.

The 1960 VW law stipulated that Germany and Lower Saxony were each entitled to appoint two members to VW's supervisory board as long as they owned shares.  The German federal government is no longer a VW stockholder, but Lower Saxony is its second-biggest investor and said it intends to keep its VW stake of 20.1 per cent.

Porsche said it would be in favour of Lower Saxony's two board representatives remaining in their positions.  Both Berlin and Lower Saxony said they accepted the court's decision. The German justice ministry said it would immediately start the process of amending the legislation.  The EU executive is using the court to stop member states using strategic stakes in companies to thwart takeovers.

In June it gave Portugal a final warning to scrap special rights the country holds in two energy companies – Energias de Portugal and GALP Energia.  It also started legal action against Poland over a law giving the state special rights in 15 companies.  And it warned Romania over its share in the country's biggest oil and gas firm, Petrom, a unit of Austria's OMV.