" /> The IUF's Private Equity Buyout Watch: October 2008 Archives

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October 28, 2008

Carrefour's blues: global retailers squeezed by private equity fund activism

While retail concentration gives global supermarkets the power to set prices and squeeze food manufacturers and farmers, the retailers themselves are being squeezed from another direction - private equity funds.

The pattern is similar to private equity buyouts and strategic investments in the hospitality sector, where real estate assets are the prime target. The real estate is used as collateral to finance the leveraged buyout (through mortgaging and re-mortgaging property) then after the takeover it’s separated from the hotel or retail business. The real estate side of the business then charges rent to the hotel or retail business, generating a steady cash flow that - a we’ve seeen so many times with private equity funds - means cash outflow. In the case of the UK retail chain Debenhams, this left the company massively indebted.

As we have also seen (particularly in the case of Japan) even in the absence of a leveraged buyout, private equity funds can exert a powerful influence on companies, imposing short-term financial targets and excessive rates of return. By taking a minority stake in a company and behaving as activist investors (“Re-investment is theft! Not enough debt!”) private equity funds compel companies to divert resources away from investment and into shareholder dividends, often at rates that are unsustainable in the long-term. (In the long-term the private equity funds will be long gone anyway.)

Now the world’s second largest retailer Carrefour is being squeezed by a similar kind of private equity fund activism.

Last year a private equity fund called Blue Capital became Carrefour’s biggest shareholder. Formed by French billionaire Bernard Arnault’s Groupe Arnault and the US-based Colony Capital, Blue Capital currently holds a 13.5 percent stake in Carrefour. The fund now has two seats on the board of the company (and is pushing for a third) and 12.6 percent of the voting rights. [See "Blue Capital ups Carrefour stake further", just-food.com, 21 July 2008.]

The impact is already clear. Carrefour’s investment and growth strategy has been dramatically revised, with the promise of 4.5 billion Euros in returns to investors generated primarily through asset sales.

By selling off real estate assets to satisfy the short-term appetite of Blue Capital, Carrefour supermarkets and hypermarkets throughout Europe and around the world would in the long-run pay higher rents, raising operating costs. [See "Shopping around - is Carrefour an example of activist investing gone wrong?", The Economist, 18 October 2008.]

The Economist quotes a spokesperson for Blue Capital denying that the private equity fund has an direct involvement in Carrefour’s business: “We never intervene in pricing at Carrefour as we consider that it is not the role of the board.”

But the reality is that the short-termism and high returns that underpin the logic of private equity funds has a direct and lasting impact on how Carrefour does business. The impact will also be felt beyond Carrefour. To absorb the costs of higher rent the retailer is unlikely to raise shelf prices. Instead it will be food manufacturers and suppliers - and in turn food workers and farmers - who will be squeezed even more.

October 01, 2008

European Parliament Adopts Eurosocialist Call for Regulation of Private Equity, Hedge Funds

The European Parliament adopted, by a vote of 562 to 86 on September 23, the report prepared by the Party of European Socialists (PES) on legislative regulation of private equity and hedge funds. Though heavily amended in the final form which was approved by the European Parliament, the report's proposals for legislation address a number of key labour movement concerns. These include: limitations on debt levels in leveraged buyouts; measures to contain asset stripping of portfolio companies by private equity owners; greater transparency and disclosure rules for private equity with far greater scope than the voluntary "Codes of Conduct" which have been promoted as alternatives to regulation; greater capital adequacy requirements for financial instruments and institutions (including private equity and hedge funds), limitations on the easy securitization of leveraged loans ("originate and distribute") which have fuelled both the buyout boom and the financial crisis generally; and ensuring that employees in private equity-owned companies exercise the same rights to information as other EU private-sector employees.

"It is the first time that the European Parliament has ever demanded regulation of private equity and hedge funds," stated PES President Poul Nyrup Rasmussen. "Commissioner Charlie McCreevy has got to respond, and respond positively. With millions of families worried about their savings and pensions it would be very unwise to remind us that until very recently he believed that self-regulation was best. The financial crisis has forced the conservatives in the European Parliament to accept sensible reform, now it is the turn of the European Commission to prove that they no longer believe that the market alone knows best.”

The report is available on the website of the European Parliament here.

Sharp Rise in LBO-Related Defaults

The global meltdown in mortgage-"backed" debt threatens to obscure a rapid rise in LBO-related defaults.

According to a recent report form Standard & Poors, "In the first eight months of 2008, 55 entities have defaulted globally, compared with just 22 in all of 2007 and 30 in 2006. The global speculative-grade default rate has increased to 1.9%, more than double the year-end 2007 level of 0.86%. In the US, which accounts for 53 of the 55 defaults, the default rate increased for eight consecutive months to 2.5% in August…We expect the default rate to continue this ascent and reach 4.9% in the next 12 months. (our emphasis)

Of the defaults recorded, the report continues, nearly 70% record some form, somewhere, some time, of LBO exposure. "Ownership of the 55 defaults…reveal that generally, large shareholders of these defaulted entities are asset management firms, alternative investment funds, endowment and pension systems, and individual stakeholders." Tracking the interconnections along the debt trail reveals the complex interweaving of various investors as well as the extent to which the buyout debt has spread throughout the investor universe: "For example, endowment and pension funds are invested in alternative investment funds, which also have exposure in other asset-management funds, which also have exposure in other asset-management firms, which then manage the finances of high-net-worth individual investors who also have stakes in alternative investment funds…"

Among the corporate defaults can be found some of the restaurant and gaming companies taken private and previously noted on this website (see for example Casino Business Wobbles at High Stakes Debt Table and All-you-can-eat Dividend Recaps Sink Major US Restaurant Chain .