Tether a lame goat in the desert at night and it will be gone in the morning. It is a Darwinian treatment but it saves vets bills, leaves little mess and improves the survival chances for the rest of the herd.
Brammer, Europe’s largest supplier of bearings, is one of the UK stock market’s lame goats. In October Meinie Oldersma, chief executive of the industrial repair kit business since August, tied it to a stake. By Wednesday last week the vultures had landed. Brammer agreed to a cash offer from Advent International of 165p a share, or about £216m. The company said it would be too difficult to turn the business around as a public company. Shares in the Manchester-based business had fallen from more than £4 in 2014 to less than £1 by June, following an ill-judged expansion across Europe that doubled net debt to just over £100m.
Last month, Mr Oldersma warned investors he would have to raise £100m from them or the company would breach banking covenants. By last week Brammer’s working capital outflow, exacerbated by sterling’s weakness, had lifted debt to £193m.
The board’s list of the previous management’s mistakes reads like a manual on what not to do. Brammer had lost sight of key small and midsized business customers. Instead, it had chased sales growth with the big multinational clients without regard for pricing power, cash flow and profitability. The result was inefficiencies in distribution and disastrous levels of overstocking, made worse as customers tightened the purse strings. The company said last week it needed costly “structural and behavioural changes” that would create years of uncertainty.
There are plenty of smallish listed manufacturers and industrial companies that show similar signs of affliction. Last week, Small Talk highlighted Devro, the maker of sausage casings, which has ratcheted up debt to build new factories across the world even as its pre-tax profits have halved and shares have plummeted. Essentra, the filter-to-plastic-packaging company, issued another profit warning last week. Its boss Colin Day departed this summer having overseen Essentra’s heady expansion. Net debt has tripled even as returns on capital have halved. Laird, the shipbuilder turned electronics business, warned last month profits would be a third less than forecast and the shares halved. Meanwhile, David Lockwood, its former chief executive, is joining Cobham, the endebted FTSE 250 aerospace company that has had three profit warnings in a year.
However, Brammer is a rarity. Once the dust stirred up by private equity firms circling such juicy prey would have created a storm. Not now. The environment allowing private equity groups taking weakly managed businesses apart in private is more hostile. Preqin data shows that the number of public-to-private deals in the UK fell from 10 in 2010 to six in 2015. There have been none so far this year.
“The mechanics of doing deals are worse and more expensive,” says Jon Moulton, the venture capitalist who founded Aim-quoted Better Capital.
Restructuring is high risk. Fixing-and-flipping a business, despite low interest rates, is far from cheap, he says. Changes to tax relief on debt interest make deals less attractive. Proposed cuts to tax breaks on corporate borrowing in Spreadsheet Phil’s Autumn Statement will make it harder for the numbers stack up. The rules on takeovers and disclosure have also become more onerous, says Guy Weldon, chief investment officer at buyout group Bridgepoint. Boards are also less willing to sell out, demanding higher premiums.
The private equity industry has itself to blame for the hostility. Institutional investors still mutter about the vulture funds that took businesses private, loaded them with debt and returned them to the stock market at inflated prices. Directors swap stories round the camp fire about Woolworths, where private equity bidders flew in and then pulled out at the last minute. Last year, Better Capital was called up by MPs after City Link, the parcel delivery business it bought from Rentokil for £1 in 2014, went into administration on Christmas Eve.
Nonetheless, private equity firms perform a useful function in clearing out the stock market’s lame goats. Their methods may seem rough. But public market investors would be poorer without them.