Often seen as a contentious issue within the Australian domestic & political arena, a private equity buyout is “A situation in which the shares of a public company are bought in order to make it into a private company”.
Throughout Australia’s robust investment history, there have been a wide array of positive and negative news stories when it comes to ‘private equity buyouts. These include the saviour of some companies and the complete and utter failure of others.
There is a wide variety of rationale for private equity buyouts, for both investors and shareholders alike. Private Equity allows the company to be taken out, presumably by a more skilled operator and then essentially take their business underground. Meaning that they can restructure, reorganise and remarket themselves as a ‘new and improved’ business.
How are private equity buyouts funded and how can you invest in them?
Often seen as ‘corporate raiders’ Private Equity Buyouts are undertaken usually through funds, that as previously discussed are created for the purpose of purchasing, getting, restricting and spinning off – selling the whole or the best parts – of the company in the short to medium term.
Other Private Equity Buyouts are done through a fund, but with the long-term play at hand, looking to buy, build and grow the assets, with fund unit holders realising their returns from the successful implementation of this strategy.
So, like an investment in a managed fund, a private equity buyout fund will have a prospectus or information memorandum that is available for investors to review and apply to invest in should they meet the investment criteria.
With these sorts of investments, they can often be risky depending on the nature of the business and the financial and operational state it is currently operating under. As such, they are usually restricted to institutional and sophisticated investors – such as your industry superannuation fund or Gina Rinehart.
An example of these sorts of Private Equity Buyouts are those undertaken by Quadrant Private Equity in Australia, who have a range of funds and portfolios with an asset mix to diversify the risk and provide the best possible returns for shareholders.
Why are Private Equity Buyouts so important to Australian business?
In 2019, “Pacific Equity Partners’ data on the number of deals greater than $200 million suggests activity was relatively stable, with 17 deals done in 2019, up from a five-year average of 15 deals”. “While as a whole, in 2018 private equity registered $28 billion for 72 buyouts, rising 85.2 per cent from the year before with $15.1 billion covering 67 deals”.
As can be seen, the sheer volume and value of these transitions are huge for the business owners and investors of Australia. In addition, being part of a buyout fund is equally important.
In Australia, we have a long list of high-profile casualties, the most recent of which are well-known retailers such as Harris Scarfe and Dick Smith Electronics. However, often, Private Equity Buyouts have significant upsides, and it isn’t just brands or companies in trouble that are being acquired, with the 2019 buyout of Arnott’s Biscuits being purchased for $3.2billion AUD!
What do Private Equity Firms do with companies once they have acquired them?
There are several key reasons private equity firms purchase companies, or they acquire large stakes within companies.
Purchasing distressed assets to build back up is a key reason for a private equity firm’s existence. That is, where the original management has either mismanaged or doesn’t have the skills or capabilities to take the business through the transition it needs to take to become a great company with long term prospects.
As such often, there are ‘fire sales’ in which investors seek to exit the market in a hurry to minimise their losses (through the share market), or are offered a price for their shares – often pennies on the dollar of what they originally paid – to sell their shares to the private equity firm.
The goal is then, for the private equity firms to bring in management consulting companies, administrates and install their own management teams to bring the company up from the brink of collapse – or even long term losses – to being a successful entity in their own right.
Purchasing companies to pull them apart and spin-off
One of the more aggressive strategies is that of private equity firms valuing particular assets or departments within companies, which are able to be cut out of the business and sold off.
Similar to a car wrecking yard - in which the value of the individual parts of a car are sold off, far outweigh the value of the car sold as a whole – the companies are acquired, consultants are brought in to strategically manage the process, and the company is literally carved up and sold off for profit.
This can be most successful when companies have a range of core and secondary offerings, such as an airline that may have a frequent flyer program, the airline operations, the ground staff, catering and more divisions, that can essentially be picked apart and sold off as individual entities.
Strategic purchases companies to gain a competitive advantage
Many companies rely on their supply chain to operate an effective business model. Often, be it a physical asset such as a railroad, port or manufacturing facility; or a technical asset such as Intellectual property, technology or employee skills, a competitor or upstream/downstream company within the supply chain will often look to acquire companies through private equity deals.
For example, a drinks company may be looking to sure up its supply chain and purchase a bottle making company and a small logistics company, to ensure it always has supplies available.
An example of this is Hancock Prospecting purchasing Atlas mining company in 2018, which held a strategic port that Hancock required for its mining expansion and movement of iron ore. As such, shareholders were offered a ‘buyout offer’ at a premium to the current share offering. This then required a minimum acceptance rate by shareholders, and Hancock was able to gain the strategic asset.
Activism investing
One other rationale for private equity buyouts is that of Activism investment. There are a wide number of activism investment firms and funds that seek to purchase outright or portions of companies that they feel require a new set of values.
This is most apparent in the banking sector, mining companies and anything essentially that has an adverse effect on people, the environment or is considered at the ‘behest’ of the community. It should be noted that these funds and companies often ‘bet against’ these companies, such as buying derivatives against them, to push the price down, but there are many instances where the private equity route is perused, and the company is purchased as a whole.