In August, we described how the uncertain economic climate had hardened the approach to buy-outs by both buyers and lenders. Here, Peter Wilsher presents four casebooks of aspirant tycoons who cleared the hurdles.
Roger Davenport had spent most of his working life with the former Express Dairies group, with its £1 billion a year turnover in everything from Gold Top to yoghurt. When its then owner, Grand Metropolitan, decided it was going to get out of doorstep delivery and concentrate on building up global brands, he loyally helped to sell off the milk-distribution business and some of the more easily recognisable subsidiaries, such as Eden Vale. But when, at the end of 1991 he found himself left with the core cheese-making unit, Express Foods, he and a handful of senior colleagues decided that - despite the near £100-million price tag - it was time they had a go.
'We were totally naive,' he remembers. 'We got books out of the library and borrowed a video to tell us how to make the first moves.' But after a nail-biting year of false dawns, almost-terminal setbacks and 'fairly commonplace' 4am meetings, they successfully swung it, at £96 million. 'Even if it failed now, for some reason, we wouldn't have missed the experience. ' At first GrandMet was sympathetic but sceptical, not least about their ability to raise the money. Several trade buyers were interested in some, or all, of the Express specialities, particularly Stilton, and could have provided a more straightforward exit. But the Davenport team, recognising that such a solution must almost inevitably mean mass redundancies, gritted their teeth, put in a pro forma bid, and negotiated a period of grace with their parent so they could line up the necessary backers and partners - and discover exactly what they were getting.
That meant bringing in Coopers and Lybrand, the accountants, to do a 'due diligence' survey. The results were fairly eye-opening, even to people who thought they knew the Express set-up backwards. 'They were superb,' says Davenport admiringly. 'They even counted the bristles on the brooms.' At the end of the day they produced a complete appraisal of everything embraced by the deal, and even made it possible to shave a few million pounds off the asking price.
GrandMet was still proceeding very cautiously. It had, after all, its shareholders to consider, and a fiduciary duty to make sure that they were not missing out on a better offer. The turning point came when Davenport happened to run into Simon Oliver, now Express's non-executive chairman, when they were both walking round one of the international cheese fairs.
Oliver cut his business teeth as sales director with Unigate but left the company back in 1978 to strike out on his own. Since then he has built up his Mendip Foods operation into Britain's biggest independent cheese importer and trader. In 1992, when the two men started thinking about co-operation, he and his advisers had recognised a need to get closer to some large and relatively safe source of supply. Express Foods seemed to fill the bill.
Oliver's arrival finally tipped the scales. It switched the basic proposition from a slightly iffy buy-out to a very solid buy-in-buy-out (BIMBO), with the involvement of one of the best recognised figures in the brie-and-cheddar industry. It also brought in, immediately, some really heavyweight financial muscle. Oliver's principal banker was, and still is, Bank of Tokyo, who already knew something about Express. The Davenport team had already chosen the venture-capital house, Electra Kingsway, as their own main adviser, and the Japanese showed little hesitation about backing the buy-out, once the details had been satisfactorily arranged. Bank of Scotland and Union Bank of Switzerland came in to further beef up the package, and suddenly, 10 months ago, Davenport was, for the first time in a longish career, his own master.
It is a heady experience, he says, but one to be recommended. 'At least, when you write a business plan, it is not just paper for someone else's files, it is something you can go out and make happen.' To anyone contemplating buy-out risks and rewards, he says: 'Go for it.'
The price tag on Gardner Merchant, Britain's biggest contract caterer, was £402 million when Trusthouse Forte finally agreed last December to let the management grab the ball and run with it. That made it by far the most substantial deal of its kind since the heady days of the late 1980s, and a sign that the badly bitten banking and venture capital fraternity was at last regaining its confidence. But it was also one of the most complex, in both its inception and its execution. The MBO that finally happened was the fourth to be put together in the space of 12 months. In between there were alternative plans for a stock-market flotation, and a couple of major trade sales, in which the existing executives might, or in one case, would definitely not, have played a part. After all that, as chief executive Garry Hawkes cheerfully acknowledges, actually running the business on a day-to-day basis could be counted as a tranquil activity. That assessment is close to the literal truth. Gardner Merchant, though long an integral part of the Trusthouse operation, has, throughout its 110-year history, always been run as a largely autonomous unit. Indeed, the five-year rolling expansion plan, on which the £400 million was raised and the company is now being run, dates from the days when no buy-out was even contemplated. All that needed determining was who would ultimately enjoy the benefit, and Hawkes and his fellow incumbents are appropriately grateful that, after all the upheavals, it was they who carried off the prize.
The rewards will be reasonably widely spread. Some 1,000 executives (out of a staff total of around 46,000) have taken direct stakes of between £1,000 and £40,000, according to salary and length of service, and the inner core of 15 senior people (including Hawkes himself) substantially more. Initially their participation bought them an 8% share in the firm, which turns over around £350 million a year (providing canteen and similar services to some 70 of the companies which make up the FT-SE 100 index), and operating profits which, in 1991, topped £32 million. But if pre-set targets are met, that share will double to 16%, and if the company outperforms expectations - which Hawkes is confidently predicting - this share could rise to 20%.
When it all began, in September 1991, Hawkes, as a Forte main board director, was one of those who agreed it was time to hive off the catering side of the business and concentrate all the parent's resources on hotels and restaurants. But although he was always happy to continue running the business, he had plenty of doubts about the divestment terms initially proposed. Among other things, he wanted no part of the airline catering division his colleagues sought to include in the package, and, in any case, he thought the price they were proposing was too high. So many months passed as people lurched from solution to solution.
At his request, Citicorp Venture Capital looked at the deal but decided to walk away. Then SG Warburg introduced Forte to the Wall Street hotshots, Kohlberg Kravis Roberts (KKR), who were seeking a London launch pad. Their proposals got within two days of acceptance, when Compass, Gardner Merchant's most significant trade rival, stepped in with a £590-million offer for everything, including the airport trade. That put KKR out of the picture, but interest waned when the Monopolies and Mergers Commission expressed doubts, and fresh arguments started over the price. Granada was rumoured to be showing interest, likewise P and O through its Sutcliffe Catering subsidiary, and there was one more serious approach, from Gardner Merchant's French equivalent, Sodexho. Only when these had fallen by the wayside, were Hawkes and his main adviser, CINVen (the venture capital arm of the coal industry pension fund), able to come back into the fray for the final, decisive round.
In the end Hawkes got very much the terms he had always wanted, including the exclusion of the airline side, which he regarded as a different business. Now he reckons he and his fellow-enterprisers have won their independence just at the right time. 'Recession brings opportunities,' he says, 'especially for people like us who specialise in taking over responsibility for other people's problems.' His mouth waters particularly at the thought of all those public sector institutions - ministries, hospitals, colleges, civil service agencies - who previously insisted on making their own catering arrangements but are nowbeing forced to embrace the notion of private tenders.What is his strongest argument for going it alone? 'Ownership is motivation,' he growls, and plans to give another 4,000 managers a slice of the action.
Gardner Merchant is an outstanding example of the pure buy-out, where the incumbent management seizes the reins, secures the backing, shoulders the debt, and, with luck, picks up a handsome slice of the ultimate rewards. This is becoming rarer, as the City, with thousands of such deals under its belt, increasingly sees the advantages of a more hybrid arrangement.The financial community likes to see people who have already shown some sort of independent track record brought in to reinforce and underpin the efforts of those whose enthusiasm and access to opportunity has not yet been subjected to the rigorous testing of the unsheltered market place. This is the buy-in-buy-out, and it is almost the norm nowadays as once-bitten backers seek an element of added insurance. Morgan Grenfell, with its impressive track record in mergers and acquisitions, believes in this approach. 'We're pretty cynical about the motivation thesis - the idea that managers will perform better once they have a personal stake,' says Matthew Collins, one of their MBO specialists. 'We like BIMBOs because they bring in new blood, and get round the black hole problem, where the incumbent managers are the only people who really know where the weak points are.' This year's £72-million buy-out of Streamline (UK) from Shell makes a number of good, illustrative points. Streamline is in many ways a classic case of what goes on inside a multinational conglomerate whose main concerns are focused elsewhere. It started life because Shell, through its bitumen interests, had a peripheral involvement with the building and maintenance of roads. Over the years, without anybody particularly noticing, it built itself up to become market leader in such arcane but profitable areas as road marking and the erection and maintenance of motorway signs. Its second string, also bitumen-related, is in roofing felt and draft-proofing, where it also has a dominant role. But for easily understandable reasons, its strengths were leading it progressively away from the mainstream priorities of a major oil producer.
The problem was that its existing executives, though excellent at their own jobs, had little autonomous business background. Their skills had flourished inside an organisation which essentially took care of everything from meeting the payroll to tending the office flowerbeds. So when it was decided that Shell would be better off leaving them to make their own way, the immediate question was: could they cope?
Enter, at this point, Terry Simpson, a footloose chief executive, and Ernest Burton, an itinerant finance director. Until 1988, Simpson had been running the wide-ranging and generally successful Norcros group, while Burton, similarly, had quit one of the top jobs at Rockware Glass when BTR moved in. Since then they had each undertaken a variety of challenging consultancy and trouble-shooting commissions - which is how Morgan Grenfell had come to know them - but had made it known that, if the right challenge came along, they would be very keen to get back in the corporate driving seat.
Streamline, with its strong position in a number of remunerative but relatively uncontested markets, offered exactly the right sort of challenge. After a short, sharp tussle with Candover, who had its own favoured buy-in team ready to roll, Morgan Grenfell won the business, put Simpson and Burton together with the existing top echelon, headed by David Leach, Arnold Delaney, Divendra Pratap and Gordon Pirrett, and proceeded to line up the necessary cash and loan support. Bank of Scotland, always one of the most active MBO supporters, took up a substantial slice - partly because it hoped to get most of the newly independent firm's clearing bank business. Meanwhile Morgan and Charterhouse worked closely together on unravelling the legal and jurisdictional complications, which at one point - because road maintenance often spans several frontiers - meant working with seven separate sets of national laws.
Cynicism apart, Collins would welcome more such challenges. 'Buy-out companies are usually interesting and exciting companies. They can't afford to rest on their laurels, and they are always receptive to new ideas.
Just what we corporate finance people cherish.' Challenges are fine but the success or failure of any buy-out is inevitably judged from the smiles (or grimaces) when the various participants come to cash in their chips.
Recently it has been necessary to exercise considerable patience here. Recessionary markets and stagnant stock exchanges are not good places to realise returns. But in the last few months conditions have significantly improved. Flotations (including those of several former buy-out vehicles) have both got off the ground and then gone on to significant premiums, while there has been a noticeable revival of acquisition-hunger.
The most spectacular beneficiary has probably been the Parker Pen company, which has claims to be the archetypal MBO. The famous Wisconsin-based manufacturer of high-class writing instruments had fallen on hard times following a reverse takeover by the then much smaller Manpower group. No one was interested in providing the capital or innovation needed to sustain its market lead, and an ill-judged move into cheap ball-points nearly brought it to its knees. But its European managers, led by a Frenchman, Jacques Margry, thought this was a tragedy which could be reversed. In 1986, when they bought it for £71 million with the help of London's Schroder Ventures, it was losing money at the rate of £2 million a month. Since then it has never looked back. The Margry team did everything the textbooks said they should - cut costs, simplified communication lines, abandoned unprofitable activities, turned their back on anything to do with mass-selling disposables, concentrated investment on both old and new winners, beefed up marketing and promotional support and pushed the operation into the black in a year.
The first pay-off came quite quickly. The inner management group, who had paid just £300,000 for their 25% equity share, were able three years later to draw out around £10 million, without causing any noticeable deceleration. Schroders, whose managing partner, Jon Moulton, had become Parker's deputy chairman, was able to withdraw rather more than the whole of its original £10.3 million investment and still leave itself with shares that it was able to realise for £75 million this spring.
Desultory efforts to unload the remainder of the company ran into trouble. A 1987 flotation plan was scuppered by Black October. Lazards and Cazenoves tried again the following year, but failed. Pentland took a look. So, too, it is rumoured, did both Dunhill and Guinness. Then finally in May this year, Gillette, which owns both Papermate and Waterman, put its name to a cheque for £285 million. Schroders' Pam Scholes, who has been involved with Parker almost since the day she first went to work in the City, reckons that leaves Margry and several of his colleagues richer by around £15 million apiece, and her organisation looking at a 75% per annum return.
Of course, as good buy-out practitioners will tell you, it's the satisfaction that really counts. But there is no doubt, it is quite pleasant to pocket that kind of recompense for rather less than a decade and a half of effort.