UK: BUY-OUT MARKET, BRISK BUT GRITTY. - In the 1980s MBOs were seen as a licence to print money. Today they have become a life raft for managers intent on survival.

by Peter Wilsher.
Last Updated: 31 Aug 2010

In the 1980s MBOs were seen as a licence to print money. Today they have become a life raft for managers intent on survival.

Management buy-outs, says Ron Hobbs of Phildrew Ventures, which has been involved in £388-million worth of them, are 'a particularly pure form of capitalism'. Even throughout an extended recession they have retained many of their attractions. Graham Murray, who researches management buy-outs at Warwick University Business School, lists their advantages as 'a good alternative to receivership, redundancy or being sold off to a competitor; an opportunity to get back to business basics and release your animal spirits; and still, occasionally, a once-in-a-lifetime chance to make a lot of money'. They are far less risky than a stone-cold start up, as at least you begin with a business-in-being.

They are not easy. It takes time and effort to raise the finance, convince the backers, fix the price and ensure no hidden pitfalls exist. All this will be compounded if liquidators are breathing down your neck. For Allen Amey, the 46-year-old managing director who led the rescue of Leyland DAF Vans this spring, the exercise combined all the ingredients of a baptism of fire and legal brimstone.

Following the bankruptcy of his company's Dutch-Belgian parent, Amey and his small but tenacious executive team fought a 12-week, non-stop battle against British government indifference, the vehement scepticism of his local paper, the Birmingham Post, suppliers who had to be forced by the courts to maintain some sort of component flow, hungry rivals who promptly tried to poach key elements of his distribution chain and Lloyds Development Capital's last minute decision to withdraw £1.5 million of promised equity finance. Against all the odds they finally won through. The workforce accepted longer hours and an up-to 8% pay cut; the Department of Trade and Industry and Birmingham Heartlands Development Corporation managed to find ideologically acceptable ways of providing an £8-million cash injection; the 3i group, after much cogitation, agreed to replace Lloyds Development Capital; most of the UK DAF dealers agreed, in the end, to remain loyal. By 26 April it was possible to break out the champagne (one bottle each for the 1,000-plus people whose jobs had, at least for the time being, been saved). 'Now,' says Amey, with an understandably triumphant ring in his voice, 'we are ready to build the foundations for a viable, stand-alone operation - and brace ourselves for the day our competitors start a price war.'

The gritty desperation of the Leyland DAF story is a long way from the glamorous deals of the 1980s. It was these high-profile affairs which first brought the notion of management buy-outs into the headlines. These days the chances of gaining mouth-watering profits similar to those which tempted the City (and Wall Street) into gambling sums such as the £718 million spent on the splitting up of MFI and Asda, or the incredible £2.4 billion on the hijacking of Gateway supermarkets from its previous directors, are few and far between. Among recent examples of MBOs, only the £402-million amputation of Gardner Merchant, the catering arm of Forte, has been even remotely on that scale, and that was much more to do with corporate house-tidying than financial buccaneering.

All this reflects today's economic climate. After three years of unrelieved recession, the typical MBO is now much more likely to involve either an on-going concern which is energetically (or prudently) shedding non-core activities, or the acquisition of still-useful assets from the hands of some victim's administrators or receivers. According to Nottingham University's authoritative Centre for Management Buy-out Research, almost one in five of last year's transactions fell into the latter category, with the Maxwell empire and a string of smaller public company failures providing a particularly rich source. There is certainly no shortage of buy-out opportunities, or enthusiasm to take advantage of them.

The 3i group is a leading light of the MBO industry. It more or less invented the buy-in (MBI), where an ambitious manager arranges to take over someone else's assets; and the buy-in-buy-out (BIMBO), where he pools his resources with those of the existing staff. The 3i group has figured in more than 50 of the 382 big, £10-million-plus transactions completed in the past decade - as many as its nearest rivals, Candover and Charterhouse, combined. It estimates that in the last two years at least 900 management teams have seized the chance to take over ownership of the firms who previously employed them.

These, it might reasonably be argued, are the 'real' MBOs - the ones where a smallish group of colleagues, using their own resources and the backing of a single investor, acquire a voting majority of the shares and full responsibility for the crucial business decisions.

It is the other kind, the misguidedly ingenious miracles of financial engineering, attempted purely for profit, which have withered on the vine. Examples of these are the Lowndes-Queensway, Magnet Joinery and Isoceles-Gateway disasters.

Inevitably, some of the 'real' ones also fail. Around 309 MBOs and MBIs have been forced to call in the receivers since 1990. However, that figure needs to be kept firmly in context: since 1982 there have been 3,755 buy-outs and 833 buy-ins, and the great majority of the rest are successfully soldiering on.

Due to the recession and the failure of many MBOs, the pool of money available for commitment to the buy-out and buy-in sector has shrunk by well over half since its 1989 peak (from £7.5 billion down to £3.3 billion in 1992). But the number of actual deals moved sharply higher in 1990 and has since stayed at a consistent near-600 each year.(See charts above.).

The figure may well rise even further now, as demands for executive independence receive a fresh boost from Whitehall. The Government's commitment to privatisation remains rock solid, and is due to embrace an increasing proportion of traditional civil-service activities, as the idea of 'semi-autonomous agencies' takes root. There are around 80 of these Next Step operations now in business - covering anything from the dispensing of social-security benefits to the care of public buildings. Several of these have already been nominated to test the level of market interest, either for a conventional trade sale, or an internally-driven buy-out initiative. Recently, three of the better-known venture capital groups, Electra Kingsway, Schroder Venture Advisers and ECI Ventures have joined forces with Capita Corporate Finance, a public sector specialist, to back any ambitious and self-starting bureaucrats who care to try their luck. Under Capita's managing director, Clive Ward, the object is to provide them with expert advice and, perhaps more importantly, access to a £100 million investment fund assembled for this specific purpose.

Capita itself shows, vividly, the size of oak that can be grown from even that tiniest buy-out acorn. When it was spun off, in the mid-1980s, from its unlikely parent, the Chartered Institute of Public Finance and Accountancy, the exit price paid by the original partners (led by the present chairman, Rod Aldridge) was just £300,000. Since then it has helped mastermind a stream of local government and state-industry buy-outs. These include London Coaches Ltd, the £71-million employee takeover of West Midlands Travel, and the emergence of Westminster's street-cleaning and garbage-collecting arm, MRS Environmental Services. Moreover, Capita has seen its own capitalisation grow to a healthy £80 million. Ward is confident there will now be plenty of fresh propositions coming forward. Government departments and their endless offshoots frequently offer the essential ingredients for a successful buy-out: 'Strong management teams, secure, thriving businesses and good opportunities for growth in the wider marketplace.'

Potential rivals, such as 3i and Candover, are torn between envy and caution as these developments unfold. They see the possibilities and fully understand why some bureaucrats might want to take the plunge. But they always come back to one crucial question: how easily - and how quickly - will Capita and its capital-providing partners be able to get their money out?

This has always been a determining factor in MBO financing. Most of the 100 or so funding groups built up during the 1980s raised cash from their institutional and private investors on a double promise: that they would see very substantial gains and that they would be realised within a maximum of three or four years. Those hopes took a severe battering with the onset of the gloomy 1990s - one result being that loan/equity structures have become much more conservative and conditions more stringent. Thus, there is reluctance to get locked into any relationship that may become long-term or permanent.

Nevertheless, the outlook for successful and profitable exits is showing signs of improvement. The turning point seemed to come in July 1992 when MFI, which ran into near-disaster almost before the ink dried on its £718-million acquisition documents five years' ago, was successfully refloated - at a stock-market price which not only covered those costs but is now even showing an £80-million surplus.

Since then there has been a steady stream of successes. Kenwood Appliances, bought out of Thorn EMI for £68 million in 1989, has more than just survived the retail downturn and its shares are now re-listed at a level which values the business at £115 million. Anglian Group, the old Anglian Windows firm which repurchased its freedom for £84 million in 1990, has done even better, showing Candover, its main backer, a four-fold return on its stake. It is not only the giants who have been doing well. Motorworld, which sells automobile spares and accessories has been welcomed back to the share market at virtually three times the £13 million its managers bought it for five years ago. Such achievements send out a fresh glow of encouragement, to both backers and would-be entrepreneurs.

For those merely seeking the opportunity to be their own bosses, rather than aiming to make a good profit as well, the conditions could hardly be more favourable. Interest rates are low, inflation is under control, recovery is under way, big companies are still eager to slim down and divest, prices are as reasonable as they are ever likely to be, and the City is once more eager to invest. Those, on the other hand, who are driven by necessity into MBOs, like the DAF Vans people, now at least have some hope of f inding the necessary resources.

Few of the many hastily-assembled conglomerates of the '80s really understood the potential value of the assets their more astute executives were looking for the chance to take over. A KPMG/Price Waterhouse study revealed that 93 large, private-sector spin-offs produced an average return of 54% to their backers, rising to 116% in the case of publicly-owned examples such as National Freight, Allied Steel and Wire and the shipbuilders, VSEL. The staff, who put up little cash and lots of 'sweat equity', reaped even more spectacular rewards. No wonder a Harvard Business Review survey reported that two-thirds of its UK respondents were 'highly satisfied' with their buy-out experience and 40% ready to claim that the results of going-it-alone had 'exceeded their highest expectations'.

It is certainly not as easy as that any more. Sellers may be cash-strapped but they are now much more keenly aware of value, and it is a rare inside team nowadays which gets its hands on one of those 'promising but underpriced subsidiaries' without facing keen competition from several outside trade buyers. Even if they then achieve a text-book style success with their acquisition - sharpening up efficiency, cutting costs and smoothly paying down the initial loans out of profits and asset sales - there is still the problem of how to cash in the chips. With only a handful of exceptions, the majority of late-1980s buy-outs are still being run, willingly or otherwise, by the original takeover group. Today's managers recognise that the MBO is no longer an automatic passport to affluent early retirement. For most it is likely to be a job for the long haul.

It is, however, a job. In a harsh world, where whole layers of middle management are being eradicated, there are sizeable attractions in taking charge of one's own destiny - especially for independently-minded, innovative, self-motivating executives. In 1992 the 580 deals recorded by the Buy-out Research Centre totalled just under £3.3 billion, and the evidence so far this year is that this trend is being more than fully maintained.

Often the buyers and their backers have to move extremely fast. When Lilley, the big Scottish construction group collapsed under the weight of its massive property-development debts this January, it took just one week, from a standing start, for Bill Shearer, managing director of its MDW house-building subsidiary, to put together a £2-million buy-out package and secure the jobs of his 265-strong contracting staff.

Bankruptcy obviously concentrates the mind, but sometimes it is also necessary to crystalise the opportunity. Paul Fabian ran Fifth Avenue, the women's clothing business which accounted for around a third of the old Berketex Group. In 1990 he had fixed up all the arrangements to take it independent (with support from the Bank of Ireland and 3i) when the parent, at the last minute, put another £500,000 on the price. He withdrew. But in September 1992, when Berketex failed, he was able to step in, with all the preparations still in place, and claim the prize at a much lower cost than he had first proposed. Nine months later, he happily reports all jobs saved, sales up 10%, costs under control and no regrets about taking the plunge in the middle of an undoubted retailing slump.

It took Peter Mills of Poole Potteries, in Dorset, five years to seize his prize. He first set his sights on the pottery when he was working for Dartington Crystal, then part of Rockware; the ceramics firm belonged to BTR. Unfortunately, when his Dartington colleagues went to BTR to discuss the deal, they made their own business look so attractive that the conglomerate put in an offer to swallow it whole. Luckily for Mills, it was the company's tiles and glass that had been the real interest. This left ceramics as a neglected sideline. Last year, after giving up his job in order to work full-time on the deal, he was able to put together a £3.7-million Bimbo (combined buy-out and buy-in) which left him and a couple of Poole's own executives in control.

Previously a backwater living mainly on its past (Poole plates of the '30s now change hands for £500 a piece), the pottery is now a thriving concern. There are plans to boost the workforce by 30% and capitalise on the 750,000 visitors who tour the site every year. This, of course, is what the properly-structured buy-out can almost always deliver - well-focused enthusiasm and full-time attention. A particularly pure form of capitalism, true enough. In the September issue we study several examples of MBOs.

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