A number of major plcs have seen divisions they sold through MBOs/ MBIs turn into high-achievers. Are parent company shareholders right to ask whose interests were served by such sales?
Frankly it doesn't look good. A major plc sells off a subsidiary or division to its managers through a management buy-out (MBO). A year or so later the new company is sold to a trade buyer or floated on the stock market at a vastly increased valuation. Few people would deny the buy-out team their success, but hasn't the parent company been left with some egg on its face? Do major corporations really deliver shareholder value by allowing spectacular profits to slip away into other shareholders' hands?
Over the past decade many major plcs have divested themselves of subsequently super-performing businesses (see table). These overachieving offspring apparently have few proud parents. BP, for example, doesn't want to discuss the topic of Inspec Group or Zotefoams. BP sold the former, a speciality chemicals group, to the management in August 1992 for £42.5 million. Less than two years later, when operating profit had risen from £2.9 million to £7 million, Inspec was floated with a price tag of £136.4 million. Last year, Inspec paid BP £80.4 million for a chemicals plant in Antwerp and the group now has a market value near to £400 million. Zotefoams, sold to its managers for £22.5 million in September 1992, was floated early last year at a value of £52.6 million.
Tight-lipped BP is not the only sufferer from super-baby syndrome. Thorn EMI has 'insufficient time' to discuss the disposal of lighting manufacturer TLG to its managers for £172 million in 1993. Just over a year later TLG floated at a value of £204.8 million. ICI, however, is 'extremely happy' for those former employees who bought out Victrex, maker of the high-performance plastic PEEK, for an estimated £25 million in September 1993. Floated at £130 million in December 1995, Victrex is now valued nearer £190 million. GrandMet, too, is pleased that the buy-out team who purchased its cheese-making division, Express Foods, for £96 million in 1992, made a tidy profit when they sold the business less than three years later to Waterford Foods for £122.8 million. Similarly, media services group Flextech (UK) was happy to rid itself of its oil services arm, Expro International Group, to the management for £55.3 million in April 1992. Last March, Expro floated at a value of £103.2 million.
As float capitalisation figures generally underestimate the uplift in buy-out backers' fortunes, clearly gains - pretty remarkable in some cases - have been made. In view of the scale of these gains, shareholders in the parent plc might have a question or two to ask. Did the parent sell too cheaply? Why did the business perform less effectively under its control? Were shareholder interests best served by disposal at that time?
David Myddleton, professor of finance and accounting at Cranfield School of Management, believes that an MBO/MBI provides plenty of scope for shareholder interest to suffer. 'When a management decides on a strategy of focus, it wishes to get rid of divisions and may not be too fussy about getting the maximum price. I suspect some companies may believe it is quicker, easier and less troublesome to sell to the people it knows. It's rather like the Government which, during privatisation, was determined to sell at whatever the price. With hindsight it's clear that some utilities were sold off too cheaply.' Duncan Angwin, mergers and acquisitions lecturer at Warwick Business School, agrees that maximum returns may not always be high on a corporate agenda. Selling to people you know has advantages, he says. 'The businesses may be interlinked and will continue to trade after the sale, so getting everything done on an amicable footing is advantageous. Keeping it all in the family reduces publicity, advisory fees, avoids upsetting customers and reduces the management time tied up in the problem.' Myddleton points also to a basic conflict of interest between the MBO team and the interests of shareholders in the parent company. 'Given the huge sums of money which are potentially at stake, it would be surprising if the managers of soon-to-be divested divisions were not tempted to make things look black or lower the value of a business prior to a buy-out,' he says. 'Obviously that's going to be difficult to prove as neither side will admit it.' Unproven suspicions are not restricted to management-school lecture-rooms. Plc divestment is a sensitive issue and the venture capital industry, which supplies finance for the majority of buy-out teams, is quick to defend the honour of all involved. Let's put the figures in perspective, says Lucinda Horler Webber, director of BZW Private Equity. 'There are occasions when MBOs and venture capitalists do extremely well but you can't judge anything from one or two success stories.' Figures for MBO/MBI divestments by major plcs during the period 1987-94 reveal that while 9% of the new companies subsequently floated and 14% sold on to a third party, 10% went into receivership and 67% still remain in the original MBO/MBI hands. Since most venture capitalists look for an exit within five to seven years in order to realise their profit, a buy-out which remains in the new owner's hands for longer is not their idea of a soaring success.
It's hard, years after the event, Horler Webber points out, to assess the risks which existed at the time a divestment was made, or the extent to which the parent company explored other sale options. Ken Robbie, of the Centre for Management Buy-out Research at Nottingham University, believes that, while it's easy to find cases where tremendous uplifts in value have occurred, this is scarcely proof that parent companies wantonly mismanage their assets. 'Cyclical factors may have depressed prices, no other bidders may have wanted the company or perhaps the only likely bidders were competitors which the parent company did not want to have crawling over their accounts,' he ventures.
The perception that in the past few years buy-out teams have repeatedly taken advantage of their parent companies is simply unfounded, insists one venture capitalist. A better explanation, he says, citing the example of LEP's buy-out of Swift Distribution Holdings for £25.9 million in 1992 (sold on the following year to Christian Salvesen for £83.9 million) is of opportunistic purchases from distress sellers. 'LEP had overstretched itself both financially and managerially and when the recession hit, found itself in financial hot water. With the benefit of hindsight you could argue that this was a bad deal for LEP's shareholders, but it was probably the best deal it could do at the time.' Moreover the allegation that managers deliberately run down their divisions when a buy-out looms on the horizon is too simplistic. 'The financial controls operated by large corporations make lax financial management difficult. A more likely explanation is that a parent company neglects a subsidiary, perhaps because it is no longer core to activities. In that environment, it is unlikely that management will go the extra mile.' Major plcs are quick to justify their policies and procedures regarding MBO/MBI divestment. 'The decision to sell Victrex resulted from ICI's restructuring policy,' explains ICI chief press officer John Edgar. 'We have a finite sum of money available for investment and we decided to concentrate on those areas of expertise where we possessed greatest technical and market edge and the greatest potential to enhance shareholder value. Victrex was not a bad business but it wasn't core.' Victrex was trailed around a few trade buyers and ultimately sold to a management team headed by Peter Rowley and David Hummel.
But did they acquire it too cheaply? Not at all insist both parties. Says Edgar, 'ICI was happy with the price at the time. The new owners invested in Victrex which we weren't prepared to do. We put money into other businesses and drove them instead. It is in the best interests of our shareholders to concentrate on profitable areas. The rise in our share price since 1993 suggests that we have been successful in doing just that.' Rowley, too, agrees that the price was right. 'Seen against the circumstances of the time, ICI got a fair price for a product which had doubtful future growth prospects,' he says.
GrandMet considers that it did its best for shareholders in two high-profile deals, the sales of Compass Group in 1987 and Express Foods in 1992. The divestments resulted from GrandMet's declutter programme and all options had been considered prior to the buy-outs, says GrandMet's strategy development director Peter Cawdron. Compass Group, sold to a buy-out team headed by Gerry Robinson, was floated 18 months later. 'It's true we could have floated the company ourselves but its profits had just increased when we sold it and the market wanted a period of consolidation. At the end of the day, we may have squeezed a bit more out of flotation, but then again we might not. We felt Gerry's offer was very competitive and we wanted the cash to plough into our branded businesses.' GrandMet also wanted rid of its unbranded cheese-maker, Express Foods, which no longer fitted with company strategy. GrandMet talked with a number of potential buyers but ultimately a price was agreed with a buy-out team led by Roger Davenport. 'We had a target price for all three businesses and the offer for Express Foods exceeded that. The cash raised was recycled into repaying the debt incurred when we bought the branded Pillsbury business in 1989.' Selling off non-core businesses to buy-out teams is perfectly in keeping with shareholder interests, says Andrew Joy, chairman of the British Venture Capital Association (BVCA). The share-price performance of BP, for example, has improved following its policy of divestment. So, whether or not it achieved the very best price for comparatively small divestments such as Inspec may not be the point. 'The effect on the share price is the vital thing,' says Joy. 'And what works for shareholders is focus.' In any case, proffers Robbie, after years in the recessionary doldrums the acquisition market is now considerably more competitive. 'It is very hard today for an MBO/MBI to achieve the gains we saw in the early '90s. Trade buyers are now more aggressive, there are more of them and major plcs engage in more sophisticated divestment processes. It is now very rare for a sale to occur without some sort of overt or covert auction process.' That said, should shareholders now be satisfied that their interests are well protected? Venture capitalists, major plcs and buy-out teams are eager to stress the following: buy-out teams have enjoyed some massive turns but not as often as a few high-profile examples would suggest; major plcs sell at the best price available in the market - they are not fooled into underestimating the value of their assets by the creative accounting of buy-out hungry managers; and while strategic focus is unquestionably a source of shareholder value, holding onto a business until more buyers emerge or floating it oneself, is not.
Those arguments do not, however, get everyone off the hook, claims Duncan Angwin. Basic managerial questions remain. Why do major corporations fail to realise the 'hidden' potential of some of their assets? Was the original decision to enter a market or acquire a company a likely means of enhancing shareholder value? Did ICI, for example, err on two counts with Victrex? First, in entering a market which did not suit its structure and culture and, second, in failing to adequately motivate its staff once there?
The inability to inspire staff is a problem shared by many major corporations. Victrex chairman Peter Rowley, who led a five-strong managerial team and 60 employees away from ICI in 1993, spells it out. 'Within ICI we were constrained from doing what was right for the business by what was right for the corporation,' he says. 'We were in thrall to central policy. At Victrex, within six months we had achieved a highly individual reward-orientated culture. All our staff own shares and a process operator earns an average annual bonus of 30%. People are more motivated if you give them scope to be motivated.' Major plcs could, suggests Angwin, do more to incentivise managers through share options or bonuses but are unlikely ever to provide the motivation which running one's own company provides. Financial strategist Keith Ward points to the advantages which buy-out teams enjoy over their former owners. 'A business can run itself very differently when it is divorced from a large organisation. Managers are freed from many constraints on their time. They can implement decisions more quickly and they do not have to carry overheads for a larger group.' However, given the potential for buy-outs to achieve eye-catching success, Ward believes that parent companies could do more to ensure that they share in those potential profits. 'By keeping option stakes, they retain the possibility of sharing in any future uplift in value. It's a good way of taking two bites at the cherry and insuring against any future shareholder complaints,' he says. So when in December 1992 Forte sold its contract catering arm, Gardner Merchant, to a consortium of management and institutions for £402 million, it retained 24% of the company. Consequently Forte shareholders also benefited from its uplift in value when Gardner Merchant was acquired by Sodexho in January 1995 for £730 million.
Hedging against the future success of its divestments may save some corporate embarrassment. However the success of corporate nest-flyers clearly raises other concerns. Perhaps the recent corporate rush to 'focus on core activities' is neither the sole nor necessarily best means to enhance shareholder value. Creating a climate in which employees strive to improve the performance of their businesses may ultimately prove to be a better way of upholding shareholder interests.
GOOD TURNS: SOME MBOS/MBIS WHICH CAME BACK TO THE MARKET 1990-1994
Vendor Divestment Year of Sale Year of Market
divestment price £m flotation Cap £m*
Scot'sh & Newcastle Taunton Cider 1991 101.0 1992 153.0
BET Anglian Group 1990 84.0 1992 183.5
BICC Vero Group 1994 33.0 1995 132.3
BP McBride 1993 282.0 1995 329.0
Electronic Inds Roxboro Group 1990 17.5 1993 80.5
Phipps Group 1992 14.4 1994 73.6
Flextech(UK) Expro Intl
Group 1992 55.3 1995 103.2
Logitek Azlan Group 1991 6.5 1993 50.2
Parkway Group Hunters
Armley Grp 1990 5.6 1992 18.3
Stakis Ashbourne 1993 61.0 1994 80.5
Williams Holdings Cortworth 1993 40.3 1995 71.6
Source: Centre for Management Buy-out Research at University of Nottingham
* at time of flotation
WHAT HAPPENED TO MBOs/MBIs SOLD BY MAJOR PLCs
Year of divestment No exit Float Trade sale Receivership
1987-1989 140 27 43 34
(57%) (11%) (18%) (14%)
1990-1994 212 21 30 17
(76%) (7%) (11%) (6%)
TOTAL 352 48 73 51
(67%) (9%) (14%) (10%)
Source: Centre for Management Buy-our Research at University of Nottingham.