Private Equity: With the same brush


Industry insiders say that a recent report prescribing the pitfalls of private equity backing misrepresents the bigger picture. Are they right? Or is there hope on the horizon?

While a recent report has damned the performance of private equity-backed businesses, market commentators have refuted the findings, spying a wave of investment on the horizon.

In a paper entitled Private Equity Takeovers and Employment in the UK: Some Empirical Evidence, Warwick Business School, Cardiff University and Loughborough University looked at all publicly listed firms that had undergone a PE buyout in the UK between 1997 and 2006.

Summarising the report’s findings, Geoffrey Wood, professor of international business at Warwick Business School, said: “What we found was the promised productivity gains of a takeover rarely materialised. Rather, there was evidence of PE buyouts reducing the number of workers and squeezing wages, without making the firm more efficient.”

He added: “Why do firms that are taken over perform worse? We believe it is because outsiders find it more difficult to cost the worth of a firm’s human assets, and their combined knowledge and capabilities. Hence they are more likely to lay off staff, less aware of the consequences this may have for future performance.”

Misrepresentative sample
The British Private Equity & Venture Capital Association was vocal in questioning the conclusions of the report. It said in a statement: “The study concerns itself with a very small subsection of PE deals and, therefore, any claims this represents the PE industry as a whole are erroneous.

“It appears the authors have started with the hypothesis that PE is damaging to employment, wages and productivity, and sought to examine only those deals
which they believe are most likely to prove this hypothesis.”

Looking at some of the specific issues raised by the report, Tim Oliver, chief executive of Parabis – which is backed by PE house Duke Street – believes such investment does not undervalue the importance of staff within a business. He says: “Duke Street absolutely values the human capital here. We are a people business and [Duke Street] recognises the different types of contribution individuals make. It does not interfere in the management, but instead it looks to have a clear strategy for the business.”

Derek Coles, CEO of Direct Group, is also an advocate of PE investment. Coles bought the business in a management buyout backed by Lloyd’s Development Capital, and then trade buyer Ryan Specialty Group bought out the PE share last year. In the past 10 years Coles has been involved with three different PE houses – two during his time with Direct Group and the third when he was at GAB Robins.
He says: “They were all different. Some were very hands on and others were not. Each has different expectations and it creates different pressures.

“It is all about the way you approach the investment and the communication you have up front. You have to get the best out of it, and to do this you have to understand why you are engaging a particular house.”

Mutual benefits
According to market experts, businesses hoping to get the best out of PE investment need to make sure they have the right partner and they need to create a relationship that works for both parties. Oliver explains: “There are small, middle-ranking and large PE houses and you have to identify the right size of house that will be interested in your businesses. You want to be absolutely sure it has experience of your particular sector and you are not providing a learning curve.

“You want to be clear on where you are taking the business, and the insurer would need to buy into that particular vision. You want to make sure that, on a personal level, there is a cultural fit between the PE house partner and the management team.”

Cooper Gay Swett & Crawford CEO Toby Esser agrees finding the right relationship is essential. He says: “Companies must find a PE house aligned to their way of thinking. You have got to have the PE house buying into your management style. It can be adapted, but if it wants to do things completely differently it is the wrong partner. You have to make sure there is a fundamental agreement over what you are trying to do and how you are trying to get there. It is important to share a vision.”

While the PE house may, in some instances, ultimately own the company, it is not there to run day-to-day operations. Indeed, there are few PE houses that want this level of involvement. Claire Madden, a founding partner of Connection Capital, says: “PE houses do not buy businesses to run them. They do not know how to run an insurance business and so the management team is very important in making the investment a success.”

Over and above a clear vision of where the company is going and a strong management team, there are a number of fundamentals that PE houses look for when investing. Madden continues: “Whether it is insurance or any other sector, PE houses are looking at a number of things. Is the business cheap? Has it been subject to the market going against it? Does it fail to get on the analysts’ radar? If you get it cheap then do you need to grow the bottom line that much to make a profit? Is the business still in a growth phase with an obvious growth plan? Is it over staffed? Can we drive efficiencies?”

Where to look
If this is what PE houses are looking for, then which sectors of the insurance market offer these?

Andy Marsh, partner at Gresham Private Equity, says: “Specialist brokers that can display competitive advantages through different schemes or different market positions from where they can grow their business both domestically and internationally are interesting, but there are some areas where you wonder whether firms will really make money. It is not about the industry but more about the niches within it.

“A scalable business model is really important and much of what we look at has IT at its heart. The reason we like specialists is that they can attract business if they have the right product, so it is not about employing people on the street selling products.”

For PE houses and businesses within the insurance sector, a sound partnership will be increasingly important for the future, with a surge in the number of deals looking a possibility. Will Geer, director in corporate finance at Deloitte, says: “Over the past three to six months we have seen unprecedented levels of PE interest in the insurance sector. That is predominantly driven by the success of the Direct Line Group and Esure initial public offerings. We are seeing an awful lot of interest in motor insurance, which is where those two players are active. On a wider basis, it is clear that many of the larger PE houses have a lot of capital to put to play – they can see the attractions of the insurance space.”

Strength in depth
What is perhaps most encouraging for the insurance sector is that there appears to be an underlying desire to create stronger, more robust businesses through PE investment, rather than simply consolidating companies into larger organisations for financial leverage.

Olly Laughton-Scott, partner at Imas, explains: “Many transactions have been driven by financial engineering and an attempt to put more debt into a business, extract dividend and so on, rather than operational logic.”

He adds: “We have had the hangover from consolidation and it has been rushed in the past. People have been more focused on the land grab rather than making the most out of the acquisition. In the next five years we are going to see better businesses being built, rather than just bigger businesses.”

According to Imas research, there are significant opportunities for PE investors in the insurance market. In the general insurance distribution space, Imas says there are a total of 326 firms with a value in excess of £5m. Of these, only six are publicly listed and just 19 are owned by PE houses, with 249 still in private hands.

Meanwhile, in the general insurance risk sector, of the 229 firms that are worth in excess of £5m, 13 are publicly listed, 10 are held by PE houses and only 22 are privately owned.

For businesses seeking investment and looking to grow, PE is clearly an option. Where a good fit is found, PE backing should act as an agent for change and drive a business forward. Coles says: “PE houses challenge you to look at things faster and more aggressively. They make you address poor performance and hold the tough conversations that need to take place within the business.”

Road to success
While there is no consensus PE investment is a sure-fire route to success, it is also incorrect to suggest that it is a byword for inappropriate cost cutting and is unlikely to deliver significant improvements in a business’s performance.

Marsh says: “When it does not work it is normally because things have not turned
out as expected. Often the problem is when the growth does not come through because plans have not materialised. If we do our work right then that should not happen, but occasionally it does. When things go wrong it is not about insurance or PE, but about the model not being right and not being as good as others, or the management not delivering on plans.”

Simply Business has recently announced a deal with PE house Ana Cap and it looks likely that many more are on the cards. It would seem, therefore, that the discussion on PE investment within the insurance sector will have plenty to keep it going in the months ahead.


Tales from the archive: 2012

While market commentators believe brokers and insurers are strong candidates for private equity investment – despite recent research suggesting the opposite by Warwick Business School, Cardiff University and Loughborough University – the situation could be very different for the loss adjusting sector (

Private equity houses are growing increasingly cautious about investing in loss adjusters, and one firm has already written down its investment in the market by millions, Post can reveal.

With the demise of Royal Bank of Scotland-backed Merlin still relatively fresh, analysts believe that PE houses have become more discerning about which insurance sectors they back, and that the proposed sale of Cunningham Lindsey is a potential victim of the change in sentiment.

Davies’ PE backer Electra has already written down its ‘fair value’ holding in the group by £4.95m between 30 September 2011 and 31 March 2012. The cost of the holding – the amount Electra put into the company – was originally £35.79m.
A spokesman for Electra, which is also understood to have an approximate £30m stake in Esure, told Post the company decided on the write down because it believed the loss adjusting industry had depreciated in value.

“We looked at comparable companies when valuing the investment. We look at share prices and how they are doing generally. After evaluating those companies, we found the sector had lost value,” he said.

Despite the reappraisal, the Electra spokesman added: “Davies has had a good year, and we see potential in it. We would not have invested in it if we did not. It will continue to grow as a company. It has a good track record and we are very optimistic.”

The loss adjuster also confirmed that it had made a “small number of management redundancies”, adding that this has “been balanced by some recent hires at all levels across the organisation”.

This article was published in the 1/8 August 2013 edition of Post magazine

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