Barbarians Calling: Bonjour to Buyouts

Europeans have always been unsettled by brass-knuckles capitalism. So it's no surprise that a recent rash of multibillion-dollar private-equity bids have caused quite a stir. Over the last few weeks, firms like Britain's J. Sainsbury supermarkets and Alliance Boots pharmacy chain have become targets for American leveraged-buyout firms like Kohlberg Kravis Roberts and Blackstone, as well as homegrown players like the U.K.'s Permira. Unionists, who regularly grouse about buyout-related job cuts, have begun lobbying governments to cut the tax breaks raiders get on their massive loans. Last month, banner-toting protesters at private equity's annual conference in Frankfurt gave funds a clear message: "Slam the door as you leave the EU!"

No chance of that. Last year European private-equity funds raised $114 billion, more than double the 2004 figure. This year the number will likely rise to $130 billion. While the biggest deals are still done in the United States experts say Europe is quickly becoming one of private equity's favorite stomping grounds. Deals are cheaper, and the upside can be much higher. Not only does corporate Europe have more fat to strip, European integration has opened up the possibility for major cross-border mergers and takeovers. "Fund managers are scouring the earth for the best value deals," says Ric Lewis, CEO of Curzon Global Partners, an international private-equity fund, "And today they're finding them in the European Union."

The buyouts are increasingly controversial: German politicians routinely rail against "vulture" capitalists, and even business-friendly British Prime Minister Tony Blair recently warned funds they need to "behave responsibly." Still, there's no doubt that private equity is already bolstering corporate returns across the continent.

The chief targets so far include telecommunications and media firms, particularly those that were formerly state owned. Over the last two years, private-equity firms like 3i and Permira have snatched up VNU in the Netherlands, Eircom in Ireland, ProSienbenSat in Germany and TDC in Denmark, which remains, at €13 billion, the largest European leveraged buyout ever. Industry analysts say the ailing Vodafone—the world's largest mobile operator—could be next. Already, the deals have broken down industry barriers and pushed the "bundling" of services like telephone calls, TV and broadband. As private-equity funds strip away noncore businesses and refocus the companies, experts say Europe will also likely end up with more TV channels, and lower phone bills.

Another popular play is in retail, where raiders are spinning off the real-estate portfolios of big chain stores. If the J. Sainsbury buyout comes through in mid-April, analysts say the company might sell off its stores, then lease them back, freeing up somewhere between £5 billion and £7.5 billion of cash. That could be used to move into nonfood sales (helping it to compete with bigger U.S. players like Wal-Mart). If the plan goes through, it will follow similar private-equity deals involving Nordea, Scandinavia's largest bank, and French department-store chain Printemps.

Private-equity financiers say these sorts of deals will help make Europe more competitive. But some shareholders aren't so sure. The J. Sainsbury deal has provoked controversy, in part because company CEO Justin King, who stands to profit from the buyout, has also had a big hand in orchestrating it (the U.K.'s Financial Services Authority is watching closely for conflict of interest issues). Critics on the Continent are even tougher—two weeks ago, Luc Vandevelde, the chairman of France's largest retailer, Carrefour, resigned amid board complaints about his role in a series of botched private-equity talks. Across Europe, shareholder rights' groups, who accuse private firms of being secretive about their plans for companies, are calling for greater regulation of private-equity funds and more transparency, particularly in key industries like health care and energy (protesters in the U.K. note that store closures at Sainsbury, the third largest grocery store, would effect large swaths of the public).

Against the accusations of conflicts of interest and asset stripping, the private-equity firms offer numbers in their own defense. A recent Ernst and Young study found that private-equity firms generally double the value of companies they buy within three and a half years of owning them. Another report by Citigroup shows that over the last 10 years, private-equity buyouts in Europe have reaped more than 14 percent annual returns, compared with just 8 percent for the FTSE All-Share Index. As a result, funds are oversubscribed. "When we first arrived in Europe 10 years ago, we had to beg investors to listen to us," says Curzon Global Capital's CEO Lewis, "Now they're asking us to save slots in our funds. I've never been so popular." But in order to avoid extra scrutiny, private equity has to win the bigger popularity contest. To that effect, the industry has launched a global PR campaign to shed its "slash and burn" image. At the SuperReturn conference in Frankfurt last month, powerful industry executives called on colleagues to head off regulators by increasing fund transparency. A group of European funds is drafting a code of conduct for disclosure, due out this week, which might include a recommendation that firms outline the general plans they have for a company at the point of purchase so that the public can know what to expect. Still, it's tough to lose the vulture image when mass layoffs so often accompany takeovers. British unionists point to the 4,000 jobs lost during the recent buyouts of the U.K.'s Automobile Association and frozen-food producer Birds Eye. Private equity, for its part, points back to a new industry funded study from Nottingham University, which found that while employment does dip by 5 percent in the first year after a buyout, it rises by 21 percent after four years. The findings imply that European unionists upset about layoffs should take a longer view of the market.

Their counterparts in the United States already have. American pension funds are now the second biggest investors in private equity after fund of funds—that means their profits benefit everyone from schoolteachers to civil servants, which is part of the reason that there have been almost no union protests around private equity in the United States. Those numbers are growing across the Atlantic, too—European pension funds now account for 40 percent of private-equity fund investment, up from almost zero just six years ago. What's more, more than half the funds are planning to increase their investments this year. Banner wavers in Frankfurt might be happy to see the barbarians go. But they'd better hope they don't take their returns with them.

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