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Strategic Finance

Taking bids in your stride

Monday, 27 November 2006

Matthew Goodman looks at how finance directors should deal with an approach from a private equity firm. Michael Ball had not long been Finance Director of Esporta, the upmarket health-club chain, when there was an unwelcome approach from a private equity house. Having spent his first few weeks in office going through the books and forcing out a profit warning, the share price had predictably collapsed and the predators began moving in.

Duke Street Capital, a well-known private equity house, began building a stake in the gym operator, initially staying under the radar by keeping below the three per cent threshold at which its interest would have to be made public, but quickly accumulating stock until it had built up a sizeable stake in the business.

Eventually, the inevitable happened and Ball, who had been with the company just a few short months, found himself on the receiving end of a bid approach. Duke Street was offering, via its adviser Hawkpoint, 80p a share.

Ball and the Esporta board, taking advice from their own financial adviser Lazard, rejected the approach out of hand. Not good enough, was their response. But Ball knew Duke Street was likely to come back with a higher offer and that, unusually for a private equity firm, it would be prepared to go hostile.Sitting on a stake by that time of about 25 per cent, the private equity firm would find it difficult to unwind its position: bidding was the best option open to it.

With this attitude in mind, Ball, in conjunction with his chief executive, set about doing the best thing they could to ensure Duke Street paid up and keep the other shareholders happy. That meant cutting costs and offering heavy discounts to new members - measures designed to boost short-term profitability. The tactic worked and the board forced their unwanted suitor into paying another nine per cent.

And, once the deal was done, Ball was invited by Duke Street to stay on as finance director, a position he still holds today.

Such stories are unusual, not least because private equity groups rarely engage in hostile takeovers of publicly traded companies. But the fact that Ball was invited to stay on once the victory was in the bag, gives an indication that, in this case at least, the private equity house making the approach was impressed by the behaviour of the finance director.

But what should the finance director do when faced with an approach from a private equity group? It is far from straightforward. Asked how a finance director should react when faced with the prospect of a management buy-out, one seasoned corporate financier joked: "Gratefully."

If only it were that easy. In Esporta's case, Duke Street had put itself in prime contention by building up such a substantial stake. It is far more common for a private equity group to come knocking on the front door to ask the management team if it would be interested in leading a deal.

But such a technique is fraught with difficulty. Peter Williams, Finance Director and later Chief Executive of Selfridges, the department store group that found itself at the centre of a bidding war, says: "The private equity firms would come to us and say, 'Have you ever thought about doing an MBO, we can make you very rich people', and all the rest of it. But the view we took was that as a management team it was quite difficult for us to cast the first stone."

The problem facing a finance director who sides with the first buy-out proposal that comes along is that it can lead to a conflict of interest. The duty of the board is first and foremost to the shareholders - all thoughts of getting rich need to be left on one side.

Peter Taylor, Managing Director of Duke Street Capital, says this is no easy choice for a finance director. "The private equity group puts them in quite a difficult position. They have a conflict between their fiduciary duty to the company and the opportunity to join the bid."

But making a decision as weighty as that is really a little premature. David Simpson, a Corporate Finance Partner at KPMG, the accountancy firm, says that in the event of an approach from a private equity firm interested in making an offer for the company, some rather more fundamental questions need to be answered. "The first decision that needs to be made is whether you are potentially for sale or not. A lot will depend on the attitude of your shareholders about whether you're under pressure to accept an offer."

Private equity groups by their very nature are looking for assets they believe are undervalued but that does not necessarily mean they should be engaged as soon as they rock up. Indeed, taking the opposite stance is frequently more effective. And it is worth remembering, says Simpson, that there is no requirement on a finance director to divulge information to someone who says they are a potential offeror.

The next fundamental point that needs to be addressed is whether selling the business for the price being offered is the right thing to do. In weighing this up, finance directors, with their boards, are being asked to make a judgment call.

"The test that many boards apply is what the likelihood is of the share price reaching that which is on offer over the next 18 to 24 months," advises Simpson.

There are not just financial considerations at work, though. The other question that ought to be addressed in the wake of an approach, and one to be considered by the senior management, is whether there is a strategic imperative to sell. Would the business benefit from being owned by a private equity group? Would it be able to achieve its goals more easily than by retaining its independence?

The last factor that needs to be taken into account, assuming the price is likely to be at a level that might be acceptable to shareholders, and that there is a strategic rationale for a deal, is judging how serious the private equity firm is.

This is the area that can really cause the most problems. It is possible to get a long way down the road towards a deal and then find the private equity group pulls out. The experience of Woolworths, where Apax Partners spent many weeks conducting due-diligence before scrapping plans to bid left recriminations on both sides, although the retailer maintains it was the right thing to do to allow Apax access and the private equity group did seem to be serious in its intentions despite ultimately walking away. Intriguingly, Woolworths' Finance Director, Christopher Rogers, moved not long after to Whitbread, the leisure group, where he instigated a financial review to try to head off much-rumoured possible private equity interest.

Having decided to progress with the approach, the decision-making process does not get any easier. It is at this point the executive board, including the finance director, must decide whether they want to stage a buy-out of their own, whether that means co-operating with the firm that has made the initial approach or finding another willing bidder. If the latter option is chosen, that usually means the company's advisers have been instructed to conduct a full-scale auction of the business.

These days, most businesses that receive takeover approaches from private equity groups are subject to these auctions, mainly to ensure that shareholders get the best deal possible. Whether that means the finance director ends up on the winning team is not always guaranteed. Just look at Debenhams, where the executives felt they played by the book, had all the advantages of knowing the ins and outs of the business and ended up losing out to another bidder. Finance Director Matthew Roberts, along with Chief Executive Belinda Earl had allowed access to Permira to conduct due-diligence after deciding their indicative offer was acceptable but lost out in a high-profile bid battle to interloper CVC Capital Partners - which had its own management buy-in team.

These processes are never easy, they can take months to work through, but the potential rewards if all goes well are enormous.

Matthew Goodman is a Business Journalist at The Sunday Times, where he has written on private equity and the retail and leisure sectors since December 2001. He began his journalism career in 1995 at Legalease, a specialist publisher of products aimed at the legal market, where he rose to become Senior Reporter on Legal Business magazine. In 1998 he joined the launch team of Sunday Business newspaper, where he worked for four years before moving to The Sunday Times.