As this is Co-operative News I wonder if I can be cheeky and use this column to request some co-operation and collaboration? I have been wrestling with a problem for several weeks, which I cannot resolve. Please, dear reader, suggest your own explanations.
My unresolvable riddle is how can a private equity investor extract profit from a mutual structure. But my concern is that this is not merely an intellectual challenge. I fear we could be on the verge of the latest demutualization bandwagon and the Government’s use of mutuals as part of the Big Society initiative could, perhaps inadvertently, give this a continuing momentum.
The immediate issue is the future structure of the Kent Reliance Building Society. As this column has explained before, KRBS is to receive substantial additional investment from the leading private equity house, JC Flowers. The firm has previously bid for the nationalized Northern Rock bank as a means of entering the banking sector. It now has an alternative and apparently preferred method of entry into the industry, via its stake in an Industrial and Provident Society.
Using the Butterfill Act, it seems that Kent Reliance’s trading activities will transfer into the IPS. That same society could then perhaps be used as a vehicle to merge with other building societies that could benefit from extra capital. Societies mentioned include the extremely troubled EBS (formerly Education Building Society) in Ireland, which is being propped up by the Irish government, and the Daily Telegraph has also suggested Skipton Building Society could be on the menu. Skipton’s former head, John Goodfellow, has now been engaged by Kent Reliance to advise on the mutual sector.
But it is no use merely wondering idly from afar what is going on. Consequently I asked JC Flowers to explain to me in simple terms how it is going to extract a profit from the arrangement. This is a reasonable question, as the purpose of a private equity firm is to achieve a return on investment that is above that normally provided by a PLC. This, on the face of it, conflicts with the objectives of a mutual, for whom profits should be reinvested as improved services and conditions.
Some possible means of ‘extracting value’ (as it tends to be termed in the City) from the deal occur to me. One is that this is a means of Flower learning more about banking for it to take over a PLC later. That possibility does not convince me. Another interpretation is that a subsequent PLC purchase would share back office services with the IPS, in order to achieve economies of scale and cut costs. But if that is the objective, does this require the acquisition of several building societies to fulfill? One further possibility is that the IPS will buy-in services from Flowers, from which it will take the profits. This is feasible, but under an IPS structure there would be constraints on the prices the secondary business could charge.
All this leads me to one anxiety – that this is seen as an opportunity to demutualise. When I raised this with JC Flowers it referred me to its external PR agency. A day later the agency came back with a statement which did nothing to either reassure me, nor to help me understand the structure of the deal.
“JC Flowers is a financial investor, but we are also loyal and supportive partners,” said the spokesman. “We do not plan to take any dividends from this new bank for several years. Indeed, we expect to be putting capital into it, rather than taking capital out. We believe that by making this investment, we will be able to help Kent grow to the benefit of all its stakeholders. JC Flowers will benefit, but so will members, staff and the communities in which Kent operates.”
Note, please, both the reference to ‘this new bank’ and that dividends will not be taken ‘for several years’. Remember also that the traditional private equity model is to acquire, restructure and then sell – for a substantial reward.
This matters a great deal, I suggest. All the political parties are discussing ways in which public services can be transferred to co-operatives, other mutuals and social enterprises. But, one wonders, do the politicians know what these are? Come to that, is our own movement entirely sure?
Peter Holbrook, chief executive of the Social Enterprise Coalition, has just addressed exactly this issue. He responded to the point that a new report – ‘Approaches to measuring the scale of the social enterprise sector in the UK’ – put the number of social enterprises as between 16,000 and 234,000. An order of magnitude of difference there! The numbers, of course, reflect variations of definitions. The larger figure includes sole traders – which, I suggest, it could not honestly be argued are social enterprises.
If we don’t know how we define social enterprises, it then becomes very difficult (or impossible) to argue that any form of positive support should be given to them in the awarding of public contracts. This includes, for example, the transformation of the NHS into a network of social enterprises. How can we be assured that ‘social enterprises’ running health care services will not simply be bought up by a major provider, which will then perhaps increase charges paid by the NHS? We have previous experience of ‘social enterprises’ being bought by PLCs.
The wider co-operative, mutual and social enterprise sector needs to take caution, I suggest. Where we see opportunities, we also need to see dangers. Above all we must remember not only previous demutualisations of building societies, but also Andrew Regan who tried to demutualise retail co-operatives. He did not succeed. I fear others now have new demutualisations on their agenda.