Public service or private equity?
by Paul Gosling
The contentious world of private equity might seem a planet away from the public sector – but it isn’t. Utilities, education, health, social care, leisure and support services all have private equity-owned companies not just contracting with the public sector, but often now owning what used to be public assets.
Private equity involvement in the public sector ranges from the peripheral to the massive. On the small scale ranks the disposal by local authorities of dilapidated assets, such as underused leisure centres, to private equity-based leisure firms, such as Esporta. At the very large end of the spectrum lies the privatisation of the former Defence Evaluation and Research Agency (DERA).
Six years ago, DERA split in two, with the majority privatised as Qinetiq. Part of the equity was initially sold to US private equity firm Carlyle (European chairman, Sir John Major), chosen as the partner to prepare for Qinetiq’s initial public offering (listing and public sale of shares). And Carlyle turned a £42m investment into a £300m profit.
This type of return across UK industry has put private equity into the headlines and the House of Commons Treasury select committee. Now one of the most pressing tasks of new Chancellor of the Exchequer Alistair Darling is to decide whether to raise the tax levied on private equity partners. At present, those involved in one kind of private equity deal – leveraged buy-outs (LBOs) – typically borrow most of the capital, with the interest cost being tax exempt. Partners also benefit from a very low rate of capital gains tax. As a result, private equity firms and their members can make millions in profits, yet pay little in tax.
There are, though, other types of private equity. Venture capital puts in the investments for start-ups, expansions and sell-offs – all of which can come from the public sector – with investors sometimes looking for an exit in a year or two, with others content to wait a decade or more. Hedge funds – memorably described by a German politician as “locusts” – mostly look for short term profits.
Despite the recent crisis in the capital markets, there remains a large amount of private equity money awaiting further speculative investment – Labour MP and private equity critic David Taylor suggested to Public Finance that there could be £200bn available to buy public sector and other assets.
Private equity has already grabbed a strong hold over what was once the preserve of the public sector. An example is Liberata, which is now 99% owned by US private equity house General Atlantic, but back in 1975 was formed as CIPFA Services Ltd, later becoming CSL. Down the line, CIPFA sold-off CSL, which in turn spawned Capita. CSL itself became owned by accountancy firm Deloitte, before being sold on again about five years ago to General Atlantic.
Today Liberata is one of the UK’s largest business process outsourcing companies, 70% of whose clients are in the public sector, including the Learning and Skills Council and the Ministry of Justice. Another customer is Sandwell council, where Liberata is working jointly with BT to run the Transform Sandwell Partnership – a £300m, 15 year, outsourcing contract.
Sandwell’s Labour-controlled council says the project will lead to 500 council staff being transferred on existing terms and conditions to the new company, while potentially generating an extra 450 jobs through the use of a newly built operations centre to provide services for other clients. The council says the contract will lead to improved support services – and consequently better frontline service provision – which would have been unaffordable without an external partner.
Robert Gogel, chief executive of Liberata, told Public Finance: “Typically the driving force [for outsourcing contracts] is to go out and get value for money.” He says its clients expect improved quality and lower costs by contracting-out such services as tax collection, benefits payments and payroll, while benefiting from reliable and advanced IT systems.
According to Gogel, such objectives are made easier by having a private equity owner. “We have got a unique shareholder,” he says. “It’s not a hedge fund, it holds its shares for six or seven years.” Gogel adds that because the owners have a medium-term investment horizon, they are less concerned about quarterly earnings and more interested in sustained growth. And, because General Atlantic only invests in outsourcing and technology businesses, its appointed directors provide specialist expertise.
Barclays Bank private equity fund has also invested heavily in public sector assets, in particular by putting in the capital for a range of Public Private Partnership schemes, including Building Schools for the Future and LIFT – Local Improvement Finance Trusts that provide new primary care centres for the NHS – and has raised more than £1bn for PPP and PFI projects. Barclays Private Equity has also invested in joint ventures with the Ministry of Defence and in Ryhurst, which provides community hospitals for the NHS.
Nick Salisbury, head of structured finance at Barclays Bank, believes that the level of investment provided to the public sector through funds such as his would not be happening without the involvement of private equity. “PLCs don’t like to commit long term funds to projects,” Salisbury told Public Finance. “Building Schools for the Future will probably commit primary or secondary funds for 25 years and building contractors might not want to commit money in that way. If they did it would usually be as a means to an end, to obtain the contract, but many will then recycle that equity as quickly as they can to get a return. They don’t usually see themselves as long term holders [of equity investments].”
Barclays is also an investor in the private equity fund Bridges Ventures, which has a specific community benefit purpose. Other investors include the West Midlands and South Yorkshire municipal pension funds, All Souls College, Co-operative Financial Services and the Government. Bridges’ investments include a company offering administrative services to primary care practices and Key Real Estate, which provides affordable homes for nurses and doctors employed by Plymouth Hospitals NHS Trust.
But much private equity involvement in public services is of a different character to that in mainstream industry and can be longer-term in character. Pension funds are looking for reliable returns for several decades, matching their profile of increasing liabilities as the population ages. David Hall, director of the trade union-linked Public Services International Research Unit at the University of Greenwich, says this type of private equity fund has put billions into such assets as water companies, housing, school and health centre buildings.
Hall has written a series of research papers on private equity involvement in European public services, yet he remains “uncertain” about the medium to long-term impact of the investments. “If there is genuinely a different category of private equity emerging, which is infrastructure funds looking for long-term income streams, then it’s not necessarily worse than various other forms of privatisation that we have seen,” he concedes.
What disturbs Hall is the developing use of leveraged finance in the water and waste industries. When water was privatised, it was financed almost exclusively through share issues, and was largely debt free. Now, though, the industry – much of it owned by private equtiy – has on average 70% debt, with some water companies owing even more. In the waste management sector, adds Hall, the trend across Europe has been for some of the largest private equity partnerships – including Blackstone, KKR, CVC and Terra Firma – to buy companies and sell after two or three years to international conglomerates, aiding consolidation of the industry and providing the private equity houses quick returns.
Concerns about private equity have been put most forcefully by John McDonnell in his unsuccessful attempt to become a Labour Party leadership candidate. McDonnell told Public Finance: “Private equity involvement in the public sector has epitomised the short-termism of the current market, generally seeking to generate short term profit by ruthless cuts in jobs, wages and conditions, increasing charges and even targeting pensions, leading to a longer term decline in the quality of service delivery and the loss of democratic control. In years to come the PPPs and PFIs and all the other privatisation devices promoted within our public services by Gordon Brown over the last decade will be looked back upon in the long term as one of the most inefficient, managerially incompetent and wasteful follies ever entered into by a Government of any political persuasion.”
It looks like private equity, and its involvement in the public sector, will remain a hot topic for quite a while.
Box
Public sector, or private equity? How private equity owns and runs public services.
Several water companies are owned by private equity, including Thames Water – the UK’s largest water provider. Thames is owned by Kemble Water Ltd, a consortium led by Australian bank Macquarie’s European Infrastructure Funds.
Cognita is the UK’s largest private schools company, set-up by former chief inspector of schools, Chris Woodhead and owned by private equity house Englefield Capital. Another leading provider of independent schools in the UK (and the Middle East) is GEMS, owned by Middle East private equity firm, Abraaj Capital.
ZooBiotic is a spin-out from Bro Morgannwg NHS Trust, selling maggots as a sterile treatment for infected wounds. It has been financed by private equity, including from PUK Ventures – the specialist private equity fund established by Partnerships UK, the body established by the Government to promote Public Private Partnerships.
Annington is the largest private owner of residential homes in the UK, having bought the Ministry of Defence‘s married quarters stock. It is owned by Terra Firma Capital Partners.
In June, BUPA sold 25 hospitals to private equity firm Cinven, which already owned 17 health mental health facilities.