Select Committee on Treasury Written Evidence

Memorandum submitted by Permira Advisers LLP


  1.  Permira Advisers LLP welcomes the opportunity to contribute to the Treasury Committee inquiry into private equity funds.

  2.  Permira is an international private equity firm. It has a staff of around 200 with operations in Frankfurt, Guernsey, London, Luxembourg, Madrid, Milan, New York, Paris, Stockholm and Tokyo.

  3.  The Permira funds' focus is on investing in large companies that are not fulfilling their potential and would benefit from a period of private equity ownership. The value created in these businesses by the changes effected during this stage in their life—helping them to become stronger, more competitive and sustainable—in turn generates the return for the funds' investors.

  4.  Permira has raised and advised funds with a combined total of more than €21 billion over the last 20 years. The most recent fund received commitments from more than 70 public and corporate pension funds, more than 40 charities and endowments, more than 20 life insurance companies and eight governmental development agencies. The fund has more than 30 million underlying pension fund beneficiaries, including approximately one million current and former UK local authority employees. By geography, some 55% of the capital committed to the most recent fund came from European institutions, 35% from North American, 8% from the Far East and 2% from the Middle East.

  5.  Since 1985, the Permira funds have completed more than 180 private equity transactions. The Permira funds are currently invested in around 30 portfolio companies based in Europe and the US and with operations around the world. Examples include New Look, Gala Coral, Birds Eye, AA, All3Media and Principal Hotels in the UK; SBS Broadcasting, Dinosol and Borsodchem in Continental Europe; and Intelsat and Aearo Technologies in the US.

Is the current regulatory regime for private equity funds suitable?

  6.  In the UK, Permira is regulated by the Financial Services Authority ("FSA") through its authorisation of our regulated activities of investment advice and management.

  7.  The FSA's discussion paper "Private equity: a discussion of risk and regulatory engagement" does identify and attempt to assess the impact of some key risks for the private equity industry. Permira's view is that this paper represents a reasonable and balanced description of the private equity industry in the UK, and in particular the risks inherent in the industry. As part of the consultation process, Permira has commented on some of the key areas in the report. Permira agrees with the FSA's own conclusion that its current approach to supervision is broadly the correct approach.

Is there sufficient transparency on the activities, objectives and structure of private equity funds for all relevant interested parties?

  8.  The recently appointed working group lead by Sir David Walker will review the transparency and disclosure in the private equity industry in general, and how levels of disclosure could be improved. Permira fully supports this initiative.

  9.  However, with regard to investors, Permira believes it communicates with a high level of transparency and openness. There are specific and detailed requirements set out in the fund legals as to information which the investors are entitled receive. In addition the investors in the Permira funds receive regular updates on the activities and performance of both the investee companies and of the fund itself. There is an annual meeting of the investors in each fund at which the performance of the fund is presented and discussed and the investors receive annual audited accounts of the funds. In addition, each fund has an advisory board composed of representatives of its largest investors.

  10.  Permira's most recent fundraising lasted approximately six months. During this time investors were able to meet all of Permira's senior investment professionals, were able to submit detailed questionnaires about all aspects of the firm, conduct detailed due diligence on the firm's track record, as well as being able to call on advice from highly sophisticated investment consultants. Our investors' satisfaction with the information they receive is reflected in the high rate of reinvestment in our funds; approximately 90% of the investors by weight of capital in our first European fund, raised in 1997, reinvested in our most recent fund.

  11.  In the case of the other financiers of private equity-backed companies, such as the debt providers, we believe that the disclosure is adequate and is dealt with in the very detailed information requirements set out in the loan documentation.

Has there been evidence of excessive leverage in recent transactions and what systemic risks arise in consequence?

  12.  There is clear evidence that leverage levels have been increasing over the last few years. This has been driven by a rise in the supply of debt from financial institutions and the improved economic environment.

  13.  However, Permira does not believe that these higher leverage levels should necessarily be regarded as excessive. The appropriateness of leverage should be seen in the context of the ability of the business to service the debt. Equally, at the same time as the leverage levels have been increasing, the cost of debt has been falling.

  14.  Permira does not believe that there is any systemic risk from current levels of lending—the lending is syndicated widely amongst a large number of banks and a vibrant institutional fund community, meaning that individual company risk is widely distributed. We are focused in achieving the right balance between an efficient capital structure that is low cost and the financial flexibility for each company to grow and develop.

  15.  Permira agrees with the conclusion of the ECB's recent report ("Large Banks and Private Equity-Sponsored Leveraged Buy-Outs in the EU" April 2007) that the likelihood of LBO activity posing systemic risks for the banking sector in the region appears remote.

What are the effects of the current corporate status of private equity funds, including both their domicile and ownership structure?

  16.  Most private equity funds are established as limited partnerships. The key reasons for this are in summary: firstly, to ensure that the investors in the funds have limited liability status so that their maximum exposure to the fund is limited to the amount of their commitment; and, secondly, to ensure that the funds are transparent for the purposes of tax. The investors in the fund are limited partners and take no part in the management of the fund. The management of the fund is carried out by the general partner of the fund.

  17.  The investment by the Permira funds in a company has no effect on the corporate status or domicile of the investee company itself. After the investment has been made, the investee company and its management will continue to be domiciled in the same place they were before the investment was made.

Is the current taxation regime for private equity funds and investee firms appropriate?

  18.  As mentioned above, many private equity funds are established as limited partnerships. From a taxation perspective, these limited partnerships are fiscally transparent, which has the effect that the investors in the funds are taxed on their investment in the fund as if they had invested directly into each investee company of the fund. This is important for investors such as pension funds and charities which are taxed on a different basis from companies and individuals and, for good reason, in many cases pay no tax or lower rates of tax. For other investors who pay tax on a conventional basis, the fiscally transparent nature of the partnership structures avoids their investment returns being taxed twice.

  19.  Private equity-backed companies are, and should continue to be, taxed on the same basis as other companies.

  20.  On the particular issue on tax deductibility of interest, we agree with the recent comments by Ed Balls MP, Economic Secretary to the Treasury:

    "There is of course nothing specific to private equity in the tax deductibility of interest. Any kind of company can claim it, and most quoted companies do. It is also the international norm—that interest is in general treated as a business expense and deductible from taxable profits for companies in any form of ownership."

  21.  Accordingly we believe that the taxation of investee companies continues to be appropriate.

Are developments in the environment and structure of private equity affecting investments in the long-term?

  22.  The Permira funds are structured to reflect the long-term nature of their investment activity. They are closed-end funds that require the investors to commit their capital for 10 years. The first six years are described as the investment period and the subsequent four years are described as the realisation period. There is generally no significant recycling of the capital, reflecting the intention of making long-term investments. The structure of the funds makes them one of the longest term sources of investment capital in the market.

  23.  On average, the Permira funds are invested in their portfolio companies for approximately five years. This compares with an average holding period for public market investors of around 12 months.

  24.  The length of holding period depends on the nature of the investment plan for the business in question. In the case of Hogg Robinson, for example, the Permira funds held the business for more than six years so as to be able to back the management in effecting a complex transformation and repositioning of the company. This involved separating the travel management business from the back office services business; building a strong presence in the firm's key markets of North America, continental Europe and South East Asia both organically and by acquisition; expanding its activities in the US; designing, building and implementing a new IT system that would allow it to fulfil international travel planning demands; and eventually listing the company on the London Stock Exchange.

  25.  The length of investment period also allows the Permira funds to back substantial and challenging capital expenditure investment programs. In mobile satellite business Inmarsat, for example, the Permira funds along with a partner supported a $1.5 billion investment program culminating in the launch of new satellites. In one of the Permira funds' most recent investments, the Hungarian chemicals business Borsodchem, the core of the investment thesis is built around a €500 million capital expenditure program that will considerably increase the firm's production capacity.

  26.  Developments in the industry, such as growing fund sizes or deepening credit markets, have not affected our fundamental long-term perspective on the investments the Permira funds make; the developments have not had any bearing on the speed with which change can be successfully implemented in a business.

To what factors, including the macroeconomic context and position in the economic cycle, is the current rise of private equity attributable?

  27.  In Permira's view, the recent rise in the scale of private equity activity is attributable to both supply side and demand side drivers.

  28.  On the supply side, there has been a big increase in the appetite among institutional investors globally for investment in private equity. The highly positive experience of longstanding investors such as pension funds of the strong performance produced by the asset class has been reflected both in the increases in fundraising and the increases in allocations. This has been supplemented by an expansion in debt markets, with the effect of making it possible to structure larger transactions than in the past.

  29.  On the demand side, there have been a number of important long-term drivers that have combined to provide productive investment opportunities for private equity firms. In the first instance, private equity has shown itself to be a capable part of mainstream merger and acquisition activity that can support the ongoing process of corporate deconglomeration. Private equity buyers have the preparedness to take on business challenges, such as turning around underperforming or unfocused companies, which many other businesses lack.

  30.  Similarly, private equity is equipped to play a role in distressed business situations and in helping disentangle family and succession issues where other sources of finance are not relevant. This has created a number of our recent investment opportunities. For example, the Permira funds invested in the heavily loss-making German pay-TV business Premiere, helping to dramatically turn around its performance and restore it to profitability.

  31.  Furthermore, European integration, globalisation and the speed of technological change have intensified competitive pressures on business. This, in turn, has expanded the demand for the sort of long-term investment and support provided by private equity. In effect, private equity firms are specialists in helping businesses through difficult periods of profound change.

What are the economic advantages and disadvantages of a firm being owned by private equity funds as opposed to being publicly listed?

  32.  Private equity benefits the UK economy by building strong, sustainable and fast-growing businesses.

  33.  Permira believes that the key feature of private equity that makes it a positive agent for change is the attractive form of governance that it represents, particularly in comparison with public markets. It offers:

    —  Shortened lines of communication between shareholders and managers.

    —  The ability to implement major change programmes and long-term strategic initiatives away from the shorter-term pressures imposed by public markets.

    —  Easier access to further funding.

    —  Close alignment of interest between active owners and highly incentivised management.

  34.  Permira has repeatedly demonstrated its value as a catalyst for positive change in businesses and industries going through periods of rapid transformation. This is relevant both for businesses that have been publicly listed and for those that have been part of a larger conglomerate or privately run.

  35.  In the media sector, for example, where technological change is having a major impact on business models, the Permira funds have invested in companies such as Premiere and Prosiebensat1 in Germany, and SBS Broadcasting in the Netherlands. In the telecommunications sector, similarly impacted by technological change, the Permira funds have backed Inmarsat in the UK, Intelsat in the US, and debitel in Germany.

  36.  In the consumer sector, where changing patterns of consumer spending and customer expectations have created substantial pressures on established businesses, the Permira funds have invested in Homebase and Birds Eye in the UK, Cortefiel, Dinosol and Telepizza in Spain, and a number of others in related areas. The common theme across all these sectors has been the pressure they felt from forces of change, whether international competition, technology or shifting consumer behaviour.

  37.  Permira believes that it has also demonstrated its value in backing businesses that are positioned to grow very rapidly, either organically or by acquisition. Recent examples include fashion retailer New Look, which has opened a million square feet of new retail space and created more than 3,000 new jobs since acquisition; budget hotel chain Travelodge, which opened 104 new hotels and created more than 2,000 new jobs under the Permira funds' ownership; bingo business Gala, which the Permira funds and partners backed in its acquisition of bookmaker Coral to create one of Europe's leading gaming businesses and one of the UK's largest private companies that now employs more than 18,000 people; and Italian boat builder Ferretti, which was backed by the Permira funds in making more than ten acquisitions to become a world-leading luxury boat businesses.

May 2007

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