Select Committee on Treasury Written Evidence


Memorandum submitted by The Blackstone Group

1.  INTRODUCTION

  1.1  Naturally, as the Private Equity industry has grown in the UK, so has people's desire to understand it. Blackstone welcomes the opportunity to contribute to the Treasury Select Committee and is committed to playing its part in increasing understanding of the industry.

  1.2  It is not in the industry's interests for private equity to be misunderstood, nor is it in the interests of the UK as a whole. Blackstone is hopeful that the current debate will help to clear some of the myths around the place of private equity in the UK's economy.

  1.3  This submission gives some background to Blackstone and explains its approach to private equity. It then turns to some of the general questions posed by the Committee. These general questions have also been addressed to some extent by the CBI and the BVCA.

2.  ABOUT BLACKSTONE

  2.1  It is important to bear in mind at the outset that every private equity company will have its own approach. Blackstone buys companies and builds them, often through strategic acquisitions, new investment programmes and organic growth. This long-term investment strategy creates jobs. The example of Southern Cross (see para 8.2) demonstrates how the value of such investments continue to be felt after Blackstone realised on its investment.

  2.2  Blackstone is an international investment and alternative asset management firm. It started as a firm specialising in Mergers and Acquisitions and rapidly became synonymous with private equity, although it has nine different business units globally. With a staff of over 760 it has offices in New York, Los Angeles, Boston, London, Mumbai and Hong Kong.

  2.3  Since 1987 the firm has invested in over 100 companies in a variety of industries, countries and economic environments. Blackstone opened a London office in August 2000 to better focus its activities in Europe.

  2.4  Blackstone's founders pledged to only invest capital in friendly situations and to support strong management teams. The founders also decreed that the firm would always put significant amounts of its own money into investments, thus aligning its interests with those of its investors. Blackstone also aligns the interests of its management teams by insisting on their personal financial involvement in the company. Thus the rewards are directly linked to the long-term success of those companies.

  2.5  The total enterprise value of all transactions effected up until March 1st 2007 was over $158 billion. To date, Blackstone has raised capital across five private equity funds (Blackstone Capital Partners I, II, III, IV, V).

  Since 2000, Blackstone has been a major investor in UK companies including United Biscuits, Tragus Restaurant Group, Center Parcs, Merlin/Madame Tussauds, Cineworld, Southern Cross Healthcare, Spirit/Scottish & Newcastle Pub Group, Savoy Group and LIFFE.

3.  IS THE CURRENT REGULATORY REGIME FOR PRIVATE EQUITY FUNDS SUITABLE?

  3.1  The regulatory environment for private equity in the UK is robust. The existing regime has overseen a substantial growth in private equity in the UK in a constructive and responsible manner.

  3.2  Private equity houses are fully regulated by the Financial Services Authority. The FSA's statutory objectives include the need to "promote efficient, orderly and fair markets" even-handedly to all regulated investment vehicles, including private equity.

  3.3  The FSA stated in a recent discussion paper that the current regulatory architecture for the private equity industry is "effective, proportionate and adequately resourced".[95] Blackstone agrees with the FSA that regulation must balance the needs of adequate investor protection with the need to foster an environment which is conducive to the growth and sustainability of the private equity sector.

  3.4  Blackstone welcomes the FSA's most recent paper on the private equity industry in which the regulator stated that the "current approach to supervising this market is broadly appropriate".[96] We support the FSA's acknowledgement that high leverage levels are not necessarily linked to lower credit and risk management standards. Further, we have confidence that two of the main areas of risk that the FSA identified (market abuse and conflicts of interest) can be managed effectively and we will work with the FSA to achieve this.

  3.5  In general, Blackstone has an ongoing dialogue with the FSA to ensure that any risks present within the private equity sector are thoroughly understood and managed in an appropriate manner.

4.  IS THERE SUFFICIENT TRANSPARENCY ON THE ACTIVITIES, OBJECTIVES AND STRUCTURE OF PRIVATE EQUITY FUNDS FOR ALL RELEVANT INTERESTED PARTIES?

  4.1  Blackstone supports Sir David Walker's aim of establishing a voluntary code of compliance regarding new standards of disclosure and valuation. We believe that such a code, introducing a more standardised level of disclosure, will be in the interests of the private equity industry and all its stakeholders. David Blitzer, Blackstone's UK Managing Director is sitting on David Walker's working group—the review is expected to report in autumn 2007.

  4.2  The appropriate level and form of transparency is clearly linked to the nature of private equity's investor base. Blackstone recognises that the interests of private equity firms, the management and employees of private equity owned companies and regulators are all best served by having access to accurate and timely information.

  4.3  Effective communication with investors is a high priority for Blackstone. The Investor Relations Department is in constant communication with investors, face to face and on the phone. All Blackstone's investors have access to detailed, real time information on the performance and strategy of the companies in the funds' portfolios.

  4.4  As well as ongoing daily engagement, Blackstone holds an Annual Limited Partner Conference during which CEOs are invited to present their company's performance and strategy. This provides an opportunity for investors to understand and question management's investment thesis and the growth strategy for the firm and the effect it has upon stakeholders.

5.  HAS THERE BEEN EVIDENCE OF EXCESSIVE LEVERAGE IN RECENT TRANSACTIONS AND WHAT SYSTEMIC RISKS ARISE IN CONSEQUENCE?

  5.1  Blackstone agrees with the European Central Bank's recent report that there are no current systemic risks posed by the growth of the private equity market. Clearly though there is no need for complacency. As financial markets evolve there is a need to remain vigilant and to adapt to changing investment environments.

  5.2  The amount of leverage has to be judged in the context of a businesses' ability to service its debt. This needs to be taken on a case by case basis as each business has different requirements based upon its business cycle. Blackstone's investments are based on a sophisticated understanding of both the macro-economic climate and the potential of individual markets. This approach has served us well—our record in the UK has been successful, both for our portfolio companies, its stakeholders and for our investors (a large proportion of which are pension funds).

6.  WHAT ARE THE EFFECTS OF THE CURRENT CORPORATE STATUS OF PRIVATE EQUITY FUNDS, INCLUDING BOTH THEIR DOMICILE AND OWNERSHIP STRUCTURE?

  6.1  In common with the rest of the UK's private equity industry Blackstone's limited partner structure is designed to limit the liability of investors and to ensure that the funds are transparent for tax purposes.

  6.2  The EVCA's 2006 benchmarking report identified a number of key features of the UK limited partnership structure which made it an attractive vehicle for private equity houses, including tax transparency for investors and the fact that international investors need no local permanent establishment in the UK.

  6.3  Blackstone's funds are managed by the firm's senior partners—the investors, as limited partners take no part in the management of the fund.

  6.4  There are internal procedures that must be completed before any investment is made. The first stage in this is the "Review Committee" which analyses the risks and benefits of a potential deal. The final decision about whether to invest in a given company is taken by the investment committee which is made up of Blackstone's Managing Partners.

7.  IS THE CURRENT TAXATION REGIME FOR PRIVATE EQUITY FUNDS AND INVESTEE FIRMS APPROPRIATE?

  7.1  The private equity industry does not make the tax code in the UK, it follows it. Just like the regulatory regime, the tax regime should be aware of changing domestic and international economic conditions.

  7.2  Concern has been raised over tax relief on debt. A key point here is that the tax deductibility of debt is available to all companies, not just private equity.

  7.3  As the Economic Secretary Ed Balls MP recently said, it is "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 ... 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."[97]

  7.4  The Treasury are currently reviewing the rules surrounding the use of shareholder debt where it replaces equity in some private equity deals. We are happy to work with the Treasury to ensure that the tax regime in this area works as intended.

  7.5  Private equity has a broader impact on the UK's economic health than may be immediately obvious. The industry's activity creates jobs across the financial services industry, in accountancy, law firms and the banking sector. The mobility of the industry is demonstrated by the international talent that private equity attracts to the UK. As the CBI have noted, this is a key reason for maintaining the competitiveness of the UK's tax and regulatory regime.

8.  ARE DEVELOPMENTS IN THE ENVIRONMENT AND STRUCTURE OF PRIVATE EQUITY AFFECTING INVESTMENTS IN THE LONG TERM?

  8.1  Typically, private equity investments are held over a 3 to 5 year period. This compares to an average hold period for stock across the FTSE 100 and FTSE 200 of 4 months.

  8.2  Blackstone's success comes from investing to increase the value of the companies in its portfolio. Our strategy is to invest in the long-term future of our companies, building on existing strengths and working with a committed team of management and employees. To date, Blackstone has followed a "buy and build" strategy in the UK which has seen companies continue to prosper after its investors have seen their return.

  8.3  For example, Southern Cross, acquired by Blackstone in 2004, has continued to prosper since it was floated in 2006. The company has best performing stock in the FTSE 250 to date this year and is the fourth best performing stock in the FTSE 250 since it went public on July 6th 2006.

  8.4  When acquired by Blackstone, Southern Cross had 12,000 employees. The company now has 41,000 employees, 30,000 of whom are care staff and nurses.

  8.5  While owned by Blackstone, Southern Cross acquired, built and refurbished care homes across the country and became the largest provider of care homes in the UK. The company now operates over 570 care homes and has over 28,000 beds, up from 7,754 beds at the time of acquisition in March 2004. Blackstone's role played a large part in consolidating the care home sector and raising the overall standard of care homes across the UK.

  8.6  Merlin Entertainments Group is another example of job creation. Since acquisition in 2005, Blackstone has focussed on growing the company organically and through strategic acquisitions. This has seen the Group's employment numbers grow from 789 to 1300 through acquisition and direct employment.

9.  TO WHAT FACTORS, INCLUDING THE CURRENT MACROECONOMIC CONTEXT OF POSITION IN THE ECONOMIC CYCLE, IS THE CURRENT RISE OF PRIVATE EQUITY ATTRIBUTABLE?

  9.1  The success of private equity in the UK is underpinned by a number of factors. The fact that many private equity funds now have long and successful track records means that the confidence in private equity as a viable asset class has grown among institutional investors and many of these investors have increased their exposure in this area.

  9.2  As pension fund managers have increasingly looked to access well-performing investment vehicles, private equity funds have come to play an increasingly significant, though as yet not widely recognised role, in helping restore the balance sheets of occupational pension schemes.

  9.3  The breakdown of investors in Blackstone's current private equity fund, Blackstone Capital Partners V, shows that public and corporate pension funds account for over 60% of the total capital committed.

  9.4  So while the investment base of private equity is naturally inclined towards institutions rather than individuals, the individual is still able to benefit from exposure to the fund's investment returns through their pension fund managers investing on their behalf. Thus the ultimate beneficiaries through both public and corporate pension funds include teachers, healthcare workers, law enforcement personnel, firefighters and a host of other public and private employees from all walks of life.

10.  WHAT ARE THE ECONOMIC ADVANTAGES AND DISADVANTAGES OF A FIRM BEING OWNED BY PRIVATE EQUITY FUNDS AS OPPOSED TO BEING PUBLICLY LISTED?

  10.1  The type of ownership that suits a company will depend on the nature and age of a business as well as its management's aspirations. This is why many firms switch from public to private ownership and back again. Center Parcs, for example, has seen periods under both types of ownership. In fact, five out of our six UK portfolio companies have had periods of private and public ownership.

  10.2  There are intense pressures on managers in both public and private companies. However, compared to public companies, private ownership involves a distinctly different relationship between the "investor" (the private equity fund) and the "investee" (the private firm). This is characterised by a streamlined reporting structure, which is made possible because of the narrow investor base and the subsequently closer relationship between the investor and investee. This enables alignment of the interests of owners and managers. A private equity investor will act as a business partner and help produce quick and effective decisions which reflect the long-term interests of the company.

  10.3  The need to act in the long-term good of the company may involve the need to forego earnings (dividend income) in the short-term. Typically, such a position would be unpalatable for the shareholders of a publicly owned company. A mature public company faced with the need to restructure, or undertake costly long-term investment, can find that the pressures of public status limits its ability to fulfil its potential. In addition to this issue of ownership, there are also regulatory requirements, for example the increasing weight of EU securities regulation and listings requirements on public companies.

  10.4  The Economic Secretary summed it up when he said: "From the point of view of the health of the British economy—no particular form of ownership is inherently to be preferred over any other ... The real issue for investors, for the health of the company concerned, for those workers whose jobs depend on the health of the company's success, and ultimately for the economy as a whole, is how effectively that ownership is exercised."[98]

11.  CONCLUSION

  11.1  We hope that this submission is useful in setting out The Blackstone Group's approach and in demonstrating that, alongside the industry, we are committed to improving the way that private equity communicates the benefits of its work to stakeholders.

June 2007









95   FSA Discussion Paper, November 2006. Back

96   FSA, Feedback on Private Equity Risks, June 2007. Back

97   Ed Balls MP, London Business School, March 2007. Back

98   Speech by the Economic Secretary to the Treasury, Ed Balls MP, London Business School, 8 March 2007. Back


 
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