Using convertible unsecured loan stock (Culs) along with cash could help different types of deals break the impasse between existing shareholders and bidders.
In an example like the first failed bid for Debenhams in July by Blackstone, Goldman Sachs and Permira, where a fairly full price was offered but institutional shareholders were unhappy with the decision to take the company private in principle, those shareholders could elect to receive 20% to 30% of the bid in the form of carried interest instruments.
Where a target company's share price has fallen so low that institutional shareholders are unwilling to sell despite a nominally high premium, they could elect to take a much greater proportion of carried interest instruments. An example is 3i's failed attempt to acquire Nestor Healthcare. In this case talks were broken placed their pensions in the hands of a long-only equity fund manager have done so because they want to take on only conventional risk. Clients might not want private-equity exposure. It is the job of pension fund trustees to decide if they want to allocate their money to private equity, not the job of the conventional equity portfolio manager. And if trustees do want private-equity exposure, they will probably want private-equity experts to choose the deals for them, not long-only fund managers that only dabble in the sector occasionally.
For private-equity houses, too, the partial private structure has drawbacks. Essentially it is a compromise. It reduces public-to-private deals to only partially taken private deals and means that they have to share the profit with others.
Listing a security also inevitably requires some degree of transparency and reporting, although on the relatively lightly regulated Aim this would be only on a biannual basis.
A listed security with a value that can be seen at any time might also put some of the same pressure on the management team and private-equity sponsors to show upward-only performance that convenoff largely because 3i was unwilling to bid more than £3 a share and several institutions had bought into the stock at £6 to £7 a share. Here an approach that is more like a joint venture, where institutions elect to take 60% to 70% of the consideration in the form of a carried interest, could work.
What distinguishes Culs is that they enable institutional shareholders to participate in a public-to-private deal. As a form of hybrid capital they can also be used in conjunction with, or instead of, other financing instruments.
The size of the coupon might vary according to the precise role the security is playing in the financing of the deal. Culs could be replacing mezzanine finance in the deal and so a 4% to 5% cash running yield would be appropriate. Alternatively, it might be more appropriate to measure the Culs' yield against the yield on a target company's ordinary equity. So if a target's equity only yields 2% there is no need for the Culs to yield more. . "It is a clever way of trying to create an alignment of interests, which is always beneficial for the market," he says.
The partial private structure won't be ideal for every deal, every investor, or every private-equity house, but it isn't intended to be.
What it offers is flexibility and a way to ease the antagonism between institutional shareholders and PTP deal supporters by allowing the institutional shareholders to participate, creating new and possibly bigger opportunities.