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Anyone wondering the real reason why so many UK companies may be about to be sold to private equity should consider the case of supermarket chain Morrisons.
Just prior to disclosure of the first bid approach earlier this year, Morrisons’ share price was 178p, compared with 186p five years ago. In other words, zero capital appreciation over five years. During that period, Morrisons paid out roughly 90 per cent of its net income in regular and special dividends. This is not capitalism, it’s liquidation on the instalment plan.
Why would any company do this? It’s simple: the UK has a pension and insurance company savings system biased in favour of dividends rather than capital appreciation. Indeed, the FTSE 100 has been the one of the poorest performing markets in the industrialised world in capital appreciation terms, rising just 14 per cent over the past 20 years.
But the vast majority of the FTSE’s entire return over the period was generated by dividends (120 percentage points of a total return of 134 per cent).
What is it about the UK ownership system that has led to this? On the pension side, it’s three features of typical funds: they have a finite life since they’re largely closed to new members; they’re very small, with an average size of £300m; and they are structurally risk averse. Insurers need to ensure their assets match long term liabilities, so they prioritise income in equity investment as it can be projected with more assurance than capital gains.
Investment decisions made with such priorities then shape the UK corporate behaviour. British management and boards are sometimes criticised for risk aversion. But this largely reflects the aims of their owners, which are accommodated through over-distribution of dividends. This also favours incremental projects rather than moonshots and disruptive technologies, one of the reasons the UK has so little exposure to growth and innovation.
This is the main reason UK companies are so cheap relative to their global peers and why they appeal to private equity: the average 2021 price-earnings multiple for the FTSE 100 is 13.0 times compared with 23 times for the companies in the MSCI World Index.
And after years of over-distribution and low growth, it is no surprise that company boards find themselves in an impossible situation when presented with a private equity bid or other offer — there is usually no credible growth plan to justify turning down a bid premium. And if there were such a plan and the board were to reject the bid, there is no deep reservoir of domestic equity capital to support their long-term growth.
No wonder, then, that the UK’s few global success stories, such as Ineos and Dyson, remain private while so many of its fastest growing technology companies go to the US for their initial public offerings. Nor that some of the UK’s best performing fund managers invest the substantial majority of their assets outside this country.
The UK needs a complementary alternative to private equity to reinvigorate its corporate sector, extend its time horizon and protect its businesses from further value depletion and loss of competitiveness.
The clue for where to find this lies in the investor base underlying private equity itself. Canada’s CPPIB, Ontario’s Ontario Teachers’ Pension Plan and Quebec’s PSP and CDPQ are representative examples from my home country.
These funds bring scale — $100bn-$500bn assets is typical (against an average UK pension fund size of $500m); an indefinite time horizon; and an appetite for, and capability to take and manage, risk with a view to enjoying long-term capital appreciation.
These are the deep-pocketed and long-term investors any large economy needs. We must start to create pension funds like these today if British capitalism is to have much hope of a thriving tomorrow.
The writer is co-founder of Ondra Partners