TPGs Private Equity Purchase of Myer Group and the Outcome of the IPO - Case Study Example

Running Head: A review of TPG’s Private Equity Purchase of Myer Group and the outcome of the IPO Student Name: Instructor’s Name: Course Name and Code: University: Date of Submission: A review of TPG’s Private Equity Purchase of Myer Group and the outcome of the IPO Introduction The private equity purchase of Myer Group by TPG has continued to exude increased debate on its viability; especially following the IPO of Myer Group. In the most common views however, the purchase was a good move for TPG. TPG (Texas Pacific Group), a private equity investment firm, purchased Myer Group from Coles Group at a cost of A$1.4 billion in the year 2006. After undertaking a considerable number of restructuring activities, including the installation and updating of new IT and logistics systems, the company was sold to the public through what was referred to as the largest IPO since the beginning of the credit crunch. By the end of the IPO, the Myer Group was worth A$2.1 billion, having sold 581 million shares at A$4.10 per share. One would therefore wonder; did TPG profit from the private equity purchase and the IPO? Was the company really worth investing in? The questioning is further triggered by the scrutiny of the huge tax bill that the Australian government issued TPG following the IPO. Despite all the reactions towards the private equity purchase and the IPO, the investment offered considerable returns to the investors and can therefore be considered a successful investment endeavor. This paper is an analysis of the private equity purchase and the Myer IPO conducted by TPG. Analysis of the private equity model The private equity purchase TPG made a major impact in the business sector through the acquisition of Myer Group, a large company operating numerous retail chain stores. The company purchased Myer Group at for A$1.4bn in 2006 thereby adding to the company’s investment portfolio. At the time of the purchase, Myer Group was making a profit of $60 million yearly (Ceoforumgroup, 2010). The company was bought from Coles Group which was struggling financially and was later acquired by Wesfarmers Ltd (Thomas, 2009). TPG greatly improved the company through changing various business systems including the logistics and information technology systems. This combined with increased manager motivation and the clearance of old stock increased the profit per year to $160 million per year. Following the purchase of Myer Group, a significant number of changes were implemented. According to the Myer CEO Bernie Brookes, the stores’ look was updated and new IT and logistics systems were installed. $150 million worth of distressed stock was cleared and there was a general cultural change within the Myers (Ceoforumgroup, 2010). The management has further been modified and the management reward systems adjusted in order to fit those of the private equity model. Apart from gaining in from the profits and the proceeds of the IPO, TPG had the opportunity to diversify its activities. TPG most definitely benefited from increased diversification following the purchase of Myer, whose business is entirely different from what other companies it owns concentrate on. There are several advantages associated with such diversification. Firstly, diversification allows a company to gain more through exploring different markets (Haslem, 2003). Myer Group for example gave TPG an opportunity to gain from the clothing and cosmetics market which the company ventured in thus incresing profitability. Secondly, it allows a company to spread its risks as noted by Haslem (2003). According to Sadler and Craig (2010), companies benefit from the fact that they can effectively cross-subsidize their various businesses with surpluses that are earned in their various investments in a manner that other firms cannot be able to thus increasing competitiveness. Diversification further provides a viable avenue for channeling underutilized resources within an organization while providing a new source of revenue (Sadler and Craig, 2010). The IPO After investing on the Myer Group for three years, TPG floated 581 million of the company’s shares in an initial public offering that aimed at earning A$2.6 billion if the shares were bought at the maximum possible price. Macquarie Group, Credit Suisse and Goldman Sachs were hired to manage the sale which was valued at $2.1 billion ($A2.5 billion) (Thomas, 2010). The investors TPG and Blum Capital received a return of A$1.8bn. The investors sold their entire stake (Thomas & Thieberger, 2009). 7.7 percent of the stake was held by the Myer management while the Myer family took 1.5% of the stake (Spencer, 2009. The shares were sold at A$4.10 each and this was considered as a pace setter for other companies that intended to sell their shares; given earlier fears due to the credit crunch (Thomas & Thieberger, 2009). According to Thomas and Thieberger (2009) however, this was less than what was initially expected from the sale. The value of the shares had been set between $3.90 and $4.90 during preparation for the IPO (Spencer, 2009) and Myer expected to sell at A$4.90. Paton (2009). The total value of the issued shares was 581 million shares which were expected to give the company a value of A$2.6 billion. A$2.1 billion was realized. Profitability of the private equity purchase and IPO The TPG private equity purchase was profitable to the company and was therefore a viable investment. Records indicate that the company was originally bought at A$1.4 billion. The IPO realized A$2.1 billion such that the gross income from the purchase was A$0.7 billion. In order to obtain the actual profits, the expenses incurred by TPG would have to be calculated. TPG apparently spent over A$370 million in the renovation of stores and in updating operation logistics (Thomas & Thieberger, 2009). The IPO charges amounted to $96.4 million (McNamara, 2010). The net profit gained can be calculated by subtracting these costs from A$0.7 which would result to A$0.2336 billion. There may be other hidden costs that may not be available to the public such that the net income identified above could reduce even further. The profits obtained from the IPO however did not meet the expectations of the owners; given that the shares were bought at only A$4.10 per share. Accordingly, the investment cannot be said to have achieved its full potential. The owners of the company originally expected that the shares would reach the maximum price of A$4.90 per share. The response from investors however made the company to sell the shares at A$4.10 per share. TPG would probably have made more income if it had operated Myer for a longer period of time in order to allow full recovery of the economy following the credit crunch. Presumably, investors were still uncertain about investing their money then. The potential profitability of TPG profits from the IPO was nearly curtailed by the Australian tax Office’s determination to tax the profits. According to Lattman (2009), the Australian tax authorities sought to recover $620 million worth of taxes and penalties from TPG following the Myer IPO. This was met by a lot of resistance and was said to be a hindrance to future investment in the country. Unfortunately for the authorities, the funds had already been transferred offshore by the time they were deciding to freeze the company’s accounts. The argument for taxation was that since private equity firms only purchase businesses for several years and then sell them at a profit, this should be counted as ordinary income and should therefore be taxed. Further, the authorities maintained that TPG’s structure of ownership was designed to benefit from Myer Group and then channel the proceeds to other countries without paying taxes to Australia. This was referred to as a tax-avoidance plot (Lattman, 2009). TPG has however insisted that it met all the tax requirements while operating Myer and taxes from the IPO were uncalled for. A review other private equity takeovers Various firms around the globe have enjoyed major benefits resulting from private equity purchases. Companies including Archer Capital, Blackstone Group, Apollo Global Management, CVC Asia and KKR have benefited immensely from their investments in private equity. The purchase of Hilton Worldwide by the Blackstone Group for example has increased the company’s revenue significantly. Hilton Worldwide’s makes an average of $8.162 billion per year in revenue. In addition Blackstone has either acquired or invested in other companies including GSO Capital Partners, Haynes International, AMF Group, American Axle, Financial Guaranty Insurance Company and SunGard among other companies. Blackstone recorded $113 million in revenue for the third quarter of 2010, up from $95 million in the third quarter in 2009 (Jones, 2010). The 19% increase in profits indicates that the company is getting considerable returns from its investments. KKR (Kohlberg Kravis Robert) has undertaken a significant number of buyouts including the purchase of American Re Corporation, Bank of New England, RELTEC Corporation, Toys R Us and Shoppers Drug Mart among others. The Shoppers Drug Mart IPO in 2002 returned KKR’s investment in the retailer while retaining 78.3% voting power along with its partners Ontario Teachers' Pension Plan Board, Bain Capital Partners and Charlesbank Capital Partners (Chain Drug Review, 2001). The IPO aimed at obtaining $600 million (Canadian) through the sale of 30 million shares at between $18 and $20 (Chain Drug Review, 2001). Like TPG however, KKR had to offer a lower price for the shares than what had been predicted. According to CBC News (2001), the shares fluctuated between $17.35, $16.85 before finally selling at $18 per share. Despite the gains associated with private equity purchases however, some companies have also made major losses from their investments. Apollo Global Management for example lost $365 million worth of investment following the high profile bankruptcy of Linens ‘n Things, a US retailer that the company had invested (Merced, 2008). Archer Capital has also been experiencing losses in the recent years; with the latest financial reports indicating that the net profit after tax fell from $9.2 million to $5.5 million (LeMay, 2010). Advantages of private equity model The investment decision made by TPG may present a significant number of benefits to the company and its shareholders as follows: To begin with, private equity firms are likely to invest highly in determining the viability of their potential investments. According to Caselli (2010), these companies make use of experienced research teams to identify and assess risks that would otherwise go unnoticed and thus lead to poor outcomes upon investment. Private equity firms employ skilled management teams because they are more profit oriented (Bierman, 2003). As a result, they are likely to be more profitable as opposed to public firms. It is also notable that such firms are likely to hire young, qualified and enthusiastic employees who are likely to be more effective in bringing in fresh and valuable ideas (Caselli, 2010). This promotes the company’s profitability potential such that private equity firms are highly desirable for investors. Private equity firms work outside the auspices of the public eye such that they are not expected to follow the same rigorous transparency standards associated with public firms (Caselli, 2010). Furthermore, they may not endure government scrutiny as public companies would. This allows private equity firms to operate efficiently. This further promotes speedy decision, which in turn increases efficiency (Seidman, 2005). This can be evidenced by the changes that have been effected at Myers with an aim of promoting efficiency. An example given by the CEO, Bernie Brookes is the clearance sale that led to the disposal of $400 million worth of goods for only $150,000 million (Ceoforumgroup, 2010). This was intended to eliminate the old stock so as to make room for new supplies. Such a decision would have been difficult to undertake if the company was publicly owned. It was a good decision however because it would improve earnings from $62 million to $160 million per annum. The span of control which only involves about thirty stakeholders made the decision easy to implement as compared to a public company where lengthy decision making procedures are involved (Ceoforumgroup, 2010). A shorter ownership chain that characterizes private equity firms ensures that partners can take an active role in running the company (Povaly, 2007). This not only gives them a high degree of control but also gives them an opportunity to contribute valuable ideas towards the running of the company and thereby determine the direction of the firm. This means that the management’s incentives are well aligned with those of the shareholders. Cumming (2010) notes that most private equity firms are very keen on ensuring that their managers are well paid. Additionally, employees are well remunerated thus increasing the level of motivation. It has been repeatedly proved that motivated employees generally perform better because they feel like part of the company (Sadler & Craig, 2003). Such firms also invest highly on training and development of employees. Accordingly, they are expected to perform better and are therefore viable forms of investment. Most private equity firms give carried interest to managers and employees. Carried interest represents a portion of profits that are awarded to the managers and employees (Povaly, 2007). These are effective in motivating managers and employees to perform better which could lead to desirable results to the investors. Carried interest is seen as a way of taking money from shareholders but indeed plays a big role in increasing efficiency. Generally, private equity firms tend to be more efficient and profitable. This results from the use of skills management and constant motivation of employees which keeps them efficient. The direct involvement of owners also plays a vital role in ensuring that the firms effectively address the objectives of the owners. Disadvantages of the private equity model The disadvantages associated with the private equity model as follows: Emergence of conflict of interest has been identified as the most prominent disadvantage of the private equity model (Povaly, 2007). This is related to the freedom of control possessed by the owners in the running of the firm. Their priorities are therefore expected to clash with those of the managers which could result in undesirable outcomes (Bierman, 2003). The profitability of the firms may be affected such that they could end up making huge losses or lead to liquidation. In Myers, the operations of the organization were highly affected; a factor that led to a 60 percent change in the management (Ceoforumgroup, 2010). The environment following the change of ownership was challenging for most managers. Private equity firms normally have shorter investment horizons. Caselli (2010) notes that they rarely focus on long-term growth and the owners in most cases sell the businesses after a few years in order to gain profits. This can be ascertained by TPG’s purchase of Myer which was sold three years later having been purchased in 2006. While such a move benefits the investors, it could be detrimental to the company due to the frequent changes in the management structures and power controls. The private equity model is largely affected by lack of transparency (Caselli, 2010). As identified above, such companies are only set up with a view of making profit over a short period such that owners may engage in unscrupulous trading practices so as to get profits. This could in turn affect the company’s profitability potential. The fact that they are less accountable to the workforce and are not required to publish their activities to the public leads to a considerable lack of transparency which could be harmful to the company’s future welfare (Bierman, 2003). A notable disadvantage of the private equity model is greater leverage which makes companies more vulnerable to market risks and economic downturns. Haslem (2003) notes that because of the huge degree of influence and control from the owners, managers may not have enough authority to make management decisions. Poor decision making among the owners could therefore lead to jeopardy and eventual liquidation. A private equity model risks job destruction by seeking to extract value (Caselli, 2010). This means that major restructuring is likely to occur once a company has been purchased through private equity as the owners seek to identify the best way to increase profits. Examples could include the sale of assets, scrapping of pension programs and increased debt among other changes. As noted in the case of Myer, there were significant changes in the management leading to the exit of some members of staff. The changes at Myer were however reasonable as they led to increased efficiency later. Conclusion The private equity model applied by TPG to purchase Myer can be considered a viable move. This discussion effectively establishes that the eventual sale of the company was profitable to the investors, which definitely indicates that the project was worth the investment. According to reports from the purchase and the IPO, TPG managed to obtain a gross return of A$0.7 billion. This is an indication that TPG’s shareholders had made a well calculated move by the time they decided to sell the company. The advantages of the private equity model are prominent in this purchase which led to significant positive changes at Myer. It is notable that the powers held by the directors played a significant role in ensuring that critical measures were taken; a factor that may not be present in public companies. The clearance of stock at a loss and the huge investment in IT logistics for example signify the owners’ willingness to take risk with a view of making profits in the future. The employment of well qualified managers and the review of their benefits were bound to increase motivation thus leading to increased profitability. All these indicate how direct control by the investors could be advantageous to the company. The model however was not without limitations as various disadvantages could be identified. Firstly, it was difficult for managers to adjust to the increased involvement in the business which led to the replacement of some managers. The risk of failure due to the short duration of ownership before Myer was sold could also lead to disruptions in the management thus affecting productivity. Overall however, TPG highly revolutionized Myer Group; given that its profitability rose from $62 million per year to an annual profitability of $160 million. The private equity model is therefore an efficient method in enhancing business performance and profitability. Word Count: 3002 References Bierman, H. (2003). Private equity: transforming public stock to create value. New York: John Wiley and Sons. Caselli, S. (2010). Private Equity and Venture Capital in Europe: Markets, Techniques, and Deals. Salt Lake City, UT: Academic Press. CBC News (2001). Shoppers Drug Mart shares off on first day of trading. 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