A perfect storm of factors has pushed BT into a vulnerable position – and the vultures of private equity are circling. This month, the company’s shares sunk to their lowest in more than a decade after chief executive Philip Jansen suspended the company’s annual dividend due to the coronavirus pandemic.
This, combined with a commitment to spend £12bn to link up 20m homes to full fibre broadband, and a pension deficit totalling an estimated £9.8bn, has bred investor “angst”. Private equity is currently sitting on top of a record $2.5tn in “dry powder”, i.e. money waiting to be spent. An opportunistic purchase of BT during the current downturn has been portrayed by analysts as an excellent way to use up some of this cash. Jansen has reportedly advised Goldman Sachs to prepare a defence against a potential £15bn private equity bid looming on the horizon.
Given the politically fraught nature of such a deal, there’s no guarantee that it would go through. But if it did, it could spell disaster for the UK’s chances of ever rolling out full fibre broadband – something that has been repeatedly named as a political priority, but on which the UK still trails other countries.
“It’s not alarmist to say a private equity buy-out of Openreach would be very bad for the roll out of full fibre broadband,” says Luke Cooper, consultant researcher in the Conflict and Civil Society Research Unit at LSE. “If a private equity company did take over BT Openreach it’s hard to see how they’d be trustworthy partner for the government in the rollout.”
Boris Johnson backed a ‘full fibre broadband by 2025’ pledge as recently as July 2019, until industry figures called the proposal unrealistic. The promise is now full fibre and ‘gigabit-capable broadband’ by 2025, with £5bn committed in the latest budget to connecting up the country’s most isolated areas. At present, only 13 per cent of UK households have full fibre broadband and the UK is ranked a dismal 35th out of 37 countries by the OECD for the proportion of fibre connections in its overall broadband infrastructure.
This is largely a failure of privatisation. The selling off of BT more than 40 years ago didn’t halt the stream of public money to the company. Areas where market logic fails – where it’s too expensive or difficult to set up broadband, so companies don’t bother competing – are areas where government funding is solicited to “incentivise” companies to provide what is by any account, an essential modern-day utility. (The myth of competition falls down elsewhere too – in most of the country, the broadband market is dominated by a duopoly comprised of Openreach and Virgin.)
Research from the Department for Digital, Culture, Media and Sport shows that providers are competing for over 75 per cent of the UK’s broadband market, but mostly ignoring the rest. (The same report makes the case for a government-owned monopoly for faster broadband roll-out, by taking Openreach into public ownership.)
There is every reason to believe that BT being sold to a private equity company would exacerbate all of these problems. Private equity firms are infamous for loading companies with debt in order to pay less tax, sucking the profit out, and discarding the left-over husk. “It’s their business model, which is based on high-leverage, tax avoidance, sweating the assets, generally low investment,” says Prem Sikka, chair in accounting and management at Sheffield University. “At the end, they milk the creditors and that does not provide any stability whatsoever for the business.” This swathe of the global financial system has even been labelled “pirate equity“, for its barbarous approach to profit extraction.
“In the case of BT Openreach, I think there must be some salivating at the prospect of £5bn to be provided by the government,” says Sikka. He says the potential likelihood is that “the entity keeps the £5bn, keeps the assets that result from it, and then also collects the income stream from it as well”. Private equity is renowned for its opacity, and ability to obscure important financial information from view.
Sikka investigated the buy-out of poultry business Bernard Matthews by a private equity firm for the Work and Pensions Committee in 2017. He says that in the end, the business sold all the assets and dumped all the liabilities, “dumped the unsecured creditors, including the pension scheme, monies they owed to HMRC” and “walked off with all the loot”. He says this was the same pattern for Maplin Electronics, a UK chain that met its demise due to a financial model that tinkered operating gains into losses on the balance sheet in order to better enrich shareholders. On the retail side, Claire’s and Toys r Us represent other high-profile private equity flops.
Private equity funds have been on a buying spree across the retail, hospitality and travel sectors over the past ten years. At present, private equity companies are putting pressure on the UK government to allow companies owned by private equity firms to claim coronavirus business loans. The UK government is currently attempting to come up with ways to do so, as they are held to ransom over the prospect of tens of thousands more job losses.
Care homes in particular, are enticing to private equity. Will Hutton writes in the Guardian that this is because these businesses have lots of mortgageable property, meaning the companies can borrow billions to buy the companies, using the company’s assets to secure loans. Secondly, care homes have a regular stream of income, which allows the firms to “service the resulting debt offsetting it against tax”.
Private equity firms intentionally burden companies with debts in order to avoid paying taxes – showing up losses on the balance sheet even when they’re profitable. A quirk of the coronavirus business loans – worth up to £200 million – is that the taxpayer is liable for up to 80 per cent of the repayment costs if the business folds.
Given BT’s role in national infrastructure, the government would have the final say on any deal, but there’s no telling which way it would go. “I think they really need to look at what is good for the country and it can be good for the country to have asset-strippers control a vital part of the infrastructure,” says Sikka.
Of the UK government’s pondering over state-backed loans for private equity, the Financial Times editorial board writes: “Offering taxpayer money to an industry whose financial model is based in part on reducing the amount of tax it pays would be controversial at the best of times, and even more so today”. Allowing the sale a piece of vital infrastructure to the same industry – along with a £5 billion sweetener in taxpayer money – would prove equally controversial.