Prem Sikka: British Steel crisis shows dangers of private equity

Greybull Capital has been associated with a string of bankruptcies but is financially healthy itself.

Steelmaking is a crucial sector for all industrialised economies. It was privatised by the Conservative government in 1988 and has since stumbled from one crisis to another, culminating in the appointment of liquidators for British Steel Limited (BSL).

Some 5,000 jobs are directly under threat, as well as another 20,000 jobs in the supply chain. The roll-on effect on the sector and local economies could threaten tens of thousands of jobs.

Private equity wreaks havoc

The latest crisis at BSL began in 2016 when Tata Steel sold the company to Greybull Capital, a private equity entity, for £1.

Government should have seen the dangers as private equity is the equivalent of Dracula to blood banks. Greybull has been associated with a string of business bankruptcies.

For example, in 2012, it bought electrical retailer Comet for £2, but a year later it entered administration.

In 2012, it acquired Rileys, snooker halls and sports bars, and by 2014 it ceased trading.

In 2014, it acquired Monarch Airlines and by 2017 it entered administration, leaving 860,000 passengers stranded.

In 2015, Greybull bought M Local convenience store chain from Morrisons and it was closed in 2016.

Greybull did financially well and has little difficulty in securing resources. This invites a brief overview of the business model of private equity.

Financial engineering and asset stripping are central to private equity business models.

It invests little in the share capital of the acquired company. Instead, it saddles companies with secured loans.

These are provided by friendly banks and intragroup entities, often located in offshore tax havens which do not levy corporation tax on profits made outside that particular jurisdiction.

The interest payments qualify for tax relief in the UK and reduce tax liability of the company.

This enables the owners to extract high returns from the business in the form of interest payments.

When the financial rug is eventually pulled, the owners and friendly banks ranking as secured creditors walk away with most of the proceeds from the sale of assets, leaving next-to-nothing for unsecured supply chain creditors.

The private equity business model has brought devastation to Bernard Matthews, Maplin, Toys ‘R’ Us and elsewhere.

British Steel – another victim

Greybull operates through complex corporate structures. BSL is owned by British Steel Holdings Limited (BSHL) which in turn is owned by Olympus Steel 2 Limited, a company incorporated in the secretive tax haven of Jersey.

There are numerous other related entities which adds complexities to understanding its financial affairs.

Greybull put £1 into the share capital of BSL in 2016. Soon afterwards, it was loaded with a loan of £154m from Olympus Steel, repayable in November 2019.

The interest on this is payable at the rate of 9% + LIBOR. The current LIBOR is 2.64%, so BSL pays its Jersey-based owner interest at the rate of 11.64%.

In 2017 and 2018, BSL paid interest of £17m per year on intragroup loans. Greybull also charged a management fee of £3m in 2018.

High cash extraction in difficult trading conditions and failure to modernise contributed to BSL’s financial downturn.

The 2017 pre-tax profit of £92m turned into a loss of £29m in 2018. BSL’s cash balance plummeted from £35m to £5.1m. Directors collected remuneration of £3,299,000 (2017, £2,007,000),

The losses and dwindling cash should have raised concerns about BSL’s ability to remain a going concern.

On 12 July 2018, BSL’s auditors Deloitte gave the company a clean bill of health and asserted that its financial statements were ‘true and fair’.

In relation to going concern, Deloitte said: “we have nothing to report in respect of these matters”.

Deloitte collected £475,000 in fees from BSL and its parent company, including £66,000 for tax and other consultancy services.

The 2018 collapse of Carillion raised concerns about the inclusion of dubious intangible assets in the company’s balance sheet.

This has not resulted in any change to accounting practices. BSL’s 2018 balance sheet includes £4.3m for “software and development costs”.

This is imprudent as the software is business specific and unlikely to be of much use to anyone else.

A prudent practice would have been to expense it, which would have resulted in a higher reported loss and possibly greater urgency for scrutiny of BSL.

Whatever the outcome of BSL insolvency, Greybull is likely to recover most of the debts due to it. Some £331m is owed to supply chain creditors and HMRC who are unlikely to recover anything substantial.

The arrangements by Tata Steel and The Pension Regulator (TPR) before the sale to Greybull safeguarded most of the pension rights accruing to employees, but the accounts of BSHL show a deficit of £46.5m on three other pension schemes operated by the group.

How safe are these schemes and how is the deficit going to be addressed?. Hopefully, the regulator will clarify.

The collapse of BSL once again highlights the dangers of private equity and shareholder-centric model of corporate governance.

The government has no effective industrial strategy and has been content to leave everything to shareholders, directors, auditors, asset-strippers, takeovers and merger bazaars.

Without major reforms of corporate governance and insolvency more disasters are inevitable.

Prem Sikka is a Professor of Accounting at University of Sheffield, and Emeritus Professor of Accounting at University of Essex. He is a Contributing Editor for Left Foot Forward and tweets here.

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8 Responses to “Prem Sikka: British Steel crisis shows dangers of private equity”

  1. Tom Sacold

    The British Steel crisis clearly demonstrates the way ‘green taxes’ such as the Climate Change Levy and the EU’s Carbon Emissions schemes damage workers jobs

  2. NHsgp

    Throw some more jobs on the scrape heap to the altar of the Greens.

    100 million fine by the EU

    Who needs taxes when you can fine people and companies, making them bankrupt.

    After all, some has to pay the price for the socialist asset strippers running a pension ponzi.

    So Prem, why are pensions off the balance sheet?

    Isn’t that accounting fraud?

  3. nhsgp

    How safe are these schemes and how is the deficit going to be addressed?. Hopefully, the regulator will clarify.

    Perhaps you will clarify the plans for the public sector schemes?

    Civil servants, 1,600 bn pound deficit

    State pension, 8,000 bn pound deficit.

  4. peem birrell

    Ta ta steel.

  5. Patrick Newman

    Tom, it is so obvious you are no socialist. Just a foot soldier for the Faragists!

  6. Peter Burgess

    The demise of British Steel is a pretty sad state of affairs. The asset stripping associated with private equity is a very profitable scam enabled by financialization … financial engineering, offshore jurisdictions, ineffective audit and oversight, and so on. Professor Sikka sets out all of this very well.
    But there is something else that bothers me as well. It looks like the writing was already on the wall when Tata walked away from the company. Tata has a lot of management competence but they are not miracle workers and heavy engineering in Britain has been in decline for a very long time with totally inadequate investment in the sector.
    While I am very much pro-worker and decent wages, benefits and working conditions, there is also the problem of work rules and union imposed inefficiencies. When I was close to the steel industry (in the 1960s and 70s), productivity in the US steel industry was many times what it was in the UK. Of course, the US industry is a shadow of its former self as well in spite of this productivity.
    The underlying obscenity is that private equity and asset stripping puts pensions and other earned benefits of workers at risk and the law allows this.

  7. Rupert Pitt

    Well explained. The important bit is that the owners Greybull loaned British Steel £154 million through Olympus Steel, I assume owned by Greybull, at an interest rate of 11.54%. in one year BSL paid £17 million in debt repayments to it’s owners Grebull. Greybull also collected £3 million in “management fees”. So at a time when the company was struggling it had to pay £20 million to it’s owners who had paid £1 for it.

    The owners Greybull were therefore taking a lot of money out of a company they owned when it was struggling. They had loaded the company with debt so they could collect interest payments and would also be assured of recovering their loan as secured creditors.

    It is time for reform.

  8. steve

    New Labour received donations from private equity tycoons despite trade union objections on the grounds of the track record of asset-stripping.

    Any chance of the LP closing the loop-holes if elected to government? This has got to be doubtful in view of Blairite dominance of the PLP.

    So what’s to be done? The only chance for the employees is an Upper Clyde Shipbuilders-style work-in with a national campaign built around it. To prevent further loss of support a weak Tory government will be compelled to act. But if the campaign doesn’t happen the steel communities will go the way of the ex-mining communities – plagued by drugs, alcoholism, ill-health and despair.

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