How A Private Equity Firm Brought About The Death Of British Steel
https://www.forbes.com/sites/france...bout-the-death-of-british-steel/#5bc5c7d74824
The iconic U.K. steelmaker British Steel has collapsed into insolvency. On Wednesday May 22 the High Court in London forced it into compulsory liquidation, the U.K. equivalent of
Chapter 7 bankruptcy, after the U.K. government refused to advance it £30m ($38m) to cover short-term financing needs.
There had been rumors for some time that the company was in trouble. Three weeks ago, the U.K. government gave it
an emergency loan of £120m ($152m) to enable it to pay carbon dioxide emissions dues to the EU. British Steel, along with other U.K. manufacturers, has been shut out of the EU’s carbon emissions trading scheme since December as part of EU preparation for no-deal Brexit. It seems the U.K. government thought it was reasonable to help British Steel pay the dues arising from its own failure to get a Brexit deal through Parliament.
But the additional £30m ($38m) was a step too far. In an official statement, the Business Secretary, Greg Clark,
said that the request would break EU state aid rules:
'The government can only act within the law, which requires any financial support to a steel company to be on a commercial basis. I have been advised that it would be unlawful to provide a guarantee or loan on the terms of any proposals that the company or any other party has made'.
He had good reasons for his decision. On Wednesday May 15 - one week before its failure - British Steel was scheduled to complete the acquisition of French steelmaker Ascoval for a cool £40m ($50.6m). It couldn't afford this, so it
approached the U.K. government for help. This was of course refused. But according to the French daily
Le Monde, the acquisition went ahead anyway. Ascoval is now owned by Greybull. So in effect, Greybull had asked the U.K. government to fund its acquisition of a French company. It takes some chutzpah to ask your government to pay for your foreign spending spree, and even more to pull the plug on the home business when it refuses to do so.
There isn’t much doubt that it is Greybull that has pulled the plug. British Steel’s accounts show that it is heavily indebted… to Greybull.
In May 2016, Greybull, via an opaque company called Olympus Steel registered in the British tax haven of Jersey, advanced British Steel £154m ($195m) at an interest rate of 9% over six-month sterling Libor. Sterling Libor is currently just under 1%, so the effective interest rate on the loan is nearly 10%. British Steel also has loans from banks at 3% over sterling Libor. The company’s owner is extracting cash at a rate 6% higher than that charged by banks.
The accrued interest on the loan from Olympus Steel will be capitalized after 36 months, and six-monthly thereafter until the maturity date of the loan, which was originally November 2019 but last year was extended to November 2021. So the first interest capitalization would occur at the end of this month. As British Steeel is now in liquidation, Greybull stands to lose not only the loan but also the interest on it. No wonder it was keen on the U.K. Government bailing it out.
But what was the purpose of this loan? Well, British Steel’s predecessor company, Longs Steel, was deeply insolvent. It recorded a loss of £122m ($154.4m) in March 2016. As it was at the time a wholly-owned subsidiary of Tata Steel, it had no shareholders’ funds of its own. So, when it was spun off by Tata, it had negative equity of £122m, partly covered by £74m ($93.67) of loan notes from Tata. When Greybull acquired Longs Steel for a notional £1, it wiped the negative equity (including Tata’s loan notes) and advanced £154m ($195m), representing the costs of acquisition plus a substantial injection of additional funding. The newly formed British Steel spent this on plant and assets, much of it bought below book value. The eventual negative goodwill recorded on British Steel’s books due to Greybull’s acquisition of Longs Steel amounted to some £50m ($63.3m).
Negative goodwill is a double-edged sword. It can indicate that the acquirer has gotten itself a bargain: if it can extract more value from the assets than the discounted purchase price, then it is in the money. This was no doubt Greybull’s hope. And not just for British Steel: in 2017, Greybull bought a Dutch steelmaker, FNsteel, for £15m ($19m) less than its book value. This too ended up on British Steel’s books.
But negative equity is also a warning. A company whose market price is far below the book value of its assets is deeply troubled. And assets sold off in a fire sale may or may not be worth more than the acquirer pays for them:
caveat emptor, and all that. Growing through heavily discounted acquisition is a risky strategy. Many, if not most, of the companies purchased at a heavy discount will eventually fail. Many of the assets will turn out to be worthless. For companies that specialize in discounted acquisition, extracting value as fast as possible is a survival strategy.
This is Greybull’s business. It buys deeply distressed companies. It says this is to turn them round, and to be fair it has had a few successes: for example, in 2010, it supported a management buy-out from administration (the U.K. equivalent of Chapter 11 bankruptcy) of Plessey Semiconductors Ltd, which is now a thriving business. However, too often Greybull’s strategy has amounted to milking its acquisitions dry then discarding them. Hence the very high interest rate on the loan to British Steel, and the “management charges” that have progressively drained the company of cash.
Greybull has
previously been involved in the failures of Monarch Airlines, the electronic retailer Comet and the supermarket M Local. Maybe I am cynical, but it looks to me as if Greybull targets troubled companies that have very large workforces, in the hope that governments - scared of the political consequences of allowing thousands to lose their jobs – will bail it out if it all goes wrong. In the case of British Steel, this strategy very nearly worked.
But the British Government knew Greybull’s record. Why did it allow this vulture to take on Britain’s second largest steelmaker?
Successive British governments have blithely assumed that a private sector solution is always best for a failing company. And it is true that private equity acquisitions can prevent, or at least delay, disastrous failures. If Greybull had not bought Longs Steel, Tata would probably have closed it down in 2016. Just as the private equity owners of
Maplin kept it going far longer than the company probably deserved, so Greybull preserved thousands of jobs at British Steel for three years.
But there’s a deeper reason too. British Steel was privatized by Margaret Thatcher’s Conservative government in 1988. It was a flagship policy. For a Conservative government to take it back into public ownership, barely alive, would be tantamount to admitting that the privatization strategy pursued by the “Iron Lady” was a terrible, terrible mistake.
Even now, the government is desperately trying to find a way of keeping it in the private sector. But there is little hope of a buyer. The Conservative government faces an awful choice: allow British Steel to fail, with the loss of up to 25,000 jobs, or swallow its pride and nationalize it.
