Who's next for private equity bidders?

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The Independent Online

"Bigger is better in private equity," was the conclusion of a meeting of some of the industry's greatest minds in Davos last month. And as if to prove that, along pops Blackstone, CVC and Kohlberg Kravis Roberts to have a tilt at J Sainsbury. A successful bid for the supermarket chain would set a new private-equity record in Europe and raise the bar for all future deals.

Analysts at ABN Amro believe an acquisition in the region of €50bn "looks achievable". That makes it open season for the long list of cash-rich, asset-backed FTSE 100 companies that tick the boxes on private-equity shopping lists. The eight prime private-equity bid targets presented by The Independent below are but the pick of a big bunch that also includes the publiser Reed Elsevier; Home Retail Group, the owner of Argos, and even AstraZeneca, the pharma giant.

What financial buyers are after, according to Roger Cursley, at Investec Securities, is "pretty predictable cash flow and solid, rather than necessarily growing, businesses that can withstand a lot of leverage". He adds: "There's been a move towards having asset-backed businesses with strong brands and good visibility. Two years ago, when private equity was focusing on retailers, the industry was just following cash and not really looking at asset backing deeply enough. That posed risks from the level of operational leverage. Now it has got a little more conservative, hence the interest in infrastructure and utilities. Take Sainsbury's - the economy can dip without wiping out demand for food."

WM Morrison

Within milliseconds of the news that Sainsbury's was officially in play, attention turned to Morrisons. Like Sainsbury's, Morrisons looks tasty, both in terms of the potential for a profit recovery and the amount of freehold property it owns. In fact, Morrisons owns almost twice as much freehold property as Sainsbury's, with close to £7bn on its balance sheet according to some estimates.

Although Sir Ken Morrison believes this amount of property helped to carry the group through its toughest times, the prospect of all that money on offer from potential sale-and-leaseback deals is a tantalising one for prospective financial bidders. Plus, Sir Ken's impending retirement as chairman could prove the catalyst for a bidder to pounce.

Unilever

Many private-equity groups consider the Anglo-Dutch consumer products giant to be the ultimate prize. Unilever has a larder full of brands that throw off steady, if unexciting, cash flows. Away from the public eye financial owners would not have to worry about growing the group's top line and could instead use its free cash-flow yield of 9 per cent to pay down debt.

The company would be easy to break up because it splits neatly into divisions, from its food arm to its home care business. Indeed, rumours that the private equity industry has Unilever in its sights swept the market only last week, buoying the group's enterprise value, including debt at equity, to just north of £25bn. Despite that, the stock trades on an undemanding 14 time earnings.

Pearson

The publisher of the Financial Times is another one on KKR's radar. The group has three legs to its business but is dominated by its educational publishing arm, raising questions marks over its financial publishing business and its Penguin books arm. Both of these have few synergies with the education business and would be considered trophy assets to any buyer, making Pearson an easy buy-and-break-up target for private equity. It is also under-geared, leaving further room for a takeover. Furthermore, Marjorie Scardino, Pearson's chief executive, has just turned 60, so her days in charge of the company may be numbered. Her successor may be more willing to open talks with a prospective suitor.

British Airways

The bid for Australia's national carrier Qantas from Texas Pacific Group and the investment bank Macquarie focused the spotlight on British Airways. Analysts believe the strategic rationale is simple: despite its dip in profits it generates strong cash flows and rules the roost at the world's No 1 traffic hub.

The recent agreement with the unions on its whopping £2bn pension deficit removed a potential poison pill. The main caveat would be that prospective bidders would need to be UK-domiciled, given that BA's lucrative bilateral flight agreements with foreign states such as the US and China bar a non-UK company from acquiring more than 50 per cent of BA, but that still leaves plenty of private equity cash to play with.

Experian

The only reason why this credit-checking business did not succumb to a private-equity bid when it was hidden inside the GUS conglomerate was because the company's directors felt that shareholders would do better from a deal if Experian was spun off first. Hence, it has already batted off some private equity attention.

Experian offers financial buyers the prospect of a quick "flip" in the form of an American listing for its US business, which comprises the bulk of the company. It throws off cash - Merrill Lynch estimates Experian converts 90 per cent to 100 per cent of its net profit into cash - making it an ideal bid target for a private-equity consortium.

BT Group

BT Group has raced into view as a potential takeover target on the back of a number of private-equity backed telecoms deals in Europe. Blackstone purchased a 4.5 per cent stake in Germany's incumbent operator Deutsche Telekom while Danish operator TDC was acquired by a consortium of venture capitalist firms including Apax Partners and Permira.

BT's strong cash generation and recurring revenue stream appeals to private equity companies that might also fancy breaking up the operator to create value through the sale of its network, IT services or retail operations. However with a market capitalisation of more than £25bn, any attempt to take BT private would dwarf other private equity deals in Europe.

Scottish & Southern

Infrastructure assets were in vogue in 2006, and analysts believe the same will hold true for the year to come. One equity strategist tipped Scottish & Southern as a prime target for the big guns of private equity because it's "fairly cheap, very defensive and it's got some good brands in there. You could arguably run it even harder in private equity hands."

Not only does the group have strong asset backing but it also owns some unique assets in that it has the UK's largest proportion of hydro-electric electricity-generating capacity by far, plus the largest wind farm assets. This boosts its defensive appeal because it means that its profit margins get fatter even when the cost of power producing inputs such as gas, coal and oil are rising.

Ladbrokes

Ladbrokes has been seen as a leading private-equity target ever since the bookmaker was left as an independent business after the sale of Hilton Hotels last February. The operation has many of the characteristics beloved of private-equity firms. It is highly cash generative with solid, reliable earnings. It also has market leading positions in Ireland and the UK with attractive overseas growth opportunities - Italy, Spain, China, Turkey, Vietnam, are all works in progress.

Chris Bell, the chief executive of the betting shops chain, has so far resisted the temptation to cash in by going private. However, the world's biggest gambling group, Harrah's Entertainment, has succumbed to a buyout, and Europe's biggest, Gala Coral, is also in private hands. CVC is reportedly sniffing around, so how long before Ladbrokes follows suit? Now that would be an interesting bet for its financial betting operation to price up.

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