Jeremy Warner's Outlook: Private equity is targeting everything in sight. Are there no limits, or has it missed the boat?

Quoted companies are becoming more adept in playing private equity at its own game. The standard defence is to gear up through capital returns
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Further evidence of the takeover fever that grips the UK stock market came yesterday with news of a private equity bid approach for Kesa Electricals, owner of the Comet electricals chain in Britain and Darty in France. Whether anything comes of it - the board has already unanimously rejected the offer, saying it undervalues the company - remains to be seen, yet the emergence of another private equity bidder for a previously unloved stock is powerfully illustrative of some important themes.

One is the wall of private equity money seeking with evident desperation some sort of an investment home. Over the last year, a record quantity of money has been raised for private equity funds. With many existing funds still underinvested, there's a growing shortage of suitable investment opportunities. This in turns means that private equity houses must reconcile themselves to rather lower rates of return than they have previously been able to command.

In the last month or two, there has also been a pronounced increase in the cost of debt, and a possibly greater reluctance on the part of lenders to provide it. This increases the cost of the leverage on which private equity relies for the alchemy of its deals, and the level of equity that has to be provided to fund them. None of this is necessarily a problem if the pool of private equity money chasing a limited number of opportunities is as large as it is at present. It just means the returns are lower.

Yet the squeeze doesn't stop there. As equity markets and valuations march ever higher, that too reduces both the opportunities and the returns. What's more, there appears a growing reluctance among investors in publicly quoted companies to accept the private equity shilling, emboldening management to reject offers which once might have succeeded. The example set by Marks & Spencer in rejecting Philip Green's £4 a share has spawned a whole sequence of similar responses to the private equity calling card.

At the time, the M&S board was criticised by some investors for not allowing the due diligence Mr Green demanded as a condition of his bid. Its reason was a familiar one - that on examining the books Mr Green would have found all kinds of excuses for not paying the full £4, but some lesser amount which the board would then feel obliged to accept.

M&S's intransigence has paid rich rewards. Today, the shares change hands at 569p, encouraging others to take a similar stance when faced with a low-ball private equity bid. HMV and Kesa are the two latest examples of it. Expect Mitchells & Butlers to make the same stand if and when Robert Tzenguiz gets round to putting an offer on the table.

The greater resistance private equity is encountering from boards and their shareholders is mainly a cyclical phenomenon which dictates that investors are much happier to sell when shares are down in the dumps than when they are riding high.

Logic would dictate that it ought to be the other way around, but then there is no accounting for the herd-like instincts of the investment community. Quoted companies are also becoming more adept in playing private equity at its own game. The standard defence against private equity is these days for the company to gear itself up through capital returns.

Three years ago, the cult of equity was declared dead, and though they knew it made no sense, pension funds and life assurers, traditionally the UK's two biggest holders of equities, began to dump shares en masse. The buyers, such as they were, came from overseas, private equity, and, through buy-backs, companies themselves. Now the worm is turning again. Even among pension funds, there is some limited revival in appetite for equities. All this is making life more difficult for private equity than it was. My heart weeps for them.

Whatever happened to energy policy?

The Government's approach to energy policy can broadly be summarised as "let the market provide". For most industries, this would be welcomed as an outbreak of enlightened ministerial thinking. For energy, it's turned out to be just a dereliction of duty.

If there is one thing people ought to be able to rely on the politicians to ensure, it is reasonably priced energy for warmth, light, work and entertainment. Only national security might seem to rank higher as a priority for government.

Yet by relying so wholeheartedly on the market to provide, the Government is perilously close to failing in these duties. Just before Christmas, the South-east is said to have been within minutes of electricity blackouts. The present cold snap has prompted a similar shortage in supplies of gas, with National Grid being forced to warn big industrial users for the first time in its history that they may have supplies cut.

As in previous episodes of this type, Britain has been quick to blame Continental suppliers, who are accused of hoarding gas that could easily be sold at reasonable prices to us. The reality is that in times of plenty we've squandered our own precious reserves of North Sea gas. With these reserves now running out, we find ourselves short of both the storage facilities to cope with peak demand and the long-term contracts with gas importers to fill them.

Our immediate problems have been greatly exacerbated by the Rough storage facility in the North Sea being out of action due to a fire. Yet even if up and running, we'd still be in trouble. If the North Sea taps were turned off, Britain has sufficient storage to guarantee just four days' supply. In Germany, the equivalent number is 75 days and in France it is 60.

The situation recalls the Aesop fable of the Ant and the Grasshopper. The ant works hard in the withering heat all summer long, building his house and laying up supplies for the winter. The grasshopper thinks he's a fool, and laughs, dances and plays the summer away. Come winter, the ant is warm and well fed. The grasshopper has no food or shelter so he dies out in the cold.

As it happens, the present constraint on supplies should prove a temporary phenomenon. Belatedly, the industry is responding with investment in adequate storage and the setting up of long-term contracts with overseas suppliers.

Yet this rescue remedy will take time to kick in, and will in any case leave Britain's energy needs highly dependent on imported gas. One consequence of the "dash for gas" encouraged by profligate use of our North Sea reserves is that more than 40 per cent of Britain's electricity generating capacity is now gas-fired. The Government is in the midst of a renewed review of energy policy. The last stab at the problem three years ago was risible in its conclusions and prescriptions. This latest one surely must be some improvement. Then again ...

Goldman Sachs: an example to us all

Can the capital markets possibly get any more accommodative for the money-making machine that is Goldman Sachs? After another record quarter for earnings - up 52 per cent on the prior three months to an astonishing $2.48bn - this might seem as good as it gets, yet Henry Paulson, the chief executive, sees the potential for better still. Client activity remains high, he insists, and there are attractive opportunities everywhere.

Who's right? The unrelentingly bullish investment banker, or the prophets of doom who predict that a catastrophic unwinding of global trade and capital imbalances is about to bring the present phase of rip-roaring economic growth to a juddering halt?

For the time being, the money is with Mr Paulson, but as a Wall Street veteran he'll know that trouble always arrives from where you least expect it. Mr Paulson thinks the good times have a way to run yet, but he's fully prepared for an unexpected outbreak of the bad times too. Goldman Sachs lost its shirt in the bond market correction of 1994. It doesn't intend to make that mistake again.

j.warner@independent.co.uk

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