Jeremy Warner's Outlook: Private equity tilts at Sainsbury. That's good for shareholders, but what about the company?

Britain's gambling law: a terrible mess; John Thain is spot-on about AIM
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The Independent Online

Shares in J Sainsbury haven't been as high as they got to yesterday since the tail end of the 1990s. Yet it wasn't the company's recovery story which finally put them there, but confirmation, after a week of increasingly fevered speculation, that a consortium of private-equity players - including CVC, KKR and Blackstone - might be interested in bidding.

Shareholders are hardly likely to complain about that. Even poor old Sainsbury's, until recently widely thought of as a dog, is attracting the attentions of private equity now. Has something changed, or is private equity just desperate?

The truth is that, as a company, J Sainsbury needs a private- equity buyout like a hole in the head. What possible benefit could private equity bring to an enterprise which only so recently emerged from the sick ward? The answer scarcely needs stating. None whatsoever.

To the contrary, to mortgage this still weak and emaciated supermarkets group up with debt at this stage in its recovery will only condemn it to a permanent future of decline. Could private equity do any better with these assets than the present chief executive, Justin King? It is hard to see how.

The margin is still thin compared to peers, but that's only because Mr King has had to slash prices to keep customers loyal. Over the next year or two, margins should in any case recover markedly. That recovery is already in the price.

So if not the recovery, then what's the attraction? You don't have to look far. Embedded within Sainsbury, and for that matter Wm Morrison and Tesco too, is a substantial portfolio of freehold properties. The debt leverage used in the bid could fast be paid down by mortgaging this property off. Yet this would also lumber the company with a hefty ongoing rental bill, further undermining its competitiveness against Tesco and Wm Morrison.

Not that the buyers would care too much about that. A great deal of private equity is essentially just a conjuring trick, or rather an exercise in financial engineering. Move in, take the turn, move on and hope nobody notices that what's been left behind is a hollowed-out husk of a business with nowhere left to go. A number of German politicians have likened private-equity activity to a biblical plague of locusts. I wouldn't want to go that far, but it is easy to see what they mean.

Three years ago, you could have bought Sainsbury for less than half what would have to be paid today. The possible opposition of David Sainsbury and the rest of the Sainsbury family, collectively accounting for around 25 per cent of the shares, is not the reason it didn't happen back then.

Rather it is because three years ago, private equity was still not big and brave enough to do what even today would be Europe's largest private-equity buyout to date. Now hugely fashionable, the private-equity houses have money coming out of their ears. Continued, incredibly benign, credit conditions make highly leveraged takeover bids as easy as stealing candy from a child. The targets therefore become bigger, more numerous, and crucially, higher-risk. It's an accident waiting to happen, yet for the time being it is also the way of the world and it is hard to see what might stop it.

Even the descendants of J Sainsbury's founding fathers would be hard pressed to refuse if private equity bids big and high enough. Anything pitched at 550p a share or more will get the private-equity consortium through the door and it won't require much more for shareholders to take the money and run. David Sainsbury's "blind trust" has been a seller at much lower prices.

Next month he'll be back in direct control of his share stake, having last November given up his position in the Government. There's no reason to believe he's going to be sentimental about the holding. To the contrary, he may welcome the opportunity to realise it.

As for the publicly listed sector, its future looks increasingly bleak. As all the choicest assets are bought up by private equity and foreign investors, we are left with an eclectic mix of overseas mining stocks, dodgy software providers and online betting firms to invest our money in. All most vexing.

Britain's gambling law: a terrible mess

Manchester was this week named as the surprise choice for Britain's first supercasino. Locations were also named for a further 16 large and small casinos. Yet celebration among the anointed cannot cover up for the fact that the new gambling legislation under which these casinos are coming into existence is a hopeless muddle which heaps another lorry load of largely unnecessary regulation on an already highly regulated sector.

The Government's starting point on gambling seemed reasonable enough. As in so many other industries, globalisation and technology is turning the business of gambling on its head. The internet means that gaming no longer has to be location specific; for some years now it has been possible to offer it remotely from offshore centres. This has made gaming increasingly difficult both to regulate and to tax.

By allowing a significant expansion of the physical gaming industry, ministers hope to stem the inroads being made by online sites into Britain's gaming pound. That should make the industry both easier to control and to tax.

Yet the Government hopes to go further. By providing what is billed as a relatively liberal licensing and regulatory regime, ministers hope to make Britain a centre for remote gaming groups, rather in the same way that the light-touch regulation applied by the Financial Services Authority has helped to make the City into the world's leading financial centre.

Regrettably, it is unlikely to work that way with gambling, where tax is still the dominant determinant of where remote gaming groups locate themselves. However benign the law, it will make no difference at all as long as the tax regime remains so unfavourable. The Government has promised a "low rate of remote gaming duty". Take into account other taxes such as VAT and income tax on employees, and the effective marginal rate on remote gaming revenues in the UK is already more than 50 per cent. Many offshore centres can offer less than 10 per cent.

Participants at a gambling conference this week arranged by the City law firm Olswang were left in no doubt what the decision on location is likely to be while such a steep differential remains.

Nor, in any case, is the new gambling law benign. Rather, it is vague, confusing, open to interpretation, complicated and demanding all at the same time, a veritable honeypot for the lawyers. It is a curiosity of governments that legislation which masquerades as market liberalisation generally ends up only heaping yet more rules and regulations on hapless participants.

Britain has one of the lowest levels of problem gambling anywhere in the world. The old system seemed to be working remarkably well, even 40 years after it was put in place. Now why does it seem so inevitable that the new regime will only succeed in making things a great deal worse?

John Thain is spot-on about AIM

John Thain's criticisms of London's Alternative Investment Market have been dismissed in Britain as just sour grapes. Yet the scandal of the AIM-listed Torex Retail has made the point about lax standards of corporate governance and advisory diligence better than the chief executive of the New York Stock Exchange could ever have done. AIM is loudly cheered as a British success story. The reality is that it has been hugely successful in attracting listings and earning fees for advisers, but less so for investors. Over the past year, the market has gone nowhere.

j.warner@independent.co.uk

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