Jeremy Warner's Outlook: Rock must not be given away for nothing</i>

Private equity does the bare minimum; S&N bid defence hinges on BBH value
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The Independent Online

One of the curiosities of Northern Rock and now Paragon, which yesterday became the latest mortgage lender to hit the canvas, is that, despite their travails, they both apparently remain highly profitable. Northern Rock should make profits of around £450m this year, and there is good reason to believe the company is capable of making the same again the year after.

Likewise Paragon, whose share price collapsed yesterday after the buy-to-let lender said it may have to refinance its borrowing facilities with a rights issue, made record profits in the year to the end of September of £91m. Not withstanding the fall-off in the housing market, the chief executive, Nigel Terrington, is confident of making good money this year too.

Yet neither company is thought by markets any longer to be worth much, if anything at all. With Northern Rock, the reasons for this assessment are more obvious than with Paragon. Northern Rock's problems lie not in lack of profits, or even capital, but rather with a £30bn funding requirement, which, with markets as they are now, no one other than the Bank of England with the full weight of the taxpayer behind it is prepared to lend.

In these circumstances, anyone capable of getting the Government off the hook by providing alternative funding can have the company for nothing and thereby end up making a fortune. Unfortunately, none of the so-called "bids" for Northern Rock offers the Government anywhere near this prospect.

Outline details of the JC Flowers offer publicised yesterday look like no more than the polished banter of the snakeoil salesman. The American private equity firm holds out the temptation of £1bn of new equity, but actually that's not what Northern Rock needs. The need is for more funding, not new capital.

JC Flowers also promises immediately to repay £15bn of the Bank of England loan facility, but actually this isn't the problem either. The first £15bn of the Bank's exposure is fully backed by decent collateral and is comparatively easy to refinance on the same basis.

It is the balance, amounting to £9bn or more, which is the difficult bit. Furthermore, the refinancing of the first £15bn is, as I understand it, a facility that Citigroup and Royal Bank of Scotland are prepared to make available to almost any credible bidder. JC Flowers offers not so much a solution as a rip-off.

Sir Richard Branson's proposal isn't in substance any different. The intention of both is to take advantage of the Government's embarrassment so as to wipe out existing shareholders and have the spoils for themselves. There is no need for ministers to do this, other than through a perverse delight in seeing existing shareholders punished for all the embarrassment caused.

By agreeing to Flowers or Branson, the Government only transfers the Rock's value to new owners. How good is that going to look when it emerges that they've made billions at the taxpayers' expense? Much better to carry on running the Rock as a going concern.

Private equity does the bare minimum

Markets nearly always make better, self-correcting, regulators of societies and industries than politicians, and so it is proving with private equity. Six months ago, everyone was up in arms over an apparently unstoppable bandwagon of ever-bigger leveraged takeover bids by shadowy private equity players.

Today it all seems a lot of fuss about nothing, or, rather, the cause of it seems almost entirely to have gone away. The credit crunch has succeeded in bringing the leveraged buyout market to a halt far more effectively than any legislation might have done. Nor is there much prospect of a return to those heady days any time soon.

Yet the process of responding to public concern was already under way before the credit markets closed to private equity. Yesterday its efforts emerged blinking into the cold light of day in the form of Sir David Walker's "Guidelines for Disclosure and Transparency in Private Equity", a voluntary code of conduct.

Perhaps predictably, this is a somewhat underwhelming document which according to some accounts has been watered down at the insistence of the industry's big boys. To them, private has always meant private. They've never accepted the public's right to know beyond the disclosure rules of established commercial law.

This was always a somewhat silly point of view for, as the deals got bigger and more high-profile, there was bound to be legitimate public demand for greater accountability. Does yesterday's code of conduct answer these concerns?

Not really. What's been offered is necessarily the result of compromise and therefore the bare minimum the industry thought it could get away with to head off statutory regulation. With characteristic bluntness, Jon Moulton, managing partner of Alchemy Partners, says the whole thing could have been drawn up in an afternoon. Certainly, it falls so far short of the disclosure obligations placed on publicly listed companies that the two regimes bear no comparison at all.

That said, the code is plainly an improvement on what went before, and there's also to be a monitoring committee under the guiding hand of Sir Mike Rake, chairman of BT, to ensure compliance. Yet the new disclosure rules don't, and cannot, cover sovereign wealth funds, which now that private equity has been neutered by the credit markets are the new bogies of the takeover scene.

S&N bid defence hinges on BBH value

It's a curious type of bid defence that kicks off with an effective profits warning, but that was about the sum of it for John Dunsmore's first outing as chief executive of Scottish & Newcastle yesterday. The former investment analyst could give only the gloomiest possible of updates on the situation in western Europe, with sales still expected to be in negative territory for the second half and big problems in France. Much of the rest of the defence was pretty thin gruel too – £20m of promised cost cuts and the disposal of the troublesome wholesale operation in France.

More promising was Mr Dunsmore's analysis of the substance of the offer from Carlsberg and Heineken, which, even after being raised a bit last week, still quite plainly undervalues the UK brewer. It was unwise of the chairman, Sir Brian Stewart, to describe the continentals as "wholly unwelcome", for, of course from a shareholder perspective, nearly all bids are very welcome indeed, especially those that put a rocket under the share price and focus the existing management on creating value.

Yet the case S&N makes is none the less a good one. The sum of the parts is reasonably demonstrated to be worth quite a bit more than the 750p a share the consortium is offering. Take for instance the widely acknowledged crown jewels of the S&N portfolio, the company's 50 per cent interest in Baltic Beverage Holding (BBH). According to S & N, its equity interest in BBH is valued by the consortium bid at around £3.2bn, though there is room to argue about the extrapolation applied. This is a multiple of just 14 times consensus estimates for BBH earnings this year, which is smaller than that paid by SABMiller earlier in the week for Grolsch and hardly recognises the Russian brewer's far superior growth prospects.

If Carlsberg as the owner of the other half of BBH went through the established "shotgun" or arbitration approach to buying out its partner, it would certainly have to pay a lot more. By ganging up with Heineken to make an offer for the whole of S&N, Carlsberg is seeking to circumvent this process and get the assets on the cheap.

Mr Dunsmore reckons that, whatever happens, the partnership arrangement with Carlsberg over BBH must now be at an end. After the hostile bid approach, there is no way of returning to the status quo. Either he ends up buying out Carlsberg, possibly with money provided by an alternative partner, or Carlsberg ends up buying him out. Either way, he's determined a proper price should be paid. The chess game has quite a way to go yet.

j.warner@independent.co.uk

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