MBOs too pricey, warns Bank

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The Independent Online
THE Bank of England has warned that the explosive rise in prices that investors are willing to pay to participate in management buyouts may be reaching unsustainably risky levels.

In an article to be published tomorrow in the Financial Stability Review, a periodical produced in association with the Financial Services Authority, three officials from the Bank write: "Competition between banks and other lenders to finance these transactions has increased the risk of this type of lending."

Management buyouts occur when a management team, from inside a company, buys a company from its parent, supported by outside investors.

In their article, the Bank officials note that the current boom is "comparable to that in the late 1980s, which was followed by a series of failures of highly geared structures when interest rates rose sharply and the economy entered a recession".

There is little prospect of a rise in interest rates now, although UK manufacturing technically entered recession last week. However, the Bank officials agree that, as long as the economic environment remains stable, deals will face fewer problems than they did in the early 1990s.

Robert Lucas, a director of CVC, one of the largest private equity investors in such transactions, said: "This is a question all of us in the industry are asking ourselves every day, and everyone is very mindful that prices are very high. Anyone who says otherwise is kidding themselves."

While he accepts that competition has intensified, he believes that more sophisticated methods of investment can protect against the worst excesses. "We need to be more clever about what we're doing," he said.

Last week, CVC swooped on chemicals concern Brunner Mond in a pounds 140m deal to take it private again. It was an original backer for the business when it backed its buyout from ICI.

Price/earnings ratios in MBOs are reaching 16 times earnings - a level last seen in the late 1980s, says the Bank. It is also concerned that the higher level of gearing has increased the risks of providing finance to MBOs.

The private market has already seen the first signs from bankers unwilling to accept the higher returns available from these deals, because the risks are too high. Earlier this year, bankers refused to lend the money to fund the creation of HMV Media, the merger of HMV's music stores with the booksellers Waterstone's. The deal had to be restructured.