Focus on MBOs is taking on a new dimension

Are management buyouts in publicly quoted companies coming more into vogue? With the Jones Group already down that hatch, and with increasing speculation that IWP will do likewise, the focus on MBOs has taken on a new dimension. And with so many second-liners out of favour with institutions because of their smallness, and institutions' increasing addiction to index-linked totem poles, that is a healthy development.

Certainly the environment for these highly leveraged operations has never been better. Moreover, with interest rates set to remain low for the foreseeable future, one of the major risks has been erased. It is probably forgotten that funds for venture capitalists were given a boost in 1994 when the pensions industry, with a nudging from the Government, decided to commit 0.4 per cent of their funds, representing about £50 million, over a five year period.

That period is ending this year but those budding MBOs on the sideline need not worry, as industry sources say this funding will continue. The scheme has been a general success, with few failures and has provided a platform for enterprising managers to take control of their work effort, and also given the outside investors - the pension funds - a better return. Investors, of course, have vested interests, like every one else, and welcome buyouts of publicly quoted companies because these companies are not going anywhere. Jones, the most recent, was heading for the scrap heap.

However, a tinge of blue emerged on the horizon as an assets sales programme, and the buyout, gave investors a bundle of lucre - a course hardly opened to it had it remained intact, with an uncertain gait, as a quoted group.

That management buyout team will now have to look after its own insular interests, by increasing the asset value of the group. That way the team, and ICC, the venture capitalist, can get out, in a more rosy condition, at a future date. However, it is highly unlikely that Jones will re-emerge as a publicly quoted group. Instead, the peppered up and more valuable company (provided the team is successful), is likely to be sold, giving the team, and ICC's clients (the pension funds), a profit.

Investors in some other companies would openly welcome, indeed salivate at the idea, of an MBO. Crean immediately comes to mind. If IWP were taken private it would, of course, be for a very different reason. In contrast to Crean's performance, IWP has had an unblemished record, with rising earnings and a busy acquisition record. Well, that was true up to earlier this month when it warned its shareholders it will not meet its earlier growth forecast for the year - this upset IWP stalwarts as it represented its first glitch since the chairman, Mr Joe Moran, reorganised the group a decade ago. However, IWP, like other second liners, has had to contend with other hurtful arrows, being accorded a second class share rating. That prompted an unusually concerted effort by the board, with no less than seven directors, including Mr Moran, to buy shares IWP shares, because they felt (according to Mr Moran) the share price represented exceptional value.

Moreover, he warned that unless Irish institutions placed, what the company believed was an adequate value on the company, it would have to consider three alternatives. These were listed as (1) an adequate valuation for the company: (2) a takeover bid: (3) an MBO. So how realistic is an MBO?

With the market estimating a takeover value for IWP, in excess of £150 million, representing a 20 per cent premium, the venture capitalist would have to be British. No problem about that, but IWP itself is highly leveraged. With an estimated net debt of €156 million, the debt/equity ratio is a high 217 per cent.

In addition, the estimated interest cover is a tight 2.7. That, of course, is in the glitch 1998/9 year, and a strong recovery is expected in 1999/2000. Nevertheless, there is no surplus liquidity to help an MBO and any that is generated would be needed for the business.

So what about dividend income to service the participating shareholders in an MBO? IWP is expected to pay a dividend of more than 6p (7.62c) this year. The dividend yield is 3.2 per cent, on the estimated value of the company. That would only service less than half the estimated costs of loans (this does not take convertible preference loans into account ) raised in an MBO.

While an MBO cannot be ruled out, it must be considered a remote possibility. When Mr Moran bought 1.25 million shares at 216c per share last December, at a total cost of €1.5 million, they subsequently fell to 160c. But talk last week about the possibility of an MBO, or takeover, was sufficient to push IWP's shares up from 175c to 210c.

Moreover, with the seven directors buying the shares at an average of 177c to 187c, they are all showing good paper gains, ranging from €82,500 (£65,000) each for Mr Neil Popham and Mr Louis Murray, to €165,000 (£130,000 ) for Mr Paddy Dowling, a non-executive director and former deputy chief executive of AIB, and to €330,000 (£260,000) for Mr Moran and Mr Richard Hayes, in less than a week.

Had the seven been serious about an MBO they would (or should) have announced it when they bought the shares, rather than a make a buyout more expensive by pushing the share price northwards. As institutions are not going to mend their ways, that leaves the third option, of a possible takeover, wide open.