Cerberus is a Test for Old-style Capitalism

February 2, 2009


Cerberus had become a flagship for Private Equity, the dynamic but controversial approach to business success under conditions of old style capitalism. Will it remain an example of a successful business model in the current financial turmoil?

The fate of Cerberus over the next year or so will serve as in indicator of the robustness of what is now seen as old-style unbridled capitalism grounded in financial instrumentation, high risk and high return to stakeholders.

Leaders we deserve has come across two examples of its investments one large and internationally famed (Chrysler) , one smaller and UK-based (Focus DIY).

The secretive Cerberus acquired Focus DIY from Duke Street and Apax Partners two years ago in a £225m deal, which involved it acquiring the home improvement chain’s debt at a big discount and buying its equity for a nominal £1.

This is a drop in the ocean compared with the $7.4bn (£5.4bn) Cerberus spent on a 51 per cent of GMAC, the financing arm of General Motors, or the $7.4bn it used to acquire 80.9 per cent of Chrysler from Daimler in Germany. Cerberus has been forced to go to Washington with cap in hand, seeking a bail-out of Chrysler, which is in talks to sell a stake to Fiat in Italy after receiving $1.5bn of government loans, and GMAC, which received a $6bn lifeline from taxpayer funds

Paying dirty and the supply chain

If there was any doubt that retailing is a cut-throat business, current reports dispel them. The elegant business school models of supply -chains may have to be modified to capture a bit more of the nasties. ‘Dirty money’ another FT article called it.

“We are seeing more retailers shift their risk to the supply side and try to extend terms,” said a direct apparel manufacturer that sells to clothing chains, department stores, and discounters. “It’s been a minefield for vendors,” he noted, adding that the industry is bracing for a record-number of retail bankruptcy filings from February to March [2009].

Focus DIY

Focus DIY is feeling the crunch as its credit insurance dries up. Focus feels this is entirely to do with the seizing-up of the financial situation, and that its primary credit insurer Atradius

http://www.atradius.co.uk/corporate/inside/overview.html [“Our mission is to enable you to achieve more”] .

Focus CEO Bill Grimsey has gone public about his dissatisfaction with Atradius

“I’m not getting anyone not co-operating, it’s just that it becomes hand-to-hand combat for a while. Those conversations are not helping us sell more products.” Mr Grimsey explained that he had written to business secretary Peter Mandleson and had also put together a letter from 20 Focus suppliers to all three political parties demanding an investigation into the Atradius’ business model.

“They are fair-weather friends who don’t go into enough detail, make unilateral decisions with short notice, and jeopardise the future of businesses.”

A spokesperson for Atradius said: “We have been in dialogue with Focus DIY for some time. Ultimately, our duty is to effectively manage the risks of our customers and we only withdraw cover as an absolute last resort.”

The insurer is not alone in withdrawing cover for suppliers to high street retailers. Its actions have been mirrored by two other leading credit insurers, Coface [who withdrew credit to Woolworths, recently] and Euler Hermes.

It’s not just Focus DIY

It’s not just Focus DIY, but an entire business model at risk. Banks will not support uninsured corporates. Our financial correspondent Dr Ismail Erturk writes

There is a good article by Froud et al on the private equity business model. Their view is that PE is not a superior corporate governance model that turns companies around with exceptional managerial skills but a conjunctual opportunity to extract value from cash-rich companies. As the conjuncture which lasted from the burst of dot.com bubble to the burst of housing bubble facilitated cheap leverage finance PE firms benefited. If PE was a truly superior form of efficiency then it should have continued under present conditions where there are lots of companies that need turning around.

Credit for healthy companies is very difficult to get although there is no obvious deterioration of their credit risk. Similarly, banks simply do not lend to almost anyone. If markets were efficient, such credit-rationing should not have happened. Clearly, most assumptions about efficient markets and efficient governance models are falling apart in front of our eyes. Much academic work published in the last two decades were based on these assumptions. So, this is not only a crisis in the material world, but also a crisis of cerebral activity in the mainstream academia on such subjects.

I think we are entering a new phase of capitalism where the balance will shift towards the social from the market. How quickly or how exactly the academic paradigms on markets will shift is another interesting question.


You can find more about the work of Ismail and colleagues on their Crest website
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