Vulture funds load British firms with huge debts

A 900 million pound (€1 billion, $1.11 billion) restructuring plan wasn't enough to save Thomas Cook, the 178-year-old travel industry icon from bankruptcy. At the last minute, the firm's bankers demanded an extra 200 million pounds in funding to pre-pay for next year's package holidays.

The travel firm's demise this week has reignited concerns about the over-indebtedness of many British firms and the financial engineering employed by private equity firms, who often acquire and quickly dispose of ailing firms, or invest during periods of restructuring. 

The UK economy has seen a spike in corporate insolvencies, particularly in the retail, manufacturing and travel sectors over the past three years, and the heavy debt burden imposed by private equity — or vulture funds — has often been a factor.

Critics charge that private equity firms are parasitic. They say the vulture funds profit by buying up troubled firms, pile on substantial new debt, then restructure and sell the relaunched entity as if it’s in good health, only for it to collapse a few years later. Private equity firms regularly benefit from tax breaks and are often based offshore.

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Decade-old debt

"Thomas Cook was already in difficulty 10 years ago and went through a refinancing in which combination of equity and debt was put in," Iain Begg, a Professorial Research Fellow at the European Institute, London School of Economics, told DW. "But that seemed to mushroom to an unsustainable level."

Private equity firms played intermediary in the tour operator's 2007 merger with competitor My Travel, along with several subsequent consolidation deals. The transactions eventually left one of the world's oldest travel agents with a 3.1 billion pound debt pile that became a noose around its neck. This year, it was obliged to sell three million holidays a year just to cover interest payments.

Thomas Cook's executives will now be called to a parliamentary inquiry into the firm's collapse, with lawmakers expected to focus on executive pay, accounting and the auditing process.

Another of Britain's best-known high street brands, Debenhams, announced in April the largest loss in its 206-year history, a pre-tax loss of 491 million pounds, and entered a Corporate Voluntary Arrangement (CVA) which allows firms to continue trading while restructuring.

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Huge profits for some

The department store's woes can be traced back to a takeover by several private equity firms in 2003. The financiers made huge profits after relisting the firm on the London Stock Exchange three years later, albeit loaded with 1.2 billion pounds of extra debt.

Fellow department store House of Fraser entered a CVA in May 2018 after struggling to rid itself of a debt pile worth 1 billion pounds which had built up since its private equity purchase in 2006.

Music and film retailer HMV, meanwhile, went into administration last December for the second time in six years. Again, private equity firms were implicated in the downfall of the 98-year-old brand, although it is still trading today after further restructuring by its new owner, Canada's Sunshine Records.

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Low interest rates

British firms have also taken full advantage of record-low interest rates and easy credit facilities to take on huge amounts of new debt. According to the Luxembourg-based Link Asset Services, total corporate debt in the UK climbed to record levels in 2019, hitting 638.3 billion pounds, following eight consecutive years of rises.

Although the research firm said the level of debt still wasn't a cause for concern across the whole economy, it noted that several companies and sectors were under strain and warned that an interest rate hike could see a significant rise in debt restructurings and defaults.

The Bank of England has warned that interest rates, which were dropped to 0.5% in 2009 during the financial crisis and remain at 0.75%, can't stay so low forever. The central bank's bond-buying program of Quantitative Easing has further stimulated lending and has since totaled 435 billion pounds.

"The fact that interest rates have stayed low for a decade has probably induced a false sense of security,” Begg said. "If you get into a position where you've increased debt and then interest rates go up, your flow of money to fund this debt can dry up quite quickly."

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Celebrity chef burned

He gave the example of celebrity chef Jamie Oliver, whose British restaurant chain went into administration, another form of bankruptcy protection, in May, owing 83 million pounds.

Another canary in the coal mine could be the luxury British carmaker Aston Martin, which this week confirmed it will pay 12% interest on an extra $150m of borrowings. If orders for its new DBX model don't hit targets, the firm's interest rate could spike to 15%, which led one financial analyst to label the iconic company a high-risk entity.

Despite the failure of more than 20 of the UK's largest retailers over the past three years and even a manufacturer like Wrightbus, the maker of London's famous red double-decker buses, some economists think overindebtedness isn't yet impacting the wider economy.

"If we look at the underlying data across the UK economy, the number of companies going into liquidation and CVAs is actually pretty low,” Thomas Pugh, UK economist at Capital Economics, told DW.

"The retail sector is getting a bit harder hit than your average firm, along with the airline industry, which has always been a very competitive market subject to a lot of swings between profitability and losses."

Rather than taking on too much debt, Pugh said lackluster economic growth, in part due to the uncertainty over Britain's departure from the EU, has kept demand growth "pretty subdued." Companies are instead facing high wage growth but are unable to increase prices in response amid intense competition.

Pugh predicted that UK wage growth would continue to increase, while inflation will remain subdued. "This squeezing of margins is really going to hurt firms, and the least profitable of them are likely to be forced out of the market at some point."