UK Pension Schemes Threaten Mergers, Acquisitions
Under-funded pension schemes have hit the headlines for many reasons in recent years, but they had never been seen as a threat to mergers and acquisitions.
That was until last week when WH Smith suspended talks with Permira, the private-equity group, after it attempted to slash its �940m offer for the high-street chain.
The move was in response to demands by WH Smith's pension-fund trustees that it plug at least part of the �200m hole in its pension fund. Now the whole deal may be in doubt.
This was not the first time that a large pension deficit had frightened off a suitor, but industry sources said the deal may have been scuppered by new government rules so draconian that they pose a threat to Britain's fragile recovery in corporate finance.
It all started a world away from retailing - in steel. Allied Steel and Wire went bust in 2002 and 60,000 workers lost their pension funds when their underfunded occupational scheme was wound up.
There was a great deal of campaigning on the matter, and the government unveiled its response - a pensions bill designed to create the Pension Protection Fund, which would bail out schemes that could not pay employees the money they were entitled to. It would be funded by a levy on companies.
This was laudable enough, but in April, the pensions minister announced some amendments to the bill that were intended to stop employers avoiding their obligations.
The idea was to deal with the risks of "moral hazard" in other words unscrupulous employers who might sell their business or restructure their company to avoid their pension liabilities and instead rely on the Pension Protection Fund to bail out their staff.
Two amendments were tabled. The first allowed the new pensions regulator to force companies that tried to dodge their pension obligations to pay a contribution into the scheme. The second gave the regulator the power to make solvent parent companies pay up where a restructuring has left a subsidiary with pension obligations it cannot meet.
Furthermore, it was proposed that these rules would apply to all actions taken after June 11, 2003.
Popular concern over pensions is well founded. Robert Maxwell looted the Mirror Group pension scheme. In the weeks after his death in 1991, it was found that he had plundered some �450m to prop up his ailing business.
On a different scale but nevertheless fanning the flames of popular discontent was the carmaker MG Rover, which last year hit the headlines when it was revealed to have an apparent �73m pensions deficit while a �13m trust fund had been set up for the company directors. They were forced to defend themselves in front of the trade and industry select committee.
Nobody would argue that there should be some protection for workers' pensions, but the wording of the two amendments is so vague that virtually anyone connected with owning a company - shareholders, directors, private-equity investors as well as their immediate families could be held responsible for filling black holes in pension funds. And the rules would be retrospective.
One senior private-equity source said the amendments were a serious threat to corporate activity because for the first time they could "pierce the corporate veil".
This legalistic term applies where the liability can extend beyond a company to its ultimate owners. He said: "This is a huge issue. If we bought a company and it went bust, the liabilities could extend to all the directors, their families, and our own investors rather than just the company. If that happened, our investors would not invest in Britain's venture-capital industry."
Could this really spell the end to an industry that invested �16 billion in Britain last year? Several advisers to the private-equity sector said it was no empty threat because a fund could be wiped out by the failure of one investment.
Chris Steed, founder of Argyll Partners, said: "If there is a business failure, it tends to be because management did not achieve its plans or the assumptions were incorrectly calculated, and it is not fair if one failure could lead to the loss of the whole fund."
The affair has caused tension between the Department for Work and Pensions and the British Venture Capital Association, which represents private-equity interests.
The department has tried to calm things by promising that the proposals will apply only in cases where avoidance of pensions obligations is found. Companies that are planning to make acquisitions will be able to approach the regulator and seek assurance that there will be no interference later.
It has also promised to issue clear examples of how the regulator will respond and also give examples of activities that will be deemed unacceptable.
But as Donald Duval, head of professional practice at Aon, the risk group, said: "How on earth is the regulator going to deal with these approvals? The biggest area of corporate activity is where a company is selling off parts of itself. The whole thrust of the regulation is that 'thou shalt not take risks'."
Insiders said that the game was far from over, however. The Treasury is believed to be keen to avoid anything that will put the brakes on corporate activity and may yet lean on the Department for Work and Pensions to make some changes.
But a meeting on Thursday between the Department for Work and Pensions and the British Venture Capital Association was not conclusive. Both sides said that the meeting was useful and that they will be working closely together in future - but time is of the essence.
While WH Smith is so far the only large deal that may have been affected, others will be abandoned if nothing is done.
Figures from Dealogic, the market-research group, found that mergers and acquisitions were up by 47% to �516m in the first half of 2004 compared with the same period in 2003. In fact, �12.3 billion was spent on British companies by foreign investors during that period.
Deals are all about risk-taking but if the rules stay as they are, they could spell one risk too many for the private-equity industry. If the government does not want that to happen, the Department for Work and Pensions will need to rewrite the rules.
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