Transcript: Private equity now says sharing is caring

This is an audio transcript of the FT News Briefing podcast episode: ‘Private equity now says sharing is caring’

Marc Filippino
Good morning from the Financial Times. Today is Thursday, May 30th, and this is your FT News Briefing.

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It turns out that Nato’s air defences have a pretty serious weak spot, and Israeli bonds are a huge hit in the United States. Plus, private equity firms aren’t exactly known for being cuddly.

Brooke Masters
They have a reputation for being rapacious, asset-stripping, job-cutting, nasty people. I mean, they used to get called locusts in Germany.

Marc Filippino
But that might all change with profit-sharing. I’m Marc Filippino and here’s the news you need to start your day

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Russia’s war against Ukraine has underscored just how important it is for Europe to protect its skies. But Nato’s own internal figures show that its defences are not quite up to snuff. The military alliance can only provide 5 per cent of the air defence needed to protect eastern European members from a full-scale attack. And this vulnerability is a big deal. Some European leaders and military officials think Russia might be able to attack a Nato member state by the end of the decade. So the hope is to solve the problem quickly. There’s a Nato summit in July where a main goal is to beef up European defences.

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Believe it or not, one of the biggest investors in Israeli bonds is not a trader on Wall Street. He’s an elected official who’s in charge of investing the tax dollars from people living in Palm Beach County, Florida. And he’s not the only US municipal official putting voters’ money into Israel’s bonds. The FT’s emerging markets correspondent, Joseph Cotterill, is here to explain. Hey, Joseph.

Joseph Cotterill
Hi, Marc.

Marc Filippino
So who exactly is this elected official that I mentioned and what did he tell you about his decision to buy Israeli debt?

Joseph Cotterill
Yes. This is Joseph Abruzzo, who is the circuit court clerk and comptroller of Palm Beach County. For those listeners who are outside the US, that’s an elected official who’s overseeing public finances and in particular is investing what are basically tax dollars. So if you’re paying property tax in Palm Beach County, your taxes go into this kind of pot. And as Abruzzo explained to me, he’d been looking to buy Israel bonds, these special issuances, well before the war started.

Marc Filippino
OK, so what’s the history there? Because it sounds like these types of bonds that Israel is selling to American municipalities aren’t exactly new.

Joseph Cotterill
No, they’re not new at all. These bonds have been sold since the 1950s, when Israel was a very young nation, and they were set up with the purpose of encouraging the Jewish diaspora around the world to fund Israel’s development. But over time, the investor base has expanded from the diaspora towards US municipal investors. And that’s because in the last two decades, legislation was passed, often at state level, to allow local government investors to invest in Israel bonds when they could not do so for other foreign governments.

Marc Filippino
Yeah. Tell me a little bit more about that. How political is this type of investing, particularly now given the war between Israel and Hamas?

Joseph Cotterill
Yeah. Firstly, whatever you think of the war in Gaza, wars cost money, and Israel is having to issue quite a few more bonds at the moment to finance a budget deficit, which is expanded because of military spending. And soon after the October 7th attack, you know, many US states and counties said they would buy Israel bonds to show solidarity. States from Indiana to Ohio to Florida. I mean, since the start of the war, about $3bn of these bonds have been sold, which is about three times the annual average.

On the other hand, it’s also become an obvious target for divestment campaigners who had already been looking at the connections of university endowments and other institutions to investments in Israel. That can come as a shock to many taxpayers as well, that their tax dollars are going into these investment pools, which then invest in Israel bonds.

Marc Filippino
Would governments actually divest from Israel bonds, though? Or at least is there enough pressure on government entities that they might rethink these investments?

Joseph Cotterill
There have been protests. There have been some lawsuits announced already, including over the Palm Beach County investments. However, Abruzzo told me they would not change his investments. He would continue to buy Israel bonds today. Now, in the background, it’s important to remember that these investment pools, they can only invest over two- to three-year periods. They can’t really hold bonds for much longer than that because they need to make these tax dollars available for spending. That said, they also can’t be traded or sold easily in the meantime. They have to be held to maturity. So that will make divestment campaigns relatively difficult. However, these bonds do roll off. So if you don’t want your state or county government to continue investing in these bonds, that’s probably what you would target.

Marc Filippino
Joseph Cotterill is the FT’s emerging markets correspondent. Thanks, Joseph.

Joseph Cotterill
Thank you, Marc.

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Marc Filippino
BHP’s bid to take over Anglo American has officially finally collapsed, and it’s been a doozy of a couple of weeks. Let me walk you through it if you missed it. BHP wanted Anglo mostly for its copper business, but it didn’t have any interest in some of Anglo’s platinum and iron ore projects. So BHP’s first proposal asked Anglo to divest from all that. Anglo responded with a polite no, thanks. Maybe thinking Anglo was just playing hard to get. BHP then tried to sweeten the offer three more times. The latest bid was £39bn. But in the end, Anglo walked away and its investors were kind of sad about it. Shares in the company were down 4 per cent on the day in London.

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Private equity has gained a reputation for buying up companies and slashing jobs in order to cut costs. It hasn’t exactly made them popular with workers, but now PE firms are trying a very different approach with those employees. It’s called profit-sharing. Here to explain is the FT’s Brooke Masters. Hi, Brooke.

Brooke Masters
Hi.

Marc Filippino
OK, so when we say profit-sharing, how exactly does that work within the structure of private equity?

Brooke Masters
Well, if you imagine a private equity firm buys a company, at the end of owning it, which is usually a few years, it either floats it on the stock exchange or it sells it to another company. And if it’s floating on the stock exchange, it can give shares to some of the workers. If it’s selling it on, the private equity firm can give workers a share of the profits that the private equity firm has gotten from improving the company and selling it at a higher price.

Marc Filippino
OK, so they’re trying this thing now where they give workers equity in the company they work in. Got it. Why do PE firms feel like they gotta do that?

Brooke Masters
Well, I think you need to understand that higher interest rates are particularly problematic for private equity because of the way they have traditionally made money. What they often do when they buy a company, in addition to cutting costs and other things, is use a bunch of debt. And that debt is loaded on to the portfolio company that they’ve bought. And when interest rates were really, really low, having a lot of debt didn’t really matter because the debt payments were very low. Now that interest rates are higher, if you load a company down with that, it has high interest rate payments. And that cuts into profitability and makes it harder to get the improvements that private equity wants so that they can then float it or sell it to somebody else.

Marc Filippino
And PE firms think that profit-sharing can help with that.

Brooke Masters
Basically, what they now need to do is find another way to make companies more profitable. If they can’t load them down with that, they need basically for the companies to run better. And you can . . . obviously, historically they used to fire people and really cut to the bone, but that doesn’t always work because there’s only so much cutting you can do. The other way you can improve things, obviously, is to find ways to generate more revenue. And I think the idea here is that if employees are motivated and they feel they have a stake in the outcome, they may come up with really cool ideas. They may work harder. We’ve always said that CEOs do better when their interests are aligned with shareholders. Well, surely that applies further down the chain.

Marc Filippino
Brooke, do you think that profit-sharing will continue even after interest rates come back down?

Brooke Masters
I think if profit-sharing turns out to be a way to motivate employees and leads to better performance at companies, I think profit-sharing will definitely continue and spread to other kinds of companies. If they can absolutely show that they are working with workers and helping people, it gives them a great marketing tool because if they actually are doing employee ownership, it could help change their image. And it also could make it easier for them to attract capital from, say, pension funds that represent workers. Because a pension fund, given a choice between giving money to a hedge fund and giving money to a private equity firm that is actually sharing with other workers, may feel some social responsibility in addition to obviously wanting great returns.

Marc Filippino
Brooke Masters is the FT’s US financial editor. Thanks, Brooke.

Brooke Masters
Thanks for having me.

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Marc Filippino
Before we go, juice manufacturers are now saying, orange you glad we have mandarins too? In 2022, a hurricane and a cold snap hit Florida, the world’s second biggest orange producer. And this year, the world’s biggest producer — Brazil — got nailed with diseased crops and its own bad weather. All of this put a big squeeze on juice prices, which recently hit record highs. So juice manufacturers are now thinking about replacing oranges with mandarins. Their trees are apparently more resilient to climate change. Hey, you gotta get that vitamin C somehow.

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You can read more on all of these stories for free when you click the links in our show notes. This has been your daily FT News Briefing. Make sure you check back tomorrow for the latest business news.