(Bloomberg Opinion) -- Greybull Capital paid Tata Steel Ltd. just one pound sterling ($1.27) in 2016 for a steelworks in northern England with more than 4,000 employees.
On Wednesday that business, British Steel, went bust after the U.K. government refused to grant it another emergency loan (the state had already cut the private equity firm a 120 million-pound check because of a cock-up related to carbon emission credits). By the time U.K. politicians have finished grilling Greybull’s owners about how their turnaround effort came so spectacularly and rapidly unstuck, the London-based firm might wish it had kept hold of its pennies.
Letting British Steel sink into liquidation is a tough political call. The Westminster government is partly to blame for the company’s cash flow problems because of the country’s failure to reach a Brexit deal. British Steel exports more than half of its product, and overseas customers have doubtless been unsettled by Britain’s dithering over leaving the European Union. Politicians are beginning to realize too that letting the nation’s industrial base wither or be sold off was an economic mistake (a topic I explored here). British Steel is a major supplier to the U.K.’s rail network and its skilled employees received decent wages, until now.
Following the collapse of another Greybull investment, Monarch Airlines in 2017, the government will have had understandable doubts this time about getting involved again with the firm. On that occasion, the U.K. spent millions flying home thousands of customers and it emerged that Greybull had risked comparatively little of its own money. Once bitten, twice skeptical.
So what has gone wrong at British Steel? Buying a business for a pound often means accepting heavy liabilities, but Greybull seems to have received a lot of favors from the former owner. India’s Tata wrote off a 135 million pounds inter-company loan, according to the accounts I’ve studied, plus the buyer was freed from onerous pension liabilities.
Tata had hired consultants from McKinsey & Co. the year before the sale to execute a comprehensive restructuring, and thus the British Steel unit was already well on its way back towards profitability when Greybull bought it. Staff agreed to a temporary 3% pay cut as part of that effort. Annual depreciation expenses were minimal as the acquired assets had little book value, plus the business created large amounts of so-called negative goodwill because of the small purchase price paid. Helped too by rebounding prices for its chief product, British Steel could boast in March 2017 that it had already returned to profit.
Unfortunately, it was still on thin ice.
Greybull arranged about 500 million pounds of funding for British Steel, but almost all of it was in the form of loans secured against the company’s assets. Greybull contributed only about 20 million pounds in equity, the Financial Times has reported. Meanwhile, the roughly 155 million pounds shareholder loan it provided accrued interest at 9 percent. As it’s not the primary creditor – there are banks involved too – that loan might now be at risk.
Pumping more equity into the business would have been helpful because steel is an inherently volatile and capital intensive business. Currencies, energy (and carbon) prices, raw material costs, tariffs, and competitors’ capacity additions can all cause unexpected difficulties. There’s a risk of operational mishaps too: One of the Scunthorpe plant’s blast furnaces suffered an outage last year. Before Greybull showed up, the plant had suffered from years of under-investment. It’s questionable whether it received enough from its new owner.
Greybull didn’t win any friends over the Monarch collapse, but there’s an argument that at least it gave it a good shot with British Steel. There probably weren’t many other investors waiting in the wings in 2016, so Tata might otherwise have had to shut down the plant. In the meantime, workers got paid for another three years and the government took its share of taxes from those wages. British Steel’s employment costs totaled about 240 million pounds last year. So where’s the harm?
The problem is that this is Greybull’s second such mishap in as many years, and its limited financial commitment will raise hackles once more. The private equity firm’s experiences could make it harder in future for similar investors to convince sellers of distressed assets that they are responsible, long-term owners (particularly if those assets are in any way politically sensitive or strategic). In capitalism it’s prudent not to bite off more than one can chew, especially if steel bars are on the menu.
To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Chris Bryant is a Bloomberg Opinion columnist covering industrial companies. He previously worked for the Financial Times.
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