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Centrica AA: Inside the contract race

Auction sales have long been a major transaction source for private equity houses, but at the same time a source of constant complaint. Christopher Bown, co-head of private equity at Freshfields Bruckhaus Deringer, examines the recent AA deal and asks whether Centrica’s behaviour during the auction was a special case, or whether it was a sign of sellers’ increasing disenchantment with the process as a whole.

On the face of it, in current market conditions, (with debt still relatively cheap and available in large quantities), it should be in the interests of the seller of a quality business like the AA to conduct the familiar process of sale by auction. After all, it isn’t the seller who, at least on a statistical basis, faces a 90 per cent chance that the effort involved in carrying out due diligence, writing an investment case, and spending money with external advisers will be wasted as the ten bidders who get into the second round are eventually whittled down to one winner. It isn’t the sellers who have to explain to their limited partners why it is that different funds they have each invested in are bidding each other up in competition for the same asset.

Press comment suggests that the two bidders in the AA contract race were pre-selected based on their existing portfolios, and the synergistic advantages they had compared to any other buyer. That sounds perfectly logical. But on the other hand it is a brave adviser who tries to predict the winner of a normal auction sale at the outset, and most auctions have a mixture of bidders with synergistic benefit and those without.

There is one aspect of the Centrica AA sale process, which clearly has in the past worked to the seller’s advantage: the mechanism of the contract race. From the seller’s viewpoint, a contract race maintains competitive tension until the last second, and the seller retains the tactical initiative throughout. It is unusual for a contract race to have as many runners as did the sale of Seat Pagine Galle, (a dozen bidders in four consortia), but there is no doubt that the process in that case helped the seller obtain a price way above most market, and bidder, expectations.

But life for the seller stops being quite so straightforward when the bidders don’t play by the rules. Even though the auction process letters that bidders sign up to usually specifically prohibit them from talking to one another, it is normal on any sizable auction nowadays for the winning bidder to be a consortium. However much they may protest to the contrary, sellers may suspect that a major motivation for each consortium member is the benefit of taking two or three others out of the bidding competition. On some auction sales, the formation of competing bidding consortia can change with bewildering speed, which can force the seller into some fancy footwork in order to keep price competition going. Sellers can even find themselves forced into a position where they are paying competing bidders to keep going, because they refuse to push the button on the significant cost of “final confirmatory due diligence” without exclusivity. And many sellers, or at least their advisers, still have vivid memories of their experiences from the mid 90s when an early grant of exclusivity to a private equity house on the back of a carefully worded offer often was followed by steady but dramatic price erosion as confirmatory due diligence threw up one unexpected problem after another.

Whilst the proprietary deal, or early exclusivity in an auction process, are the holy grail of deal process for private equity houses, everyone has now got used to the rough and tumble of multi-stage auction sales and have resigned themselves to the constant drain on time and resource, and huge cost, of pursuing abortive transactions. This explains the expressions of shock by many in the private equity investor community that an asset of the quality of the AA be sold by a UK PLC advised by a top-tier financial adviser, by a process in which most of the potential buyers do not get a look in. Although the AA may have been a special case, the private equity buyer community must make sure sellers have no reason to lose trust in the auction process. And at the same time, of course, the canny investor will be busy working out how it can get on the inside track with sellers of other attractive assets and persuade them that the Centrica process is the one to follow – provided always of course it is they who are in the race and not their competitors.

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