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How to make investment decisions

Updated Thursday 11th October 2012

To invest or not to invest? Jon Moulton shares stories of success and failure from his life as an investor of private equity.

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Jon Moulton was talking to Janette Rutterford after a recording of The Bottom Line.

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Professor Janette Rutterford:  Well, Jon, we’d like to talk about private equity and how you make decisions on investing or not investing.  Now you could argue that Rover was the one that got away, perhaps you could talk about that?

Jon Moulton:    Well I mean we would have liked to invest in it, that’s one for Alchemy, and BMW were selling the very loss-making Rover.  They were selling it to us with about £2 billion and assorted bits of cash to sort out the pension fund, the redundancies and so on.  And the politicians got heavily involved, and they decided it was better to sell it to four people who have subsequently been disqualified as directors, because of what they did with the company.  It ended up with a billion pounds’ worth of additional cost to the UK taxpayer and a billion less out from BMW.

So you can imagine why BMW were enthusiastic not to do the deal with me.  I've no idea if we’d have made a success of the Rover car company but we could hardly have done worse than the guys who did buy it, and left virtually everybody jobless and in many cases lacking their full pensions and their full redundancy they’d have got with me.  It’s a deal which was messed up by the politicians.

Professor Janette Rutterford:  Basically politicians can’t do financial calculations perhaps.

Jon Moulton:    I don’t think you need to qualify it with the word ‘financial’.

Professor Janette Rutterford:  Perhaps we could talk about your biggest failure in private equities.

Jon Moulton:    It’s rather an odd one: it’s a company called Newbridge Networks, started up by a very famous Welsh entrepreneur called Terry Matthews, albeit largely based in Canada.  And we made four and a half times our money and sold it in three years.  And you may wonder why that’s a failure.  Well the answer is if we’d have held it four years we’d have got 72 times our money.  So my biggest loss in private equity was one which was all too apparent and very visible, that was a big loss.

Professor Janette Rutterford:  Well that sort of gets to my next point, which is I could argue that private equity is just leverage, I mean you needed a lot of leverage to make that kind of return, so why is it that people who are in the private equity business seem to think that they need tax breaks that the rest of us can’t have?

Jon Moulton:  Actually the Newbridge Networks deal was completely unleveraged, I’m afraid, but it was a fast growing business in the dotcom boom really.  Most private equity uses a lot of leveraged debt in the deal to drive the returns and to avoid paying tax because of the interest bills that are run up on the debt.  To the extent that returns are generated by that, that isn’t very intelligent and doesn’t really deserve a great deal of reward.  Quite often I’m afraid it does get a great deal of reward.  Private equity can do the same things that any other form of manager can do and run a business better, and for that they deserve a better reward when they do it properly.  But the high leverage on return absolutely doesn’t deserve a higher reward, and it certainly doesn’t need extra tax breaks to make it worth doing.

Professor Janette Rutterford:  So what proportion do you think of deals are driven by good management and others are driven by leverage?

Jon Moulton:    It’s actually very very dependent on time period.  When leverage went mad in the 2005/08 period, leverage dominated.  In the early 90s, middle of the 2000s, up to 2005, it was management, and today it will be mostly management.  Leverage is not available in large quantities; the economies aren’t booming; the only way you’re going to make serious money out of buying things for a fair price is actually to make them perform a lot better, so management will matter more today.

Professor Janette Rutterford:  Thank you very much.

Jon Moulton:    Thank you.

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