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Commercial awareness: think like a professional about... Northern Rock

The Gateway reveals how a banker, lawyer, accountant and consultant react to the Virgin Money take-over of Northern Rock

Commercial awareness rock steady

Formerly nationalised British bank Northern Rock has been bought by a consortium comprising Virgin Money, the majority of which is owned by Richard Branson’s Virgin Group with financier Wilbur Ross holding a 21 per cent stake, and Abu Dhabi-based fund, Stanhope Investments. The purchase price is reported to be £747 million, which includes cash payments of £260 million from Mr Ross, and £50 million each from Virgin Money and Stanhope.

Richard Branson first attempted to buy Northern Rock shortly before its nationalisation in 2008. This time around, his successful bid faced competition from several other potential purchasers, including NBNK, the buyout venture of Northern Rock’s ex-chief executive Gary Hoffman.

The deal represents the latest development in what has been an eventful few years for Northern Rock. A former building society, it demutualised in 1997 and ten years later in autumn 2007 suffered a severe liquidity crisis, prompting the first bank run in the UK in 150 years. The bank was nationalised in spring 2008 and subsequently divided into two divisions, a new banking business and an asset management division to hold the bank’s book of existing mortgages. The latter remains in the hands of the government.

The government set a number of conditions to the deal. A further cash payment of £50 million is due within six months of completion. If Northern Rock’s owners take the company out of private ownership and list it on the stock exchange within 5 years, the government could receive a further windfall of up to £80 million. Virgin Money has also agreed not to implement any redundancy programme for three years and to keep the headquarters of the bank in Newcastle.

The deal has attracted some criticism. Labour's Shadow Chancellor Ed Balls has questioned whether now was the best time for the government to sell the bank, given the current instability in the economy in general, and in the banking sector in particular. Other argued that a remutualisation of the bank should have been considered more fully.

Thinking like an ...accountant

  • Calculators out! British taxpayers paid £1.4 billion into Northern Rock, and we’re getting back £747 million, plus the possibility of some additional payments depending on how the bank progresses under its new owners. But to me, that still looks like a loss. So why is the Chancellor selling Northern Rock now? We hear he thinks that the chances of an equally good offer coming up in the next few years are small.
  • Mutual benefit: When Northern Rock, along with a number of other British building societies, became public companies in the late 1990s, there was some discussion of the fairness of such transactions from an accounting perspective. The argument went that the capital of building societies had been built up over decades for the long-term benefit of a community, so it was unfair for one set of members effectively to extract all this cash by receiving the proceeds when shares in the company were sold for the first time. Northern Rock responded by setting up the Northern Rock Foundation, an independent charity which aims to tackle disadvantage and improve the quality of life in the North East, and which Virgin Money has pledged to continue to support.

Thinking like a ...lawyer

  • Haberdashery rocks: In its building society days, Northern Rock was legally structured as a mutual – a type of business, usually a company, owned and run by its members, often its employees or, in the case of a building society, investors. There are no external shareholders, so the business’s profit are not extracted in the form of dividends but ploughed back into serving the members. Other than the remaining building societies, the best-known business running this way still in action is the peerless department store, John Lewis.
  • Inner circle: Take a look at the law firms instructed to work on this deal. You’ll find quite a few mentioned in the legal press, but I’m guessing that most of them are solely in it for the prestige and only two will make any real money on it – the ones instructed by buyer Virgin Money and target Northern Rock. And who are these? Two of the five magic circle behemoths, Allen & Overy and Freshfields respectively. Yet another example of how these five firms tend to dominate on the City’s biggest deals.

Thinking like a ...banker

  • Perfect fit: Virgin Money chief executive Jayne-Anne Gadhia has pointed out that the deal is a great one for both parties as Virgin Money is strong on credit cards, insurance and investment products, but could do with the mortgages, savings and current accounts business that Northern Rock can bring them. We bankers call this kind of match-up, where two businesses could be worth more together than the sum of their parts, synergy, and we think it’s what great M&A deals are made of.
  • Capital idea: It’s interesting to take a closer look at how the deal will be funded. Yes, the three investors involved in the consortium will be paying upfront, but the buyers will be using Northern Rock’s own assets to fund part of the deal. We’ve heard on the grapevine that Virgin Money thinks it can find £250 million “excess capital” down the back of Northern Rock’s sofas which it can put into covering the purchase price. Using target assets in this way to finance an corporate acquisition is standard practice – loans taken out by buyers to fund takeover deals are often secured by the target’s assets, and after completion all the debt incurred is usually “pushed down” by the purchaser to become a liability of the company acquired.

Thinking like a ...consultant

  • North-eastern promise: I think that Virgin Money’s vow to keep the headquarters of Northern Rock’s business in Newcastle is great news for the north-east as the business can then continue to provide jobs and opportunities in this part of the country – and it’s a good plan for the business to align itself with the government’s efforts to diversify the UK’s economy away from the City in the wake of the financial crisis. But even though the business won’t be uprooted, it will be renamed – we hear that the intention is to rebrand it as part of the Virgin empire within the next couple of years, and in our experience, bring two big names together is not always an easy exercise...
  • All change: Consultants always have to keep a close eye on the sectors in which their clients operate, and right now is an interesting time for retail banking. The Vickers report on the sector published earlier this year called for more competition for the dominant four – Barclays, HSBC, Lloyds and Natwest – and we’ve seen some new players with interesting new ways of doing things spring up recently, most notably Metro Bank. What will Richard Branson, always a fan of the unconventional, bring to the scene?
By

Hannah Langworth
Editor

Published

Issue 46

p44

23 November 2011

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