Thursday8 August 2019 ★ 11© The Financial Times Limited 2019 Week 32A decade ago, private equity groups in
Germany were likened to ‘locusts’ amid
outrage over asset stripping and job
losses. But, with changing attitudes
and hungry investors, buyout groups
are dominating Europe’s largest
market and deals are set to hit $25bn.
AnalysisiPAGE 13Germany gains appetite
for ‘locust’ buyout firmsMADHUMITA MURGIA— LONDONDeepMind, the artificial intelligence
arm ofAlphabet, saw its losses rise
55 per cent last year to £470.2m and its
debts surpass £1bn as the world’s big-
gest technology companies continue to
pour huge sumsinto AI research and
development.DeepMind now has a cumulative debt to
its parent company, which also owns
Google, of £1.04bn that is due for repay-
ment by October. DeepMind said there
was no risk of default and the debt had
been guaranteed by Google.
The London-based company saw its
revenues nearly double to £102.8m in
2018, according to its latest accounts at
Companies House, but staff costs andother expenses rose to £568m, up from
£334m the year before. DeepMind’s
staff costs also doubled in 2017.
The heavy spending reflects the rising
cost of talent as big tech companies race
to develop AI technology. Tenured uni-
versity professors are being offeredup
to 10 timestheir academic salaries to
work for the likes of Google, Facebook,
Amazon, and Microsoft.
DeepMind’s sales are exclusively to
Alphabet and are described as technical
service fees. The DeepMind for Google
team, which embeds its AI technology
into other Alphabet products, is split
between London and California and
now consists of about 100 employees.
“We want Google and Alphabet to be
successful and to get benefit out of theresearch we’re doing,”Demis Hassabis,
DeepMind’s chief executive, toldWired
UK in an interviewthis week.
Since Google bought DeepMind in
2014 for £400m, the latter’s leadership
has maintained that it operates autono-
mously as a research unit.
But as its costs and losses mount, and
it lacks a saleable product, some have
questioned the commercial value of its
ultimate aim of creating“artificial gen-
eral intelligence”.
“Google paid half a billion dollars for
DeepMind five years ago and now they
spend that much every year just run-
ning the company,” said Pedro Domin-
gos, author ofThe Master Algorithm, and
a computer scientist who leads the AI
unit at hedge fund DE Shaw.Alphabet’s DeepMind racks up £1bn
debt as tech group pours cash into AI
accounting firms begin to quit tricky
audits. Andrew Tyrie, chairman of the
Competition and Markets Authority,
said in December:“If a company’s books
aren’t properly examined, people’s jobs,
pensions or savings can be at risk.”
The auditors claimed the reassess-
mentwas triggered by higher costs from
increased regulation and the potential
risk of large fines for poor quality work.
But criticssay the largest firms are try-
ing to subvert far-reaching reform.
Atul Shah, professor of accounting at
City University, said it was “an attempt
by the Big Four to use their power to
object to the serious audit reforms being
consulted on by government”.KPMG has already shed a number of
building society audit contracts because
of comparatively low fees and the high
cost of compliance.
Grant Thornton is expected to quit as
auditor ofSports Direct, one of its larg-
est listed clients, next month, following
criticism of the retailer’s corporate gov-
ernance and concerns over the non-dis-
closure of a €674m tax bill.
The firm hasstarted a “line by line”
review of its audit book, which includes
Neil Woodford’s quotedWoodford
Patient Capital Trust, in recent weeks,
according to a senior partner.
Some observers have flagged the risk
to the stability offinancial markets iftrols and governance were the most
likely to be dropped.
PwC started a review of its audit book
in June.Hemione Hudson, its head of
audit, said it would “ensure we achieve a
return that allows continual investment
in and focus on quality”. The process
would lead to an increase in fees and
there would “undoubtedly” be some
instances in which PwC walked away
from audit clients, she added.
EY wrote to its large listed clientsto
warn them it would be increasing audit
fees because of “unprecedented market
forces”.Hywel Ball, head of audit at EY,
said the firm expected to part ways with
some clients as part of the process.TABBY KINDER— LONDONThe UK’s largest accountancy firms are
set to purge risky or unprofitable audit
clients after a string of corporate col-
lapses and scandals sparked increased
regulatory scrutiny of the sector.
Big Four firmsEY,KPMG,Deloitte
andPwC, and mid-tier accountants
Grant ThorntonandBDO, have
launched sweeping reviews of clients to
weed out those they consider poten-
tially problematic.
Auditors warned that companies in
volatile sectors, such as retail or out-
sourcing, and businesses that have
faced criticism over their financial con-Big Four purge risky audit clients
3 Scandals spur more scrutiny 3 Regulation and costs rise 3 Firms accused of stalling reform
Diageo, the world’s largest spirits maker,
has taken a majority stake in“game-
changing”non-alcoholic spirit brand
Seedlipas it seeks to cater to the growing
number of teetotallers.
The move builds on a 20 per cent
investmentin Seedlipby Diageo’s
accelerator unit for small businesses
Distill Ventures in 2016. The financial
details of the deal were not disclosed.
Seedlip is a premium-priced non-
alcoholic spirit often sold as an
alternative to gin. It was launched in
2015 byBen Branson, then a teetotal
marketing executive, who created the
bitter-tasting drink from distilled
produce on his farm inEngland.
Seedlip has since launched in more
than 25 countries and is served in more
than 300 Michelin-starred restaurants.
In February, it reported year-on-year
volume growth of 270 per cent.
John Kennedy, president of Diageo’s
European, Turkish and Indian
operations, said Seedlip was a
“game-changing brand in one of the
most exciting categories in our
industry”.
Research firm Nielsen calculates that
sales of low- and non-alcoholic
alternative drinks in the UK rose 25 per
cent to £116.6m in the year to June.
Alice HancockSoftly, softly
Diageo buys into
gin alternative
Stability in
financialmarkets
might be atrisk if firms
quit trickyaudits, say
observersCompanies / Sectors / People
Companies
ABN Amro.............................................10,
AT&T.............................................................. 12
Anadarko...................................................... 19
BDO.................................................................. 11
Bayer................................................................. 7
Berkshire Hathaway.............................. 19
Bridgewater................................................ 19
Burford Capital...................................10,
CBS................................................................... 12
Charles Schwab....................................... 20
ChemChina.................................................... 7
Chevron......................................................... 19
Commerzbank.....................................10,
Continental.................................................. 12
Covestro.......................................................... 7
Deloitte........................................................... 11
Discovery Communications............... 12Disney........................................................... 12
Dow Chemical.............................................. 7
DuPont............................................................. 7
E*Trade........................................................ 20
EY...........................................................10,11,
Facebook................................................10,
FireEye............................................................. 4
Glencore..................................................10,
Grant Thornton......................................... 11
Huawei............................................................. 4
IAC................................................................... 20
Imagination Entertainment............... 12
Johnson & Johnson................................. 7
KPMG............................................................... 11
Kik...............................................................10,
Klarna.............................................................. 12
Lions Gate....................................................
Mannesmann................................................ 7Match............................................................. 20
Monsanto........................................................ 7
Muddy Waters.....................................10,
NBCUniversal............................................. 12
Netflix............................................................. 12
New York Times Company............. 10
NextEra Energy....................................... 20
Occidental Petroleum........................... 19
Paramount................................................... 12
Paramount Pictures............................... 12
Pemex............................................................. 19
PwC................................................................... 11
Quindell......................................................... 10
Royal Bank of Scotland........................ 11
Sirius Minerals............................................ 11
Sony................................................................. 12
Sports Direct............................................... 11
Standard Chartered................................ 11Syngenta......................................................... 7
Teva................................................................. 12
Time Warner.............................................. 12
UniCredit................................................10,
Viacom........................................................... 12
Vodafone...................................................7,
Walt Disney................................................ 20
WarnerMedia.............................................. 12
Weight Watchers.................................... 20
WhatsApp.................................................... 10
Woodford Patient Capital Trust.....
Sectors
Automobiles............................................2,
Banks........................................................10,
Chemicals....................................................... 7
Energy........................................................... 20
Financial Services..............................10,
Financials.........................................10,19,Industrial Goods......................................... 2
Industrials....................................................... 2
Media........................................................12,
Mining............................................................ 14
Oil & Gas...................................................... 19
Pharmaceuticals....................................... 12
Technology...........................4,10,12,13,
Travel & Leisure..................................... 20
People
Bakish, Bob.................................................. 12
Ball, Hywel.................................................... 11
Barnett, Mark............................................ 10
Baumann, Werner...................................... 7
Block, Carson.......................................10,
Buffett, Warren......................................... 19
Dalio, Ray..................................................... 19
Degenhart, Elmar.................................... 12
Dijkhuizen, Kees van............................. 14Feltheimer, Jon......................................... 12
Freyberg, Peter..................................10,
Glasenberg, Ivan................................10,
Hudson, Hemione.................................... 11
Icahn, Carl...............................................11,
Livingston, Ted...................................10,
McClellan, Michael................................... 12
Middleton, Peter...................................... 10
Milken, Michael.......................................... 11
Mistakidis, Telis..................................10,
Murdoch, Rupert...................................... 12
Mustier, Jean Pierre.............................. 14
Peltz, Nelson............................................... 11
Redstone, Sumner................................... 12
Schultz, Kare.............................................. 12
Siemiatkowski, Sebastian.................... 12
Wenning, Werner....................................... 7
Woodford, Neil....................................10,Red lineGlencore hands mining veteran
challenge of reviving fortunes— ANALYSIS, PAGE 14
Stockholm syndromeCan Klarna avoid
falling captive to Big Tech?— INSIDE EUROPE, PAGE 12
Robert
Smith
Tail
Risk
What should a company do when its traditional funding
channel is either closed or too expensive?
One of the oldest tricks in capital markets is to tailor your
pitch to an entirely differentaudience.
When taken to extremes it can appear akin to preying on
the less financially sophisticated. But this technique can
also benefit all involved, as institutions that are better
suited to taking on the risk get access to a new investment
opportunity.
Sirius Minerals, developer of an ambitious mining
project on Britain’s North York Moors, recently adopted
this strategy. After early funding ideas fell through, it
wrapped a risky project finance deal in the clothing of a
corporate high-yield bond, pitching the deal to investors
who typically invest in the debt of companies with less than
stellar credit ratings.
Yet Sirius fell at the first hurdle. The high-yield
communitydid not bite, even though the deal offered the
highest yields seen outside China this year.
To understand why, it is
worth looking at the high-
yield history books, particu-
larly as the enduring popu-
larity of riskier corporate
bonds actually stems from
one of the greatest examples
of this capital markets ploy.
So-called “junk bonds” at
one time only existed when
investmentgrade companies
were downgraded and then shunned by fund managers.
In the 1970s, a young Los Angeles-born bond trader
calledMichael Milkendemonstrated the hidden value in
these previously taboo bonds. “Junk” was out — “high-
yield” was in. As the seventies turned to the eighties,
Mr Milken realised he could take this one stage further.
While a mergers and acquisitions boom was in full swing,
the early progenitors of private equity could only raise lim-
ited debt from traditionally conservative banks.
Mr Milken filled the void, marshalling his devoted high-
yield disciples into funding heavily indebted new acquisi-
tions. This minted the fortunes of so-called “junk bond
raiders” such asCarl IcahnandNelson Peltz, as immortal-
ised in Connie Bruck’s 1988 bookThePredators’ Ball.
One thing has remained constant for high-yield inves-
tors since the Milken-era:cash flow is king. Companies
need to generate enough money to service their debts.
Sirius is still building its mine so does not yet have any
cash flow. If it defaulted today, bondholders would be left
with agiant hole in the ground, into which they would need
to pour more funding.
Sirius’s chief blames the failed deal on temporary mar-
ket jitters and plans to relaunch it next month. The fate of
the largest new mining project in UK for a generation now
hinges on whether he has correctly read the psychology of
high-yield bond investors.[email protected]One thing has
remained
constant for
high-yieldinvestors:
cash flow is kingCharlie Bibby
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