Deck shuffle

At first sight, the proposed sale of British bank Barclays plc's iShares business to CVC Capital Partners Group for $4.4 billion might appear as sleight of hand. The bank is lending the private equity house $3.1 billion, close to three-fourths of the entire purchase price, and has pledged to hold 51% of the loan on its own books for at least five years. The remaining 49% of the loan can be syndicated after one year.

To some, it might look as though Barclays is merely shifting the value of the business from one column in its accounts to another. The bank is gambling that regulators will accept it as making a genuine capital disposal and relinquishing majority control of its exchange traded funds business. An approval from regulators would allow Barclays to deconsolidate the exchange-traded-funds business from its balance sheet, where it is included with the group's San Francisco-based asset manager, Barclays Global Investors. The money manager will appear to shrink, the bank will book a net gain of $2.2 billion, and its regulatory capital ratio will get a boost. But the risk-weighted assets on its balance sheet are set to rise by $4 billion.

In a sense, therefore, the sale would be neither the huge boost to the bank's coffers nor the dramatic rehabilitation of private equity's traditional leveraged buyout model that the headline price of $4.4 billion appears to signal.

After all, even a firm with the financial muscle of CVC, which in 2008 raised a fund of €10.8 billion ($14.3 billion), would have a tough time financing a deal this size from anyone other than the seller.

CVC's bargain is not unprecedented. When the Federal Deposit Insurance Corp. sold failed Pasadena, Calif., thrift IndyMac Federal Bank FSB to a PE consortium for $16 billion last month, it sweetened the deal with a massive $9 billion of loans. The financing came from the FDIC itself and the Federal Home Loan Bank. The new owners stumped up just $1.55 billion of common equity. The two deals are not entirely comparable, given the different pressures on the sellers, but neither can be taken as the first light of a new dawn for leveraged buyouts.

From Barclays' point of view, however, the sale of iShares is very likely to prove a astute maneuver.

Some shareholders might balk at a transaction that hands Barclays president and CEO of investment banking Bob Diamond Jr. a net cash dividend of $6.9 million, despite management's earlier decision to do without its bonuses. Others may fret if CVC makes easy money from a quick(ish) flip of iShares should the market pick up. The clever expedient of including a go-shop clause in the deal should satisfy some of the dissidents on that point, however. It may not be realistic at this stage to expect the clause to flush out an even better price for the unit, or perhaps produce a bigger transaction including other BGI assets, but it will be more d ifficult to claim the bank rushed into a sale just to ensure its independence from intervention by the British government.

Barclays antagonized investors once before, when it rushed into an expensive financing deal with Middle Eastern investors last fall, and it is reluctant to repeat the experience.

But, suspicion of private equity apart, at 10.1 times 2008 Ebitda, the bank has garnered a ­decent price for iShares, which includes both a fair assessment of current value and a reasonable representation of future earnings. Given that investor enthusiasm for both exchange-traded products and asset managers such as BGI may not quickly return to pre-crunch levels, CVC could be stuck with its new portfolio company for longer than it hopes.

More importantly, the bank has bolstered its capital adequacy at a time when markets, regulators and, of course, cautious and conservative shareholders are more obsessed with Tier 1 ratios than future earnings streams. Barclays says that a deal would raise its estimated Equity Tier 1 by 54 basis points pro forma as of Dec. 31, 2008, meaning it would have reported an estimated Tier 1 ratio of 10.3% and an estimated Equity Tier 1 of 7.2%. That's a quite strong position and should enable the bank to avoid the need to issue new shares either to the U.K. government or to Middle Eastern investors.

Perhaps not surprisingly, the markets agree. On April 14, the first full trading day after the CVC deal was announced, Barclays closed at 195.5 pence a share, up 18 pence, or 10.14%. Not a bad reaction to an accountant's conjuring trick.