The credit crunch, much like the recession of the early 1990s, has had quite an effect on the fortunes of many private-equity owned companies. Many deals hastily completed in 2006-2007 involved loads of cheap debt bankrolling the tax-advantaged acquisitions. The inevitable result has been several high-profile blow-ups in recent years as the cost of debt overwhelmed the small margin of safety possessed by the highly leveraged businesses.

In the United States, the collapse of Linen ‘n’ Things, KB Toys and Steve and Barry’s garnered attention, as did the local failure of Australian Discount Retail, owner of discount chains Crazy Clark’s, Go-Lo and Sam’s Warehouse. But little rivals the animosity being witnessed in the United Kingdom over the catastrophic failure of record label EMI (the record label responsible for the Beatles, Rolling Stones, Pink Floyd and Coldplay).

In May 2007, private-equity firm Terra Firma, run by Guy Hands, paid £4 billion ($A7.2 billion)  (of which about £2.6 billion was debt) for EMI. May 2007 was the zenith of the private-equity boom, only months before the collapse of two Bear Sterns hedge funds caused the first market cataclysms.  Hands had previously been a Goldman Sachs banker and was in charge of the private-equity division of (Japanese investment bank) Nomura until 2007, when he created Terra Firma.

It appears that Hands’ timing left a little to be desired. In a little more than two years, Terra Firm has written off almost the entire value of its £1.5 billion equity investment. Like any true businessman, Hands is blaming someone else for his folly — in this case, Terra Firma’s investment adviser, Citigroup. The Financial Times reported that the banking monolith (which is now partially owned by the US taxpayer) “tricked [Hands] into [the acquisition] by wrongly claiming that a rival bidder was still in the running”. A lawsuit against Citigroup filed last Friday alleged that “in order to induce a bid in a private-equity auction for EMI, Citi misrepresented fundamental facts about that auction to Terra Firma”.

The private-equity firm claimed that the lead banker on the transaction, Citi’s David Wormsley, indicated to them that Cerberus Capital Management was a rival bidder when the other firm had in fact withdrawn from the race.

The allegations of impropriety don’t end there. FT also reported that “Hands [is accusing] Citi of plotting to undermine EMI in a bid to cause it to fail its quarterly covenant test, allowing the bank to seize control of the business and orchestrate a sale to Warner Music, its US rival.” Relations soured earlier this year after Citi (which was also the major lender to the EMI purchase) refused to write off £1 billion of monies owed to it in exchange for a further cash injection by Terra Firma.

While Citigroup may well be guilty of some the claims leveled by Hands, they are, in reality, completely irrelevant. Private-equity managers are paid hundreds of millions of dollars by (often naïve) investors to purchase stakes in companies. Private-equity firms should not be deferring critical decisions to investment advisers and should certainly be undertaking their own basic research as to the existence of rival bidders. Even if Citi had fed Hands a bunch of lies (and that is yet to be proved), a former investment banker should have been well aware that advisers are paid when transactions complete, and their counsel should be taken with a hefty grain of salt. (Further, EMI was hardly a picture of financial health before Terra Firma’s acquisition — the company had lost hundreds of millions of pounds in 2006 and was facing lawsuits and the departure of several well-known artists, including Radiohead and Paul McCartney. Some claim that EMI has only remained a viable entity by virtue of its ownership of the Beatles’ works).

Of course, it is likely that Hands was aware of those obvious facts, but like many caught up in the boom, was more interested in securing more management and performance fees, which required additional investments, like that in EMI.

The EMI purchase (along with myriad other failed or faltering private-equity deals) proves that many of the feted masters of the universe are really, more like the Wizard of Oz — mostly show and very little substance.