The Hunt for Fast Growth

Comm update faces_27 Nov

Genuinely game-changing innovation may be something of a rarity, but if companies are to prosper then it’s imperative that they invest in R&D and look to find ways of standing out in what continue to be tough markets. The good news is that plenty of companies are doing just that, investing in technology, looking to conduct acquisitions and expand so as to accelerate growth.

Marnie Millard, Group CEO of soft drinks business Nichols Plc, says: “Internationally, while our core markets continue to perform, it is newly developed markets within the African regions which provide growth and development.

“Although indicators suggest the economic conditions are improving, the UK consumer, we believe, remains cautious. They are still using their weekly budgets wisely which means value for money remains very important. We will invest in products which are core in terms of meeting the growth areas of health, well-being and convenience.”

It’s always somewhat difficult to pick out specific sectors for growth, but it’s evident that healthcare, TMT and financial services are set to be hotbeds of activity for the foreseeable future. “The recovery in the UK and global economy are macro factors in increasing demand,” comments Chris Hurley, Regional Managing Director at private equity firm LDC. “But at the micro level, it is technological innovation that is probably the key growth driver across most sectors.”

Chris gives examples of a number of portfolio companies, including Angus Fire, a specialist in fire fighting technology, and NRS Healthcare, which are investing in new services and products to boost growth and capitalise on the opportunities in their respective markets. There’s also been M&A activity, such as the merger between the production company Boom Pictures with Twofour Group.

The mid-market has received a lift from improved financing conditions, although it remains a fragile state of affairs. “The continuing difficulties SMEs and growth companies have in accessing funding is still an issue,” adds Chris. “Various finance industry and Government schemes, plus a great willingness by banks to lend, have helped but businesses do need to be able to have access to adequate funding… Here confidence remains key all round.”

Ambition to burn

On the public markets, there has been a positive change in mood during the past year. Alastair Walmsley, Head of Primary Markets at the London Stock Exchange, comments: “The mindset of public market investors has been yield focused for an extended period of time, whether you’re talking about equities or fixed-income instruments…

“In the broadest possible terms, I would say businesses that want to pursue growth, whether it’s geographical or in terms of product line, M&A or organic led, are finding funding through the markets more readily than for a number of years.”

At student housing provider UNITE Group, CEO Mark Allan has been busy ensuring equity funding to the tune of £215 million is in place to support ongoing growth (in addition to an already secured pipeline). He explains: “In London, we have been busy developing and growing over the last three to four years but land prices are now getting more expensive… While there is still good customer demand, the margins on investing in development activity in the capital are eroding in our view.

“Whereas, in the regions, customer demand is still very high, certainly for the strongest universities, but the input costs are much lower. It’s more a case of we think costs have fallen as much as they are going to in the regions, we’ve got good customer demand, and now is a good time to be investing while the costs of doing so are pretty much as low as they are likely to get.”

Globalisation presents the big opportunity for many businesses (not without a significant number of risks, naturally). Mark Garrett, COO of global technology consultancy Ricardo, says: “The US and mainland Europe are both very interesting areas for us to expand a little bit more outside of the UK business.”

Latest figures for Ricardo sees revenue up by 16 per cent to £229.7 million and underlying profit before tax increasing by 31 per cent to £23 million (the company acquired environmental consulting specialist AEA at the end of 2012 for £18 million). Approximately half of the company’s sales come from the UK and the plan is to address that by diversifying geographically.

He says: “We’ve seen Europe in the doldrums for quite a long time and there’s no immediate prospect of a bounce-back. China has been reasonably strong all the way through and, although the US has obviously had problems, it seems to be coming back strongly too.

“The UK economy now seems to be on a path for growth… [but] if we are all in one location we are very much bound by the local economic conditions. We’ve also found a lot of our customers are based globally too, and so we want a business which matches them on the basis of our geographical footprint.”

For Geraint Anderson, CEO of TT electronics, which supplies electrical systems to manufacturers in the defence, aerospace, medical, transportation and industrial markets, there are plenty of good signs. “We’re a big player in the German luxury auto market and that’s continued to perform well over the last couple of years,” he says. “We’re seeing an acceleration of demand, particularly coming out of very strong North American and Asian [markets]. Europe is not necessarily getting any worse, but it’s still early days to say it is getting better.”

Some £30 million is set to be ploughed back into the business over the next couple of years to develop operations. “We’re investing heavily in the right manufacturing cost centres around the world,” he explains. “So, we’ll make sure we continue to invest in Asia, Eastern Europe and over in Mexico as well.”

For many executive teams, the past few years have largely been about restructuring and change management. Now the focus is going to be on finding ways to win back customers or to identify new ones, which may be seen to require an altogether different kind of high-performing executive team.

I hope to see you soon.


How to Maximise Value in M&A

Comm update Faces_9 Oct

With the M&A market tantalisingly poised to reopen, it’s encouraging to find that management teams have the confidence to execute their plans for growth by completing ambitious deals. That said, only those companies that remain disciplined about selecting an acquisition target, and have a clear idea about how to integrate a new business, will generate real value and meaningful returns for investors.

David Turner, CEO of private equity-backed call centre firm Webhelp TSC, who has been given an £84 million warchest to fund acquisitions, says: “You’re looking for those businesses that are additive in terms of capability, so that it is different to the existing combination and it aligns to your strategic goals.”

In these markets, the case for a deal has to be crystal clear. Paul Walsh, who led a number of major acquisitions when he was CEO of global drinks business Diageo, comments: “You have to understand your objectives and what you’re trying to do. In [Diageo’s] case, are you trying to buy distribution? Are you trying to buy the local brand? The local management? You need to be very clear about that and it could be the case you need all three – just because something is out there and available, it doesn’t make it the right deal for you.”

A forensic approach is required if you’re going to maximise value from a transaction. Mark Garrett, Chief Operating Officer at technology and engineering consultancy Ricardo Plc, says: “We are constantly on the lookout for suitable targets and when one in particular starts to look right, we energise a small specialist team to dig deeper and review on a step-by-step basis so we can close the opportunity down at any time and try to eliminate any emotion or personal agendas from creeping in.”

It’s a case of separating responsibilities. Paul Budge, MD for the UK & Ireland at consumables distributor and outsourcing business Bunzl, comments: “The operational leadership is charged with finding the prospects, putting the case together and presenting it to the board… [whereas] the M&A team will actually run the transaction, in terms of tabling the offer, commissioning the due diligence and handling the process of negotiation.”

Deals on the horizon

Although there has been caution over M&A transactions, it does appear like things are finally going to pick-up. Sean Longsdale, Managing Director for Santander’s Structured Finance Group, says: “We’re seeing limited M&A activity from mainstream corporates, public companies or larger independent businesses looking to acquire…

“But we are seeing a very active private equity market, which has found renewed confidence, good volumes and leverages beginning to creep up a bit… In businesses that are stable, predictable and with strong market positions we’ve seen debt leverage of 4 to 4.5 times.”

Charlie Johnstone, Origination Partner at PE firm ECI Partners, comments: “There are more growth companies than we’ve ever calculated in the UK at the moment and a lot are interested in expansion capital… The big drivers of growth for the companies in our portfolio are internationalisation and M&A; we’ve done five bolt-ons in the last 12 months.”

Of course, deals are getting done on the public markets too. Adrian Gunn, CEO of recruitment agency Matchtech, which last month paid £4 million in cash for technology concern Provanis, says: “We’ve been giving [the City] a consistent message for the last few years… so I knew it wouldn’t come as any major surprise to the investment community as to why we went for it.”

Good fit

As ever, the integration of a new business will determine whether a deal is to be successful. David says: “[It] must be top down led and involve senior management from the acquired company. The way I’ve done this in the past is that you have a steering group led by the two leaders of the businesses, then you have a project team in place which has joint accountability from both leaders… If you get the integration right, you get very little problems coming back to the steering group.”

Julia Robertson, Group CEO of outsourced HR services provider Impellam, comments: “It’s vital to have absolute clarity of expectations, spending sufficient time listening carefully to the point of view of incoming management and communicating clearly, over and over again.”

I hope to see you soon.


Boards and the Pension Crisis


As investments and strategic deals get blocked because of pension deficits, directors, trustee boards and regulators need to work together to find ways to see through some of the madness created by actuarial assumptions. With an ageing population, volatile equity markets, low gilt yields and eye-watering levels of debt, compromises do have to be made in order to arrive at real-world solutions.

First and foremost, if a corporate does have a problem, there’s no excuse for senior leaders burying their heads in the sand. Those executives at the top have to own the issues – not delegate them. Lady Barbara Judge CBE, Chairman of the Pension Protection Fund, says: “It’s absolutely fundamental that executives understand the risks surrounding their pension fund; directors need to understand that the pension fund liability is essentially a debt of the company.

“Companies have a responsibility to their employees and the pension fund, as well as other stakeholders. Accordingly, any pension fund liability is clearly an issue on which company directors should be educated and company finance directors need to manage their pension fund exposure as part of their broader balance sheet management.”

Alastair Lyons, Chairman of outsourcing company Serco and car insurance provider Admiral, comments: “I would expect the CFO to have an in-depth understanding of the… accounting deficits [and] to changes in market and non-economic assumptions. I would also expect the CFO to have examined different mitigation strategies – for example, investment de-risking – in order to reduce the potential impact of pension scheme volatility.”

That said, it’s unrealistic to suddenly expect directors to become pension experts. Richard Farr, Partner in BDO’s pension advisory team, says: “How many of those in the C-suite actually understand pension risk? They’re struggling with corporate risk, let alone pension risk and it is a completely different universe of understanding.”

David Harding, Deputy Chairman at private-equity backed Malaysian lottery operator Magnum Berhad and former CEO of bookmakers William Hill, comments: “It is reasonable to expect senior execs and non-execs to focus resources on major risks. However, this is a specialist area and not one many execs or non-execs will have dealt with, so it is not reasonable to expect them to come up with solutions without specialist help; and it is unlikely to climb the risk ladder and grab their attention unless it is flagged by specialists.”

The danger is for executives to fail to see how a pension deficit is intrinsically linked to the sustainable performance of a business. Jeremy Stone, Chairman of Trustees of the WH Smith Pension Fund, says: “It’s almost a fiduciary requirement but often plc boards lack patience with the subject. They don’t have much appetite for understanding why the numbers have moved against them.”


A question of trust

Undoubtedly, the pension crisis is a man-made disaster of epic proportions. Recent figures released by The Pension Protection Fund in the UK show that the aggregate deficit of 6,316 defined benefit (DB) schemes – representing about 12 million members – increased from £201.5 billion in February to £236.6 billion in March. Total liabilities in the UK now exceed £1.3 trillion.

This dire state of affairs makes the interaction between the trustee board and the executive team increasingly important. Anthony Arter, London Senior Partner and Head of Pensions at law firm Eversheds, says: “Given the liabilities at stake it is vital that pension schemes are run by an effective and properly constituted trustee board with clear leadership. The Pensions Regulator has made clear that ensuring good pension scheme governance is one of its top priorities.

“This means that trustee boards need to be well run; be on top of the issues affecting their scheme, and be able to make good decisions that are not tainted by conflicts of interest in a timely manner.”

Alastair says: “Particularly important is the quality of the Chairman of trustees as those on the board will typically follow his or her lead. The Chairman needs to be highly knowledgeable of the intricacies of pension scheme funding and preferably have confronted difficult situations before – if they have they will, therefore, have confidence in their own judgement as to what shape and structure of solution is appropriate for the scheme concerned.”

Inevitably, there will be some that need to raise their game. “All schemes will have properly constituted boards but whether they actually have the right distribution of competencies on that board is another question,” says Jeremy Stone. “The way it’s set up, some are nominated by the company, often people from the finance or HR function, so they know something about the subject, then you might also have some independent representatives.”

According to Richard, a real problem in arriving at perfectly achievable solutions is the lack of knowledge among some trustee and corporate boards about what is possible. “The trustee boards are not aware of the potential solutions because they’re not being told,” he says. “There are very competent and committed trustee boards out there, but the lawyers, accountants and actuaries need to give them more options – however, that also involves the advisors understanding the economics of the employer as well.”

The future lies in finding ways to share risk. “You have to change the framework, the guidelines and encourage partnerships – if there isn’t an answer through that, then there is no answer at all,” says Richard, who predicts greater activity among investors, especially hedge funds, in taking on pension risk as schemes are restructured and sold on at a discount.

While there may need to be more regulatory flexibility around how corporate and trustee boards can de-risk their schemes, the less involvement from Government on the issue is uniformly seen as a good thing. Ian Harley, Criticaleye Board Mentor and Senior Independent Director at media distribution company John Menzies, argues that “regulation and politicians have been a large part of the reason for why we are where we are”.

Alastair says: “It is important to determine early-on the position of the Pension Regulator so that where there are material deficits that require imaginative funding solutions, a lot of time is not spent seeking a detailed solution with a pension fund that the regulator itself will not support. Ultimately the pension fund trustees will be constrained by the need to satisfy the regulator that any solution to which they are a part is, in the regulator’s view, in the best interests of their pensioner body.”

Communication and education is what is needed. Jeremy Small, Group Company Secretary at insurance company AXA UK, says: “Companies should treat deficits as one of the largest risks that the company faces and deploy resources accordingly. All the senior executives on the board need to understand what the issues are and to have a shared commitment to resolving them in an effective way.

“They have to recognise that there are clearly trust arrangements in place designed to protect the assets and to ensure the assets are used to pay the beneficiaries, the so-called ‘pension promise’, but it’s important not to underestimate the magnitude of the severity of risk being faced… It is a big challenge to decide how best to fund the scheme in a way that allows them to fulfil the promise made to members but links back to the company in a way that doesn’t ultimately destroy it.”

What’s painfully clear is that solutions do need to be found as it’s difficult to see how the current situation can carry on for much longer.

Can Banks Win Back Trust?


The banking industry faces a huge task ahead if it is to restore trust and credibility. While it’s understandable that much anger and suspicion is directed towards ‘bankers’ for their role in the financial crisis, it has always been too simplistic to blame this group entirely for what happened. It’s time to move on, not least because a strong banking system is in everyone’s interests if the economic recovery is to gain momentum.

Getting there is another matter. The measures taken by regulators, such as the introduction of the Dodd-Frank Act in the US and Basel III in Europe, are necessary to reduce some of the remarkable risks that were being taken with unwitting customers’ money. There does need to be a limit, however, so that the political necessity to be seen to act in order to satiate public opprobrium, combined with a very rational need to reduce alarming behaviours, does not result in throwing the proverbial baby out with the bathwater.

Brian Stevenson, Non-executive Director of Agricultural Bank of China and former Chairman of Global Transaction Services for The Royal Bank of Scotland, says: “If you look at the new regulation that’s being put in place in Europe and the US, together with the FSA in the UK and the new authorities being given to the Bank of England under the new structure of regulation, when you add all of that together, you could legitimately argue that in combination it is going too far. If you’re a large international bank operating in a lot of countries around the world, you’re currently facing a multiplicity of new regulations and new regulators, and they’re not the same.”

The lack of standardisation around the world is a problem, creating a serious competitive disadvantage for some international banks, whereas at least the country-focused banks know they’re competing on a level playing field. “For domestic banks in the UK, it is very difficult to argue that the regulations have gone too far,” adds Brian, citing the issues around payment protection, liquidity and capital planning, to name but three.

Within this, there is also the question of the false sense of security that can occur in the clamour for safeguards and buffers. Steve Pateman, Head of UK Banking at Santander, says: “I may be wrong, but I don’t see that capital and liquidity management in isolation will effectively prevent another banking collapse. It has to be seen in combination with risk management. Anglo Irish would have gone bust with 30 per cent Tier 1 capital, so let’s not kid ourselves that if you’ve got Tier 1 capital of 10 per cent, you won’t go bust.”


Tone at the top

Risk management has to be right – it’s no use, for example, having a well diversified mortgage book if there’s a massive concentration of exposure in highly leveraged corporate entities, as HBOS discovered to its cost. Omar Ali, Partner and UK Banking & Capital Markets Leader at Ernst & Young, says: “In terms of the issues we’ve had since 2007, fundamentally it comes down to a few critical questions; what is the organisation’s attitude to risk?; its culture?; how does it operate? Because, let’s be clear, all banks had rules and policies and regulation was in place already – regulation by itself is not the answer.”

Mary Jo Jacobi, Criticaleye Associate, former MD of Lehman Bros and advisor to the board of HSBC Holdings, says: “The banks need to clean up their own act and demonstrate that they are capable of occupying a position of public trust and of managing their own affairs responsibly. That doesn’t necessarily mean chasing huge profits through highly risky ventures. Of course, one of the reasons we got into the current situation was because the banks were coming up with more and more complex instruments to make money out of basically repackaging the same things. I’m a capitalist and I believe in the profit motive, but I also believe that businesses have a responsibility to understand what they are doing and address the potential consequences of what they are doing.”

Rebuilding faith in the competence of banks will not be easy. According to research from E&Y, some 40 per cent of banking customers globally have lost trust in the industry over the past year; customers are also becoming less loyal and increasing the number of banks they use, with a third of them now dealing with three or more banks.

At least banks now realise they actually need customers and success depends on winning back their trust. Paul Staples, Head of Corporate Finance at BNP Paribas, says: “Regaining public confidence in the provision of banking services will require progressive, visible changes in how we deliver value to our clients. The pursuit of shareholder returns must be blended intelligently with a tangible commitment to social responsibility.

“The project has begun and the next stage is genuine engagement with stakeholders to ensure that key initiatives are better designed through proper consultation. Clarity of communication is essential to regain credibility and to rebuild progressively an enduring trust.”

Over time, banks have been the most ruthlessly profit-focused of businesses. It’s now time for them to reconnect with customers and get back to basics, which means looking at how to provide the best possible service with transparency, such as being clearer about pricing and charges. Whether that is going to occur can be debated long and hard, as the aforementioned cultures within many organisations is entrenched, but given the public’s cynicism towards the industry, those banks that do respond will be at a distinct advantage.

“When you boil it down, banks only really do five things,” says Brian. “They provide a vehicle for customers to make investments; finance for customers; move money from A to B; risk management services; and information and advice on all of those services.

“So, in each category, they have to be careful enough to make sure that what they’re actually providing for their customers is ultimately what they want and there isn’t any form of grand deception or sleight of hand involved in the process.”

Helping first-time buyers, supporting businesses, making services quick and accessible across a variety of channels, that’s what people want to see and, if done in the right way, banks should not be pilloried for making profits. “The most important task we as an industry have ahead of us is to show that banking done well is a good thing, but it’s not a battle we’ve done a particularly good job with so far,” says Steve.

Omar suggests that it should be an enormous wake-up call for banks to appreciate the role they have to play in society: “This could create an industry that is better for everyone. Better for shareholders, taxpayers, regulators, customers, the overall economy and the country we live in. I think we have a unique opportunity to improve banking for all stakeholders and I just hope there is the collective will to do so.”

The Smart Money in Private Equity

If you bring private equity investors into your business, the contract you’re entering demands sustained high performance and good returns. Given that anything else will be deemed a failure, it’s surprising how many management teams accept PE backing without understanding how these investors operate and whether they are the right partner for delivering success.

The financial firepower that PE carries does matter, but there’s a whole lot more to it when it comes to growing a company. Nicola Mendelsohn, Executive Chairman of Karmarama, part of the PE-backed Karma Communications Group, explains: “It’s a really good model, if you get the right partners. It allows you to dream big and accelerate the ambitions you have and that can only be a good thing. But it comes down to doing your homework in the early days to make sure that the company and the people are the sort that you want to be tied to for quite a long time.”

In other words, the due diligence has to be done by management on potential PE investors and not just the other way around. There are questions to be asked about the lifecycle of a fund a PE firm may be drawing on to invest in a business, sector expertise and it never hurts to get references from portfolio companies (not necessarily those recommended by the PE firm).

Geoff Brady, Chairman and Non-executive Director of Harvey Jones Kitchens and until recently Chairman of Robert Dyas, says: “Probably half of the time, the board that is going out to get private equity investment does not necessarily understand the PE market. So [they don’t understand the need for] questioning what their normal churn lifecycles are, what fund it’s coming out of or when that fund is due for repayment, or the chemistry and whether you can work with these people… You need to talk to people they’ve done deals with before.”

According to Chris Hurley, UK Portfolio Managing Director at PE firm LDC, it is important for the management team to scope out how an investor responds when KPIs aren’t being met and dreams are turning to nightmares, as can happen in any business. “I’d want to know how a private equity house would deal with bad news. Would they be supportive if things got tough? If you ring someone up as a reference, and they’ve made five times their money on an exit, they’re going to say nice things.

“The best references, and the ones we give, are from people where things haven’t gone quite according to plan, but we’ve been supportive. It’s those companies, where we’ve seen them through the tough times, that we always use as the best references because they’re real.”

Iain Robinson, Managing Partner at consultancy AMG and former Chairman of business travel company Reed & Mackay during its sale to ECI Equity Partners, says: “A key question to ask the PE firm is around the specific experience and contributions made in successful investments with identical or similar businesses, and what criteria they are using to judge ‘similar or identical.’”

Launch pad

Once both parties are satisfied, the hard work can begin in scaling a business. Nicola says: “There’s no question that PE does bring a lot of strategic advice and support as well as the financial side. Obviously the money is a driver, but there is huge value in people that do this on a daily basis. I found their desire to make us more ambitious to be absolutely brilliant.”

The elements for achieving ultimate success (i.e. a lucrative exit) are the same as for building any good business. Chris comments that, certainly when evaluating a business to work with, there has to be a compelling profit story, a robust business model, a respectable market position and for management to possess both a strong track record and to be highly motivated going forward.

Tim Irish, Non-executive Director at the venture capital-backed healthcare concern Nexstim, comments: “There aren’t many young businesses with strong cash flow, and debt obviously increases the risks for your business, so patient investors who want a dividend or a crystallised sale at a later stage [are attractive]. You also get access to experts and networks, and a good PE or VC name backing you ups the interest in your company tremendously.”

In terms of exit timelines, market conditions in recent years have made trade sales or secondary buyouts harder to come by. Geoff says: “PE houses are taking a longer view. Whereas it used to be three to four years, I think now most of them have had to extend their investments because they’re waiting for some GDP growth and better news in the economy before selling.”

Horror stories do exist where businesses have been bought or invested in by PE houses at too high a price. As a result, they’re over leveraged and management and investors are simply running to stand still, unwilling to take the inevitable haircut.

Chris states that this must be watched carefully. “The business has to have the capital and cash resources to enhance its strategic journey by investing in people, products, plant and equipment or whatever it is the business needs. It can’t be about ripping every last penny out of the business to repay interest and to stay on the right side of banking covenants. It’s crucial you have a capital structure in place that doesn’t strangle the business and its strategy for growth.”

Again, the management team needs to take responsibility here when terms and conditions are being agreed to at the beginning. It’s all too easy to be blinded by year-on-year double-digit growth predictions and champagne visions of a wealthy post-exit lifestyle.

John Allbrook, Executive Chairman of IT financiers Syscap, comments: “People that I’ve spoken to very often find that the reality of private equity ownership is somewhat different to what they were expecting, so you need to go in with your eyes open. This isn’t just free access to capital.”

The rewards are there, provided you’re not blasé about the risks. “You can’t lock everything down before signing as the world doesn’t work like that, but there are more bases that you can cover than perhaps you think of,” says John. “The value creation strategy needs to be agreed, the board composition needs to be discussed early, alignment of interests needs to be determined and the exit strategy needs to be planned.”

If something doesn’t seem right, then walk away and look elsewhere as high-growth businesses will get backing given the money that a number of PE firms still have to invest. Paul Brennan, Chairman of cloud storage provider OnApp, says: “Go after the smart money. If they have limited experience in your sector, then they’re not going to help you very much [with the] industry experience and connections that could open doors… Just having good financial people inside the PE house is not enough.”

Derek Neil, Corporate Finance Director at professional services firm BDO, says: “They should bring more than just money to the table. Sector expertise is interesting as if they happen to have had a successful exit in the same industry, then they’re likely to understand it and the business you’re selling. Likewise, if you’re a retailer with five outlets and want to take it nationwide or international, then a PE house with a track record of going through that is likely to add value along the way.”

PE continues to be an effective accelerant for companies that are serious about achieving scale and growth, be that organically, acquisitively or a blend of both. From the perspective of management, it may be flattering to know that an investor is interested in the business, but you have to understand that, in the final analysis, the route to exit is what matters.

As Nicola puts it: “Your choice depends on how interested they are in your business. You want to know that they care about the opportunity as well as the very important question of whether or not they do really have the money.”

Please get in touch if you have any comments about the issues raised here.

Navigating the Euro Crisis

As Italy, Portugal and Spain get downgraded by credit-rating agency Moody’s and leaders from the EU go cap-in-hand to Beijing, it’s understandable that businesses remain confused about how to navigate the euro crisis. That said, executive teams cannot fall into a state of paralysis and must recognise there will be opportunities amid the ongoing chaos.

Mark Spelman, Global Head of Strategy at Accenture, says: “Chief executives should continue to focus on how they can protect their market share in their core markets, especially in Europe, while at the same time seeking out those hotspots of growth elsewhere. Events are going to be more uncertain and one has to live with that, but it doesn’t mean that one should be paralysed.”

The challenge is to manage the uncertainty and be flexible enough to move when market conditions are favourable. Chris Stooke, Chairman at broker Miles Smith, who is also a Non-executive Director for insurance entities Chaucer and NFU Mutual, comments that problems in the eurozone “are generating numerous steps forward and back which is leading to great volatility”.

He explains: “For Chaucer and NFU Mutual in particular, this means that we are having to manage quite large investment portfolios in this volatile environment and have to balance the effects of short-term fluctuations with our views of opportunities which will only emerge over the longer term. NFU Mutual, for instance, has some relatively large equity positions and, while the investment team is of the view that there is some good value to be found in this asset class, on a month-to-month basis large swings in value and income statement volatility can occur.”

Paul Staples, Head of Corporate Finance at BNP Paribas, observes that within the banking sector the European sovereign debt crisis is having a profound effect on the strategic options being considered by executive management teams. “The competitive landscape within both corporate and investment banking is in a clear and, candidly, unprecedented state of flux…

“The extensive de-leveraging exercise that is underway will have a meaningful impact on the way in which corporate clients manage their relationship banks and is already changing expectations of what can be sensibly expected, both in terms of pricing and balance sheet commitment.”

Shop around

For companies with the financial firepower, the crisis presents a special moment in time to look at potential acquisitions. “The eurozone crisis may create an opportunity for UK companies… who wish to expand in Europe as previously it’s been very expensive to compete there,” comments Aleen Gulvanessian, a Partner at law firm Eversheds. “Up to now Europeans have been buying more UK assets; if sterling starts getting strong would UK companies be better buyers as a consequence?”

It’s a scenario that has been jeopardised by the threat to downgrade the UK’s triple-A credit rating, but without question other businesses and investors are scouting Europe for deals. Daisuke Ishida, General Manager of Financial Markets Business Department at general trading firm Mitsui & Co Europe, says: “Many businesses are more financially constrained so they may want to dispose of some assets which wouldn’t normally come out in the market otherwise, so we’re very keen to identify those situations.

“We’re looking across all our target sectors, not excluding the opportunities coming out of the private equity portfolio, but more the corporates and specifically the banks that need to dispose assets [in order to] shrink their business in terms of geography and scale. We’re not trying to buy at the bottom of the market, but rather identify attractive deals that only come to market as a once-in-a-lifetime opportunity – and we’re willing to pay a fair price.”

In its way, it has to be said that this also heightens the mood of uncertainty and lack of confidence as venerable corporate institutions become targets for bidders. “The assets of business in Europe are vulnerable from sovereign wealth funds, particularly by those countries accumulating large amounts of capital,” says Mark. “China, for example, has 3.5 trillion renminbi accumulated in reserve. These funds are now taking positions in infrastructure projects and also in companies, such as the [Chinese Investment Corporation’s] 9 per cent stake in the UK’s Thames Water.”

Plan of action

The stark reality for many boardrooms is to adopt a ‘go slow’ mentality and monitor the situation carefully, which is true of Asian multi-nationals and European ones. Pankaj Ghemawat, a Criticaleye Thought Leader and Professor of Strategic Management at IESE Business School, Spain, says: “All kinds of investment projects have been put on hold which is really the worst thing for the eurozone right now, as people wait and watch and figure out what’s going to happen. I’ve seen relatively little attention paid to what business strategists would normally recommend, such as scenario analysis and trying to figure out contingency plans.”

Such an impasse is deeply damaging. “If you look at the eurozone’s international interactions, 60 to 65 per cent of exports and imports are to or from other European countries,” continues Pankaj. “In terms of inward foreign direct investment in the EU, 62 per cent is from the rest of the EU too. So, there will be these important cross-border interactions to manage and Europe will continue to be its own largest trading partner in multiple ways, which is why simply focusing on Asia is not an adequate response.”

Those speaking to Criticaleye largely have faith that the euro will not fail, mainly because of the political will that has been invested in it. Michael Cox, Professor of International Relations at the London School of Economics, says: “There has been one thing missing from the debate among economists and business people about the euro crisis: Europe is at the heart of a political project whose failure would not only lead to a run on the banks, massive inflation and the reintroduction of war-time like controls to prevent a flight of capital to safety (where the US would be the most likely destination),  but it would also loosen the political ties that have made Europe safe for peace for the past sixty-five years.”

The postponed decisions and lack of unity from EU leaders adds to the frustration and anxiety. Tom Taylor, Chief Executive of the Agriculture and Horticulture Development Board, says: “We would all like to see a solid stability pact, where the vulnerable countries take serious action to reduce sovereign debt. Personally, I think that the EU will get there but not without some bumps in the road and a prolonged period of no or limited growth and, as a consequence, weak demand as the austerity needed will have a recessionary effect.”

A similar point is made by Chris Merry, former CEO of financial services concern Matrix Group. “I would like to see decisive action and a quick resolution to the crisis, probably through the ECB [European Central Bank], which would in turn be supported by the eurozone countries. I think the euro will muddle through and there will be much dissatisfaction at the speed of decision making, but the alternative is too scary to contemplate.”

It’s a picture of Cubist complexity where tomorrow the situation may have taken yet another dramatic twist. Mark says: “My message to business leaders would be: don’t underestimate the political will as there will be ups and downs with the euro in 2012 and you do need to think quite carefully about risks and contingencies around it, taking into account low or negative growth rates and banking uncertainties, particularly when the banks start taking significant write-downs on Greek and other country debt.”

As Paul puts it: “The primary challenge is to design business models that deliver a sustainable risk-adjusted return on equity that can reassure, and in due course be embraced by, stakeholders.”

A mantra that will hold true for the boards of both public and private concerns for some time to come.

Please get in touch if you have any comments about the issues raised here.

I hope to see you soon.


Private Equity: The Future

The future of the private equity model for financing young, growing companies has come under fire as the UK and the world embarks on a fragile recovery. The lack of recent exits is putting continued pressure on private equity funds that, like many organisations, are having trouble finding cash. Does this spell the end of this method of financing?

At last week’s Criticaleye Private Equity CEO Breakfast, a group of experienced executives and non-executive directors from private equity backed organisations met to discuss the issues concerning PE, the future of the model was widely debated.

Private equity’s history of high returns may have led to its troubled present. “There is no doubt that many PE companies have generated spectacular returns for the investors and PE executives alike. There is some considerable debate as to how much of this was due to upside generated by the financial engineering possible with the high levels of leverage and how much was due to the value added to the business model by the PE investment. What we do know is that the level of leverage seen in 2007 and 2008 was also there in the late 80s during the last serious crash. What was different this time is the weight of debt was many times higher than last time,” explains Sam Ferguson, Chief Executive Officer, EDM Group.

Iestyn Roberts, Chief Executive Officer, Freeport Leisure, agrees and explains further. “My personal view is that we will see significant evolution in the PE model as we know it.  There appears to be a general belief that the period 2000-2008 was ‘normal’ and this will eventually be restored. My view is the opposite, this was an aberration founded mostly on a tide of cheap money. Most of this work was financial engineering aided by a booming world economy. There will be a role for PE in the future and it will be much more about providing funding for emerging ventures or providing equity in situations where it is needed (eg, MBO). From the investor point of view, it will be part of their portfolio exposing them to higher risk/reward situations.  Inevitably this is a smaller industry than before.”

The lack of successful exits in the past year is troubling the market, as it was questioned how long PE houses are willing to finance companies. By preventing organisations exiting, leaders feel that business is being constrained, turning well-run, positive cash–flow organisations into ‘zombies’.

“The paucity of exits with the resultant lack of liquidity has undoubtedly put pressure on the traditional LP/GP private equity model.  This will inevitably lead to a shake-out in the medium-term.  Leverage and exit multiple arbitrage cannot be relied upon to deliver returns, those private equity firms who work with their investee companies to add value are likely to emerge as leaders.  At LDC our evergreen funding model and commitment to supporting initiatives to both grow the revenue and improve the operational efficiency of the companies that we invest in should ensure that we are well placed,” says Tim Farazmand, Managing Director, LDC.

According to experts, only 25 per cent of private equity funds are doing well, a figure that does not bode well for the future of the model. This low percentage of well performing firms may be due to the fact that models can vary significantly.

“I feel we have seen the end of highly leveraged buy-outs as a widely used structure. For some businesses, it may still be appropriate but for many it will not work in the future. Medium levels of gearing, sensible mix of financial tools – payment in kind (PIK) vs repayments, etc, can still enable businesses to expand and create significant returns. I’ve already seen the wiser PE firms restructuring their portfolio investments in this way to be sure they lead the way out of this recession,” explains David Tydeman, CEO, Oyster Marine.

There are still PE funds that are doing well, for example, funds that work off the balance sheet of banks or well-established financers have had strong showings.

“In this discussion it is important to distinguish between funds that still have money available to rescue ailing portfolio companies and snap up new deals at low valuations versus funds that no longer have access to money and are struggling to raise fresh capital from institutional investors,” says Peter Roosenboom, Professor of Entrepreneurial Finance and Private Equity, Rotterdam School of Management.

Although cash is important, the experience and knowledge of the partners is vital, especially in these tumultuous times. Peter continues: “Academic research shows that funds that are doing well, do so persistently over time. They employ the best general partners, recognise opportunities early on, before everybody joins in and valuations go up (money chasing deals) and most importantly they do not raise too much capital (ie, they only invest in a limited number of portfolio firms so as to not spread their general partners expertise too thinly). My educated guess is that the funds that are younger, with less able general partners and funds that got invested in the recent years (when high multiples were paid for deals and deals were more debt financed) are going to struggle. The others have better chances of survival.”

The importance of private equity in the pre-recession world is undisputed; however, the model is now in flux and evolving to meet post-recessionary circumstances. Rupert Cockcroft, Chief Executive Officer, CancerPartnersUK says, “The PE model is still important. However, the model seems to be changing from short-term, high multiple returns to longer-term investments that require a closer alignment with management teams.”

According to Sam, the change in private equity comes from the sheer volume of firms. “I think there are too many PE companies now compared to the days of super returns made in the late 90s to the period just before the ‘crash’. These companies are chasing too few good investment opportunities. This has meant that the longer established PEs have pushed up market to ever larger and larger deals.  These larger deals bring with them the same risk profile that conglomerate plcs had in the 80s. The competitive market created by the number of PE funds and the larger deal syndrome mean that the equity deal shapes have to change and investment periods will be longer with less opportunity for spectacular returns; measuring these deals as a multiple of money invested. That is the way to deliver longer-term future for business rather than rely on the cyclicality of the debt and equity markets to generate the high returns,” he contends.

Although there are questions about the continued feasibility of the private equity model, many believe that the method of financing is essential for some growing businesses. “While the PE model is under great pressure it is still viable and represents an attractive route to growth and success for many portfolio companies,” says Murray Hennessy, Chief Executive Officer,

The next Private Equity CEO and NED Breakfast will take place in May. If you would like further information on today’s subject please see the Insights page.  In the Community Article Variant Viewpoints: Private Equity versus public management teams, Criticaleye speaks to Jacuzzi UK’s Mark Prince, and LDC’s Tim Farazmand about the challenges and benefits of working with/being part of a management team that is new to private equity.

Please get in touch if you have any comments about the issues in today’s update.

I hope to see you soon