der and wi - terra firma article.pdfterra firma 1ml acquired in 2007, lud been seized by its...
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der and wi.losing a £1.6bn equity investmei
$Mands met PEI in his Guernsey office to
jiscuss what he has learned from the last three years and how
he intends to get Fund III 'back to flat'. By Toby Mitchenall
P H O T O G R A P H Y BY T O M T A R D I F
MARCH 2011PRIVATE EQUITY INTERNATIONAL
Guv Hands was not, as was reported in the press,"furi-
ous" when lie found out EMI, the music group his firm
Terra Firma 1ml acquired in 2007, lud been seized by
its creditor Citigroup in Fi'brujry.
Tlu t was jusl not true; I wasn't furious at all," I lands reflects
from the other side of the vast boardroom table in Terra Fiona's
Guernsey offices.
Behind him, through floor-to-
ceiling windows, is a panoramic
view of the peaceful shurcfront town
of St. Peter Port, tin1 se.i beyond
and the other Channel Islands.
"We agreed with Citi that a capital
restructuring needed to take place."
Neither was he as other
commentators had suggested
delighted to have EMI taken off his
plate.
If it was neither anger nor reliel
that he felt, what was it? Hands
glances to his right as he considers
the question. "Sadness," lie says alter
a long pause. "I think most of all it
was ju>t SJ<1.
The sadness, he explains, was for
two reasons.The first being that he
had genuinely held out hope that
Cili would come around to Terra
Firma's valuation of the business,
which would have paved the way
to a consensual restructuring of the
music group's debt load.
Terra Firma, the private equity
firm founded bv I lands in 2002, has
over the last three years become
inextricably linked to its doomed
investment in EMI, the musk-
publishing giant lliat Rinds" linn
dc-listcd from the London Stock
Exchange at the height of the credit boom in the summer of 2007.
Terra Firma paid 1.4 billion for it, which included a debt package
underwritten bv Citi. It was soon clear that the company was
saddled with too much debt. After failed negotiations to restructure
the loan, which due to currency tlucluatkms grew in size to around
£ J.4 billion, ami a court case hi which Terra Firma unsuccessfully
tried to sue Citi for tricking it into doing the deal. Hands' firm
ultimately lost thecompny in February ibis year, along with Ll .58
billion of Terr a Eirnia funds.
The second reason for his sadness, I lands continues, is that he
feels that under Citi s ownership, 0MI is likely to broken up, split
into its two divisions: recorded music and music publishing. 1'cna
Pinna, savs Hands, bad .supported
the EMI management's view that
"maintaining a .single entity made
most sense".
When pressed on why a break-up
of EMI woultl be a cause lor sadness,
Hands launches into a detailed
analysis of the fundamental >lufts
underway in the music industry, how
niiB.ii1 is Milil to consumer* .itid what
ihe industry will look like In 2016. It
seems clear from the discussion that
the sadness fell at the loss of EMI
is in part because here is a man
who enjoved the extreme challenge
of trying to steer J vast historic
business through the choppy waters
uf on industry undergoing dramatic
structural change.
I Ie speaks animatedly about the
different skill sets and personalities
that make a recorded music
executive different to a music
publishing executive ("they are both
creative, but in different wavs"). As
A\I investor. Hands is renowned in part for bis attention to detail
and this conies across loud ami clear as he dissects the state of the
music industry today and where it is headed.
The challenge of steering the FME investment to a successful
conclusion was made impossible by the confluence ol live separate
factors, says Hands: a perfect storm. "Just about everything ihdl
could go wrong did," he laments. First Citi was unable to syndicate
the loan out to other investors. Terra Firma, meanwhile, was
unable to syndicate uut some of its equity. A planned sccuritisation
of EMI's assets did not go ahead. The debt had been hedged to
protect against currency moves in such a way that it grew in
M/.e. Falling multiples meant F.MI instantly dropped in value as
Hands: sadness over EMI
•>AM 2 3P f i tVAr t i HQiJfTV INTERNATIONALMARCH 2 0 ! 1
with soim1pride. "Ironically, if we hadn't made those changes, Citi
would be oeHinsj nothing b.u'k on their loan."
TIii' notion ihat Imannai market turmoil aiidc the i:MI
imcitnicnl was actually s>oin« very well adds a little 1 ('edibility
to (In1 rumours thai suggest Terra l-inna mi«ht make another pby
lor 1:M1 .There is certainly ,1 hint of unfinished business in die wav
[ [amis discusses Uit> company.
TI111 rumours, howeuT, have oiilv .1 slim gruumlinu in reality,
says! lands. I It- i* careful nol to rule it mil altogether, Suit in his
view tin1 ih,iinvi>"\vrv, vrrvMiull". ("uiisidrrinv; J l>iil i .si.in'iv
from j)i!llifi«o»iMi)."\\vli<i\r !iiokc<i
•it IBritiflt footluil i-iuii) MiinhiNU-i1
Uuiutt lliive tiim-s, but «v luu- m-wr
|iiil .1 bid in or i-vrn .ippro.trlicil it>;
OWIKTS."
! fdtids' p.iiMIII'1 willi Man United
is .111 iiUeroim^ one. 11 In1 ilioii»ht
liissliiii) with lliv st.ikoiioldors <>l <i
ivconl lain1! liigliiv |)>H*] im]>kijiis
jmon« tin-in \vas,i tricky liusiiii-^s,
; !io would want to stm- wt-1! cliMr ul
footliail fans, wiiosi- vitriol against
iniancial invisfois is K-jinnLirv,
; DON'T DOUBLE DOWN
ll'.s h,\nl to stH- lion ,s UTV jmblif
t i . 6 billion loss amid nol slukt- an
investor's lonfidcna1, even oiu- witli
.1 track ivrord like Hands has at !en.i
I'iniu. I lif itmi\tor*,v.Hv I!.««!'.. li.wt*
(old him to try to not let the ocj ini-
eniv knot k him.
"Around Chrislin.ii lime through
t<i the NewVc.ir jsoim- weeks .liter flic
lri.il bad com iudi'd[, 1 had a lot oi <:,i!ls Irom itive>tf>rs telling me
to just sUv calm .md don't let it .ilit-cl mv ('oiifi<kiliv,"lic ret,tils.
"Thev said'(in v, if \oti «u h.ick to jtiif hifliti" •.ingles, we will li.iek
vou next tiiiie, II vou trv to hit the !>.)!! mil of tin: j).irk jgain.. .even
ii'vmi do hit the b.ili otn tjf tlie park,.. we JIV «oing i<» be ner\mis'."
What LPs wanltd him to avoid, he elaborates, is tin- feeling tliat
lie has something to prove. I hnds lurks back to !iis i-xpmcmvs
as a voun« man on atrjdmii desk in lite 1980S,"'MK' n.ilur-d thino
jafier a !>i« bet th.it goes wrong] is to uaut to pn>\e untrsi-ll. It's
lou^h Ui (OI IK b.uk in just sinjll stages, but it's good advice ,md
we .ire trvin» 10 keep to i l . "
As .1 uiung U'ciuger, lUnd.s used to play poker jml win
atv.iinsl tlu- lurdi'iu'ii middle-joed workers oi a ni ld storage
company 111 a local pub called the Btiillinch in Seveimaks, the Kent
town in which In- grew up. Decades Liter he is reciiibratmji iiis
.iiiorlite fur lisk.
,t biisiness. " i f oniv three out of l i\e
liaii -,;unr i\n>n«, we would have been
fliH-," vivs Hand-..
On tin- various issues coiuiedei!
with l i iuiuial markets, Hands is
ad,tnianuiui.ifur its bailout bv the US
"ovenimenl ihirint; the financial crisis,
Citi would have been unable to help
1-M1, even if il had wanted to.
"()iit*iuive view when we wi'ill idtii
this deal was that Citi was our partner"
be \a\s. Alter the government bailout
and departure oi cbiel executive Chuck
Prince am! vice chairman Michael Klein
"the people who took o\er the business
w.mlvd \i> shoot i-wTvlhiii'J created
bv tin- loniit'i' rejjimt1, which i* no!
umiiti.il in business. We werr seen as
tin- ultiniatf emiiari Mssment in terms ol
i\hat Citi ii.ic! done. We had no Iriinds
left tJiero .imi we became a lightning
rod for the bank's iiitenul bailies,"
in jtilv .?(H)7 I'rince b.id I'.imousK fvmarked on xhe bank's
it'u-r.ioed lendingaeiivitv:"As lung,is tin- nm-sic U playing, you've
"ot to get up and li.ince. We .ire still dancing."
"I ba\e no doubt in inv miml lh.it he was reJerring to 1-MI,"
.••jvs Hands.
WHAT WENT RIGHT
ilieoperaiionalch^nges'lena lirnianiadc tol-.MI w ere more elec-
tive than had ewiibcen hoped, explains H.mds, Alter ac(|Utriiig a
business with earnings oi i.170 million (Terra Hrma iud based its
bid mi tin- "hopelessly optimistic" current year earnings ol 1520
million presented bv the management, sav* Hands), Terra Hrma's
turnarouniiol the business led to iMniin«sol LH4 million in 2010.
"The iin.uui,il elieds oi'those (hati^es uere incredible," he savs
MARCH 2011PRIVATE EQUITY INTERNATIONAL
The sporting reference to "hitting singes" "When VOU WIDQ OUt vcr-v P^fi^ble.Your effect on them is moregradual, it's a lot of smaller steps and there
is loss volatility."
As a professional investor, I IJIUIS lias felt
the pain of the l>ooin-bust cycle as intensely
as anyone. But importantly and unlike .some
of his peers he is still in business..As we have
said in these pages k'forc, the £? billion in dry
powder remaining in Fund 111 eould be Terra
iirma's saviour.! lands knows how his inu>toi>
want him to put it to work slowly and steadily
- but does he feel the investment environment
tot lav, with price multiples as high .is ever and
debt availability coining back fast, is conducive to such prudent
investment? Arc we not approaching the hcadiness we saw in 2007?
"It's f»nnv,"he savs. "It fed* very, very dillcmil, hut the nunuVra
would indicate it's quite similar.There was a confidence in 2007
which doesn't exist today. Although the numbers might give you
similar indications, peoples' approach is much more sensible than
it was in 2007."
Throughout the meeting Hands gives much thought to the
questions posed and takes time to consider his responses.
I le take;, a lung pause and looks away to consider the intricacies
oftoday's deal-doing vminminent. "Tin1 reality is," he picks up
the thread, "that most of the people who didn't invest at the
time were ju.st lucky.The pressure one fell at the lime to invest
and to use money raised was extraordinary. No one foresaw the
interconnections in the markets and the crash that would result
from the subprime collapse."
I IN, he continues, were el a mo tiring for (((-investment
opportunities. "This is why Terra Firma did 30 percent in EMI;
the idea was to sell it down tn our co-investors. We never aimed for
the fund to l*c JO percent EMI, and we were doing exactly w Iiat we
said we would do in providing lots of eo-investment opportunity.
It's just that, given what happened in the market immediately after
we did the deal, virluallv no-one wanted it."
Hand* switches his locus hark to the original question of
how the investment environment today differs from 2007. "The
rather than trying to .smash die ball out ol the
park refers to making smaller investments;
huv-and-builds that can he drip fed equity r I ,i- I I i
. , ,,. . fund, qettmq back toover tune rather than taking one Urge ' -> *-*
injection up front.
As an example of the deal model be knows
he has to follow, Hands points to Inlinis, a
renewable energy business that started life
as a corporate carve-out with (.10 million
in earnings in 200 i and now has earnings of
more than L100 million, "We have just steadily
added on to ihe business with a mixture of
organic growth and acquisitions over five years and we will
probably make Jx or 4x on i t . . . maybe a hit more."
But, he continues, "it's not a verv noisy business; it's not very
ilramatic.There are no dramatic key decisions to lie made, hut lots
of small ones. It's just trying to get the operations heller, trying to
get the conversion up if you are a wind farm.Trying to get the gas
collection in terms of energy waste higher and downage lower."
It is dear that then* is only so much excitement that a business
like [nfinis can rouse, especially after the roller-coaster ride of
EMI. The same could be -said of Terra Firma's iim'slments in
Australian cattle ram lies. "First you w ork out a plan lor increasing
the carrying capacity of a farm, then you start to put in the
infrastructure to achieve it. Then you start to breed the cows
out so you can fill thai capacity. Four years later you start to sell
the cows and you get the economics," he continues. "It doesn't
attract much attention. When you say you haw increased the
carrying capacity from 40,(100 head of cattle to 48,000 head ol
cattle, no one gets that excited."
LESS EXCITEMENT, MORE PROFIT
Hands happily discusses the finer points of renewable energy
ami Australian agriculture, but he is significantly less animated
than when talking alioul 1-MI. Are these investments hnring
by comparison? They're less exciting businesses, but they are
30 percent of your
flat is not easy"
THE CHRISTMAS BOOK D I L E M M A
we didn't really think it was suitable."
Mark Twain wasa hugely charismatic and entertaining man,
who unfortunately lost much of his fortune on a misguided
investment in a novel printing machine railed the Paige
Compositor. He subsequently worked hard to overcome his
financial troubles and repaid al! his creditors in full, even though
his bankruptcy alleviated his responsibility to do so. Perhaps it
wasn't such a bad choice of buck after all.
Friends ami business contacts of Hands may have been a little
disappointed not to receive their Christmas hook this year. The
annual gift was forsaken understandably so for t«« reasons:
one was for straight -forward economy (this was not the time to
be spending monev on niceties) and the other was that Hands
could not settle on an appropriate tome. "Unusually we actually
looked at MarkTwain's autobiography; it has just been published
after 100 wars," Hands notes enthusiastically. "In the end though
PAGE 2$PRIVATE EQUITY INTERNATIONALMARCH 2011
difference today is llu: mentality. We have all been hit pretty hard.
Memories art' normally short fur these sorts of things, but no one
who has Win through ilu- List fvw years will forget it ijuicklv."
Evon the expensive looking deals done todav could turn uut
reasonably well, generating "solid mid-teen returns, rather than 20
percent-plus", he says.
While I lands fullv recognises the fact that industry- wido returns
will come down, where does he sec his third fund, which raised
C5.4 billion in 2007, finishing up? It is tattling, after all, again;.! an
immediate iO percent handicap follow ing tlu- loss of LMI.
"Our aim is to get back to Hat and nuke a small margin. When
vou wipe out 30 percent of your fund, getting hack to Hat is not
easy" A quick mental calculation concludes that gross of fees
Fund HI is going In have to make 2x on the rest ot its ccjuity.
The refrain that I lands returns to again is that he cannot again
"mil the dice" on a big bet like I:MI. If he is going to double
the remaining capital in l;und II!, he is going tu have to do it by
hilling singles.
OUT OF THE LIMELIGHT
In previous conversations with LPs inTerra Firma funds, one topic
raised was tlu* very public nature of tin- entire EMI investment
from start to finish, ll is one thing to sutler a meaty investment
loss; investors can forgive this, It is another thing, however, for LPs
to see die drama [-laved out on a near daily lusis in the mainstream
press. This was something they were not used to and something
they do not welcome.
But in his long career, I hinds has never been one to shy away
from tn^jging with the piv>* or standing tin a conference podium
and delivering forthright opinions to his peers. Indeed, he was
addressing conference delegates in Paris just a couple of weeks after
the conclusion of the trial against Citi in New York.
One might think that the very public drama of the EMI
investment would make him reconsider his position as one of the
industry's most open figureheads. Not so, he says. "Prom Ivbruary
2008 up until when t'iti look over EiMI I was not speaking to ihe
press at all. Publicity during tliat time was greater than it has ever
been before and most of it was negative. I don't think the lesson is
that one wants tu be more private and hide Iron) the press."
Instead Hands is resolved to steer clear of deals as high-profile as
EMI."Tin* guild news,"he tjuips, "is that is there isn't another deal
out there that would attract as much attention... except perhaps
Man United football club."
Hands shifts from a moment of jocularity to serious
contemplation. After a long pause, he says: "I am trying very hard
to not take the negative and often completely wrong press coverage
during the period as meaning I should be negative towards the press."
Three wars of increasin^h intense media coverage has taken its
lull on Hands from aiiiTSon.il peripet1iu\Td be Ijingif I said it
MARCH 2011PRIVATE EQUITY INTERNATIONAL
seems in ukc some heart from the 85
percent vote lie received lo inject more
money into F.MI List August."We know
they wvrc willing to put nifirc money
into EMI last August. We don't however
yet know if they will be willing to put
more monev into Terra firmafhe stales
plainly. "The track record over the last
15 years, even with EMI, is very i»ood,
and we have learnt fnmi l:Ml."
Therein lies a deal-breaker in many
Li's' eyes. What exactly has Guy I lands
learned from the F.M1 investment?
Aside from the continuing theme
of getting back to "hitting singles",
Hands is adamant .Omul a couple of
very s|tccific investment lessons. The
first relates to underwriting equity
for to-investments, five years ago.
Terra Pinna would underwrite a deal
with $0 percent of the fund's equity
and look to sell down 20 percent to
en investors, leaving a 10 percent fund
exposure, from now mi it v. ill prolublv
only underwrite 1S percent and look
to sell down just 5 percent."That cuts
our risk bv 75 percent in terms of
overexposure,"he notes.
The second lesson relates to
participating in take-private auction
processes. Tin not sure I'd want to
do another competitive auction on a
public-to-private," he says.
Private equity has two great
advantages, explains Hands. One is the deep due diligence it can
do on its target away from the glare of public markets. The other
is the deep operational control it im subsequently cxvrcm1 on the
asset it lias acquired. A competitive public auction gives away one
of those advantages. "And that is an advantage that I think is worth
an awful lot oi monev," he asserts.
In 2007,! lands notoriously described bankers as being like
whimpering dogs, who had been hit hard and were "not going to
come out of their boskets*. As we sit in the Guernsey boardroom he
lurks hack to the comment. "We have been hit pretty hard, and even
the most resilient person is unlikely to want to put themselves in
the same position again. It's going to take an awful lot for someone
to persuade me to do another competitive public-to-private high
profile deal."
After a moment lie adds,"! thinkonc EM! in one's life is enough."
That should be music to his Li's' ears. •
wasn't incredibly upsetting. It's a lough
tiling to go through and it's tough lor
the family too." Hands has a wife and
four children.
The press coverage intcnsilicd
during the very public law suit that
Terra Firms brought against Citi,
accusing the bank of misleading it
during the auction process for EMI,
accelerating the bidding process and
tricking Terra Firnu into overpaying
for the business.The trial kicked off in
late October 2010 and lasted just under
three weeks.The jury ultimately ruled
against Terra Firma.
Going back over the court case.
Hands reinforces the jMiint that the
whole process of bringing the law suit
was not a matter of pride on his part, or
a personal vendetta against Citi banker
David Wormslov, but a mailer offer ra
Firma's obligations to its investors. The
people it MAS most for were were those
investors who would never invest with
us again. The only thing we could give
back lo them was pursuing what we
saw as a legitimate claim."
As far as Hands is concerned, it's
"difficult to see what sum of money we
timid ever have won which would have
justified it Irian a jx-rsonal jwint ofview."
IN FIVE YEARS'TIME
Hands: 'hitting singles' from now on
"We were seen as the
ultimate embarrassment
in terms of what Citi had
done. We had no friends
left there and we became
a lightning rod for the
bank's internal battles"
Looking down die track, I lands believes: Uiat in five years' time he
will be doinn the same thine he is today. "I think the next few years
are about formin<i, not about storming," be says.
In order to do this, he will need his team around him. After some
high profile departures from Terra Firma., the question is how to
motivate and retain a team when they are working on a fund tliat
b underwater and clearly not going to pay carry. "We arc focusing
our attention on a smaller t>roup of people," says Hands, explaining
that the firm's infrastructure had Itecn built up to accommodate a
€10 billion follow-on fund."We knew we would lose and indeed
needed to lose some of the senior people."
Perhaps more importantly, I lands will have to either convince
his current investors to back him once more, or find a new set of
LPs (or most likely do a little of both). It's obviously impossible
to sav without knowing the ultimate fund performance numbers
whether the U's vt ill U- there for him for the next fund, but I lauds