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 PHOTOGRAPHY BY T O M TARDIF

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Page 1: der and wi - Terra Firma Article.pdfTerra Firma 1ml acquired in 2007, lud been seized by its creditor Citigroup in Fi'brujry. Tlut was jusl not true; I wasn't furious at all," I lands

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

Page 2: der and wi - Terra Firma Article.pdfTerra Firma 1ml acquired in 2007, lud been seized by its creditor Citigroup in Fi'brujry. Tlut was jusl not true; I wasn't furious at all," I lands

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

Page 3: der and wi - Terra Firma Article.pdfTerra Firma 1ml acquired in 2007, lud been seized by its creditor Citigroup in Fi'brujry. Tlut was jusl not true; I wasn't furious at all," I lands

•>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

Page 4: der and wi - Terra Firma Article.pdfTerra Firma 1ml acquired in 2007, lud been seized by its creditor Citigroup in Fi'brujry. Tlut was jusl not true; I wasn't furious at all," I lands

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 5: der and wi - Terra Firma Article.pdfTerra Firma 1ml acquired in 2007, lud been seized by its creditor Citigroup in Fi'brujry. Tlut was jusl not true; I wasn't furious at all," I lands

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

Page 6: der and wi - Terra Firma Article.pdfTerra Firma 1ml acquired in 2007, lud been seized by its creditor Citigroup in Fi'brujry. Tlut was jusl not true; I wasn't furious at all," I lands

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