Steady Hands: How Terra Firma can bounce back from EMI debacle

Citigroup’s seizure of control of EMI from Terra Firma (crystallising a £1.75bn loss on the investment for Guy Hand's private equity firm) marks a milestone on the rocky road to recovery for the debt laden buyout market. 2010 saw a dramatic bounce back in share prices of the private equity funds.

EMI, best known as home to the Beatles, might point to renewed gloom ahead but could also be a welcome sign that banks are starting to tackle the morass of busted buyouts thereby helping to restore faith in the sector.

It is easy to spot what went wrong with the private equity market: too much debt driving prices to silly levels; managers extrapolating realisation rates and profit multiples from the good times – leading them to over commit their funds; and shareholders and LP investors panicking out at the bottom. All this is going to take some time to sort out but patient investors should be rewarded.

Quoted private equity funds are a diverse bunch. Direct investors like Hg and Candover , venture players like Eurovestech and Spark and pre IPO funds such as St. Peter Port and Rapid Realisations tend to have concentrated portfolios and NAVs that lurch around as individual investments come good or go bust. 

Funds of funds ought to offer a smoother ride but the price swings on these funds have been dramatic over the past couple of years. Most of the funds of funds invest in limited partnerships (LPs). When the market cracked you could barely give away LP portfolios in the secondary market.

With many funds over committed (legally binding commitments to make follow-on investments in LPs that they could not cover with their cash and debt facilities) some were forced sellers at the bottom. We seem to be well past the worst of this and funds are starting to make new investments again.

I looked at Terra Firma as it was a holding in Bramdean (now Aberdeen Private Equity ). The EMI deal was written down quite early on – a classic case of lemons ripening first – but otherwise this fund’s portfolio is relatively immature and the new manager is still adding funds to the portfolio.

I am still curious as to how Aberdeen hope to use this fund as a springboard for a larger private equity fund of funds business. It is an area that demands considerable resource and even with prices 30% or 40% higher over the past 12 months, discounts of 20%-30% are commonplace – acting as an effective block to raising fresh capital.

I spent some time looking at the feasibility of mergers in the sector – trying to find a solution to Henderson Private Equity’s problems. The main objection seems to be that fund of private equity fund managers are reluctant to take on other people’s portfolios unless they can take them at an unacceptably low discount to asset value. It is a shame though that the Henderson fund is now being liquidated rather than used to boost the assets of one of the other funds.

One fund of funds I think could be interesting, if you want to dip your toe in the water but without too much company specific risk, is Conversus Capital. Listed on Euronext (maybe not the best place for it), it is large, with a market cap. of £940m. It holds over 200 funds and, on a look-through basis, is invested in over 1,800 companies.