Overview For the second
consecutive year, we are reporting
a substantial fall in the value of the
portfolio and shareholders’ funds.
The market has undoubtedly been
difficult and, particularly for early
stage technology companies, the
operating environment has been
the toughest for a very long time.
Our Operating review considers
the performance of our product
businesses – buy-outs, growth
capital and early stage technology
– in more detail. In summary, our
mid-market buy-out business
performed well and achieved
a positive return. Our smaller
buy-out business and our growth
capital business both performed
satisfactorily but produced
negative returns, partly because
of reduced valuations arising from
falling stock markets. Our early
stage technology business saw a
substantial fall in the value of its
portfolio and was the principal
factor contributing to the Group’s
negative total return.
The return from our mid-market
buy-out business of 5% and the
negative return of 12% in our
growth capital business compare
strongly with the movements for
the All-Share Index of minus
29.8% and the SmallCap Index of
minus 33.4%. Our early stage
technology business saw a decline
of 51%, which is very similar to
the fall in the techMARK Index
of 50.0%.
At the Group level, we generated
about £1 billion of realisation
proceeds, at good prices, and this
has enabled us to retain our
balance sheet strength.
We have maintained our long term
strategy but have taken significant
actions to improve the quality of
our processes.
Market conditions The weakness
in stock markets in the year
clearly recognises the slowing
down of world economies and
the continuing pressure on
corporate profits. This has had
a major impact on the private
equity industry which has seen
falling returns and a difficult
fundraising climate.
For calendar year 2002, total
investment in private equity and
venture capital in the US and
Europe is estimated to have
increased by approximately 10%
to $91 billion. However, within this
total, buy-out investment was up
69% to $61 billion, whereas early
stage investment was down 53%
to $4.1 billion in the US and by
66% to $2.5 billion in Europe.
We have continued to invest in line
with our strategy of building a
balanced portfolio.
In our main European markets,
we invested in about 10% of
completed transactions, thereby
maintaining our market leading
position.
Liquidity for the private equity and
venture market has generally been
difficult with significantly lower
levels of mergers and acquisitions
activity and virtually no IPOs.
In this environment, it is very
encouraging that we saw such a
strong interest in many of our
portfolio companies.
Strategy and competitive advantage Our strategy is to:- develop the business
internationally;
- build a balanced investment
business;
- use the network as our key
competitive advantage; and
- invest primarily in growth
companies.
Our network enables us to use our
local presence and established
relationships to identify
opportunities in which to invest.
This, combined with our scale,
gives us the ability to use
specialist resources for winning
deals, carrying out extensive
referencing and adding value to
our portfolio companies.
A key element of our strategy is
maintaining a balanced business
with about 40% of our assets in
buy-outs, 40% in growth capital
and 20% of our portfolio in early
stage technology based
companies. The proportion of our
portfolio in technology companies
increased during the bubble in 2000 and 2001, which has
damaged our short term
performance, but we have now
broadly restored the shape of
the portfolio in line with our long
term strategy.
We seek to invest in companies
with good growth potential rather
than relying on financial
engineering as the driver of value
growth. Additionally, we look for
growth markets, a strong and
well-balanced management team
and a business strategy that will
deliver value to all shareholders.
Strategy and management
action We have adjusted our
resources and organisation to
meet the market challenges.
The process of reorganising the
business on to a product as well
as geographical basis is now
largely complete. We have also
reduced staff numbers to align
resources with market conditions.
Our business is led on a product
and sector basis. Jonathan Russell
heads up our buy-out business
and Rod Perry our technology
business. Following the
retirements of Peter Williams and
Richard Summers, who had
respectively run our UK and
continental European networks,
we were particularly pleased
to recruit Chris Rowlands back
to 3i. Chris is, in addition to
responsibilities for the UK regional
network and the northern
European countries, driving
forward our growth capital
business across Europe.
The drivers of change in our
product approach have been
specialist teams, focused
marketing and using our
resources on a pan European
basis. This model, which we
adopted in our buy-out business
two years ago, is working well
and delivering strong investment
opportunities.
Key elements of this approach
include a refined investment
process and a new performance
management system for our staff.
We closed our office in Tokyo and
subsequently our office in Dublin,
but made no other changes to our
country network. In Japan, we had
hoped to develop a mid-market
buy-out business, but after three
years it became clear that this
market was not developing at a
rate to support a local presence.
Our decision to close our Dublin
office reflected the slower than
expected development of the Irish
private equity market.
In Germany, market conditions
have been very tough, particularly
for early stage companies, and
we have carried through a major
restructuring resulting in the
closure of our offices in Hamburg
and Berlin.
Outlook In the short term, the
outlook for corporate profits
growth remains weak. Against this
background, we are actively
managing the portfolio and
focusing investment on those
companies that can thrive in this
more difficult environment.
Market weaknesses and
imperfections also create great
opportunities and we are mindful
that the recession years of
1992-93 were excellent vintages
in terms of investment returns.
Although cautious about the short
term outlook, I have every
confidence in 3i’s business.
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“Our priorities have been to pursue our core strategy,
rebalance our investment activity, improve the quality
of our processes and investment portfolio, and
increase specialisation.”
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