Total return Total return for the
year was a negative 23.7% on
opening shareholders’ funds, a
return of £(935) million. High levels
of investment in early stage
technology companies in the
three years to 31 March 2002,
combined with the current
exceptionally difficult conditions,
have resulted in a total return
of £(671) million for our early
stage technology business.
The downturn in other sectors
and the fall in stock markets have
resulted in negative returns for
our smaller buy-outs and growth
capital businesses, although our
mid-market buy-out business
produced a positive return.
Overall, the effect of falling stock
markets on total return was
£(453) million.
3i’s return of (23.7)% represents
an outperformance against our
benchmark indices, the FTSE
All-Share (29.8)%, the FTSE 100
(29.1)% and the FTSE SmallCap
(33.4)%. Over the medium and
longer term, 3i has maintained its
record of outperformance against
stock market indices, except that
over a cumulative three year
period to 31 March 2003, the
FTSE All-Share and FTSE 100 had
marginally smaller negative returns
by 0.4% and 0.2% respectively.
For all longer cumulative periods up to 10 years, 3i has continued
to outperform, and overall has
maintained its margin of
outperformance.
There was a strong performance
on realisations, with realised
capital profits of £184 million.
The negative total return arose
from the unrealised valuation
movement on the portfolio of
£1,165 million, due mainly to
reductions in the valuation of the
technology portfolio.
Given the difficult economic
conditions, the mid-market buy-out
business performed well,
delivering a positive total return of
£61 million, through a strong level
of profitable realisations and a
good income yield.
The smaller buy-outs and growth
capital portfolios have produced
negative total returns of
£(188) million and £(137) million
respectively. This is largely as a
result of unrealised losses on the
revaluation of the portfolio, caused
mainly by a fall in price-earnings
ratios used to value a large
proportion of the portfolio and
provisions for companies that may
fail. Realisations were, however,
strong, producing a satisfactory
level of realised profits and there
were also continued good levels of
dividend and interest income.
In the early stage technology
business, provisions continued at
the high levels experienced in the
previous year and the impact of
the worsening conditions
necessitated additional valuation
reductions.
Geographically, the return from our
UK investments was £(400) million
and the return on our continental
Europe investments was
£(379) million. UK investments
have earned a good income yield,
mainly in the form of dividends
and interest, and also strong
realised profits, which partially
offset reductions in the valuation
of the portfolio. In continental
Europe, the portfolio is weighted
more towards early stage
technology but the valuation
reductions were partly offset by a
currency gain of £95 million.
Our Asia Pacific business
produced a return of £(16) million,
and our US business, mainly in
early stage technology, a return of
£(140) million, which includes a
currency loss of £26 million arising
from the weakening of the US
dollar against sterling.
Statement of Recommended
Practice: Financial Statements
of Investment Trust Companies
(SORP) The recommendations of
the revised SORP issued by the
Association of Investment Trust
Companies in February 2003 have
been adopted in these accounts.
Fee income earned and costs
incurred on the acquisition or
intended acquisition or disposal of
investments are included in the
capital return. The revenue
account includes a tax charge of
£30 million and the capital account
a corresponding tax credit in
respect of expenses charged to
the capital return which are being
utilised in reducing taxable
revenue profits. Adoption of these
recommendations has had no
effect on total return and, as a
result, as required by the SORP,
comparatives for the previous year
have not been restated.
In addition to implementing the
revised SORP recommendations,
the methodology used to identify
management expenses and
interest costs available for
allocation between the revenue
and capital accounts has been
revised, resulting in a higher level of costs being available for
allocation. All finance costs, less
interest income on short term
funds, are now available for
allocation, as borrowings are now
considered to finance investment
packages, comprising equity
shares and loans, rather than
primarily loans as previously.
The proportion of available
management expenses and
interest charged to the capital
reserve has been reduced from
80% to 70% to reflect the
expected future balance of returns
from capital and revenue. This
proportion had been increased
from 70% to 80% in the year to
31 March 2001.
The effect of adopting the revised
SORP recommendations and
changes in the allocation
methodology for management
expenses and interest payable has
been to increase revenue profits
after tax this year by £50 million
and to reduce the capital return by
a corresponding amount,
compared with the previous
methodology.
Income, costs and revenue
profit Total operating income
was £308 million, a reduction from
the previous year, £355 million.
Interest receivable on loan
investments of £96 million (2002:
£113 million) has fallen due to
lower interest rates (and the prior
year benefited from some
exceptional high yields on certain
investments). Dividend income of
£123 million (2002: £130 million)
includes £46 million of dividends
received on the sale and
restructuring of investments
(2002: £44 million). Fee income,
comprising mainly unquoted fund
management fees and investment
negotiation fees, amounted to
£56 million, the same as last year.
Interest receivable on treasury
assets has fallen to £34 million
from £46 million, mainly due to a
fall in interest rates.
Management expenses were
£18 million or 11% lower than in
the previous year, as the number
of staff employed reduced from
943 to 858 at 31 March 2003.
The cost of organisational changes
in the year was £10 million (March
2002: £18 million). Costs less
fee income amount to £97 million
compared with £115 million
last year.
Interest payable on borrowings,
which are mainly fixed rate, has
reduced by £10 million but this
is offset by the fall of £12 million
in interest receivable on
treasury assets, included in total
operating income.
Revenue profit after tax was
£140 million, which is higher than
last year (£106 million), because
of changes in accounting
treatment arising from the SORP
and in the allocation of costs.
Realised profits on disposal of
investments Realised profits
on disposal of investments were
£184 million which compares
to a loss of £39 million in the
previous year.
Proceeds amounted to
£976 million, of which £110 million
were realised from the quoted
portfolio. Despite corporate
mergers and acquisitions markets
remaining weak throughout the
year, realisations from the
unquoted portfolio were strong,
generating proceeds of £829
million, significantly higher than
£514 million in the previous year.
Realisations included the sale of
Go, the low cost airline, which
generated £144 million of
proceeds and contributed
£86 million to realised profits.
Unquoted equity investments were
realised, after taking account of
write-offs, at a good uplift of 40%
over their March 2002 valuations.
Sales of holdings in our quoted
portfolio generated an uplift of
6% despite falling stock markets.
The uplift achieved on the total
equity realisations was 34%.
Overall, 14% of the total equity
portfolio at 31 March 2002 was
realised and, including loan and
fixed income share repayments,
16% of 3i’s total portfolio
was realised.
Realised profits also include
£50 million in respect of the write-off
of subordinated borrowings,
which are no longer repayable in
full. These borrowings, where
some of the risk was assumed by
the finance provider, funded the
acquisition of German technology
investments, which have failed or
been provided for this year and in
previous years.
Realised profits are stated net of
write-offs, which amounted to
£79 million (2002: £151 million).
Unrealised value movement on
revaluation of investments There
has been a net unrealised value
movement of £(1,165) million.
The main drivers have been
provisions for companies which
may fail of £379 million, down
rounds and reductions to fair value
of £361 million and the effect of
falling stock markets which
amounted to £453 million.
Reductions in the valuation of the
early stage technology portfolio
make up 62% of provisions and
75% of down round and fair value
adjustments.
Our approach to the valuation
of early stage technology
investments has changed over
the last year. At 31 March 2002,
the valuations of early stage
investments were reduced where
a down round or further financing
had taken place at a lower value.
At 30 September 2002, valuations
were reduced for down rounds
that had already taken place and
also for those that were
anticipated to take place within the
next six months. At the balance
sheet date, 31 March 2003,
valuations of early stage
investments were reduced for
down rounds that have occurred
or are anticipated, and were also
reduced to an estimated down
round value or to a fair value, even
where no further financing is
anticipated, based on the most
appropriate valuation criteria
available.
The continued fall in stock
markets has led to a decrease in
the value of the quoted portfolio of
£209 million and has also reduced
the weighted average price-earnings
ratio used to value the
unquoted equity portfolio valued
on an earnings basis from 10.0 at
March 2002 to 8.1. This has
resulted in a further value
reduction of £244 million.
There has been an increase in
investee companies’ earnings,
where these are used as a
valuation basis at the start and
end of the year, which has
generated a valuation movement
of £48 million; earnings of these
portfolio companies have
increased by 2%.
Unrealised value movement
includes a net currency gain of
£60 million (2002: £(1) million),
mainly arising from the weakening
of sterling resulting in an increase
in the valuation of European
investments partially offset by
losses on related borrowings.
Investment During the year, we
invested a total of £931 million
(£716 million invested by 3i and
£215 million of co-investment
funds). This is lower than last year
(March 2002: £1,039 million) but
there was a 37% increase in the
second half of the year reflecting
improved investment opportunities
in the market. Investment has
been balanced and aligned more
closely with our portfolio
objectives with investment in buy-outs
representing 52% of total
investment in the year, growth
capital 29% and early stage
technology 19%. The majority of
the technology investment, 78%,
has been made in supporting our
existing portfolio where those
companies continue to look likely
to deliver good returns over the
medium term.
Investment across Europe was
balanced with 43% of total
investment being made in the UK
and 47% in continental Europe.
The US invested £74 million, 8%
of total investment, reflecting the
reduction in technology investment
across the Group. Asia Pacific
invested £22 million.
Cash flow and balance sheet
Strong net realisation proceeds of
£975 million and relatively low
cash investment of £673 million
were the main factors contributing
to a cash inflow of £219 million,
before a refinancing investment of
£49 million in a joint venture,
resulting in a net cash inflow of
£170 million, reducing net
borrowings to £1,013 million.
This compares with a net cash
outflow last year, after acquisitions,
of £102 million.
The value of the portfolio
(excluding co-investment funds)
has fallen during the year from
£5,109 million to £3,939 million
largely because of unrealised
losses on the revaluation of
investments. Early stage
technology investments amount to
£589 million,15% of the total
portfolio. Buy-out and growth
capital investments amount to
51% and 34% of the portfolio
respectively.
At the balance sheet date, 63% of
the portfolio by value was located
in the UK, 30% in continental
Europe, 5% in the US and 2% in
Asia Pacific. By sector, the
portfolio continues to be well
diversified. Of the total portfolio,
5% is represented by quoted
investments, 40% by loans and
fixed income shares and 55%
by unquoted equity investments,
of which 28% have been valued
at cost and 44% on an
earnings basis.
The capital and funding structure
of the Group is strong. At the
balance sheet date, shareholders’
funds amounted to £2.9 billion, net
debt to £1.0 billion and private
equity co-investment funds under
management were £1.6 billion.
The net effect of the reduction
during the year in both
shareholders’ funds and net
borrowings has increased gearing
to 35% (March 2002: 30%).
The Group’s net borrowing
comprises long term borrowing, short term borrowing and liquid
treasury assets and cash. Original
long term borrowing of £1.6 billion,
which is unsecured and primarily
raised from the public issue of
debt under the notes issuance
programme, has been swapped
to give a predominantly fixed
rate position. Of the original long
term borrowing, £197 million
is repayable in 2003, with
£754 million in 2006 and 2007 and
£600 million in 2023 or later. Short
term borrowing of £196 million is
outweighed by cash and liquid
treasury assets of £811 million.
At the balance sheet date, the
Group had committed and
undrawn borrowing facilities
amounting to £634 million.
The Group continues to meet very
comfortably the capital adequacy
ratios set by the Financial Services
Authority, in its role as supervisor
of 3i Group plc’s status as a
deposit taker.
Pension Pension costs have been accounted for on the
basis of SSAP 24. The charge for the year to 31 March 2003 to
Group profits in respect of the main defined benefit scheme,
the 3i Group Pension Plan (“the Plan”) was £12 million (March
2002: £13 million), based on the triennial actuarial valuation
at 30 June 2001. If the SSAP 24 charge continues to be based
on the 30 June 2001 valuation, the charge for the year to 31
March 2004 would be £12 million. Details are included in note
11.
The progressive implementation of FRS17 “Accounting for Retirement
Benefits” has been accompanied by considerable debate about
its suitability as a measure of present and future pension liabilities.
Mandatory implementation of FRS 17 in full has been deferred
by the Accounting Standards Board. FRS 17 has not been fully
implemented in these accounts, but the full effects had it been
are disclosed in note
11 on page 48.
Due to substantial falls in stock
markets and declines in interest
rates used to calculate the present
value of liabilities, the FRS17
figures show a significant
deterioration during the year to a
deficit on the Plan of £90 million
(2002: deficit of £14 million).
Recognising that in the short term
at least, some of the deficit is
unlikely to be made up simply
by the recovery in asset values,
the Group has contributed lump
sums over the last two years of
£13 million during the year to
31 March 2003 and £22 million
during the year to 31 March 2002.
It has also recommenced making
monthly contributions with effect
from 1 April 2002 which have
amounted to £12 million in the
current year. Total contributions in
the year to 31 March 2003 were
£25 million (2002: £22 million).
Changes have been made to the
Plan which require existing
members to contribute 1% of
salary from 1 January 2003,
increasing by 1% each year to
5% by 1 January 2007.
New employees joining 3i and the
Plan after 1 September 2002 are
required to contribute 5% of
salary. At 31 March 2003, 578
employees were members
of the Plan.
Our policy on pensions continues
to be under active review in the
light of changes in tax legislation
and accounting and because
funding deficits have arisen from
the fall in capital markets.
Regulation of the Group 3i Group
plc and relevant subsidiaries
continue to be regulated by the
Financial Services Authority.
Risk management 3i has a
comprehensive framework to
manage the risks that are inherent
in its business. This framework
includes a risk committee whose
purpose is to monitor the
identification, assessment and
management of key risks across
the business. The main risks
comprise economic risk, treasury
and funding risk, investment risk
and operational risk.
Economic risk 3i invests mainly
in European companies and
continues to develop its
operations in the US and Asia
Pacific. However, the majority of
the portfolio is still in UK
companies and there is an
element of exposure to the UK
economic cycle. To mitigate this,
3i has invested in different sectors
of the UK economy with different
economic cycles. In addition, an
increasing proportion of assets is invested in continental Europe, in
the US and Asia Pacific, which
may have different economic
cycles.
Treasury and funding risk
The overall funding objective
continues to be that each category
of investment asset is broadly
matched with liabilities and
shareholders’ funds, with
corresponding characteristics in
terms of risk and maturity, and that
funding needs are met ahead of
planned investment. This objective
continued to be met during the
year to 31 March 2003.
All assets and liabilities are held for
non-trading purposes and, as a
result, the Group does not have a
trading book. The Group does not
trade in derivatives and does not
enter into transactions of either a
speculative nature or unrelated to
the Group’s investment activities.
Derivatives are used to manage
the risks arising from the Group’s
investment activities.
The main funding risks faced by
the Group are interest rate risk and
exchange rate risk. The level of
these risks is mitigated by the
overall funding objective and the
Board regularly reviews and
approves policies on the approach
to each of these risks.
3i’s policy for exchange rate risk
management is not generally to
hedge its overall portfolio in
continental Europe or the US.
In line with its funding policy, part
of those assets are funded by
borrowings in local currency
and, as a result, a partial hedge
exists. 3i’s largest exposure is
£0.7 billion in respect of net
assets denominated in euros in
continental Europe. The level of
exposure to exchange rate risk is
reviewed on a periodic basis.
Day to day management of
treasury activities is delegated to
executive Directors and the Group
Treasurer. Regular reports on the
Group’s funding position have
been considered during the year
by the Board. There has been no
change during the year or since
the year end to the major funding
risks faced by the Group, or to the
Group’s approach to such risks.
Investment risk This includes
investing in companies that may
not perform as expected, being
over exposed to one sector of
the economy and the portfolio
valuation being partly based on
stock market valuations.
Investment levels are set, allocated
and monitored by product area
and geography. Within this framework, 3i invests in all sectors
of the economy, except those,
such as property, where the
opportunity to invest in venture
capital backed businesses
meeting 3i’s investment criteria is
limited. Management periodically
reviews the portfolio, which is well
diversified by industry sector, to
ensure that there is no undue
exposure to any one sector.
3i’s investment criteria focus on
management ability and market
potential. Investment appraisal and
due diligence is undertaken in a
rigorous manner by drawing on
our international network and
experts in individual industry
sectors. In general, proposed
investments over £5 million are
presented to the Group’s
Investment Committee or
Technology Investment
Committee, which are committees
of senior management including
executive Directors.
The valuation of a large proportion
of 3i’s equity portfolio is based on
stock market valuations for the
relevant industry sector. Quoted
investments are valued using the
mid-market price at the balance
sheet date. About 44% of the
unquoted equity portfolio is valued
using stock market price-earnings
ratios for the relevant industry
sector discounted for non
marketability. Accordingly, stock
market valuations for individual
sectors are an important factor in
determining the valuation of 3i’s
portfolio and the total return.
There are regular reviews of
holdings in quoted companies and
exposure to individual sectors in
order to monitor the level of risk
and mitigate exposure where
appropriate. In particular, the level
of future funding of technology
companies is kept under review.
However, it is not possible to
protect against the risks of a
downturn in stock markets
generally or in any specific sector.
Accordingly, the valuation of 3i’s
portfolio and opportunities for
realisation depend on stock
market conditions and the
buoyancy of the wider mergers
and acquisitions market.
Operational risk This includes
operational events such as human
resources risks, legal and
regulatory risks, IT systems
problems, business disruption and
shortcomings in internal controls.
Line management at all levels
is responsible for identifying,
assessing, controlling and
reporting operational risks.
This is supported by a framework
of core values, Group standards
and controls, a code of business
conduct and delegated authorities.
The ability to recruit, develop and
retain capable people is of
fundamental importance to
achieving our strategic objectives.
We operate in a competitive
industry and aim to remunerate
our staff in line with market
practice and to provide superior
development opportunities.
A group-wide business continuity
strategy is in place. This strategy
has been assessed against a
detailed business impact analysis
and independently benchmarked
against best practice.
Summary Net asset value per
share has fallen, mainly due to the
fall in stock markets and the
reduction in the valuation of the
early stage technology portfolio
which at the balance sheet date
represented 15% of the total
portfolio. 3i did, however,
experience a smaller fall in net
asset value than its stock market
benchmarks.
3i continues to have the financial capacity to increase investment
should economic and market opportunities improve. |
|
“3i has the financial capacity to increase
investment when economic and market
opportunities improve.”
 |
| Total return (£m) |
|
2003 |
|
2002 |
|
| Total operating income before interest |
|
|
|
|
| payable |
|
308 |
|
355 |
|
| Interest payable |
|
(110) |
|
(120) |
|
| Management expenses |
|
(153) |
|
(171) |
|
| Realised profits/(losses) on disposal |
|
|
|
|
| of investments |
|
184 |
|
(39) |
|
| Unrealised value movement on |
|
|
|
|
| revaluation of investments |
|
(1,165) |
|
(890) |
|
| Other (changes to organisational |
|
|
|
|
| structure, goodwill, tax and currency) |
|
1 |
|
(95) |
|
| – Revenue return |
|
146 |
|
102 |
|
| – Capital return |
|
(1,081) |
|
(1,062) |
|
| Total return |
|
(935) |
|
(960) |
|
 |
|
|
|
|
|
| Total return by product (£m) |
|
|
|
|
|
| Mid-market buy-outs |
|
61 |
|
(48) |
|
| Smaller buy-outs |
|
(188) |
|
(38) |
|
| Growth capital |
|
(137) |
|
14 |
|
| Early stage technology |
|
(671) |
|
(815) |
|
| Goodwill amortisation |
|
– |
|
(73) |
|
| Total return |
|
(935) |
|
(960) |
|
|
|
|
|
|
|
| Total return by geography (£m) |
|
|
|
|
|
| UK |
|
(400) |
|
(298) |
|
| Continental Europe |
|
(379) |
|
(481) |
|
| US |
|
(140) |
|
(74) |
|
| Asia Pacific |
|
(16) |
|
(34) |
|
| Goodwill amortisation |
|
– |
|
(73) |
|
| Total return |
|
(935) |
|
(960) |
|
| |
|
|
|
|
|
| Realisation proceeds (£m) |
|
2003 |
|
2002 |
|
| Quoted equity investments and on IPO |
|
147 |
|
425 |
|
| Unquoted equity investments |
|
493 |
|
303 |
|
| Loan and fixed income shares |
|
336 |
|
211 |
|
| Total |
|
976 |
|
939 |
|
 |
|
|
|
|
|
| Net realised profit/(loss) – over
|
|
|
|
|
| opening valuation (£m) |
|
184 |
|
(39) |
|
| Equity proceeds (£m)* |
|
640 |
|
728 |
|
| Uplift over opening equity valuation
|
|
|
|
|
| (%)* |
|
34 |
|
1 |
|
| Percentage of opening equity portfolio |
|
|
|
|
| sold (%)* |
|
14 |
|
19 |
|
| * Excludes the disposal in
2002 of non-venture capital investments made in FTSE 350
companies. |
|
|
| Unrealised value movement on |
|
|
|
|
| revaluation of investments (£m) |
|
2003 |
|
2002 |
|
| Provisions |
|
(379) |
|
(400) |
|
| Down rounds and reductions to fair |
|
|
|
|
| value |
|
(361) |
|
(181) |
|
| Price-earnings ratios |
|
(244) |
|
– |
|
| Earnings growth |
|
48 |
|
130 |
|
| Other movements on unquoted |
|
|
|
|
| investments |
|
(20) |
|
(136) |
|
| Quoted portfolio |
|
(209) |
|
(303) |
|
| Total |
|
(1,165) |
|
(890) |
|
| |
|
|
| First and subsequent investment (£m) |
|
2003 |
|
2002 |
|
| New first investments |
|
585 |
|
560 |
|
| Further funding or drawdown on |
|
|
|
|
| existing arrangements |
|
346 |
|
479 |
|
| Total |
|
(1,165) |
|
(890) |
|
|
|
