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) |
|
|
|
