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Buy-outs 3i continues to lead
the pan European mid-market for buy-outs and this part of the
business, led by Jonathan Russell, has performed strongly through
the year. 3i’s focus within this market is on transactions with
a value from €25 million to €500 million. The vendors
of these companies are typically large corporates disposing
of non-core subsidiaries or private groups with succession issues.
Market statistics for calendar year 2002 show that there were
153 transactions in this segment of which 3i invested in 18.
3i is also active in the smaller buy-out market (below €25 million).
This is a more fragmented segment and one in which 3i’s local
network provides ideal access to the private vendors, management
teams and local advisers involved.
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Overview This
review comments on the operations of our buy-out, growth capital
and early stage technology businesses and covers the market
conditions and our operating performance in Europe, the US and
Asia Pacific. The review also comments on our third party fund
management activities. |
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| Ten largest 3i-led buy-out
investments in the year |
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3i and funds
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Transaction
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total
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size
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investment
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| Company |
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Business description |
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Country
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£m
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£m
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| De Telefoongids |
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Telephone directories |
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The Netherlands
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345
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45
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| Westminster Health Care |
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Care homes operator |
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UK
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301
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55
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| SR Technics |
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Repair and maintenance of aeroplane engines
and frames |
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Switzerland
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293
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70
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| Esmalglass |
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Manufacturer of frites and glazes for
ceramic tiles |
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Spain
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159
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48
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| E2V technologies |
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Switching, sensing and imaging components |
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UK
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77
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21
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| Extec |
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Manufacturer of mobile crushing equipment |
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UK
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68
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15
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| PaperPak |
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Manufacturer of incontinence products |
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US/Europe
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65
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24
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| United Transport Tankcontainers |
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Tank container operation moving hazardous
chemicals |
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The Netherlands
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65
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12
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| Partners for Finance/Legal |
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Specialist financial services |
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| Marketing Services |
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UK
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37
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9
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| Ascent Technology |
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IT software consultancy and supply |
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UK
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17
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10
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During the year to 31 March 2003, 3i made 63 buy-out investments,
with 3i and funds managed by 3i investing £482 million, of which
3i led 14 new mid-market deals investing £338 million including
co-investment funds. Realisations from the buy-out portfolio
were strong with total proceeds of £613 million, including £144
million from the sale of Go. These realisations were achieved
at an aggregate equity uplift of 69%.
Our buy-out performance is driven by a clear product strategy,
which is rigorously applied. This strategy is to build competitive
advantage from our scale and local knowledge so that we see
the market, select the most attractive investment opportunities
and drive value from our portfolio.
We see the market through the local access that the 3i network
provides, through our sector teams, through the relationships
that we have built with large corporates and through the people
programmes we run for chairmen, chief executives and independent
directors.
We aim to select the most attractive opportunities through harnessing
our international network and experience and by assembling the
best team for the job from our regional, sector and buy-out
specialists. A transaction like De
Telefoongids involved our local office in Amsterdam, two
of our sector teams, Media and Communications, as well as members
of our pan European buy-out team.
A panel of our most experienced buy-out investors ensures rigorous
application of our investment process and provides additional
guidance to try to ensure that we win the buy-outs that we want
to do at an attractive price.
Once we have made an investment, it is critical that we add
value. We do this through the investee company board, through
our knowledge and experience and through our network.
3i’s investment in Go
was a good demonstration of our approach to this market. Access
to the original investment was gained through strong corporate
relationships with British Airways and its advisers. Past experience,
track record and relationships in the sector enabled 3i to take
an informed view and win the transaction at the right price,
£110 million. Through the efforts of the management team and
staff, led by CEO Barbara Cassani, both market share and profitability
levels increased. They were supported with the introduction
of Keith Hamill as Chairman and non-executive directors, including
Paul Sternbetz, who was formerly Operations Director for Southwest
Airlines in the US. easyJet, a natural strategic buyer for Go,
made a successful bid in July 2002 of £374 million for the business.
Our view is that the medium term outlook for buy-outs is improving.
Economic conditions and depressed public markets are encouraging
corporate restructuring and the selling off of non-core activities.
Reduced levels of corporate mergers and acquisitions activity
mean there is less competition from trade buyers. We believe
that there is a significant amount of pent up demand, both in
terms of corporates with subsidiaries to sell and of good management
teams keen to gain their independence.
Growth capital Growth capital has always been a core
part of 3i’s business. It involves the provision of capital
to accelerate the growth of established businesses and generally
involves investing in a minority equity position. It is a product
suited to a diverse range of growth opportunities, including
acquisitions, increasing production capacity, market or product
development, turnaround opportunities, shareholder succession
and change of ownership situations.
In the second half, we observed signs of increasing demand for
growth capital, resulting from two main factors. Firstly, companies
were unable to raise capital by achieving an IPO on European
stock markets and, secondly, debt providers adopted a more cautious
view on the level of finance they would advance. Both these
factors are increasing demand for growth capital. Furthermore,
as and when the economic outlook improves, we would expect deferred
expansion and acquisition plans to be reactivated, giving rise
to an increasing demand for growth capital. We believe that
we are well placed to take advantage of these conditions.
Our strategy for this product targets investments from 3i of
between £2 million and £30 million, across a range of sectors.
This product is primarily focused on 3i’s European and Asia
Pacific markets and has historically had a less competitive
environment than buy-outs.
Success in this market is determined by the ability to build
long term relationships with local businesses and local intermediaries,
as well as demonstrating the capability of helping these businesses
to grow. This fits well with our strategy of local presence,
sector specialisation, sharing knowledge and offering local
businesses access to our international network of relationships.
Chris Rowlands was appointed to lead growth capital investment
in September 2002 and he has brought a more focused approach
to deal origination and the key processes for this product.
A Product Leadership Team, with representatives of each of the
targeted regions in Europe, coordinates individual country activities,
develops and implements strategy and operates as a forum for
sharing ideas on a range of best practices.
Certain sectors are ideally suited to the growth capital product.
A good example is the oil and gas sector. The North Sea exploration
and production sector is undergoing significant change and a
number of new independent businesses are emerging as the next
generation of North Sea oil companies. In the oil and gas services
sector, the ability to provide services on an international
basis is an important competitive advantage, and capital is
required to enable the development and international distribution
of products and services. 3i’s sector knowledge, local presence
and international network combine to position us as a strong
financial partner to such businesses. Major transactions by
our Oil and Gas team in Aberdeen during the year included the
investments in Petrofac Limited and Faroe Petroleum Limited,
and the partial realisation, through an IPO on the London Stock
Exchange, of our investment in John Wood Group plc. In addition,
the sale of Orwell Group plc crystallised a total return for
3i of £35.0 million on our total investment of £2.9 million.
During the year, we invested £273 million (2002: £258 million)
in growth capital transactions, 46% (2002: 32%) of which was
in companies new to our portfolio.
However, despite difficult conditions for sales and IPOs, a
good level of realisations was achieved, with proceeds of £270
million during the year and an equity uplift of 30%.
Early stage technology The continuing depressed state
of the technology and capital markets meant that 3i’s early
stage technology business, which at 31 March 2003 represented
15% of our assets, had a difficult year. A negative return of
£(671) million, arising principally from a reduction in the
value of the portfolio to reflect these market weaknesses, severely
impacted the performance of the Group as a whole.
However, following a restructuring under the leadership of Rod
Perry, we now have a tightly focused business which is targeted
at four key sub-sectors.
We have also focused this activity on a smaller number of our
locations and have refined the investment process. As a result,
we now believe 3i is well positioned to take advantage of current
market conditions and to seize the opportunity presented by
an improved environment in the medium term.
We continue to develop and nurture our relationships with key
larger corporates in each sub-sector, since these corporates
are potentially customers, partners or ultimate buyers of our
individual portfolio companies, and to share these relationships
with our portfolio companies. The events we hold for portfolio
CEOs and key larger corporates are one way in which we do this.
For example, the 3i eSecurity CEO Conference at the IESE business
school in Barcelona in November 2002 was attended by over 20
3i-backed companies and 25 corporates, including IBM, Sun Microsystems
and Microsoft.
The year to 31 March 2003 saw total investment of £176 million,
and realisation proceeds of £93 million, at an equity loss of
26% on the carrying value at 31 March 2002.
The two biggest early stage technology markets, Europe and the
US, both experienced significant falls in aggregate investment
during 2002. According to market statistics, the total amount
invested in Europe fell 66% to $2.5 billion. Most of this investment
was in support of existing venture capital backed businesses
rather than in completely new opportunities. 3i also saw this
pattern, with 78% of early stage technology investment during
the financial year being in our existing portfolio.
The US market has shown a similar fall. According to market
statistics, aggregate investment fell by 53% in 2002. Our US
business is also now making a contribution to the rest of the
Group, through the relationships we have been building with
larger corporates such as IBM.
The key factor in the weak investment performance of early stage
technology companies has been the depressed state of the markets
for their products and services. The most important cause of
this has been the significantly reduced levels of expenditure
by corporates on information technology and related applications.
A number of 3i’s investments have underperformed as their business
models have been undermined by significantly lower levels of
demand than expected.
A number of technology companies have also experienced difficulty
in translating a strong product into a commercial success. An
example is Weston Medical, a 3i investment that achieved an
IPO in 2001. Weston’s needle-free injection product was technically
respected but the company was unable to translate that into
commercial success, and recently went into receivership.
In the context of the reported performance of 3i’s early stage
technology investments made in the period 1999 through 2001,
the “J-Curve” phenomenon (so named because the reported performance
of a portfolio or vintage of technology investments tends to
dip in the early years before rising again, as poor and failing
investments become apparent before the successful ones) is interesting.
While the continuing depressed markets and the difficulty of
commercialising newly developed products have adversely affected
the reported performance of that portfolio, the J-Curve phenomenon
would hold that the performance of the remaining portfolio should
improve as more of the underlying businesses achieve success
and the investments are realised.
The financial performance of the early stage technology portfolio
was also adversely affected by falls in value. Valuation of
technology companies usually involves reference to valuation
ratios of listed companies or the price at which similar companies
have been acquired. However, the absence of an active market
for IPOs and a low level of mergers and acquisitions activity
have diminished the usefulness of these traditional benchmarks.
Another benchmark involves reference to the value at which private
companies in the early stage technology sector are currently
raising capital. During the year, capital has generally been
raised through funding rounds at lower capitalisations than
previous rounds, even when a company is meeting its milestones,
and they have therefore become known as “down rounds”. Our valuations
reflect the impact of actual down rounds undertaken by our portfolio
companies, and also at 31 March 2003 the application of this
benchmark to companies with no imminent plans to seek funding.
The combined down round effect during the year was a £361 million
reduction in value of which £269 million was in respect of early
stage technology investments.
In conclusion, the early stage technology business has seen
a significant loss of value this year but the portfolio has
been valued using prudent assumptions regarding the outlook
for market conditions, and the business has been reshaped for
the market we now face.
Europe Economic conditions across Europe weakened during
the year. In general, manufacturing sectors experienced difficult
conditions but the downturn has spread to all sectors, including
retail and services, largely driven by weakening consumer demand.
The prevailing economic uncertainty continues adversely to affect
the levels of private equity investment, as institutional investors,
banks and equity providers have become more cautious and vendors
of businesses have become increasingly unwilling to sell in
the face of falling prices. Additionally, expansion and acquisition
plans have been deferred and spending on information technology
by corporates has reduced. Offsetting these negative factors,
economic conditions have encouraged corporate restructuring
and the selling off of non-core assets, which has created opportunities
for buy-outs.
Against this background, market statistics show that the total
amount of private equity monies invested in Europe in 2002 increased
to €27.2 billion from €24.3 billion in 2001, but was
still below the €35.0 billion invested in 2000.
Across Europe, £835 million (2002: £889 million) was invested
by 3i (including co-investment funds) in 357 companies during
the year. In the UK, investment amounted to £399 million, compared
with £443 million the previous year.
Despite difficult conditions, we achieved a strong level of
realisations at good prices, comfortably in excess of the valuations
we placed on those businesses at March 2002.
In total, realisation proceeds across Europe during the year
amounted to £965 million, compared with £927 million the previous
year.
There has been a significant reduction in the valuation of our
portfolio, caused by increased provisions and value reductions
as a result of down rounds and weaker business performance.
At 31 March 2003, our portfolio in Europe amounted to £3,669
million, of which £2,494 million was in the UK.
During the year, we announced the closure of three of our offices
in Europe (Hamburg, Berlin and Dublin) and we reduced the number
of staff in our European business. These changes were made to
align resources with the market and to reflect changes in our
investment processes. 3i now has 27 offices across Europe.
US The US venture market has continued to be depressed
throughout the year.
3i continues to develop its business in the US and to focus
on managing the existing portfolio with a view to achieving
realisations in the next few years.
During the year, £74 million (down from £119 million in 2002)
was invested in 33 companies, of which £56 million was in new
investments.
Asia Pacific The Japanese market has not developed as
rapidly as we had expected, and the flow of quality deals has
not been sufficient to justify the resourcing of our Tokyo office,
which was closed in February 2003. The Japanese market will
continue to be serviced out of the Hong Kong and Singapore offices,
as will other markets in the region.
The Asia Pacific business invested £22 million during the year,
including the first investment by the Hong Kong office, which
was in a Korean multiplex cinema operator.
Conditions for realisations in the region were depressed during
the year. Despite this, £9 million of realisation proceeds were
generated.
Private equity fund management
3i manages third party co-investment funds primarily in our
mid-market buy-out business, where capital raised is co-invested
alongside our capital, enabling us to invest in companies without
3i itself holding a majority interest in the underlying business.
Since 1994, 3i has raised funds with total third party commitments
of £2.3 billion. Funds are usually raised from institutional
investors, typically pension funds and insurance companies seeking
exposure to private equity and who are attracted by 3i’s market
leading position, business model and track record. The funds
raised are typically invested on a 50:50 basis alongside 3i’s
capital.
During the year, we earned fee income of £34 million (2002:
£35 million) from the management of funds and, in addition,
received £7.3 million (2002: £1.6 million) in respect of carried
interest on realisations. At 31 March 2003, the invested portfolio
managed on behalf of third party investors was valued at £1,158
million (2002: £1,264 million), excluding undrawn commitments.
Since the balance sheet date, 3i has announced the successful
first closing of its pan European mid-market buy-out fund, Eurofund
IV. Third party investors have committed €0.4 billion and
intend to invest a further €0.2 billion over the life of
the fund and 3i intends to invest up to €1.5 billion. It
is expected that further closings will take place over the coming
months and the final closing of Eurofund IV will take place
by the end of the year.
Quoted fund management 3i’s Asset Management team manages
the Group’s portfolio of quoted investments (comprising principally
our holdings in investments that have achieved an IPO) as well
as the portfolios of the 3i Group Pension Plan and of three
quoted specialist investment companies – 3i Smaller Quoted Companies
Trust plc, which invests in smaller UK companies, 3i Bioscience
Investment Trust plc, which invests internationally in life
science and healthcare companies, and 3i European Technology
Trust plc, which invests in quoted companies across Europe whose
focus is on technology.
At the balance sheet date, total third party funds under management
by 3i Asset Management were £452 million. Fees earned from quoted
fund management amounted to £4 million for the year, a reduction
from £7 million last year, mainly due to the fall in capital
markets.
Summary Despite a tough year, we have focused the business
on the three product areas of buy-outs, growth capital and early
stage technology. We believe we have the right structures and
processes in place to gain access to and select the most profitable
opportunities and then to enhance value and generate profit
from the investments that we make. In an environment of low
growth and low inflation, this strategy will enable 3i to provide
superior returns for our shareholders. |
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