Guy Hands is a straight-talking sort of man. “I want recruits, not conscripts,” he told his principal finance team before they officially left Nomura in March. Some left. Those that stayed with him have just completed their first fund closing as an independent private-equity firm.
The success of Terra Firma’s first fund since moving away from Nomura is crucial for the firm. Many in the market would like to see Hands fail. This negative sentiment stems from two sources: personal dislike of the man and the fact that success at this stage of a first-time fund in such a tough fundraising environment reflects poorly on more established players unable to raise at least as much.
One banker involved with private equity says of Hands: “You rarely hear good things about him. He’s not everybody’s cup of tea.” Another says of the recent critical press that everyone has his or her own agenda. Citing more established funds, he asks: “How would it look if they couldn’t raise as much?”
Terra Firma has managed to raise e1.1 billion in its first closing, with an eventual target of around e3 billion. This includes e900 million of new money and e100 million from Nomura, the Japanese firm where Hands built a glittering reputation with a string of acquisitions in the 1990s often financed through securitization. Hands was one of the first to spot the arbitrage between conventional equity investors’ valuations of certain assets and bondholders’ valuation of their underlying cashflows.
Legendary exploits He exploited this hugely and boldly. How he enriched himself and his employer in the process is the stuff of City legend. Even after the parting of the ways Nomura has agreed to commit itself to 10% of the total funds raised, while another e100 million is a combination of capital from Hands himself, the general partners and Terra Firma employees.
People in the private-equity industry are unable to agree on whether the e1.1 billion first closing of its first independent fund constitutes a success. A partner at another independent private equity firm says: “To raise e1 billion is damn good.” But he continues: “I would question whether he can generate the same returns [as when he was at Nomura]. How much of the track record was driven by Nomura and its balance sheet?”
A European financial sponsor at an investment bank says: “Terra Firma has struggled to get people interested. They haven’t done a good job. They started 14 months ago and it usually takes four to six months.” He also disagrees with the notion that the firm’s struggles should be judged as those of a first-time fund. “It’s comparable to a spin-off fund,” he says.
Strictly speaking it’s a first-time third-party fund. The team has plenty of experience in investing but none at fundraising. Comparing the experience with his time at Nomura, Hands says: “It’s much easier to walk upstairs and ask for money.”
Serious distinction The “first-time third-party” designation may be a bit long-winded but the distinction between the ex-Nomura fund and firms that have neither raised nor invested a private-equity fund is one that investors take seriously. Piau Voon Wang, a partner at private-equity investment firm Adams Street Partners, says: “This year we backed some new groups. We back first-time funds but not first-time investors.” Nonetheless, Hands says: “The majority of investors that don’t usually invest in first-time funds said no to investing in us.”
Those in the industry say the period between the launch of a fund and its first close is usually around six months. Taking the official launch date as the end of March, when the Nomura team officially resigned, sets Hands’ first closing at eight months. This is a good achievement given the tough fundraising environment and the extra time needed by limited partners to conduct extensive due diligence on the first-time fund.
However, it begins to look a little less impressive if you consider that some potential limited partners were talking to Hands at the end of last year.
Well-established private equity firm Charterhouse Development Capital (CDC) also recently completed the first closing of its seventh fund in August at e1.4 billion. Officially the Terra Firma fund was launched one month before CDC’s, and Terra Firma completed its first closing only a few months later.
Kamal Tabet, head of the European financial sponsors group at Schroder Salomon Smith Barney and placing agent for both Terra Firma and CDC, says: “The [Terra Firma] fund attracted a record number of first-time investors in the first close – more than 30. Charterhouse did its first close at e1.4 billion with a greater number of investors, many of whom are existing limited partners.”
Those limited partners that have already signed up to Hands’ fund were attracted by the firm’s strategy. Adams Street Partners’ Wang says: “Their strategy is very interesting and innovative. It’s not a typical buy-out fund strategy.” He adds: “This appealed to us because to be successful you need to be ahead of the crowd. Creativity and innovation are the key drivers.”
Hands’ creativity and innovation are well known throughout the industry, surely adding to his peers’ desire to see him trip up. He is known as the man who pioneered the use of securitization in transactions. This enabled him to raise capital in the debt markets secured by the future cashflow of the acquired stable asset. This new capital could then be used to pay down the bank loan used for the initial buy-out, with the coupon payments on this secured debt being less costly than the repayments on the bank loan.
However, now that securitization is common practice for principal finance groups, some in the market question whether Hands still has the edge over competitors that will enable him to repeat his success. One banker asks: “Is the gig up when it comes to buying assets and securitizing them?”
Wang says that although Hands is known for securitization he “recognizes that he can’t rely on financial engineering all the time”. Wang asserts that Hands’ ability to also be more operationally focused can be seen in previous investments such as off-licence business First Quench.
This was a public to private transaction in October 2000 in which intensive management of the company was required in order to turn the business around. Although Hands has had some realizations on this investment he is yet to find an exit from this asset for Nomura.
Other assets that are yet to be exited from what the firm refers to as Terra Firma Capital Partners’ first fund – that is, investments made by Nomura’s principal finance group between 1995 and March 2002 – include Ministry of Defence housing Annington Homes, TV and video rentals business Thorn, German housing business Deutsche Annington, Méridien Hotels and Hyder Business Services.
Nonetheless, Hands maintains that the internal rate of return (IRR) of this fund is 59%, with the lowest return at 22%. During the seven-year period, the principal finance group invested a total of £3.8 billion, with a return of £5.1 billion.
Doubts in the market
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Hands’ comment about recruits versus conscripts is indicative of some of the challenges he has had to face in untangling himself and his team from Nomura, which he joined eight years ago to set up a principal finance group.
Despite bonuses toppling from the dizzying heights reached in the late 1990s it’s an achievement to have managed to convince bankers to walk away from this kind of compensation. Rather than annual bonuses based on the performance of the bank, the team will be compensated on returns from long-term private-equity investments.
Hands has also had to learn to deal with limited partners who can be demanding. There’s no industry standard when it comes to drawing up partnership agreements and he has had to negotiate with external investors who have grown suspicious of how private-equity fund managers reward themselves. “We don’t get fees on a deal. We give 100% of the fees back to the investor,” says Hands. “They also have a 100% escrow account, so we can’t take any money out until the investors have their money.”
The limited partners also negotiated a tight key-man clause to make sure Hands stays. Wang says that the team is very capable but “Guy is important to Terra Firma”.
As such, Hands has also managed to tip the carry – the share in the profit from successful investments that is split among the general partners – distinctly in his favour, so lending support to those who describe Terra Firma as something of a one-man show. A banker involved in private equity says: “There is a bizarre carry structure that puts most of the money in his pocket.”
A spokesperson for Hands confirms that he does receive half of the Terra Firma employee carry but that he used to receive 100% of the employee carry while at Nomura. In addition, Hands is also bearing all the expenses associated with the fundraising.
So how do his colleagues feel about the carry structure? Well, apparently Hands really is a nice Guy who used to pay bonuses out of his own pocket when times were tough at Nomura.
It doesn’t look as if he plans to have to repeat that gesture. “We expect to raise around e700 million to e800 million over the next three to four months and the final amount next year,” he says.
Bargain hunter Limited partners are demanding good returns and Hands will have to put this money to work to ensure the future of his new fund. Mark Weisdorf, vice-president of private market investments at limited partner Canadian Pension Plan Investment Board – which has invested in the fund – says: “For a buy-out fund we expect 20%, net of fees and carry, and a multiple of capital returned of at least 2.5 times net of fees over the 10-year life of a fund.”
So how will Hands make these kinds of returns? By doing what all good private-equity players do best – step in to pick up the bargains at a time of distress, when conventional equity investors are still struggling to get out and rival bidders are distracted by other problems or unable to raise finance.
Apparently he’s been spending a lot of time in Germany, where assets are looking decidedly cheap. “The UK is still expensive. The pricing in Germany is much better,” he says.
