01 May 2011
2011 Q1 Investor Letter - TFCP II and III
The New Year brought with it the hope of reinvigorated markets and a general sense of economic improvement. Whether the hope of a full recovery will grow into a financial reality in much of the West is something I don’t expect for some time. However, we have already seen the credit markets improve dramatically in the first quarter of 2011 and with this we have seen an uptick in market activity. I expect this activity to continue, though the markets are still fragile and could easily deteriorate quickly.
We have been investing capital for nearly 16 years and next year is the tenth anniversary of our spin-out from Nomura. We have invested over €14 billion and have made 28 acquisitions. We have invested in 17 different sectors and our businesses have operated in more than 60 different countries. We have made 26 major add-on acquisitions to our portfolio companies, as well as countless smaller additional investments. We have had 15 total exits and three partial exits. Our experiences from those investments that went right and those that went wrong, and what we have learnt during this time, are driving us forward as we focus on sourcing acquisitions for TFCP III and exits for TFCP II.
The private equity market for new deals continues to be very competitive as a large amount of capital still remains to be invested. For the remaining capital in TFCP III, we have therefore opted to look for opportunities that are less competitive, but are attractive because of our unique ability to build businesses. We are executing this strategy using our ‘macro-to-micro’ approach to identifying new investments – by formulating a macro view on key trends and sectors and then using our relationships to find specific investment opportunities. We are also using our specific sector knowledge to tease out unique and attractive potential acquisitions. There is no better example of this method of deploying capital than the Rete Rinnovabile (RTR) transaction, which closed on 31 March 2011. It was the quality of our due diligence and our deep industry experience that enabled Terra Firma to win the confidence of Terna (the Italian National Electricity Grid) for this transaction. Our knowledge of the green energy sector and our experience in developing assets into a standalone business, as we had done before with Infinis, were critical elements in forging the partnership with Terna. In fact, we were the only private equity firm considered for this transaction. RTR is an asset-rich business that fits neatly into our portfolio and is exactly the kind of opportunity that we look for. With operational focus and organic growth, we believe that RTR will quickly become a stronger company. A transaction like this demonstrates the creativity and operational strengths that we bring to our investments.
As to TFCP II, our team at Terra Firma is principally focused on looking at exit opportunities. Given that we are in the seventh year of the Fund, you would expect us to be actively engaged in realisation evaluation exercises to ensure we are exploring every reasonable opportunity to maximise the value of the portfolio. For example, we have been developing strategic relationships in the Middle East and China. These relationships should be beneficial both in building the current businesses and with regard to exits.
At the end of the first quarter, TFCP II’s cash-on-cash multiple was 1.75x and our aim is to increase that to a multiple of at least 2.3x by the time the Fund is wound up. We recognise that this is an aggressive objective considering that we lost almost a third of the Fund’s capital on EMI. Hence, there is still much value to be achieved for investors by executing our current business plans for each portfolio company, even as we prepare the businesses for exit. Whilst some of our investments may be more ripe than others for sale, we will not rush our exits. Rather, we will undertake them at a place and time that maximises the value of the portfolio. I think that TFCP II demonstrates that Terra Firma’s interventionist approach creates sustainable value in the portfolio businesses and, importantly, generates value for our investors.
The revised objective for TFCP III is one that balances creativity with prudence in trying to recover value. All of us at Terra Firma are eager to repay your trust in us and recover as much as we can from TFCP III. Taking into account EMI, our revised objective for TFCP III is to make at least a 1x net return to our investors. Whilst we are hopeful that we can improve on this objective, we are not interested in taking on higher levels of risk to generate outsized returns. Instead, we want to be in a position to achieve that goal with a large margin of safety. Clearly, the final investments that we make in this Fund will be critical to achieving this goal.
At Terra Firma, we have a quality group of investment and operational professionals dedicated to achieving the objective of each Fund. In order to ensure that they are fully motivated, we have taken the time and energy to make sure the appropriate incentives are in place to ensure alignment with our investors. As the biggest investor in these Funds, we clearly have a keen interest in maintaining and building the strongest possible investment team and we will continue to ensure that this happens.
With best wishes,