Chairman's letters

01 November 2007

Guy Hands' speech at the SuperInvestor Conference - November 2007, Paris

Good Morning.  

I think that we all recognise that Private Equity has changed dramatically in the last few months and, in my view, it will take some considerable time to return to the heady days of 2003 to 2007, if it ever does. 

The title of this speech was put together in what feels like a bygone era - an era which we will probably talk to our children and grandchildren about.  Those carefree days of bought deals, covenant-light loans and bridge equity.  “Those were the days my friend.” 

I don’t think the question at the moment is whether the industry can live with bigger and bigger deals or the need for regulatory involvement.  However, I’m sure that the politicians and regulators who are always fighting yesterday’s battles are even now contemplating the questions of yester year rather than focusing on future problems and opportunities. 

The big question right now for the private equity industry is “Can Mega deals be done at all?” 

As a result of the credit crunch, the debt markets for large buyouts are not just extremely challenging but closed for mega new deals in Europe. 

They are closed because the banks have stopped lending in any real size. I had one extremely proud head of European leverage finance at a major investment bank tell me that they were open for business.  When I asked him what was the largest debt ticket he could write he said £250 million! The same individual in March was offering bridge equity of £1 billion and debt tickets of several billion. 

And not only is there much less debt available, but the price of it is also much more expensive. Deals that we could get underwritten at a senior debt cost of 200 bp over libor are now indicated at 375 bp over and even at this spread are still not syndicatable.  

And while the investment banks digest the loans that are already on their balance sheets, the force of $1.3 trillion of re-financing to manage over the next five years will start to hit them.  So lending to large buyouts will continue to be very sparse for sometime. 

This was in hindsight inevitable – covenant-light deals, 14x prospective EBITDA packages, “bought” deals, vendor due diligence accepted by banks, existing management teams being listened to – all the warning bells of an overheated debt market were ringing. 

As the Financial Times put it recently, this was the M&A equivalent of self-certified sub-prime mortgages.  And we are all now bearing the consequences of these excesses. 

This is no blip.  In July as the good times were starting to end  - or “the music”, as some put it, was stopping - I guestimated that $3 trillion, yes, $3 trillion of liquidity would come out of the system over the next 18 months as the result of $300 billion of losses needing to be taken by the banks over the next two years. 

And this financial crisis will spill into the broader economies of the world and in particular to the US and UK; my own view is that recessions are inevitable even if they may be delayed by the lowering of real interest rates in the run up to the next US presidential election. 

At the same time - and I apologise for being so depressing - the world’s political climate is not looking healthy, and that’s before you even factor-in the consequences of the larger macro trends such as global warming and so on. 

In such circumstances, you’d expect the markets to be down, and down heavily, but while the debt markets are well off, the equity markets – despite their recent wobbles -  have been viewed as relatively safe haven

 – In fact for stock market investors, 2007 has been okay.  Financials may have fallen out of bed but the S&P 500 is up 4% and NASDAQ is up a whopping 14% this year. 

Thus sellers’ price expectations remain high, even if the availability of finance has decreased.  So, doing large buyout deals in the second half of 2007 has been far more difficult than in the first half of 2007 and 2008 is not going to be any easier. 

Interestingly, the number of transactions has not yet fallen greatly; however, large transactions are not being completed.  Historically it has been the larger LBO transactions which have outperformed for private equity. 

Additionally, most of those transactions which are currently being completed are deals that were being worked on prior to the credit crunch.   

Going forward, the public equity markets will at best stagnate with consumer expenditure-based companies under-performing those which are asset rich. 

So, what should Limited Partners look for in a General Partner in today’s private equity market?   

Basically there are four types of General Partner: 

Transformers – General Partners who have been in the business for years and have the proven ability, size and willingness to adjust to different environments and find attractive new opportunities. 

Focussers – General Partners who have stayed focussed on one particular strategy, developing both expertise, and a reputation in that area and who will stay focused on their strategy, working through the current difficulties. 

Traditionalists – General Partners who have experience but do not have the resources or the desire to adjust to the new environment. 

Newbies – General Partners who are new and have yet to be proven or tested. 

In the era that existed up until the summer, all of these groups should have made money as cheap leverage was plentiful and prices continued to rise.  

However, in the new environment, the “Transformers” are where everyone wants to be now.  These are the groups that should perform in different markets and include some of the best known names: Carlyle, Blackstone, and KKR are all examples of Transformers. 

Terra Firma is in contrast a “focusser” having been centred on the same type business issues for 17 years… the type of buyouts that others avoid, the big, the bad and the ugly. 

This focus was born out of the credit correction that occurred in late 1989.  Lessons from that era will, I believe, serve us and our investors well going forward. 

There are three types of deal over the next few years which Terra Firma will focus on in the large buyout space and all three have their challenges: 

First, puzzle deals - no longer will anyone be able to put a deal together in just three weeks; most deals will take months and possibly years to complete the jigsaw. 

In getting financing for these deals we should not forget that, though often loyal and keen to help private equity, bankers can act like dogs – they are most happy in a pack and when they smell an easy deal, they go into a feeding frenzy, each trying to push the others out of the way to get top billing.  But even loyal dogs, when they are hit hard, whimper and retreat to their baskets – and the banks have been hit very hard in recent months and are facing substantial losses. 

So don’t expect them to come out of their baskets and provide the level of debt on cheap terms which private equity needs for some time.  Private equity is going to need to treat their bankers better than it has and accept tougher terms, higher fees and pre-syndicated deals and work more in partnership rather than acting as masters in order to get things done. 

Second, equity deals – deals that require a very large amount of equity, and first and foremost deliver value from operational and strategic change. 

The problem is there is only so much equity you can raise.   

Third, fallen deals – deals which were over-leveraged in the recent heady environment and are in need of capital restructuring. For these deals to become available, the banks are going to have to take a hit and existing equity will need to accept a hit as well.  New equity is needed and the current owners and the banks will not accept this easily.  I suspect that this won’t happen in any real size until post-2009 when a lot of deals are due to be re-financed.   


The Private Equity market has entered a new and more challenging phase after the recent good times era of excessive leverage.  

There are still going to be money-making opportunities in such a market, but they will be more difficult to find and will rely on having a good relationship with ones banks. 

General Partners who have the experience to either adapt - the ‘Transformers”, or who have a disciplined strategy that works in such an era - the “Focussers”, will deliver the best returns and will be able to piece together big deals. 

What about regulation?  

As so frequently happens, the markets are the most effective regulator of all and frankly private equity should be the least of the regulators and central bankers concerns.  But no doubt the politicians and the regulators will spend the next few months continuing to focus on yesterday’s problems while the real economy falters around them until they are forced to act to solve the banking crisis which clearly currently exists. 

I would like to give you good news. I would like to talk my own book. I would like to be positive, but unfortunately that would not be true.  In the words of the song “Those were the days my friend, and we thought they would never end” 

Thank you.

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