22 May 2012
2012 Q1 Investor letter (Extracts)
Just like the British weather this Spring, market sentiment towards the European monetary system is unpredictable and prone to extremes. The optimism which drove the European markets’ recovery during most of the first three months of the year, helped by the money pumped into the financial system by the ECB, has already disappeared.
With evidence of a weakening economic backdrop, we are seeing a return to dark clouds and storms. No one should be surprised; it took 15 years to create the crisis in the Eurozone. It will take at least this decade to sort it out.
Until now, most of Europe has been navigating through the crisis towards the same destination, with Germany plotting the route. To a large extent, shared pain made it easier for each country to swallow its austerity medicine and to make progress with structural reforms. However, we are now beginning to see rising popular resentment to that medicine and the hardship it is bringing.
Unemployment across the Eurozone as a whole is generating pressure on politicians to change course and stimulate economic growth. This is particularly acute in Spain and Portugal where the jobless totals are now over 24% and 15% respectively, with Spanish youth unemployment at 51%. The recovery underway in the US, where employment and consumer spending are both rising, only serves to heighten this pressure.
It is therefore no surprise to see a growing backlash against austerity across Europe. In particular in France voters are favouring candidates who aggressively question the Eurozone’s drive to tackle the crisis with budget cuts. Dutch voters, who traditionally have been seen as supporters of the German view, also want more emphasis on stimulating growth rather than cutting debt. These two together are important as they have substantial influence in Europe. However those wanting growth are still only likely to be able to slightly weaken Germany’s determination that, if Europe wants its continued financial support, it must live within its means. While the German political system might on the surface accommodate some easing of their austerity measures in order to achieve a pragmatic solution at times to political conflict within the Eurozone, they still believe passionately that it is the German government’s duty to lead Europe through this crisis. In doing so, Germany feels that it has no choice but to enforce fiscal discipline on the weaker Eurozone countries if the political union is to survive. In this tense environment, any slippage on deficit targets will rapidly lead to higher borrowing costs.
Meanwhile Greece was only going to survive within the Eurozone if its fragile coalition could muster sufficient support for the austerity measures agreed with the IMF and the other Eurozone members. This looks increasingly unlikely. However Greece leaving the Eurozone would not be a disaster and indeed is something I have previously argued should have occurred at the beginning of the crisis. What is more worrying are the political ramifications across Europe of the rise of the political parties to the extreme left and right. If there is a breakdown in Western Europe of the post-war political consensus that supports a plural political system based on Western democratic values, then things will become very different indeed. This I believe is highly unlikely but the numbers of people voting for the extreme right and the extreme left as dissatisfaction with the major parties grows will start to raise concerns about Europe’s future direction.
For the European economy as a whole, and all those countries which trade with it, we can thus expect a bumpy ride. In this scenario one needs to selectively pick investments that are defensive – or in ‘essential’ industries – and that have long-term growth or recovery potential. Fortunately for the private equity market, the need of the banks to raise cash and downsize amidst political and regulatory pressure is bringing more under-invested and under-managed assets onto the market at attractive prices.
Since the beginning of the year we have made a significant acquisition in the UK: The Garden Centre Group ‘TGCG’. Terra Firma sourced this deal from one of the UK banks, where the business was brought into administration after suffering financing difficulties in the aftermath of the credit crunch. This deal – in a sector with growing demand, having been under-invested by its prior owners, and negotiable down to the right price – is exactly the sort of opportunity that I believe is going to become increasingly common in Europe in the coming years.
We announced TFCP III’s acquisition of TGCG in March, for a total consideration of €331 million (£276 million). The transaction was completed after the quarter end, on 24 April.
TGCG is the UK’s largest specialist retailer of plants and garden care products and is a classic Terra Firma deal. It has the leading position in a £5 billion per annum market that is very fragmented and has good long-term growth prospects. Gardening is part of the British culture and appeals particularly to an older demographic. Because this demographic views garden centres as a good value, healthy leisure activity, spending at garden centres is considerably less volatile than UK consumer spending overall. Additionally, the asset-backed nature of TGCG, with its ownership of the freeholds for 70 of its 129 garden centres, places it firmly within the remit of Terra Firma’s investment strategy.
We intend to sharpen TGCG’s focus in its core garden business while growing a steady concession-based income stream, as we have done with Tank & Rast. We will also grow the estate through acquisitions.
Alongside the acquisition of TGCG, we are continuing to engage in a number of discussions concerning possible acquisitions where Terra Firma’s expertise can add real value. In addition to seeking highly operational, strategic transformation deals like TGCG, we see important opportunities in the renewable energy sector.
From both an operational and transactional perspective, Terra Firma continues to focus on maximising the value of our current portfolios. Given the number of opportunities in the market that fit Terra Firma’s sweet spot, we will also continue to explore new investment ideas.
With best wishes,