13 September 2012
2012 Q2 Investor letter (Extracts)
Another quarter and another summit of EU leaders trying to calm the markets. It is a continuation of the emotional cycle of fear followed by relief that we have all been going through since late 2009.
Fears peaked in early 2010 and again in October last year. They have just peaked once more. Each time political agreements were made that settled the markets temporarily. However, each time the underlying structural problems are not being properly addressed and hence they eventually resurface.
The question is whether the Eurozone is making progress towards a lasting solution. There are two rather polarised views on the answer: the Anglo-Saxon media is obsessed with the markets and sees political dithering and looming disaster; by contrast the Continental media (particularly in Germany) see evidence of necessary, steady but painful progress towards European integration, even if it takes ten to twenty years to resolve. This contrast was exemplified by recent market concerns about the yields on Spanish and Italian sovereign debt on the one hand, and the ECB’s reassurances that it would do “whatever it takes” to maintain price stability on the other.
While much of the detail is lacking, Continental observers perceive that the recent summit made progress in building some consensus about what a banking union might look like. It is not, however, going to put that union in place quickly as there is still much to debate about the detail and its implications, but the next phase is starting to take shape.
It is clear that in the long term a move towards banking union will only work in tandem with fiscal union. This will mean common cross-border rules on how countries can set budgets. It will be a significant transfer of power by national governments to Brussels. Agreeing this will take a very long time as each country will need to come to terms with the implications.
In the meantime, peripheral members of the Eurozone are slowly making the structural changes that are vital if the project is ultimately to succeed. They are making positive progress in reforming pensions, welfare and labour markets. Even Greece is falling into line as the outcome of its recent election demonstrated; the public knows they need the money.
Continental Europeans have, over the last few years, under-estimated how much influence the markets have in a global economy. Meanwhile, the British and Americans have under-estimated how much commitment there is in Germany to do whatever is needed to support European integration over a very long period. Europe therefore will continue to try to travel down its difficult road towards full integration. However, it will take considerably more than five years before we see Europe in a more stable position than it is currently – and it may take twenty years.
Outside Europe, the picture is no longer as encouraging as it was earlier this year.
In the US, the GDP growth evident earlier in the year has fallen back to 1.5 per cent in the second quarter. Part of this slowdown is the knock-on effect of the crisis in the Eurozone, with some commentators expecting that the spill-over from Europe’s problems will knock 0.2 to 0.4 percentage points off growth in America for the year.
In addition, the US is facing commitments to raise taxes and reduce spending which will bite by the end of 2012. As a consequence, the US Government is looking again at easing monetary policy to keep growth alive.
The slowdown is not just limited to Europe and the US. Rates of growth in China, India and Brazil, three of the world’s fastest growing economies, have also started to slow significantly in recent months. The gearchange in China’s economy is particularly significant as its growth has provided an important engine for the world economy since the credit crunch.
The unavoidable fact is that the global recovery is stalling, and it is unlikely to be a temporary phenomenon. Even with the most benign outcome, Europe’s troubles will impact world markets for years to come and we have to get used to the fact that investment returns will be lower. A 4 per cent risk-free rate of return is currently very attractive if it can be found, but many investors are still a long way from recognising this.
For private equity in Europe, this means that fund-raising is going to continue to be difficult. There are more funds reaching the end of their lives and, by 2015, only those who have managed to raise money between 2010 and then will be active investors. Many investors are nervous of committing money to Europe and the resulting shortage of capital will mean that Europe will remain a buyers’ market as governments, banks and corporates continue to sell assets for most of the current decade.
From an operational perspective, the private equity industry will need to do the hard work that is required to transform businesses, but the rewards will be lower than they were ten years ago as there is less leverage available.
TERRA FIRMA NEW DEALS
From a deal perspective, we have had a busy period.
At the end of April, we agreed to acquire Four Seasons Heath Care. The transaction was completed on 12 July.
Four Seasons is the UK’s largest independent provider of care homes for the elderly and of specialist care centres. It is a business that we have followed closely for six years. Our investment gives it a stable capital structure for the first time since it last traded in 2006.
Four Seasons has achieved a turnaround in the quality of care it provides in recent years and has led the sector in the development of higher dependency care services which are seeing increasing demand. We plan to invest in the business to raise standards of care still further, to extend its niche services and to develop its portfolio.
The quality of our two most recent deals, The Garden Centre Group and Four Seasons, is symptomatic of the rich pipeline of opportunities that we are seeing in the market.
We are also seeing particularly interesting opportunities in renewable energy and, during the quarter, we made three further bolt-on acquisitions for our renewable energy businesses.
In April, EverPower acquired the development rights to a 17.5MW wind farm at Mahanoy Mount, Pennsylvania; in May, EverPower also completed the acquisition of the Mustang Hills wind farm, a 150MW project in California; in the same month, Infinis purchased a portfolio of three UK wind farms with an aggregate installed capacity of 25MW from Broadview Energy, a UK renewable energy developer.
Although not large in itself, this last acquisition marked the point when, for the first time, Terra Firma’s renewable energy portfolio companies (Infinis, EverPower and RTR) own and operate projects which, in aggregate, have an installed capacity in excess of 1GW, a significant milestone.
Within Terra Firma we have always set ourselves clear objectives, both for our funds and for the portfolio businesses within them. This creates the focus and drive needed to deliver strong results.
This year we have shared the detail of our objectives for our funds’ returns, along with how we expect to deliver those returns with all our investors. In doing so, we are being transparent and open about how we intend to deliver value to our investors. While there may be some variation in exactly how those returns will be made up over time, we are sufficiently confident in our plans, and the quality of our businesses, that we are willing to share – and then to be measured against – these objectives.
With best wishes,