Chairman's letters

30 April 2013

Letter from the Chairman, Terra Firma Annual Review 2012

2012 proved to be another challenging year for the global economy, with political uncertainty hitting markets in Europe and the US, and emerging economies seeing their growth rates slow down.

Against this backdrop, Terra Firma, in its tenth year as an independent firm, and its portfolio businesses have made significant advances. We acquired new businesses, strengthened existing ones and grew the combined value of our funds by €2.8 billion, a 47% increase compared with 2011.

We added two new businesses to our portfolio: Four Seasons Health Care (‘Four Seasons’) and The Garden Centre Group. Both businesses fit very well with our strategy, since they are asset-backed, in essential industries and are in need of fundamental change.

Four Seasons is the UK’s largest independent elderly and specialist care provider. The provision of elderly care is an essential industry which is well-positioned for growth, given the UK’s ageing population. Terra Firma’s acquisition in July 2012 will provide the necessary investment for it to continue raising the standard of care that it provides and achieve long-term sustainable growth. Our primary objective is to ensure that Four Seasons delivers consistently high-quality care for residents, service users and their families. 

The Garden Centre Group, purchased in April 2012, is the largest plant and garden-focused retailer in the UK. Gardening is an integral part of British culture, with almost half of adults participating in gardening, rising to nearly two-thirds of those aged 45 years and over. The market for garden products has shown stable long-term growth and is expected to benefit from an ageing population.

During 2012, we continued to invest in our portfolio businesses, reflecting our strong commitment to making each one a top performer in its sector. In total, nearly €2.2 billion was spent on building and developing our businesses with a further €0.2 billion invested in add-on acquisitions for Infinis, RTR and EverPower. Our portfolio companies saw significant improvement last year, with combined EBITDA growth of 10% versus 7.3% growth in the level of the Dow Jones Industrial Average and 5.8% growth in the level of the FTSE 100. We have achieved this performance by working closely with our portfolio companies to create value in five ways: changing strategy; strengthening management; improving assets through capital expenditure; building the business through bolt-on acquisitions; and lowering the business’s cost of capital.

We raised a new fund in 2012 – Terra Firma Special Opportunities Fund I – to acquire Annington from Nomura. At €4 billion, the deal was the largest European leveraged buy-out transaction since 2008. We also refinanced Deutsche Annington, our residential property business in Germany – at €4.3 billion, it was the largest European real estate refinancing of 2012.

As global markets continue to suffer from uncertainty, we have proven that we have the expertise to get deals done even in challenging markets. In 2012, Terra Firma was number one for leveraged buy-out transactions by value in Europe, the Middle East and Africa, and it was in the top ten globally.

At Terra Firma, we have always looked to the long term to generate returns, and it is good to see increasing awareness across the investment community of the value that should be placed on other, non-financial factors. Terra Firma is embracing the more systematic articulation of non-financial impacts in the investment process and with that in mind we have invited Dr Bob Swarup to contribute a piece to our Annual Review this year on the debate around Environmental, Social and Governance (‘ESG’) issues. We are building on our commitment to the United Nations Principles for Responsible Investment by implementing more in-depth ESG reporting across our portfolio during 2013, working with our businesses and investors to define the most useful metrics. We are also conducting a series of ESG reviews across our businesses, supported by an external sustainability consultant.

Portfolio Business Performance

We have been particularly encouraged by the performance of our portfolio in the face of the difficult economic backdrop.

AWAS ended the year ahead of budget in all its key financial objectives, with 20 new aircraft delivered in the year and all 25 deliveries due in 2013 now placed with lessees. These new deliveries combined with selective disposals of end-of-life assets mean the fleet now has an average age of under six years.

CPC performed well operationally in a challenging market during 2012. The joint venture with Dantong, which sells boxed beef in China, is progressing well, and CPC is looking to broaden the number of markets that it supplies with a more consumer- and retailer-based offering. There is good momentum in this area and we are optimistic that CPC will increase sales to its chosen markets over the next twelve months. Fergal Leamy, a Terra Firma Business Director, was appointed CEO in October and is making strong progress. Mark Bahen, one of CPC’s existing Australian Non-Executive Directors, was appointed Chairman in August, and we are confident that the right people are in place to move the business forward.

For Four Seasons, its focus over 2012 was on the integration and improvement of the ex-Southern Cross homes that were acquired at the end of 2011. The business also made strong progress implementing its post-acquisition plan and we have strengthened the existing management team with the appointment of Ian Smith as Chairman.

Despite unfavourable weather conditions in the UK, The Garden Centre Group’s full-year financial performance was encouraging, demonstrating the importance of the restaurant and concessions contributions to the business and the focus on weather-proofing its revenue streams. The management team was strengthened with the appointment of Kevin Bradshaw to CEO and Nils Steinmeyer, a Terra Firma Finance Director, to CFO.

Odeon & UCI continued with its expansion plans, successfully maintaining its position as the largest cinema chain in Europe. Furthermore, continued investment in the business means Odeon & UCI is now the largest fully-digital cinema operator in the world.

Following the successful fuel tender in 2011, Tank & Rast has worked hard to prepare the network for the new fuel distribution arrangements that started in early 2013. The execution of this new strategy will accelerate in coming months and we expect to see the full benefits coming through by mid-year.

Phoenix ended the year well, with new connections 30% ahead of target as the slow residential property market caused home-owners to invest in their homes rather than move house. The business continues to be a solid performer within the portfolio.

We are very pleased with the progress made in the past year by our renewable energy investments. Over the course of 2012, EverPower affirmed its position as an owner-operator of scale with six operating wind farms and over 500 MW of operating capacity, an eightfold increase since acquisition. RTR consolidated its position as the largest solar PV operator in Europe, making two add-on acquisitions in the last quarter. The business now has an operating capacity of around 300 MW, more than double the size of the original acquisition.

Last year, Infinis continued its significant growth trajectory, adding new onshore wind assets both from its organic project pipeline and selective acquisitions. The new wind farms have consolidated Infinis’ position as the largest independent renewable energy generator in the UK, operating a diversified portfolio of landfill gas, onshore wind and hydro power plants with an installed capacity in excess of 570 MW. This momentum is a positive background for the sale of the business, a key objective for us this year.

Our residential real estate investments have also performed well over the last year. We successfully completed the acquisition of Annington from Nomura and look forward to continuing our partnership with the Annington team over the next decade. Annington’s rental markets performed strongly in 2012, a trend we expect to continue in 2013.

Deutsche Annington has continued to benefit from a relatively strong and stable German economy. The strong growth in housing demand in Germany meant that, despite a reduced privatisation stock, in 2012 Deutsche Annington had the highest number of annual sales since 2006. Rolf Buch, a former  member of the Management Board of Bertelsmann SE, was appointed CEO in April 2013. Under Rolf’s leadership, we are confident that Deutsche Annington will continue to grow successfully as we consider strategic options for the future of the business.

Market Outlook

The crisis in Europe continues to grind on, but it appears that the world is getting used to this state of constant uncertainty and that it has indeed  become the new reality. Issues in Europe will continue to flare up, but they are increasingly part of the background noise of doing business.

The biggest trend we are currently seeing is that of markets taking a backseat to national politics. From 1982 to 2007, we largely had international markets in the driver’s seat, with financial institutions given increasing global freedom and support.

However, since the 2008 credit crunch, the politicians have taken over. Their constant intervention has made it much harder to know where to invest.

Nowhere is this more evident than in Europe. The ongoing crisis will not be resolved without strong international agreement, and it is difficult to see how that will occur. In fact, we are witnessing just the opposite; across Europe, maverick and extremist parties are doing better as people reject the traditional parties they see as responsible for the current crisis and austerity measures.

Most  voters in Europe are understandably unhappy with their current circumstances, but they are paying for the previous decade of living standards that rose based on debt and countries living beyond their means. Governments, confident that their economies would carry on growing, borrowed against future output. Individuals also increased their borrowing on the back of the rising value of assets such as houses. When that output didn’t materialise and asset values fell instead of rose, it was clear that the previous level of borrowing and spending could not be maintained.

Politicians will always want to be popular, so when times are good they will spend, and when times are bad they will chastise scapegoats such as bankers, whom they will blame for the ensuing spending cuts and austerity. In reality, the politicians should have saved in the good times so that they would now have resources to use in a slump. In Britain, for example, the government at the time thought high tax receipts were here to stay, and they increased government spending accordingly. Now that we know that many of those increased receipts were illusory, we can recognise the folly of this approach, but the key is to recognise when you’re living through good times, and capitalise on them.

Sweden, for example, was fiscally prudent during the boom years, and this has enabled it to ride out the recent bust relatively well. Germany is another good example of a country that used the global boom not as an excuse to increase its leverage, but to focus on exporting to the rest of the world and strengthening its economy. They are now reaping the rewards after years of hard work. But for those countries whose politicians and citizens borrowed too much in the good times, the process of deleveraging will continue to weigh on growth.

Governments across Europe have responded to the crisis with austerity measures to restrain fiscal spending and increased regulation to rein in the banks. However, increased taxation and regulation are now cutting off any possible recovery. Small- and medium-sized enterprises, which are the backbone of the British and European economies, are being destroyed by these measures, and without them, we will not be able to achieve strong, sustainable growth. In the US, the government faces a profound challenge in figuring out a sustainable solution to the country’s spiralling fiscal spending. The tools to balance the budget, such as entitlement spending caps and higher taxes, are within its grasp, but the political dangers in employing them mean we are unlikely to see a solution soon.

What will happen in Japan is very difficult to determine – on the one hand they have the political will to jump-start the economy for the first time in a very long time, but on the other hand, by pushing spending, they are trying to change cultural habits that are deeply ingrained. As someone who has spent most of their career visiting Japan, my view has always been that it would take a generational change post-1990 for Japan to really change, and we are now starting to see that happen. It is a balancing act between political action and the will of the people, and it is not made any easier by the context of uneven global growth and rapidly growing neighbours such as China. The Japanese population is ageing rapidly, and they may need to turn away from their relative cultural isolation to embrace foreign concepts, as China has done, if they want to breathe new life into their economy.

This year we are seeing a new leadership team come to power in China, and it has significant challenges to face to continue on its traditional path of high growth. The consequences of its one-child policy are making themselves evident as the labour pool is starting to shrink, which will put pressure on its large manufacturing base. However, while exports will remain vital to the Chinese economy, it appears the government will spend the coming years turning to a more domestically-focused growth strategy. The global recovery continues to be anything but straightforward; however, it is happening. Whilst the world economy is not performing as badly as many have feared, it is not doing as well as many have hoped. Life has returned to global markets, but this is largely a consequence of an unprecedented environment

of extremely low interest rates. These rates will have to go up eventually, but that day is a long way away. In the meantime, investors are getting used to the current situation and realising that this is the ‘new normal,’ and they need to start putting their money to work again. When looking at where to invest, people keep asking where growth is going to come from. Unfortunately, it’s not as simple as that. It is often assumed that growth will provide good investment returns, but the reality can be very different, or even the reverse. For this reason we have not been advocates of investing in private equity in emerging markets. The benefits of this decision are becoming clearer as growth slows in Brazil and India and private equity firms are having a difficult time realising returns in China. Emerging markets are growing more unstable and therefore high growth will not simply equate to better investment returns.

Investors shouldn’t necessarily look at growth as a proxy for returns. While Europe may continue to suffer from low growth, it may still be one of the best places to invest because the economics of investment opportunities remain very favourable. The US also looks positive for general investment, though the prolonged period of loose monetary policy carries its own risks; since interest rates are unlikely to get any better, the risk is on the downside. We believe private equity can play a critical role in regenerating the economies of Europe. Focusing on transforming businesses is what differentiates private equity from other models of corporate ownership and from other asset classes. Private equity is fundamentally about long-term transformational investment. We raise capital that is committed for ten years and we use it to improve businesses and create value.

In contrast, the demands of quarterly reporting mean that listed companies struggle to maintain a long-term perspective. The private equity model aligns the interests of owners with management by speeding up decision-making and ensuring that all stakeholders are in the same boat and rowing in the same direction. While the political risk in Europe cannot be ignored, experience shows that as long as you factor it in, then the political storm clouds can be navigated and deals made to work.


During a year of challenging markets, Terra Firma has continued to complete significant transactions and improve the performance of our portfolio businesses. We have proven our ability to adjust to the ’new normal‘ in Europe and navigate the changing political and regulatory landscape thanks to our track record of investing in complex situations and working in regulated industries. By looking past the short-term volatility and focusing on where we can add long-term value, we will continue to identify opportunities for investment. Terra Firma has ambitious plans for the coming year. We are continuing to evaluate exit strategies for certain businesses in order to return capital to our investors. 

We will also continue to look for opportunities to invest in businesses which meet our investment philosophy, and work to improve and strengthen our existing portfolio businesses. On behalf of all of us at Terra Firma, I would like to take this opportunity to thank all our stakeholders for their support during 2012. I would also like to thank the directors and employees of our portfolio companies, along with the Terra Firma team, for their achievements during the year.

With best wishes,

Guy Hands

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