How do you make a sale process even more difficult and time-consuming than it already is? Try multiplying the workload and stress by a factor of ten. That would be one surefire way of upping the ante, as Jim Clark, a director at Vantis Corporate Finance in London, knows from his experience in the emerging market for secondary purchases of private equity portfolios. If carrying out a normal sale is like herding cats, Clark says, then carrying out the sale of multiple companies in a portfolio to a single buyer is like herding herds of cats.
Clark and the team at Vantis have already completed two portfolio sales and are in the throes of their third. The first came in September 2006, selling ten companies owned by 3i to Saints Chamonix, a joint venture between Saints Capital and Chamonix Private Equity.“This deal took a full year from conception to completion,” says Clark. “It was a massive learning curve for us.”
The second, which followed a year later in September 2007, involved the sale of a further three 3i companies to City-based London & Oxford Capital Management, which bills itself as an acquirer and manager of private equity portfolios. Clark expects to complete a third, which he has been working on for several months, in the summer of 2008.
“The appeal of selling a group together is that you can get a faster deal collectively that is less intrusive to the individual businesses. This is because you work from the top down – almost the way you would when selling a mini-conglomerate,” says Tim Harrison, a partner in 3i’s buy-out business. “The result is that we were able to sell businesses we needed to sell, to free-up financial and human resources. But we didn’t walk away in an inappropriate manner. We found a buyer who was good news for the companies that made up the portfolio and brought a fresher outlook to them.”
Managing complexity
The phrase “huge logistical exercise” recurs more than once in conversation with Clark, and it is easy to understand why. The sale of the ten-strong 3i portfolio to Saints Chamonix required several months of hard work to satisfy the demands, interests and concerns of the many interested parties: the vendors, co-investors, management shareholders and other shareholders. Given Clark was also on crutches for three months of the process because of knee reconstruction, he freely admits that it was the most stressful, and most satisfying, 12 months of his career.
One significant reason for the deal’s complexity lay in bringing the UK’s Pensions Regulator onside, as four of the ten companies being sold had significant defined benefit pension fund deficits. 3i wanted to be able to walk away without the risk of future calls from the Regulator to help make good those deficits, while still treating pensioners fairly. “It was a first for us and the Pensions Regulator too, as it was the first sale they had experienced with several pension deficits to deal with simultaneously, so it was a sharp learning curve for everyone,” says Clark. In the end, the pension fund trustees declared themselves satisfied (and, therefore, so did the regulator) with the agreement that the acquirer would pay into the pension funds an amount sufficient to clear the deficits on the day of completion.
Other issues included the values that would be attributed to each individual company in the portfolio. In the US, where secondary portfolio sales are more established, a portfolio will be valued as a whole, but 3i needed to know the individual values in order to satisfy the various vested interests. Vantis also had to insist that the bidder break down the value of the bid so it could demonstrate that an independent third party had valued each one.
Because of the lengthy process and number of companies being sold, the Vantis team were constantly giving out updated financial and operational information. With ten different companies from different sectors and geographies involved, it was inevitable that some would outperform, while others would have key operating decisions go against them. This created a constant challenge in terms of disseminating information, both positive and negative, as the process ground on.
“We were well pleased with the disposal, which leaves us freer to concentrate on continental markets and newer, larger deals,” says Harrison.
A practical solution
Clarke expects to see more deals of this nature: “We have demonstrated its feasibility as a concept and demonstrated that it works in practice.”
The excess of demand for portfolio purchases over the availability of portfolios for sale indicates that there is a strong demand for these types of transactions. Nova Capital Management, which has bought portfolios worth €880m since it was set up in 2002, is out to raise funds with a €300m target this year. The firm, which buys both from private equity and corporate owners, claims an IRR of 33 per cent on 13 realised investments in the year to July 2007.
If buyside interest is there, then Clarke believes it should not be too long before sellers become aware of the benefits of a successful portfolio sale: “There is a real ability to achieve excellent value – and often a ‘portfolio premium’ – depending on the individual investments that make up the overall portfolio and the ‘upside opportunities’ they present,” he says.
“So far, there has been significant demand due to the increase in the number of institutions specifically seeking portfolio acquisitions and a limited supply from the established private equity community. This demand will continue as primary investment opportunities are scarce and take longer to complete in this more risk-averse marketplace. A number of new private equity funds have also been set up specifically to acquire direct secondary portfolios as the private equity industry matures.”
For 3i, the portfolio sale provided an effective step in its market repositioning towards larger, cross-border buy-outs. “The business model has changed in private equity as the flow of investment funds has increased faster than the ability to sell companies; the cycle of fund-raising has fallen to three years while the average period of ownership can be longer,” says Harrison. “Where this coincides with a period of changing a firm’s investing model, in terms of countries of operation, sectors or size of deal, you have to have an approach to the older portfolio. This was the position we were in 2004-06, and this disposal marked a significant step in our own transition in mid-market buy-outs.”
Special considerations
The portfolio sale has a defined process and timetable that provides some very real competition for other individual sale processes that have slowed or been suspended for whatever reason. “In all portfolio transactions we have worked on, the private equity house has actually achieved more exits during the process than the final number sold to the successful bidder. The process can be highly successful for the private equity house in terms of total ‘direct and indirect’ exits achieved,” says Clarke.
He says that the key to running a smooth portfolio process is taking the time to understand the private equity house’s expectations and, just as importantly in a complex process like this, the management’s expectations. If these expectations are unrealistic, they need to be reconciled and managed effectively from the beginning.
While the main objective is to achieve an exit for the private equity house, often other shareholders have been seeking an exit opportunity for some time. However, the new investor does not want management shareholders “cashing out” just as they invest. It may let management shareholders realise some cash, generally about 30 per cent. However, they should not see this as an opportunity to exit alongside their current investor.
They are not easy transactions, but a secondary portfolio sale can prove a great success for the exiting investor, achieving multiple exits for an excellent price and in a short timeframe, with relatively low advisory costs when compared with individual sales. Clarke concludes: “We believe there will be more secondary portfolio sales of direct investments as the private equity industry matures and seeks new ways to realise its existing investments, and invest some of the new funds being raised.”
The deals
In September 2006 3i, advised by Vantis Corporate Finance, completed the sale of its interests in a portfolio of ten investee companies with an enterprise value of about £250m to Saints Chamonix, a joint venture between Saints Capital and Chamonix Private Equity, which is entirely UK based. Both are private equity firms active in the direct secondary market.
In September 2007, 3i and Vantis completed the sale of a portfolio of three companies to London-based London & Oxford Capital Management.
Deloitte Transaction Services carried out vendor due diligence on the first transaction, providing information on six of the ten companies in the portfolio, accounting for about 85% of the value. Macfarlanes acted as legal adviser on the selling side in both transactions.
Saints Chamonix turned to Dickson Minto for its legal advice while London & Oxford sought legal counsel from Pinsent Masons, and appointed Grant Thornton to carry out due diligence.
Vantis is a corporate member of the Corporate Finance Faculty and this article first appeared in Corporate Financier, the magazine exclusively for members. To become part of the largest network of corporate financiers visit www.icaew.com/corpfinfac to benefit from seminars, debates and practical forums, 10 annual issues of the magazine, Best-Practice Guidelines and the CF qualification.
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