Private Equity Gambling with Old People? Guy Hands on Verge of Another Fiasco

Can he repeat?  Big Hands I know you're the one.

Can he repeat? Big Hands I know you’re the one.

Guy Hands, founder of UK private equity outfit Terra Firma, is about to do it again. The odds must be slim to none, but Messr. Hands just might catch lightning in a bottle. Another Terra Firma investment is inching towards an inglorious end and if the big man accomplishes this feat, he’ll be the investing world’s version of Bad Luck Brian. Already in the running for The City’s most shambolic investment firm, this would place them squarely in first place.

Every private equity shop has laid an egg here or there. Most of the time they manage to sweep it under the rug without so much fanfare and attention as whooped up when they’ve closed their latest fund. But this “Guy” appears to have a knack for both losing money and creating a PR disaster at the same time.

To refresh BFN readers, Guy Hands’ Terra Firma had the dubious honor of presiding over perhaps the worst private equity investment in history: the acquisition of UK music publishing concern EMI. Terra Firma paid £4.2 billion ($8.3 billion at the time) in August 2007 to acquire EMI. Subsequently a number of artists left the label, a financial crisis hit, and EMI had too much debt to get through it all. By 2011, the owners had run out of options and were forced to relinquish control to the primary lender, Citigroup, wiping out all of the equity (and most of the debt). Terra Firma was reported to have lost a whopping £1.75 ($2.5) billion in the transaction (roughly one-third of investor capital) as well as more than 60% of Hands’ personal wealth (who chipped in along the way to try to keep it afloat).

Although Terra Firma hasn’t been able to (and probably won’t ever again) raise even 50 pence of new investor capital since the EMI debacle, the firm had two active funds with about $2.8 billion left to invest in early 2011. Lucky for those investors, Hands & Co. got to work finding their next train wreck. They found it in Four Seasons, Britain’s biggest chain of homes for the elderly. Terra Firma acquired the business for £825 million ($1.3 billion) in mid-2012. Although the “Sponsor” (an idiotic label the industry came up with for private equity firms) put in about 40% of the purchase price as equity (not the skinniest equity check a PE “shop” has ever ponied up to acquire a target investment), the debt burden is nonetheless proving hard to manage. Now, higher-than-expected nursing costs and lower-than-expected payments from local governments are putting the squeeze on (certainly not what the “Base Case” projection showed back in 2012). The investment isn’t headed toward a dirt nap just yet, but advisors have been hired which means this thing is circling the toilet bowl.

Some are questioning (and rightly so) the motives for doing these deals and claim Terra Firma may just be swinging for the fences since they have no future anyway. As The Economist put it in a recent article (found here):

If a private-equity firm’s chances of raising new money evaporate halfway through a fund’s life, spending its remaining cash willy-nilly becomes rational. There is always the hope of making up for past losses if new ventures pay off. Moreover, buying something (anything!) prolongs the fund’s life, and thus the period during which the private-equity firm that manages it gets to collect management fees of as much as 2% a year.

The article goes on to cite data showing Terra Firma III fund’s IRR at -8.8% as of late 2014. Of course, as The Economist points out, the 1.5% management fee for the fund will still be paid by investors, on top of the losses.

If few people beyond the investors in Terra Firma III felt the pain of this investment going bad, Hands might have kept this latest invest-turd on the DL. But if things continue to sour from here, the press will probably burn the man in effigy. That’s because this won’t be the first time old folks in the U.K. have become bargaining chips in a private equity financial gamble.

In 2004, The Blackstone Group acquired Southern Cross, then the largest care homes enterprise in the UK. Their strategy was simple: strip all the real estate assets from the business through sale-leaseback transactions on all the care homes netting a huge profit in the process. Blackstone then took the company public and in less than 2 years walked away with an estimated £1.5 billion or more of gains for all their hard work. But they separated the landlord business from the homes and left Southern Cross in hock to its various new landlords with 2.5% annual rent escalations for 35 years.

Post hoc, by 2011 the company could no longer service the rents and had to withhold payments on some homes in order to keep operating and not boot elders to the curb.  It even sought a government bailout but was turned down. It’s easy to forget how bad all this looked at the time. In the era of bank bail-outs, private equity was being blamed for jeopordizing the well being of 30,000 vulnerable old folks.   Efforts to rescue Southern Cross ultimately failed, and all its care homes were taken over by their landlords with management transferred to new health care companies. The company was dissolved into oblivion.  Blackstone insisted everything was just fine with the business when they cashed out 5 years prior.

Of course Guy Hands doesn’t see things quite so dimly. In a written response to The Economist, Hands insists his interests are still fully aligned with the fund since Terra Firma has co-invested in its own fund and has “skin in the game”. He concludes: “Terra Firma III management decisions have not been made by individuals focused on their own interests, but by individuals striving to achieve the best for their investors.”  Yea right. Private Equity types are megalomaniacs who notoriously view themselves as occupying the apex of the Wall Street food chain.  Believe me when I say they don’t wake up every morning thinking about what they can do to improve the Fireman’s retirement prospects by making another sound investment with the city pension fund allocation entrusted to their care.  “Net net”, they are deal junkies and just need to do another one to keep feeling good (ie. keep the “carry” coming).

Ironically, Mr. Hands posted the letter from Geurnsey, the Channel Island tax haven where he moved in 2009 (his family and Terra Firma headquarters apparently remain in London) certainly not to focus on his own interest by avoiding higher UK taxes, but presumably to strive for better investor results in the clear Channel air away from The Big Smoke. That doesn’t seem to be working very well so far.


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