REG - 3i Group PLC - Half Yearly Report <Origin Href="QuoteRef">III.L</Origin> - Part 3
13/11/2014 08:21
- Part 3: For the preceding part double click ID:nRSM9002Wb
flow and, with capital
availability remaining high from both principal investors and debt providers (source: KPMG M&A Predictor, August 2014),
highly competitive auctions and high prices were a significant feature of market conditions. Since
the summer we have seen a reduction in M&A volumes across the market as confidence has reduced. In this environment, we
continue to be more active sellers than buyers of investments, remaining cautious and focused only on new investments where
we have a competitive advantage.
Private Equity invested in one new business in the period: A&A Manufacturing, now renamed Dynatect. Dynatect, headquartered
in the US, is a leading manufacturer of speciality protective equipment and is well positioned to grow internationally with
support from 3i. We also took an opportunity to purchase a small third-party interest in Eurofund V for E34 million,
increasing our share in that fund by c.1%.
We invested in each of the new CLOs launched in the period and provided further support to grow our Debt Management
business through ongoing warehouse facilities, used to establish portfolios ahead of future CLO launches.
Table 4 provides details of the investments made in the six month period.
Since the period end we have announced two Private Equity investments: E214 million, including third-party funds from
Eurofund V, into Christ, a German jewellery retailer, and $160 million into Q Holdings, a US headquartered moulded rubber
and silicone components manufacturer.
Table 4:Cash investment in the six months to 30 September 2014
Proprietary
Total Capital
investment investment
Investment Type Business description Date £m £m
Private Equity
Dynatect New Manufacturer of engineered, mission critical protective equipment September 2014 66 65
EFV stake New Acquisition of LP stake in Eurofund V June 2014 27 27
Other cash investment Other n/a 19 12
Total Private Equity investment 112 104
Debt Management
Jamestown IV New North American senior debt CLO June 2014 6 6
Harvest IX New European senior debt CLO July 2014 22 22
Other cash investment Other Pre-CLO warehouses n/a 67 67
Total Debt Management Investment 95 95
Total cash investment 207 199
Market conditions created opportunities for realisations, refinancing of portfolio companies and IPOs. Cash proceeds of
£324 million (September 2013: £528 million) were received in the six months, at an uplift of 12% over opening portfolio
value (September 2013: 32%). The uplift was lower than in previous periods due to a number of larger transactions occurring
earlier in the half and, as such, being materially reflected in the 31 March 2014 valuations.
Private Equity generated the majority of the proceeds. Notable full exits in the six months included the sale of Vedici,
which generated proceeds of £83 million and an uplift over opening value of 48%, and the sale of John Hardy, which
generated proceeds of £25 million but no uplift over opening value as it was valued on an imminent sales basis at 31 March
2014. There were two large partial exits in the period where we sold c.70% of our equity stake in Phibro following an IPO
in April 2014 and retained a residual loan to Foster + Partners, selling the equity in June 2014. Beijing Digital Telecom,
the Chinese mobile phone retailer, listed on the Hong Kong stock exchange in July 2014 but our investment remains locked up
until July 2015. Finally, refinancings at Element and Amor and a sale and leaseback of a new distribution centre at Action
generated proceeds of £52 million in total.
As well as the larger exits noted above, we continued to sell smaller, legacy and non-core geography assets. Consequently,
there were 72 investments in the Private Equity portfolio at 30 September 2014 down from 81 at 31 March 2014. Over time we
expect to reduce the number of Private Equity investments to no more than 40.
The realisations from the Private Equity portfolio generated an aggregate money multiple of 1.8x (September 2013: 1.6x).
Since the period end we have also completed the full exits of Hilite and LHi and sold a further share of our holding in
Quintiles, generating a further £218 million of proceeds at a money multiple of 2.5x. The value of these exits was
substantially reflected in the Group's NAV at 30 September 2014.
The Infrastructure business made its first realisation from the Indian Fund, with a partial sale of the holding in Adani
Power, a quoted power generation business based in Gujarat, India. 3i received proceeds of £8 million, at an uplift of £1
million over opening value.
Table 5:Realisations in the six months to 30 September 2014
31 March Uplift on Money
Calendar 2014 3i realised Profit/(loss) opening Residual multiple
Country/ year value proceeds in the year1 value1 value over
Investment region invested £m £m £m % £m cost2 IRR
Private Equity
Full realisations
Vedici France 2010 58 83 27 48% - 2.0x 17%
John Hardy Hong Kong 2007 25 25 nil -% 2 1.9x 9%
Derprocon Spain 2000 5 6 1 20% - 2.0x 7%
Café y Te Spain 2006 4 5 1 25% - 0.5x (8)%
Other investments n/a n/a nil 2 2 n/a - n/a n/a
Partial realisations2
Phibro USA 2009 68 68 nil -% 38 1.5x 9%
Foster + Partners UK 2007 66 66 nil -% 40 1.8x 10%
Element Benelux 2010 23 23 nil -% 112 2.5x 28%
Amor3 Germany 2010 21 19 (2) (10)% 51 1.5x 12%
Action Benelux 2011 9 10 1 11% 573 6.0x 84%
Other investments n/a n/a 5 7 2 n/a 368 n/a n/a
Deferred consideration
Other investments n/a n/a nil 2 2 n/a - n/a n/a
Total Private Equity 284 316 34 12% 1,184 1.8x n/a
Infrastructure
Adani Power India 2007 7 8 1 14% 9 0.5x (11)%
Total Infrastructure 7 8 1 14% 9 0.5x (11)%
Total 291 324 35 12% 1,193 1.8x n/a
1 Cash proceeds in the period over opening value realised.
2 3 Cash proceeds over cash invested. For partial realisations and recapitalisations, valuations of any remaining investment are included in the multiple.Loss on disposal offset by income received.
Portfolio
The value of the Proprietary Capital portfolio at 30 September 2014 was £3,672 million (31 March 2014: £3,565 million).
Value growth in the period was offset in part by net divestment activity.
There was no material change to the portfolio composition by business line with Private Equity at 81% (March 2014: 82%),
Infrastructure at 14% (March 2014: 14%) and Debt Management at 5% (March 2014: 4%) of the total portfolio.
Private Equity
In line with its strategy, the Group continues to reduce the number of assets held in the Private Equity portfolio to a
more manageable level. There were 72 investments in the Private Equity portfolio at 30 September 2014 (31 March 2014: 81).
The 10 largest investments accounted for 58% of the portfolio at the period end (31 March 2014: 54%) and the 25 largest for
84% (31 March 2014: 82%).
As shown in Table 6, earnings grew in the majority of the portfolio (78% by value) with good earnings growth in the
portfolio's largest assets in particular. The Private Equity portfolio's value weighted last 12 months earnings, the most
relevant measure of NAV impact, grew by 17% (March 2014: 19%) year on year.
Table 6: Portfolio earnings growth weighted by September 2014 carrying values (£m)1
Last 12 months' (LTM) earnings growth 3i carrying value at 30 September 2014 £m
<(20)% 20
(20) - (11)% -
(10) - (1)% 371
0 - 9% 166
10 - 19% 209
20 - 30% 899
>30% 105
1 Includes all companies valued on an earnings basis where comparable earnings data is available. This represents 59% of the Private Equity portfolio by value.
The weighted average EBITDA multiple used at 30 September 2014 was 11.0x pre discount (March 2014: 10.6x) and 10.2x post
discount (March 2014: 9.9x). These multiples remain below those seen in relevant sector and geographic public markets; for
example the FTSE 250 was valued on an average multiple of 12.0x at 30 September 2014.
Leverage in the Private Equity portfolio remained stable at 3.1x net debt to EBITDA weighted by value (31 March 2014:
3.1x). We have taken the opportunity to refinance and restructure debt in a number of portfolio companies including
Element, Amor and Mémora. The ratio reduced on average across the rest of the portfolio. Table 7 shows the ratio of net
debt to EBITDA weighted by portfolio value.
Table 7: Ratio of net debt to EBITDA - Private Equity portfolio September 2014 carrying values (£m)1
£m
<1x 566
1 - 2x 185
2 - 3x 937
3 - 4x 322
4 - 5x 692
5 - 6x 47
>6x 18
1 This represents 93% of the Private Equity portfolio, excluding assets valued on a sales basis.
The majority, or 88%, of the Private Equity portfolio by value, is now located in our focus areas of Northern Europe and
the US (31 March 2014: 86%) as the exposure to Asia, Brazil and Southern Europe has reduced through realisations and some
decline in value.
Infrastructure
3i's investment exposure to infrastructure assets is primarily through its 34% shareholding in 3i Infrastructure plc
("3iN") and through its commitment to the 3i India Infrastructure Fund ("IIF").
3iN is a listed company and our investment is therefore exposed not only to the underlying portfolio but also to
fluctuations in its share price. 3iN's underlying European portfolio continues to perform well and represents 94% of the
underlying portfolio (31 March 2014: 93%). Portfolio valuations of 3iN's rail rolling stock assets increased significantly
to reflect both operational improvements and market returns compression in recent bids to finance the procurement of new
train fleets. 3iN's share price increased from 134.4 pence to 140.0 pence in the period. Our 34% holding was valued at £421
million at 30 September 2014, or 11% of 3i's total portfolio. Further detail can be found at: www.3i-infrastructure.com.
The Group's commitment to IIF was valued at £62 million at 30 September 2014 (31 March 2014: £75 million).
Debt Management
The Debt Management portfolio consists of 22 investments, including the capital provided to CLOs managed by the Group,
Palace Street I and the Senior Loan Fund and investments into warehouses in order to build portfolios prior to future fund
launches. During the period the Group invested a total of £28 million into the equity tranches of Harvest IX and Jamestown
IV, alongside a net £67 million investment in the warehouses. At 30 September 2014 the portfolio was valued at £197 million
(March 2014: £143 million).
Financial review
Basis
Since the adoption of IFRS by the Group in the year ended 31 March 2006, there has been discussion about whether investment
companies, such as 3i, should be exempt from consolidation for its portfolio investments. The introduction of the IFRS 10
accounting standard resolved this point by establishing an investment entity exception, which is an excellent outcome as
consolidation of our portfolio investments would both be impractical and limit the usefulness of our statutory accounts.
However, the detailed application of the standard has reduced the transparency of the Group's underlying operating
performance because we are now required to fair value a number of intermediate holding companies that were previously
consolidated line by line. This fair value approach, applied at the intermediate holding company level, effectively
obscures the performance of our proprietary capital investments and associated transactions occurring in the intermediate
holding companies. As a result, in our 2014 Annual Report and Accounts we introduced separate "Investment basis" Statements
of comprehensive income, financial position and cash flow to aid users of our report, and we continue to do so in this
report. The numbers presented in the Overview and Interim Strategic Report refer to this Investment basis.
The commentary in this section refers to the Investment basis financial statements because we believe they provide a more
understandable view of our performance. We provide more detail on the impact of IFRS10 and a reconciliation of our
Investment basis financial statements to the audited IFRS statements which are presented at the end of this section. Total
return and net assets are equal under each basis; the Investment basis is simply a "look through" of IFRS 10 to present the
underlying performance.
Operating profit includes gross investment return, management fee income generated from managing external funds, the costs
of running our business, net interest payable, movements in the fair value of derivatives, other losses and carried
interest receivable or payable. Finally, total return comprises operating profit less any tax charge and movement in the
actuarial valuation of the historic defined benefit pension scheme.
Each of these aspects of our returns are considered in greater detail in this Financial review, along with the remaining
items that contribute to total return.
Returns
Table 8: Total return for the six months to 30 September 2014
Six months to Six months to 12 months to
30 September 30 September 31 March
2014 2013 2014
£m £m £m
Realised profits over value on disposal of investments 35 129 202
Unrealised profits on revaluation of investments 307 137 475
Portfolio income
Dividends 21 18 44
Income from loans and receivables 30 25 50
Fees receivable 2 6 7
Foreign exchange on investments (98) (75) (113)
Gross Investment Return 297 240 665
Fees receivable from external funds 41 36 73
Operating expenses (63) (68) (136)
Interest receivable 1 1 3
Interest payable (26) (28) (54)
Movement in the fair value of derivatives (1) 10 10
Exchange movements 25 (4) (3)
Other income 1 - -
Operating profit before carry 275 187 558
Carried interest
Carried interest receivable from external funds 19 3 3
Carried interest and performance fees payable (45) (25) (85)
Acquisition related earn out charges (5) (4) (6)
Operating profit 244 161 470
Income taxes (3) (2) (3)
Re-measurements of defined benefit plans (7) 16 11
Total comprehensive income ("Total return") 234 175 478
Total return on opening shareholders' funds 7.1% 6.0% 16.3%
Total operating expenses
Operating expenses incurred during the period were £63 million (September 2013: £68 million), and equated to 1.0%
(September 2013: 1.1%) as a percentage of weighted average AUM. With the cost reduction initiatives outlined in the June
2012 strategic announcement largely complete, there were no restructuring costs provided for in this period (September
2013: £4 million). Excluding restructuring costs, the operating expenses were £1 million lower than the previous year, but
include the additional costs associated with the new PPP Infrastructure team.
Table 9:Operating expenses for the six months to 30 September
2014 2013
£m £m
Operating expenses 63 68
Operating expenses excluding restructuring costs 63 64
Operating expenses/AUM 1 (excluding restructuring costs) 1.0% 1.1%
1 Annualised actual operating expenses measured as a percentage of weighted average AUM.
Operating cash profit
Table 10:Operating cash profit for the six months to 30 September
2014 2013
£m £m
Third-party capital fees 37 39
Cash portfolio fees1 4 6
Cash portfolio dividends and interest 38 25
Cash income 79 70
Operating expenses2 63 68
Less: Restructuring costs - (4)
63 64
Operating cash profit 16 6
1 Net of broken deal and due diligence costs incurred
2 Operating expenses on an accruals basis rather than cash, the effect of which is not considered material.
In June 2012, the Group set an objective of generating cash income, from third-party fees and portfolio income, sufficient
to cover the operating expenses incurred in the year, prior to restructuring costs. We call this "operating cash profit".
FY2014 was the first in which the Group achieved an operating cash profit in more than a decade, a significant step in
improving the robustness of the Group's operating model. This has continued and during the period the Group generated an
operating cash profit of £16 million (September 2013: £6 million).
A focus on generating cash income from the portfolio has meant the Group was able to increase its cash income despite net
divestment activity and a fall in third-party AUM in Private Equity. Cash income increased to £79 million (September 2013:
£70 million), with a £11 million increase in portfolio income and a £2 million decrease in third-party fees.
The benefits of the cost reduction programme continue to be seen with actual costs (excluding restructuring costs but
including acquisitions) stabilising at £63 million (September 2013: £64 million).
Proprietary Capital returns
Our Proprietary Capital business is assessed on operating profit before carry, which comprises gross investment return,
operating expenses, a fee paid to the Fund Management business and balance sheet funding expenses such as interest payable.
Overall operating profit before carry of £262 million (September 2013: £179 million) was £83 million higher than the prior
year and this was underpinned by strong value growth within the portfolio.
By business line, the gross investment return on the opening portfolio was 10% from Private Equity (September 2013: 9%), 5%
from Infrastructure (September 2013: (4)%) and (5)% from Debt Management (September 2013: 1%). Private Equity accounted for
81% of the Proprietary Capital portfolio at 30 September 2014 (March 2014: 82%) and remains the primary driver of
performance for the Proprietary Capital segment.
Realised profits
Realised profits for the period of £35 million (September 2013: £129 million) were lower than the previous year, despite
the Group continuing to achieve some strong exits and generating £324 million of realisation proceeds (30 September 2013:
£528 million). The uplift was lower than in previous periods due to a number of larger transactions occurring earlier in
the half year and, as such, being materially reflected in the 31 March 2014 valuations. We continue to pursue exits through
careful planning, and in total fully divested 9 investments in the period.
The majority of the realisations were from the Private Equity portfolio, which contributed £316 million of the £324 million
proceeds. Table 5 details the Realisations in the period and sets out the accounting uplift reflected in the total return
and the longer-term cash-to-cash results. The Private Equity realisations completed in the period produced a money multiple
of 1.8x over their investment life (September 2013: 1.6x).
Table 11:Proprietary Capital operating profit for the six months to 30 September
2014 2013
£m £m
Realised profits over value on disposal of investments 35 129
Unrealised profits on revaluation of investments 307 137
Portfolio income
Dividends 21 18
Income from loans and receivables 30 25
Fees receivable 2 4
Foreign exchange on investments (98) (75)
Gross investment return 297 238
Fund Management synthetic fee (22) (25)
Operating expenses (13) (13)
Interest receivable 1 1
Interest payable (26) (28)
Movement in the fair value of derivatives (1) 10
Exchange movements 25 (4)
Other income 1 -
Operating profit before carry 262 179
Unrealised value movements
Table 12:Unrealised profits/(losses) on revaluation of investments for the six months to 30 September
2014 2013
£m £m
Private Equity
Earnings based valuations
Performance 209 32
Multiple movements 13 78
Other bases
Provisions - -
Uplift to imminent sale 34 (13)
Discounted Cash Flow 33 (11)
Other movements on unquoted investments 7 -
Quoted portfolio 12 75
Infrastructure
Quoted portfolio 15 (4)
Discounted Cash Flow (6) (20)
Debt Management1 (10) -
Total 307 137
1 Debt Management includes value movement on equity stakes in CLO vehicles, direct holdings in warehouse vehicles, and the net asset value movement on Palace Street I. Unrealised profits/(losses) in the 6 months to 30 September 2013 have been restated for the change in treatment of Palace Street I under the Investment basis.
Performance
The performance category measures the impact of earnings and net debt movements for the portfolio companies valued on an
earnings basis. In general, when valuing a portfolio investment on an earnings basis, the earnings used in the September
valuations are the last 12 months' management accounts data to June, unless the current year forecast indicates a lower
maintainable earnings level. Where appropriate, adjustments are made to earnings on a pro forma basis for acquisitions,
disposals and non-recurring items. In the case of one company, Action, which is experiencing significant growth due to its
store roll-out programme, a run-rate adjustment is made to its earnings to reflect the profitability of opened stores for
valuation purposes.
Improvements in the performance of the portfolio valued on an earnings basis resulted in an increase in value of £209
million (September 2013: £32 million). Value weighted last 12 months earnings, the most relevant measure of NAV impact,
increased by 17%, demonstrating that the portfolio's largest assets are delivering strong improvements in performance. Net
debt in this portfolio remained flat at 3.1x EBITDA (March 2014: 3.1x). Excluding Action, value weighted last 12 months
earnings grew 11%.
The number of investments valued using forecast earnings has increased to seven from four at 31 March 2014.
These represent 12% of the 69% of the Private Equity portfolio valued on an earnings basis at the period end
(March 2014: 3%, 79%).
Multiple movements
The weighted average EBITDA multiple of the Private Equity portfolio, valued on an earnings basis increased from 10.6x at
31 March 2014 to 11.0x at 30 September 2014 before marketability discount, and from 9.9x to 10.2x after marketability
discount. Excluding Action, the largest asset by value and an asset with one of the highest multiples applied to earnings,
the weighted average EBITDA multiple of the portfolio increased to 9.9x before marketability discount (March 2014: 9.8x)
and 9.1x after marketability discount (March 2014: 9.0x). Stock market multiples generally fell in the period but, as noted
in the Annual report, we consider other factors such as exit plans, relative performance and size when setting the
multiples we use. We have felt for some time that market multiples were trading ahead of longer term averages and so had
not followed markets up when valuing the portfolio. Consequently, we have not had to follow markets down in the period.
Movements in multiples used for valuation led to a small increase in value of £13 million in the period to 30 September
2014 (September 2013: £78 million).
Provisions
A provision is recognised where we anticipate that there is a 50% or greater chance that the Group's investment in
the portfolio company will fail within the next 12 months. No new provisions or reversals were made during the period.
Imminent sale
Portfolio companies which are well advanced in a negotiated sales process are valued on an imminent sale basis. Two assets,
Hilite and LHi, were valued on this basis at 30 September 2014, with a total value of £193 million. Proceeds of £189
million for the completion of both sales were received post the period end and the difference to September 2014 value
related to cash income and amounts held in escrow.
Discounted Cash Flow
The Discounted Cash Flow (DCF) valuation basis is used to value portfolio companies with predictable and stable cash flows.
As at 30 September 2014, the largest portfolio company valued on this basis was Scandlines, valued at £218 million, with an
unrealised profit in the period of £34 million. The majority of remaining assets valued using the DCF valuation basis were
in the India Infrastructure Fund, which generated an unrealised loss of £8 million.
Other
Where a different valuation basis is more appropriate for a portfolio company, the "other" category is used to determine
fair value, for example, the sum of the parts of the business or industry specific methods. The largest asset in this
category is ACR, the Private Equity Asian reinsurance business, valued at £111 million at 30 September 2014 (March 2014:
£101 million). Unrealised profits of £7 million were recognised in the period to 30 September 2014 (September 2013: nil).
Quoted portfolio
The quoted portfolio was valued at £641 million at 30 September 2014 and now represents 17% (March 2014: £554 million, 16%)
of the Group's total portfolio. The Group's 34% investment in 3i Infrastructure plc is the largest asset in the quoted
portfolio at £421 million. 3i Infrastructure plc's share price increased by 4% in the period, resulting in value growth of
£17 million. Quintiles is the next largest quoted asset in the portfolio and was valued at £137 million at 30 September
2014. During the period to 30 September 2014 two portfolio companies completed IPO processes, Phibro and Beijing Digital
Telecom, and together the Group's remaining holdings in these companies was valued at £68 million at 30 September 2014.
Debt Management
The Group has investments in a number of the CLOs which the Debt Management team manages, as well as in the Credit
Opportunities Fund, Palace Street I and the US Senior Loan Fund. The Group also invests in warehouse facilities to support
the creation of portfolios for future fund launches.
Where available, CLOs are valued on the basis of quotes from the arranging brokers, with reference to internal modelling of
the future returns of the investment and third-party databases of prices. At 30 September 2014 the value of the equity
stakes in CLOs was £83 million (March 2014: £67 million). Warehouses are valued using the mark-to-market prices of the
underlying debt assets held in the facilities, and at 30 September 2014 these totalled £82 million (March 2014: £17
million).
Table 13:Proportion of total portfolio value by valuation basis
30 September 30 September 31 March
2014 2013 2014
% % %
Earnings 56 60 65
Imminent sale 5 1 1
Quoted 17 19 16
Discounted Cash Flow 8 6 8
Other 9 9 6
Debt Management 5 5 4
Portfolio income
Table 14:Portfolio income for the six months to 30 September
2014 2013
£m £m
Dividends 21 18
Income from loans and receivables 30 25
Net fees receivable 2 4
Portfolio income 53 47
Received as cash1 42 31
Cash income/opening portfolio value 1.2% 0.9%
1 Includes £2 million attributed to Fund Management (September 2013: £2 million).
Income from the portfolio was £53 million in the period (September 2013: £47 million). Dividends of £21 million were
received (September 2013: £18 million), including £10 million from 3i Infrastructure plc and £6 million from Debt
Management investments. Interest income totalled £30 million (September 2013: £25 million) and included interest of £4
million from Foster + Partners, which was partially sold in the period.
A further £2 million in net transaction fees was received in the period (September 2013: £4 million), principally relating
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