3i makes 4x return after HSS turnaround

3i has reaped the rewards of a successful turnaround at tool hire business HSS, after selling the business for £310 million. The buying consortium comprises Archie Norman’s investment vehicle and Och-Ziff, a hedge fund with a history of encroaching on the buyout space.

UK-listed private equity group 3i has completed its turnaround of tool hire business HSS, after selling it to hedge fund Och-Ziff and Archie Norman’s investment vehicle Aurigo Management for £310 million.

3i has made a 4.4 times return on its initial investment in HSS, which it bought for £145 million in January 2004. It said the business had not been up for sale, but it had been approached by Och-Ziff and Aurigo with an unsolicited offer that was too good to turn down.

It is Aurigo’s first acquisition since it was founded by Norman a year ago. It will act as an equal partner with Och-Ziff, though it will have more involvement on an operational level – Norman becomes chairman, replacing incumbent Alan Peterson, while another Aurigo representative will sit on the board. The rest of the current management team will remain in place.

A source close to the deal suggested that the two buyers planned to be long-term investors in the business. Aurigo’s model was to hold business for relatively long periods compared to the standard private equity model, he said, while Och-Ziff was planning to support the investment throughout and had no intention of ‘flipping’ the business in one or two years.

3i paid about 3.5 times EBITDA to buy HSS in 2004, when the business was in dire need of a change. The buyout group brought in a new management team and spent the next two years turning around the business, shutting down the loss-making US subsidiary and disposing of some non-core operations – which had included hiring out bouncy castles for children’s parties and repairing garden equipment. 3i also closed down badly-performing branches, cut supply chain costs, and developed a stronger online offering.

After a difficult start, which saw profits for 2004 actually drop compared to the previous year, the changes began to take effect, and in 2006 the group recorded £40 million profit on turnover of £163 million. In September last year, 3i replaced the chief executive, bringing in Chris Davies from Disney as it looked to focus on revenue growth. The sale price represents a multiple of 7.75 times EBITDA, a measure of the company’s revival.

In April, 3i held a press conference to report the group’s annual results – an unusual measure for a private equity-backed business, which won plaudits at a time when demands for greater transparency were rife. The group insisted this was not intended to market the company potential buyers, who made their approach shortly afterwards.

The deal is the latest example of hedge funds encroaching on private equity territory. In addition to Och-Ziff, which manages about $30 billion of assets and already has investments in headhunter Whitehead Mann and retailer Peacocks, Highbridge Capital Management recently hired Scott Kapnick from Goldman Sachs to run a buyout unit, while DE Shaw is reportedly planning a similar move. At the same time, buyout firms are establishing hedge fund operations and taking non-control stakes.