Friday Letter Raging bull

Whether Guy Hands can recover from the brutal blow of the EMI loss depends on how much of a fight he has left in him.  

So last Tuesday, Guy Hands finally hit the floor when EMI’s bankers seized control of the company. Hands’ firm Terra Firma, after a turbulent ownership period that has seen operational restructuring, spats with rock stars and a courtroom drama that gripped the industry, was left with nothing from its investment.

It is the enormous equity loss of £1.75 billion (€2.1 billion; $2.8 billion), which will play most on the minds of Terra Firma’s limited partners. The heavy hit dealt to the firm’s Funds II and III has pushed many to speculate whether Hands will ever be able to raise another fund. 

Hands himself hasn’t commented on the collapse of his investment, but people close to him have reportedly described him as “livid”. As far as his career is concerned, that’s a good thing. For if Hands wants to continue with institutional private equity investing, he’ll have to muster huge amounts of energy to fight his way back. His anger and hurt pride can be sources of new strength if he picks himself up and decides to go again.

History provides some telling examples of fund managers who never recovered from bad deals. We all remember Teddy Forstmann: once a man with the Midas touch, Forstmann announced in 2004 that he was quitting the private equity industry and would not be raising a new fund after two telecom investments – MacleodUSA and XO Communications – collapsed in the tech meltdown, losing his investors $1.5 billion.

However, big-ticket equity wipe-outs don’t necessarily bring franchise death. In the late 1990s, KKR invested alongside Hicks Muse Tate & Furst in the $1.5 billion buyout of Regal Cinemas, with each firm contributing $600 million of equity. Regal went bankrupt in 2001, leaving the firms with big losses. Hicks Muse went on to produce some more calamities and eventually ceased to exist. KKR on the other hand recovered and thrived. The firm’s LPs forgave and forgot.    

The question is, can investors do the same for Guy Hands? To be sure, he too has recovered from failed investments in the past. He was the financier who put together the £1.9 billion buyout of the Le Meridien hotel chain, which was acquired by a consortium of investors just prior to the terrorist attacks of 11 September, 2001. After the attacks, hotel sales plummeted and the lenders ended up owning the asset.

Importantly, Hands has a big batch of dry powder remaining in Fund III. By one LP account, Fund II is not such a bad performer, even with the burden of the EMI loss. Fund III, though, is generating a -41 percent internal rate of return and a .32x multiple as of 30 September, 2010, according to performance data from the State of Oregon.

To recover from the EMI catastrophe, Hands needs to climb back into the ring and score heavily with the remaining capital of Fund III. As personal challenges go, this one looks huge, but at 51, Hands is young enough to take it on. (By comparison, Forstmann was an old man by the time he threw in the towel.)

One LP – who happened also to be a Terra Firma investor – recently noted that he was a big fan of backing managers’ third funds. If Fund I typically shoots the lights out, then Fund II – often larger in size – can prove to be lacklustre. When Fund III comes around the manager has learned lessons and has a point to prove.

Hands will have to do just that. If he is to ever tempt LPs back into a new offering, grit and determination will be essential. A large dose of contrition will also be needed. Because investment boards everywhere would need convincing that the man they have read about in the newspapers has learned from EMI.