Friday Letter Stand and delever

How many times this year have you been shown the particular chart that plots historical economic conditions against annual private equity fund performance? You know, the feel-good one which shows that investments made when the economy as its bleakest turn out to be the stellar performers, the golden vintages. The conclusion it promotes is that now is the time to buy assets.

Where does this leave 3i Group? The London-listed private equity firm informed the market on Thursday that its levels of new investment had effectively ground to a halt over the last six months.

Over the last year or so the firm has responded to analyst concerns about its net debt levels and through a number of different measures has successfully reduced its net debt from £1.9 billion (€2.1 billion; $3 billion) in March this year to £858 million as of the end of August.

One of the measures taken to achieve this was a dramatic slowdown in investment and a simultaneous disposal of certain assets, such as its venture capital portfolio. In the five months up until the end of August 3i invested just £155 million, all of which was put to work via existing portfolio companies. During the same timeframe a series of exits and asset sales brought in £448 million.

So while 3i has nursed its balance sheet back to relative health in a short space of time, it has done so at the cost of selling assets into a difficult market and refraining from making new investments. Has the focus on debt meant 3i has missed a trick in terms of investing at the bottom of the market? Unlikely. While 3i has been battening down the hatches and investing only in its existing portfolio, most other players – especially those focusing on growth capital and mid-market buyouts – have been doing the same. Low levels of visibility, unrealistic vendor expectations and scarcity of debt financing have meant the opportunities have not yet emerged en masse. Indeed, the reason for not investing over the last six months has not been the balance sheet, says 3i, but the prevailing market conditions. It simply was not the time to go shopping.

And while the market for exits has been tough to say the least, 3i has not been conducting a fire sale. The firm says that all exits were achieved at approximately their March carrying value, with a few bright spots such as Chinese fast food chain Little Sheep, which generated a return of more than 3 times capital, and oil and gas business Venture Production, which was exited “well above” its carrying value, according to the vendor.

In terms of new investments, 3i says it has a list of businesses in which it wants to be invested, and when the time is right, it will act. And the analyst view is that the firm is in a reasonable position to do so. It has addressed concerns about group debt, and with new credit lines agreed with lenders it has the liquidity to begin investing. However, judging by the share price – which slid by around 7 percent this week down to £2.76 from £2.97 – the wider market is yet to be convinced.