Hands: Distributions to be scarce in 2010

Operational improvement will be the main driver of returns in 2010 and beyond, according to Terra Firma chairman and chief investment officer Guy Hands.

“With bargains hard to find after the rebound in equity prices, operational intervention is going to be the most important instrument,” he told a conference in Berlin Wednesday, according to prepared remarks shared with PEO.

LPs will need to have increased patience, he said, “as operational change takes time to effect, so the average holding period will increase going forward and GPs will need to hold more money back for follow on investments”. These factors mean that distributions in 2010 will remain scarce, he said, and certainly “less than some GPs and LPs currently expect”.

If ever there was a time when past performance is not going to be an indicator of future performance, now is that time. Guy Hands

He also believes deal volume will likely remain low, though will probably higher than the 25-year-low recorded in the UK last year. He pointed to the recent auction of Bridgepoint’s Pets at Home as well as Kabel Deutschland, being sold by Providence Equity Partners and Teachers’ Private Capital, as evidence that deal activity is picking up, however, he repeated past criticisms of such secondary buyouts.

“The fact that both have strong debt financing is a good sign, however for many LPs the fact that both would be deals between GPs is far less good as transaction costs will take out 30 percent-plus of the equity if you allow for 20 percent carry, management incentives and investment banking and financing fees, so you end up with the same investment just managed by different people.”

Hands said LPs will spend more time evaluating with which managers to invest, as “if ever there was a time when past performance is not going to be an indicator of future performance, now is that time”. As a result, even “the most experienced” GPs will need to treat their next fundraise as though it is their first, he said. “As headline track records mean less in evaluating the ability of a fund to invest, the quality of  the investment and operational team will mean more.”

His points were particularly interesting given Terra Firma's ongoing struggles with music business EMI, the fate of which would affect the performance of two Terra Firma funds.

Among the other issues Hands touched on were the regulatory threats on both sides of the Atlantic. “All of us need to try to push back on populist moves to regulate private equity that are needlessly being put forward currently by governments,” he said, noting the various proposals would impede private equity’s contribution to global economic recovery.

“While I think we would all admit that our industry made some mistakes over the last several years, I don’t think anyone has argued logically that private equity posed any kind of systematic risk to the economy, or that any firm was too big to fail and these political proposals will not make for a better or safer industry.”