Nigel McConnell enjoys doing what he's doing. He may at times refer to himself as just a fund manager in single-minded pursuit of maximum value for his clients, or describe the business of buying, growing and selling private companies as an overly laborious nightmare. Yet when he talks about what he and his colleagues at Electra are trying to achieve, there is a keen sense of determination about him that is difficult to ignore. Listening to his account of what it takes to do well out of the buyout market in this day and age, there's little sense of the job being particularly glamorous. But you might find yourself thinking that you wouldn't mind giving this sort of thing a go yourself sometime.
McConnell runs Electra Partners Europe, the independent midmarket buyout firm that came into being in November 1999 following its own buyout from Electra Investment Trust Plc. The new Electra emerged from a protracted period in which the Trust, holding assets that the market had put a discount on and facing a hostile takeover bid from 3i, decided to wind itself down and break the business up. The buyout operation was among the first assets to be sold.
When a private equity team buys itself out from a large corporate parent, as many of them have done in the past two years, the deal is often celebrated as the deal of all deals, the one that the team must care most about. McConnell though doesn't refer to his experience in such terms. He instead leaves the impression that the buyout was a hugely significant event both for himself and the firm, one that sharpened the mind and ambition of everyone involved, and has prompted them to go at the market with a motivation that would otherwise have been difficult to muster let alone sustain.
McConnell says the twelve months preceding the buyout were terrible. ?The firm was almost dead. The patient was on the operating table, and it had a pretty low heart beat. All our team was being crawled over by the competition, and we lost a lot of professionals. Lazards were conducting an auction of us, there were all these discussions with other financial buyers, but the only party to put a bid on the table was the management team.?
The bid led to a deal, and a new business was born. But the investment teams in Paris and Frankfurt had been decimated, and there was no money to invest. To add further spice to the mix, the group had never raised capital before. ?It was like the baby was just starting to try to walk across the room, but there was no certainty that it would get to the other end?, recalls McConnell.
To him, the remarkable thing about this period was that ?people had never any doubt we'd raise the money.? Fundraising for a targeted €750m European buyout fund began in earnest in early 2000, and a new Germany team came on board even before the firm had got to a first closing.
McConnell in part attributes the confidence that many put into the firm to the Electra brand. But he also points to the work that was done during that stressful period before the buyout, when he and his colleagues looked at themselves and tried to work out exactly how they should go about their business. He says that time was used wisely.
We pulled the team together and asked, what is the business model that we want to follow?
?We pulled the team together and asked, what is the business model that we want to follow? What are the things we've been doing in the past that we want to focus on? And what are the things we want to leave behind? Management structure, compensation ? we looked at all that stuff, which you wouldn't get a chance to do ordinarily if the firm was doing deals.? By the time fundraising began in earnest, ?we were excited about owning our own business and about having a very clear business model. We were also able to articulate what we did.?
Raising the fund was hard work nevertheless. ?Robert Clarke [a director at the firm] and I were out on the road for a year to raise the capital. Until the summer, we could hardly get anyone interested at all.? The market was still all about telecoms and e-commerce, and Electra's strategy of buying into established European businesses to improve operating performance and grow profits wasn't what institutions wanted to hear about. ?It just wasn't sexy. Then the [technology] collapse happened, and we just kept on going, didn't let the pressure off, kept on talking to investors.?
Part of what made investors listen eventually, alongside the suddenly very different sentiment in the market, was Electra's investment approach, refined during the soul-searching prior to the buyout. This strategy is to use operating partners alongside the firm's financial specialists throughout the entire deal process, from origination through to execution and exit. In any given case, the financial people will bounce an initial valuation for a company off one of the operating partners; when an indicative offer is made, the operating partner goes to meet the management team; post deal, he takes the major burden of working with management on a day-to-day basis. Financial partners go back in when a financing event is due or the business is to be exited.
?This is a powerful formula. It protects our downside in a deal, and it gets us into dialogue with companies that we wouldn't get close to otherwise. The bullshit just falls away,? says McConnell.
During the fundraising, this investment approach helped the firm develop an often strong rapport with investors. McConnell says what he hadn't foreseen was that prospective LPs would spend almost more time with the operating partners than with the financial partners.
He recalls being in a meeting, alongside operating partner Professor Brian Allison, with the CIO of a major European blue chip's pension fund, where Allison quickly became the centre of attention. ?The meeting went on and on, and the guy said to Brian, ?Christ, your job sounds great, you have more fun than I do.? It's really amazing when you get that kind of empathy, there is no way that I could ever do that. I can tell the story and articulate it in a particular way, but I have not built my own business, built my own company. Brian has done that. And these guys kind of recognise each other.?
The point about Allison's disposition to connect with an entrepreneurially minded investment executive on a level McConnell himself wouldn't (and in his own estimation, couldn't) have tried makes him sound all the more convincing when he says that Electra's culture is based on the belief that both individuals and companies should only do what they're good at. Electra's partners think they are good at making investment decisions of a certain type, and according to the boss, they will always stick to their knitting.
?We're not trying to create new businesses or be ultra clever. What we're looking for is something that probably has a great franchise but is suffering from owner neglect or mismanagement, and what we're trying to do is grab the thing and do some very basic stuff with it.?
My job is to kick the ball up the field, and hopefully people will follow
McConnell says going for a profit improvement story might sound easy, but insists there's a rub: Electra won't buy top line growth. The firm looks to get a base case return from things that management can do to the company. ?We expect them to improve the top line as well, but we don't put that into our financing model for our base case scenario. We won't buy a company unless we think we can grow the top line, but we will not pay up for it ahead of management actually doing it.?
It isn't surprising that during the second half of the fundraising, when conservatism had staged a comeback in the market, messages such as these went down well with the buy side. But McConnell still marvels at how well things turned out in the end when Electra closed on a billion euros. ?We ended up being oversubscribed. In December 2000, Robert and I were asking ourselves whether we were going to get to 750 [million]', and then about half way through January until March, the flood gates just opened and people just absolutely crushed us. It switched from us pleading for them to come in, to them asking us ?why are you scaling us down?. That was a great feeling. I immediately went on holiday.?
So Electra came away from the fundraising trail with a lot of dry powder and the luxury of being able to wholly concentrate on doing deals. The firm hired more people and replenished the Paris office. It currently employs 26 professionals, of whom eight are partners, and McConnell says the hiring is done. He thinks managing the firm is easy, thanks to a straightforward structure where everyone gets paid market rate ?and that's the end of the story?. Because there isn't much to manage, he says he gets to spend more time on doing deals than on looking after colleagues.
McConnell doesn't think of the job as a management role anyway. ?I see my role as leadership. My job is to kick the ball up the field, and hopefully people will follow. I need to make sure we're pushing as hard as we possibly can and that we don't go off song with our investments.?
Had he always expected to be doing this sort of thing one day? McConnell had been doing deals with the firm since 1991, after six years of working with Prudential Venture Managers and two with Coopers & Lybrand
Corporate Finance. He says the move into management didn't happen as part of a career master plan, but refers to it as a circumstantial event: ?If I am absolutely honest, the reason I was chosen to lead the firm was that everyone else had left. It was a question of being practical, and I think that's one of my strengths, I'm a practical person. If you look around and there's no one around to run the firm, you do it yourself.?
Another critical responsibility that comes with the role is making sure that Electra keeps open the communications channels to its limited partners. The firm is managing money for a list of blue-chip institutions including General Electric, Chrysler, AIG, Morgan Stanley, Yale, Abbey National, CGNU and the Bank of England, and according to McConnell, he and the team spend a lot of time talking to them.
Questions about investor relations bring him back to the firm's recent history and the theme of being in business with third-party money for the first time. ?You can't communicate too much with your clients, particularly as a first time fund. If we don't tell them about what we're doing every step of the way, we're making a big mistake. We're not like a Candover, we haven't raised seven funds before, this is it. If this fund is successful, the firm will live, but if it ain't, it's good night Josephine, because we won't get a second chance.?
McConnell says that being exposed to this kind of pressure is part of what gets him out of bed in the morning. ?What I like about this thing is that to me, the risk reward is crystal clear. In a very competitive market place where everybody is toe to toe raising money, you better deliver, and I like that, I like that sort of immediacy of ?are you successful?? It's quite motivating, for the whole firm.?
There are easier ways of making money right now than this business
Another important motivator is money. McConnell says you have to incentivise people properly to do the job, because the job ?is a grind. It's painful. Look at our pipeline ? we're seeing 250 deals a year, make offers on 50, twelve become work in progress and we end up doing three. Think of all the work that goes into all that stuff.?
He thinks ? and clearly hopes – that Electra will never be seen as just buying a business, leveraging it and getting out. One reason why it won't happen is because there is always going to be someone else who will pay more. Instead, ?every buck that we make is going to be operating improvement here, working capital reduction here, selling off lossmaking bits there – that is a nightmare. If you didn't think you'd make a reasonable amount of money out of all this ? why would you do it? My position is, whenever somebody comes through the door looking for a job, I always say there are easier ways of making money right now than this business, and I really mean that.?
McConnell believes investors understand this too. At a time when miles of column space get devoted to the growing frustration that LPs feel at dishing out fees and carry that are often deemed excessive, he says he doesn't get any sense that investors in European buyout funds are unhappy with terms and conditions at all. ?I would say if there is any overriding sense from the LPs, it's this: making money is difficult, but that applies to almost every other industry.?
Asked about the long-term outlook for private equity as an asset class, McConnell turns bullish: ?The reason why I believe that certain private equity firms will remain successful is that whenever I get into companies and see how badly they're run and how much improvement we can make, I know we're going to make money. And I know that we will outperform stockmarkets, because many of these companies are stockmarket-owned.?
says he finds it interesting to observe how different private equity firms follow different strategies in order to position themselves going forward. He wonders which way the market is going to choose: between the niche players and the bigger firms that offer a broad range of asset management products. He makes absolutely clear though where his own preference lies: ?As people start to plan succession, soon they will look to institutionalise the business and bring in third party capital. I personally hate that, having been owned by an institution. Managing their money is one thing, being owned by them is quite another. It's a great thing to have a customer relationship with your client, but I absolutely abhor having an ownership relationship with an institutional client.? This renders unnecessary any questions you might want to ask about whether the Electra buyout was in any way a special deal to him.
So Electra will do all it can to protect its independence, which translates into the simple objective of generating as much return for investors as it possibly can. It's still early days. The firm has been conservative so far and invested just 10 per cent of the fund in three transactions. McConnell says the deals are all ?rock-solid? and already in the money.
Whilst the market has slowed further recently, Electra's deal-flow has gone up, and the firm is wholly focussed on doing deals: ?In a climate like this, because we are value investors, contrarian, we feel quite aggressive right now. Conversion isn't easy and takes a long time, but we feel there is very little that moves and that we want to do that we don't get to look at.?
The jury may be out, and McConnell says time will tell whether the formula is the right one. But it is clear he is convinced that today Electra is in a good place. His own assessment of the story so far? ?If anybody had said in the middle of all that crap that we would be where we are today, I really wouldn't have believed it.? What he doesn't say is that he expects both himself and the firm to go a good deal further.