The mezzanine men

Among the things Graham Hutton and Matthew Collins have always had in common (and presumably share with about 90 per cent of professionals in private equity and leveraged finance) is a long-held ambition to run their own shop rather than somebody else's. In February of this year, they took a significant step towards achieving this by setting up Hutton Collins with the intention of raising a €600m fund focussed on the provision of mezzanine finance to the larger LBO market. It is not the first time that Hutton, most recently the former chief executive of Morgan Grenfell Private Equity (MGPE) and Collins, latterly global co-head of leveraged finance at Merrill Lynch, have worked with each other. In the early 1990s, they jointly put Morgan Grenfell on the European leveraged finance map.

Over ten years on, the European leveraged finance market remains, by global standards, something of a close-knit community, so the arrival of a new player is a rare event ? and has certainly created a stir already. As far as financing buyouts go, Hutton Collins have been there, done that: ?Between us we've run teams that have done something like 70 LBOs over the last ten years. Probably, if you look at the volume of those deals, [we have] a combined market share bigger than any other single entity or institution,? says Hutton, making the point in a way that makes you wonder whether his counterpart is going to add: ?yes, that rather surprised me too,? as opposed to ?we're clearly number one.?

Both men are quietly spoken and initially at least a little guarded in what they say. Interestingly, Hutton is generally more forthright on a number of key points and Collins, in what seems reminiscent of their original working relationship at Morgan Grenfell where Hutton was in charge, seems happy to defer to him at times.

Each has reaped significant rewards from their careers to date, and it is a natural question to ask why they have taken on the new challenge of building their own franchise. Certainly many were taken aback when they heard that Collins was leaving the relative security of Merrill Lynch, whilst Hutton's re-emergence after what culminated in a tempestuous time at MGPE had tongues wagging. Hutton, whose time at MGPE ended in July 2001, is first to answer. ?I felt I had done enough of getting paid a lot of money working for someone else. I had already left employment, and therefore wasn't making the break in the same way [as Matthew], though clearly I had to make the decision not to go back into it,? he says. ?The time I had after Deutsche Bank gave me a lot of time to think. After working for nearly 20 years, [I thought] here's a chance to think laterally and consider all the options.?

Meanwhile Collins, who after leaving Morgan Grenfell in 1993 enjoyed immense professional success first at Bankers Trust and then Merrills, was looking for a change and was ready to set out on his own as well: ?The real reason for doing this is that I spent more than ten years effectively doing the same job ? that is, running a leveraged lending team. I could see my career going more in the direction of being a manager rather than a ?doer?. I really do like this area of work, so the chance to work with Graham again and to go back to doing the things that I really wanted to do – there didn't seem to be a hell of a lot of personal risk involved.? Adds Hutton, ?We had worked together from 1987 and it's always been a goal to work together again. Really, we've been thinking about this for years and years ? though the real, hard planning only began in November of last year.?

Life after MGPE
At that point Hutton's circumstances were obviously somewhat different. He had left MGPE after 18 years when Deutsche Bank decided not to pursue the sale of the business, but fold it into Deutsche Bank Capital Partners instead. This is obviously something that still smarts for Hutton, and he doesn't seem entirely comfortable discussing it. ?I regard [the failed buyout] as a missed opportunity, clearly,? he says. ?It's a great shame from my point of view because I think we had built a very good business and we had shown ourselves to be a major force in a short space of time. If you look at the performance of the fund, I believe it will be very strong. There is obviously one big and well-publicised problem but pretty well everything else is doing extremely well. We would have done a very good job as an independent private equity force, but that was not to be and one moves on,? he says.

Now that he and Collins are building their new business, Hutton is determined to make good use of the experience gained during the MGPE episode. ?The lesson does seem to be that it is actually quite hard to bring about change in a short time within a private equity firm ? it's very hard to take an existing model and change it. The great thing about this opportunity is to start with a clean sheet of paper and design it the way you want it to be.?

Commenting on the chemistry that underlies his working relationship with Collins, Hutton says that both bring a lot of similar skills and then one or two things that are different but complimentary. ?What made us good when we worked together, and has made us both successful when we have been separate, is a certain creativity in the way that we approach the structuring of deals. The way we win business is quite distinctive. I know from the time that we were competing how skilful Matthew is at getting mandates and I hope I can say the same.?

What are the differences? Says Collins: ?Graham is much more numerate than I am, but I take a much more subjective approach to my analysis and I think that's a reasonably good combination. We both like to take a different approach to deal structuring or problem solving.?

How investors will respond to the proposition will soon be clear. At the time of going to press, Hutton Collins was yet to receive its licence from the FSA (the UK financial regulatory body) and hence the fundraising process had not begun in earnest. However, the firm is far from standing still. In May, Abbey National was revealed as its sponsoring investor with a commitment of €115m to the fund and a minority stake in the management company.

Christian Dummett, the person responsible for the involvement with Hutton Collins at Abbey National, is clearly a big fan of the pair: ?The opportunity struck me, on the face of it, as quite compelling,? he says. ?Our relationship was with Graham rather than Matthew, although he is clearly well known in his field and his reputation precedes him, as due diligence confirmed. We had worked with Graham and MGPE on a number of occasions, notably underwriting two of their fund deals and co-investing in three of them.? So the circumstances surrounding his departure were not a problem? ?It was clearly something that needed to be addressed. However, as we sit on the advisory committee of [MGPE] we had good visibility on the issue and were able to form an objective view as to why he left,? says Dummett.

The product
What Abbey National has bought into is a mezzanine proposition with a difference. Talking to Hutton and Collins makes it clear that the opportunity to do things differently was a significant motivation behind the creation of their firm, and that ?creativity? remains an important paradigm for both of them (they use the term frequently during the interview). Says Collins: ?Most of my career has been founded on a slightly different take on things.? He recalls helping Bankers Trust, which was in the early days outside the UK leveraged finance network, ?become part of that club,? and at the same time developing a personal reputation in the market for being an innovator. ?Deals including securitisation bridges, securitisation take-outs, the origin of the PIK market ? some of [Bankers Trust's] deals you can look at and say, ?that's a little bit different?,? he points out.

So what differentiates Hutton Collins' mezzanine product? ?The way that we characterise it is that we have drawn a very broad definition of mezzanine, from traditional European second secured right through to senior equity/junior mezzanine,? says Collins. ?The whole thing about mezzanine is that it's a very opportunistic product, you've got to be light on your feet. Obviously, there has to be an investment discipline and there will be certain things that we can and can't do, but we want to preserve very broad flexibility such that if we think that the risk and return makes sense for the deal in question then we can do it.?

Hutton says part of what the strategy implies is that the firm is probably going to be more focussed on larger deals than its competitors. ?One of the things we believe is that the mezzanine market should be a credible, totally interchangeable alternative to high yield. There's always been the perception, I think, that above a certain size you go down the high yield route and mezzanine is for smaller deals. We don't believe that should be the case; we believe there's enough capacity in the market now to do very large mezzanine deals, the problem is that that capacity isn't very often pulled together ? one of the things we have in our model is to pull it together.?

Another key objective is to bring in a number of limited partners with an appetite to co-invest alongside the fund, which according to Hutton makes it essential that they are both a structuring and an arranging business. ?We believe that by structuring and arranging deals we will be better able to provide the best product to the fund, whereas I think most of our competitors see their role as almost exclusively fund management and they don't particularly look to create deals for other people. It's almost like a combination of investment banking and fund management.?

?Investors like the idea that we're moving forward ? it's been a very good initial response?

In implementing the strategy Hutton Collins are looking to generate returns around the 20 per cent IRR level. ?It is a risk-adjusted strategy, which will provide superior enhanced returns to the conventional public markets but with a much less volatile, secure return target,? Hutton explains.

But, Collins declares, the firm is going to measure its own success not just on its own financial performance. ?As well as being an asset manager, we've set ourselves the challenge to grow the overall size of the asset class, which is slightly different. There are many institutions out there with an appetite to invest in mezzanine, yet we don't see the mezzanine asset class growing in the way that we think it fundamentally ought to.?

to be geared – no pun intended – towards private equity investors more familiar with its structure. ?Clearly the risk adjusted strategy won't appeal to everybody. Some people want their alternative asset class allocation all to be in private equity. Those people won't invest in mezzanine,? Hutton concedes. ?On the other hand, [others] are very consciously following a risk adjusted strategy and they're the people we'll target.?

The market's view
Having Abbey National willing to underwrite transactions as well as in the fund means Hutton and Collins expect to be fundraising and deal making at the same time. Some dispute whether there will be a sufficient flow of large transactions any time soon, but Collins says with confidence that finding something to be busy with is probably going to be fairly low down their list of concerns. ?There is a bit of a tabloid approach to the market? he says, ?It doesn't necessarily mean that there aren't a lot of [other] moneymaking opportunities in the middle market instead ? refinancings and recapitalisations are another huge target market for a financial engineering product,? he adds.

So far the reaction from the market has been positive. Hutton says even competitors are supportive, because ?everybody can see that this is a market which at the moment is undersupplied, and having more people coming in will help the market itself to grow. Users of the product are [also] potentially very interested, and investors like the idea that we're moving forward ? it's been a very good initial response.?

Indeed most of those we spoke to for this article were similarly positive, even though the prevailing sentiment in the market is one of caution when it comes to predicting the prospects for first time funds. Many in the market appear to be cheering for the reunited leveraged duo. ?If they do well, then that's great for everyone because it shows that mezzanine as a product is doing well,? commented another observer.

It is difficult to dispute that the Hutton Collins combination is compelling and their track record in leveraged finance speaks for itself. They are already, in a very short space of time, several important steps down the road towards achieving their goal. Nevertheless, the months ahead will be a challenge and the eyes of the market will be upon them for some time.

Robin Burnett worked in the European leveraged finance market on both the buy and sell side for nearly 10 years. He is now a training consultant at BG Training and works as a freelance writer.