Chris Brotchie's CV leaves you thinking that this is someone accustomed to the principles and procedures of mainstream business management. 16 years in industrial line management, 13 of which as a CEO in both public and private companies, with most of the time spent in Germany seems a logical progression for a chartered engineer. It's good, solid stuff.
So why is he CEO of a private equity firm that has made a virtue out of investing where others fear to tread? Baring Private Equity Partners (or more commonly, BPEP) manages over €2.2bn and has some 80 per cent of this being deployed in emerging markets. Russia, Latin America, China – you name them and BPEP's there (it's got 21 offices in 17 countries). And not only is BPEP active in these markets but it's also delivering compelling returns to its investors thanks to them. Whilst the temptation may be to think that here's a firm looking to dodge intense competition by sitting it out in far flung corners of the world, the reality is this is a firm that expects, in Brotchie's own words, ?to give you two or three times your money back and not to sit on your cash for ages either.?
Brotchie clearly wants to apply the principles of a technocrat to the sometimes hurly-burly world of private equity firms. In his world, for example, you nurture and keep your star investment professionals by giving them the security and, it just so happens, the rules that ensure your business develops the kind of longevity that extends beyond the presence of a handful of key players. ?If you look at the real performers of any size who have stayed the course,? he says, ?underlying the stardom is a very solid, process-driven system. The firm's been engineered to run as a business not just as a stable for stars? Which is great in theory, but easier to declare than execute. Has BPEP been successful?
Delivering international value
Talk to Mike Calvey, who is the co-managing partner at Baring Vostok Capital Partners, BPEP's Russia-dedicated subsidiary that is presently investing its second €205m Russian fund, and the answer seems to be yes. He and the six other partners are majority owners of the business and garner the majority of the carry from the fund but interestingly are also benefiting from a (smaller) cut of the carry on all of BPEP's other funds. This, says Calvey, encourages dialogue, lead swapping and information sharing within the group. It also ensures these people sat in Moscow and Kiev stay connected with the centre.
Brotchie, who says that incentivisa-tion is where he has spent the bulk of his time, has worked hard to make sure the system is clear, is codified in contract and works. ?The fund team get around 65 to 75 per cent of the economics with the rest coming back to London; of that quarter about half is used to reward international value that is created by the teams because we want to evidence that we are generating value globally, and not just at the local level.? Brotchie is keen to evidence the value of BPEP's ?inter-nationalness? in a very real way to its employees, let alone its LPs. ?We're now heading down the long, hard road to prove that we can provide another layer of value that a standalone regional fund cannot.? Being part of the international BPEP family certainly encourages a degree of connectivity between the different offices that ensures each feels part of the BPEP whole. Team members based in the different regions tend to see London as a value-adding influence: ?It's a supporting resource, not a controlling interference,? comments Calvey.
Positive feedback regarding the execution of the business plan also comes from one of their longstanding LPs, who preferred not to be named. You get the sense that the BPEP proposition appeals to the seasoned private equity investor who is less beguiled by startling IRR claims but instead is looking for substantive operational expertise as well as sufficient return on capital. Longevity and sustainability are issues here. ?They've got some very smart guys who are always good value to listen to – but there's also the sense that if that person's not around then you'll get pretty much all the information you need from someone else on the team. You get the impression that the internal information flow and communication lines are good.?
And in Brotchie's estimation, appreciation of this kind of trait marks a shift in LPs' assessment of private equity firms. ?Investors are now thinking that looking in the rear view mirror may not be the best way of judging a fund going forward. Succession, compensation, governance: these will be the words in the mantra instead of just track record.?
This kind of comment takes time to come through though, and a firm has to have not only set up its systems and polished its processes but also delivered on – or better exceeded – its promises for there to be real credibility. Having spent many days on the road fundraising (though less now than in the past), Brotchie clearly has had the chance to practice delivering the numbers that matter, but they, even unvarnished, are impressive. For headline grabbing there is their first Russia fund launched in 1994 that has delivered a 60 per cent gross IRR per annum and an average 2.9 cost multiple. More broadly, since 1994 BPEP can point to a realised portfolio across all of its funds that has generated €355m in value at a cost of €208m – meaning a realised gain of €147m. For the statisticians, this gives a 35 per cent pooled IRR and a cost multiple of 1.7. If you then look at BPEP's unrealised portfolio you'll find the group is invested in 160 companies in 31 countries at a cost of €1,301. Brotchie is quick to point out that the firm uses EVCA valuation guidelines to come up with a current valuation of this portfolio of €1,496m – a gain of €195m. So all in you have a 23 per cent appreciation on capital invested.
It's not all been plain sailing when investing though. The firm joint ventured to tackle TMT sector companies and hence was ?burnt, like so many others, when the bubble burst,? says Brotchie. ?At one point we thought we were seriously in the money with our central and eastern European technology investments: no more, although fortunately our portion of the commitments was relatively small.? And playing in emerging markets means that the model is a curious mix of venture and private equity investing. Not only can you buy substantial companies with track records and solid cashflows that would make buyout candidates in mature markets with venture size amounts of money, but you must also expect a venture-like level of write off in some markets. As Calvey says of Russia: ?We have realised losses on perhaps one quarter of the investments made, but we have generated five times or even ten times money on several investments as well. The end result is likely to be an aggregate return of roughly three times money for the entire portfolio.?
As the CEO of a process-driven business, Brotchie is keenly aware the impact write-offs can have – when portfolio companies ?go bang.? ?One of the key numbers I monitor is our loss ratio: of the €1,509m invested thus far we've had to write off €79m, or 5.2 per cent of capital invested. If that number starts moving up we go into red alert at once,? he says. Nor is Brotchie the only person who would be asking questions. Some may need reminding of the fact, but ING Group own BPEP and they take a keen interest in the operation let alone performance of the business. It's Brotchie's job to keep ING up to speed, and this is another reason why the risk management systems have been stress tested extensively: ING demands it.
The influence of ING, and of Barings
This relationship goes back to 1995 after the Dutch financial services group acquired the stricken Baring Brothers investment bank and asset management firms. Brotchie remembers the fateful day when he received word in the middle of the night (he was in Asia setting up BPEP's Asian business) that the house of Baring was no more. ?On February 25th, 1995 I got a call saying ?we've lost the bank? and the next day there was this media frenzy,? he says, ?but the people we'd got to know stood by us – they bought in to what we wanted to do. By 15 December of the same year we had closed our largest fund to date, the Baring Communications Equity Asia Pacific Fund, based out of Singapore with $100m of commitments.? And arguably there is a part of the old Barings that still influences, and adds value to, the BPEP franchise today. This is best described as a bottom-up approach to emerging market investment. Brotchie agrees that Baring Securities' reputation for being a research-driven broker producing in-depth analysis of diverse sectors in emerging Asia, Europe and Latin America has resonance with BPEP's activities today. As a partner at another private equity firm active in Central and Eastern Europe comments: ?They like to get set up in the heart of a market, getting to know the companies and the people running them. They tend not to go for high profile deals that will often have a political dimension to them.?
The BPEP methodology of dealing with the volatility of emerging markets means a combination of practical measures and pragmatic strategy. So to deal with political risk the firm will structure its investments in Russia, India and Asia via offshore vehicles so that BPEP actually invests in a US registered company, which then buys product or services from the ultimate investee company. It also means that BPEP will staff its local offices with a combination of BPEP indoctrinated personnel and local individuals who know the inside as well as the outside of the local market. Thus Mike Calvey in Russia counts a former cosmonaut and a former KGB head amongst his team: the former providing a widely recognised public face to the fund's operations and the latter delivering the kind of local knowledge that ensures deals can get done without running aground on others' agendas.
Local knowledge is exploited in other ways by BPEP too. The firm has developed a number of close ties with niche firms around the globe that provide local intelligence and co-investment opportunities. There's Global Finance based in Greece but spreading its net throughout the Balkans, in Sweden there's Procuritas exploring Nordic buyout opportunities and in Germany there's Polytechnos Venture Partners investing in the technology and life sciences sectors. It's an eclectic mix and in almost every instance these relationships have come from a crossing of paths between talented individuals and senior BPEP personnel. Brotchie's predecessor as CEO, Dick Onians, who started the business in 1984 but died unexpectedly in 1999, was someone who was prepared to take decisions using both head and heart. BPEP therefore enjoyed a somewhat non-conformist reputation for embracing the unexpected. Thus, closer to home, it was Dick Onians who was convinced that Jeremy Coller was on to something when in the early 1990s he started talking about a dedicated secondary fund. The firm backed him with money, space and contacts. Does BPEP still have the same freewheeling attitude? Brotchie would clearly like to say it has, but instead points out that the private equity industry – and by implication BPEP -has moved on. Process has supplanted opportunism, structure has replaced fluidity: and BPEP has changed accordingly.
Changing the model
When ING bought the business, Brotchie found some hard-nosed but receptive new owners. ?They [ING] told us we had to do two things: get out of early stage and stop relying on high net worth family offices and corporates for investment capital. They wanted us to win over big institutional investors instead and focus on the middle market.? Today over 80 per cent of the funds BPEP manages come from third party investors and nearly 80 per cent of these come from 40 major institutions. The firm is busy fund raising at present for its second Iberian fund, is planning its second Western Europe fund for 2003 and has clearly not forgotten that a third Russia fund may be ready for launch in 18 months time too.
Tellingly, Brotchie thinks that ever-increasing fund size is not the way to go for the firm. He cannot see a time when there's a billion Euro plus BPEP fund. But you do get the sense that he would like to have much more capital in total under management. E5bn is a number that clearly has resonance but true to character Brotchie first lays out the reasons why the firm is ready to manage more funds before referencing any target number. One reason is that ING has provided the operational rigour and infrastructure that has ensured Brotchie's beloved processes actually work. Another is that the average ratio between BPEP investment professional and investee company at 2.5 is low (at present there's 63 investment professionals and 160 companies) and this could reasonably be doubled without fear of criticism. And there's also the fact that the BPEP emerging market franchise has won significant support from investors: as a means of prudently diversifying within your private equity allocation a commitment to BPEP for some emerging market exposure has made considerable sense.
But that's not where Brotchie is setting his sites. Instead, increasing BPEP's Western Europe focussed funds under management is how he wants to grow. It's a tall order: whereas BPEP prides itself in being the exclusive buyer in the vast majority of transactions, having exploited its hard won local knowledge and network to get to that point, Western Europe is the land of the auction. It's also a much more crowded space with smart and aggressive private equity firms, both home-grown and international, vying with each other on a deal-by-deal basis. How's BPEP going to stand out from this crowd? In Brotchie's estimation its going to be by leveraging its international network and he goes on to describe a deal where partner Polytechnos could not win a slice of equity in US software firm Enigma which was already being courted by BancBoston and GE Capital. BPEP went to see the CEO and asked what he was looking for: it clearly wasn't cash. The answer was access into Asia and BPEP at once pointed out that it had 27 technology-oriented professionals in the region. As a result BPEP and Polytechnos won a $5m stake.
It's this kind of international leverage that BPEP is hoping will see it succeed in Western Europe, letting it win significant quality deal flow. Brotchie is confident that the structure is in place and that his vision of who will succeed doing what, where is already being evidenced: ?There's going to be standalone country or regional funds, which can't operate the way we do, and there's going to be a small number of international funds which have the management bandwidth and the disciplines, processes and governance in place to operate around the world and the two will live very happily together,? he says. It's a considered view with a beguiling simplicity, one that is going to be validated for BPEP in how it grows in Western Europe. There are going to be lots of people watching.