Back from the brink?

It's a clear and cold March morning in London. The atmosphere inside Candover's office on Old Bailey is equally chilly as senior management outline the firm's near-critical condition to an assembled group of analysts.

The following week – on Friday 13th, believe it or not – chairman Gerry Grimstone and managing director Marek Gumienny would stand up again, this time at the company's AGM, and deliver speeches lamenting the very public decline of a once highly respected pillar of the private equity community. “We are used to being the hunters, not the hunted,” said Gummieny. “This process has been a humbling experience and taught us many lessons.”

“It was a pretty quick and sombre affair,” says Iain Scouller, an analyst at stockbroker Oriel Securites, recalling the analyst meeting. “There weren't a huge amount of questions. People mostly just sat, listened and tried to get a feel for how they were going to get out of this position.”

The position was bleak. The net asset value of Candover Investments, the listed parent company that owns Candover Partners and invests in its funds, had been slashed by 50 percent. At just over £2, the company's share price had lost more than 90 percent of its value since its £22.80 peak in August 2008. Of all the listed private equity vehicles on the London Stock Exchange, Candover had been hit the hardest.

Problems at some buyout firms were well-anticipated, but Candover was a surprise. It really was

With a diminished asset base and no cash distributions coming in, the listed parent announced that it would be in no position to honour the €1 billion it had pledged to Candover Partners' newly created 2008 fund (see chart on opposite page). Without its parent's cornerstone commitment, the future of the new fund – which had by then raised €2 billion from third-party investors – was thrown into doubt. The board set about a wide-ranging review that would see jobs cut, the future of the new fund debated and the very ownership structure of Candover reconsidered. “At the present time we cannot see this model resuming in quite the same way ever again,” said Grimstone at the AGM.

Six months later and the firm's future is still in the air.

The over-riding industry reaction to Candover's difficulties is one of shock. As one pension adviser says: “Problems at some buyout firms were well-anticipated, but Candover was a surprise. It really was.”

“It was the speed,” says one secondaries broker. “People unfamiliar with it were just surprised that it all unwound so quickly.”

The same secondaries broker discloses that stakes in Candover's funds had for some time before the firm's problems were publicly aired been changing hands for discounts of between 80 and 85 percent. “People were aware of the problems in the portfolios, but hadn't necessarily focused on the impact of leverage at the listed company level,” he says.

Candover had not been the only buyout house to veer away from the mid-market to chase larger deals. It had not been the only firm to take advantage of cheap debt to make acquisitions and was not the only private equity investor to deploy an over-commitment strategy. So what tipped it closer to the edge than its peers? The seeds of the current predicament were sown a little over three years ago.

A change in board strategy, approved by shareholders, started with a management change and a return of capital to shareholders totalling £100 million in May 2006, recounts Scouller. “Roger Brookes and subsequently Stephen Curran [Grimstone's predecessors] both ran Candover Investments on a pretty conservative basis” he says, “meaning they wouldn't make huge commitments to new funds, and they tended to sit with a lot of cash on the balance sheet. The return of capital and move to leverage-up the balance sheet were significant events, which would turn out to have a serious impact in the downturn.”

Following the £100 million payout to shareholders, Candover Investments' cash position went from representing 50 percent of the group's net assets to just 9 percent.

At the same time Candover Partners was raising everlarger funds to invest in ever-larger deals, and Candover Investments was making ever-larger commitments. In 2007 it raised £150 million in debt finance from a US private bond placement to go towards the €1 billion it had committed to Candover 2008, a fund which would target €5 billion in total.

Then came the storm. Asset values began to drop and realisations dried up. With the £1.6 billion acquisition of oilfield services provider Expro International in April 2008 – the first and only investment from the new Candover 2008 fund – Candover Investments faced a capital call of £69.5 million. Between June and December 2008, amid heavy write-downs of asset values across the entire industry, Candover Investments' net asset value fell by 59 percent.

The firm's problems were exacerbated because in pursuing larger deals it had taken on more company-specific risk. The most prominent example of this was the investment in Italian yacht maker Ferretti. Midway through 2008 the luxury yacht marque was the second-largest holding in Candover Investments' portfolio, representing 10.8 percent. By February 2009 – within two years of its acquisition – the company had defaulted and been restructured. Candover had lost its equity stake.

LOOKING UP
Since the dark days of March, things have started to look up. Having suspended investment from the latest fund, the firm set about cutting costs and identifying which assets could be realised. Talk of the company being taken private flared up and then died down. A £550 million exit from oilfield services business Wood Mackenzie generated proceeds of £36.2 million.

The discussions between LPs and Candover Partners about how to take the 2008 fund forward were ongoing at the time of going to press. The recent loss of another investment – laboratory testing business ALcontrol – would have been an unwelcome distraction

The reshaping of Candover's ownership model, whereby a listed parent commits to the subsidiary's funds, hangs on the outcome of the discussions. In order to spin off Candover Partners as an independent management company, parties need to agree on its value. This in turn is dependent on whether it has a viable 2008 fund, and hence whether it will generate any fee income. “They need to get some firm commitment from investors that they will have a viable fund. That would be the best outcome,” says Chris Brown, an analyst at JP Morgan Cazenove.

Candover did not comment on the progress of the discussions. The future of Candover Investments most likely involves waiting for the gradual realisation of assets, paying down leverage and perhaps ultimately the return of cash to shareholders. If this proves successful it may even find itself in a position whereby shareholders are comfortable for it to begin committing capital again. London-listed Electra Partners went through a similar renaissance some 10 years ago.

For former industry stalwart Candover, a reasonably happy ending is still possible.