Privately Speaking: John Arney, Arle Capital Partners

In the early part of 2009, some of the remaining investment team of UK buyout firm Candover Partners assembled in a conference room at the offices of City law firm Travers Smith Braithwaite. The situation looked bleak. Their employer, a near 30-year veteran of the UK private equity scene, had been facing an uncertain future ever since listed parent Candover Investments reneged on its cornerstone commitment to the firm’s new fund. A number of staff had already jumped, or been pushed; everyone else had one eye on possible exit routes.

So they had some tough decisions to make. First, was it even worth trying to carry on? If so, in what form? And could that entity ever escape the stigma now attached to the Candover brand?

Eventually, they settled on an answer to the first two questions. Yes, there was something worth salvaging. But the firm that emerged phoenix-like from the Candover ashes would have to look very different: smaller, more focused, more hands-on. Over a period of months, they drew up a blueprint for this new business. And by the end of the following year, the team – with the financial support of Pantheon, plus £4 million of their own money – succeeded in buying themselves out of their listed parent to become Arle Capital Partners, a new and fully independent entity tasked with managing out what was left of the Candover portfolio.

So what of the third question? Three years on, as Private Equity International meets up with managing partner John Arney in Arle’s London office near Pall Mall, the answer remains unclear.

To Arney – who visibly bristles at the word ‘stigma’ – the situation is very clear. Arle is not Candover: different strategy, different focus, different people (mostly). So the firm should be judged on its own merits, not punished for the mistakes of its predecessor.

But will LPs be able to dissociate the two? And is it even reasonable to expect them to?

 

Too close to the sun

Candover Partners’ dramatic decline and fall received a great deal of attention. But some argue that there’s been too much focus on the mistakes of the listed parent Candover Investments (CIP), as opposed to those of the fund manager (hereafter CPL).

Clearly CIP made some egregious errors, notably the decision to commit €1 billion to Candover’s new fund in 2008 (that would have been bullish even in a pre-Lehman world, since it implied an average cash-call of €200 million a year, and CIP had only averaged distribution proceeds of about €120 million in the previous three years). To make matters worse, it also geared up its balance sheet, raising $150 million through a series of high-yield bonds.

So post-Lehman, when large buyout firms saw their assets marked down by 40 per cent or more and the exit environment deteriorated to such an extent that distributions virtually dried up altogether, CIP’s cash position quickly became critical – and it was forced to renege on its fund commitment, in order to avoid breaching its bond covenants. This effectively marked the beginning of the end for CPL, since it was forced to offer other LPs a chance to withdraw too – at a time when most were desperate for liquidity.

However, CIP’s balance sheet distress might not have been terminal had it not been for the problems in CPL’s portfolio – for which the manager had nobody to blame but itself.

According to Arney, there was no indication pre-crisis that Candover was particularly badly off. “At the time I probably thought it was better placed than most,” he says.

Others beg to differ, however. In the years leading up to the crisis, Candover had expanded at a rapid rate, building its headcount both in London and overseas – including Eastern Europe and Asia. Having started life as a mid-market UK investor; by the mid-2000s, it was very much a large, pan-European generalist, with a reputation for paying full prices for good assets, while offering little in the way of value-add.

“The old Candover were what you’d call a light-touch team,” says one LP who decided not to invest in the 2005 fund. “They were financial investors – they’d buy a company, go round the City, get some leverage in there and not do much with it. And because it was a rising market, and they bought good companies, they made a nice business out of it.”

It was very active in the run-up to the crisis. But it was also participating in more auctions and doing more secondary deals (which accounted for more than half of the 2005 fund’s deals) – perhaps, with hindsight, a sign that it was struggling to generate proprietary angles. Either way, it ended up buying larger and larger assets at higher and higher multiples. Cyrille Chevrillon, a former managing director at the firm who left in 2007, told Bloomberg in 2010 that the firm “lost its soul chasing large and pricey deals in competitive auctions”.

Where does Arney think CPL went wrong? “With hindsight, many would say that the ownership structure – the fact that the senior investors didn’t own the management company – was at best anachronistic. Equally, the investment strategy looks a little bit dated now – pan-European, multi-sector, mid-to-large buyout, with no great attention to consistently active ownership.”

The failings Arney mentions here are very deliberately chosen, because these are the specific areas in which he is trying to differentiate Arle. The partners fully own the (much smaller) management company. Instead of trying to be pan-European, it’s focusing on what it calls the ‘North Sea Rim’, i.e. the UK, Benelux the Nordics and ‘Germalpine’. It focuses on three specific sectors: energy, industrials and services (with a particular focus on where these three overlap). And it’s far more operational in its focus: four of its eight partners have a specific operational remit, to the extent that if necessary they can go in and run Arle portfolio companies (as Anders Pettersson is currently doing at Hilding Anders).

Arney is obviously keen to put clear blue water between Arle and Candover. However, Arle’s four investment partners are all ex-Candover – and actually led some of the deals still in the legacy portfolio. So distancing the firm from its predecessor’s mistakes is not the easiest of tasks…

 

Legacy issues

Of course, Arney wasn’t in charge when CPL was suffering from this “strategy drift”, as he calls it. He joined in 2002 from JPMorgan’s buyout arm, and quickly built up an impressive track record: his biggest hit was Vetco, the oilfield business that netted Candover a return in excess of 4x. Promoted to managing director in 2006, he was elevated to the top job in the middle of 2009, after former CPL co-heads Marek Gumienny and Colin Buffin (plus their respective protégés) had stepped aside in light of the group’s troubles. Arney claims this succession was “well planned and mapped out” – although he also admits that it was “accelerated” by events.

As this suggests, Arney is an understated sort: quietly spoken, considered and precise, with an apparently instant command of the relevant numbers. Given Candover’s dire situation, you can see why he seemed like the right man for the job in 2009. But did he hesitate before taking it? “Undoubtedly… There was already some very public uncertainty, and we’d been flattered by a number of approaches from blue-chip competitors who wanted to take all or part of the team. So we had to think carefully about the right thing to do. [But] ultimately we decided we wanted to stay together, because we really believed in the team we’d created, and we had a really clear plan about how we wanted to take the business forward.” Did he take the job in the expectation that Candover wouldn’t survive? “Yes, basically.”

He was faced with an intimidating to-do list. Candover still had to close down offices and shed staff to cut costs, even as the portfolio continued to deteriorate. This “optimising”, as he euphemistically calls it, ultimately took headcount down from over 100 to just 24 in a relatively short period.

So what kind of conversations was he having with LPs at this point? “Largely difficult ones,” he admits, with a rueful smile. “Some investors found themselves in a place they didn’t expect to be. So there were certainly some emotions around the table. But investors were incredibly supportive and rational; we sat round a table and over quite a few months, we worked our way through the problem.”

Not everyone involved remembers the process being quite so harmonious. “Some LPs wanted more blood; they wanted to see the team punished, even though this wasn’t the team that tanked the funds,” says one investor. “They felt Candover needed to be taught a lesson. Which is all very well – but then you end up with nobody managing your assets for you.”

One of Arney’s biggest tasks was to give investors comfort about the work his team was doing with the portfolio. “For three-quarters of the companies, we changed the teams that were looking after them – and we also changed or augmented many of the management teams running them. So along the way, we had to make sure investors were comfortable with what was happening, and were confident that they were getting as good or better stewardship of these investments.”

Some of the stragglers were disposed of: ALcontrol was written off and Springer sold for a small gain, while Gala Coral finally succumbed to its lenders the following year.  Of the remaining companies, pretty much every single one was overhauled or restructured – either with equity injections (like Hilding Anders, another Arney deal), with new management and non-executives, with a strategic repositioning, or with all of the above.

The key, says Arney, is to have a “very consistent, disciplined approach”. He talks eloquently about “repeating success” – how doing the same things over and again, often with the same people in charge, will constantly diminish execution risk.

Arle has already had one big win, with the $1.1 billion sale of Capital Safety Group (see box-out). But what else do Candover LPs have to look forward to (or not, as the case may be)?

The bad news is that the portfolio as a whole is still under water: according to Candover Investments’ most recent interim financial statement, it was valued at about 60 percent of residual cost at the end of the first half of 2012.

Arney is very keen to stress that his team should only be judged on its own deals – plus the performance of the rest of the portfolio since 2009. “A small minority have our fingerprints all over them, and we’ll be judged from soup to nuts, start to finish, on all of them. With the others, people should judge us on how we’ve done once we’ve stepped in and taken over stewardship.”

That’s perfectly reasonable. For instance, one of late Candover’s most notorious deals was Ferretti, an Italian yacht-maker that it bought from Permira for €1.76 billion in 2006 but was forced to hand over to lenders in early 2009. Arney and his partners were not involved in the deal, and it was all over by the time he took the job. So they shouldn’t be tarred with that brush.

On the other hand, one of the reasons for the portfolio’s current woes is the ongoing write-down of Expro, its biggest investment, which is currently valued at just under 40 percent of cost – and that deal was led by Arney himself.

Happily, banking sources suggest that Expro is finally showing some signs of recovery: Arle sold off part of the business to Siemens in May for $630 million, using the proceeds to pay down debt, and earnings were 30 percent ahead of target in the first quarter of the current financial year, according to CIP’s latest interim report.

Of its other big investments, energy services company Stork is also looking in better shape, following a judicious acquisition in Latin America and the separation of its aerospace business (now renamed Fokker Technologies), while theme park operator Parques Reunidos is still going strong, thanks to its relentless buy-and-build strategy. Meanwhile Technogym, whose value was written off entirely in 2008, has recently come roaring back – and another two 2008 write-offs, bed maker Hilding Anders and mail provider DX Group are also back on the up. Since these last three are all still valued well below cost, that’s little consolation for original LPs, but it bodes well for Arle (not to mention the secondary firms who bought fund stakes in 2008).

There have been setbacks too, of course, notably the recent loss to lenders of car information provider EurotaxGlass’s. But there still looks to be a good chance that Arle will eventually get the fund’s original LPs back into positive territory. And that would be no mean feat, especially given the economic environment in which it has had to operate.

 

Time to get creative

Which brings us to the other big question: what happens next? Again, Arney is unequivocal. “We set out to build an enduring business, so by definition we need to raise new capital. We continue to find very interesting proprietary opportunities; some of them we’ve been working on for years already. So we will in due course find capital to back those buyouts.”

Has the fundraising process already begun, then? “The process of looking for investments and talking to investors has been underway for some time…[For now], we’ll do what we’re best at – finding really good investment opportunities and then raising money to fund those – and then see where that takes us.”

Does that mean a deal-by-deal approach is more likely, at least to begin with? “Could be,” he admits. “It’s a logical first step towards raising more committed capital.” Time is a big problem, he says. “It’s an incredibly difficult fundraising market. Anecdotally, when I talk to peers, it seems to take an awfully long time to raise money – and time is one of our scarcest resources. Do we want to commit to a huge amount of time to a broad fundraising with an uncertain outcome? It’s not currently high on my list of priorities.”

So raising a blind pool fund is more trouble than it’s worth at the moment? “If someone asked whether I’d like to have one today, I’d be mad not to say yes – if it’s a sensible size and I didn’t feel compelled to put the money to work. But do I want to jump back on the merry-go-round where there’s pressure to put money to work, and a risk that you intersperse wonderful proprietary deals with stocking-fillers? I’ve no desire to do that whatsoever. Would I like committed capital, so I can quickly and nimbly execute deals? Absolutely. Is a committed blind pool fund the only way to do that? No. We think there are more creative ways to raise and structure funds.”

Clearly the performance of the legacy portfolio will be crucial. Does he feel there’s a particular benchmark or milestone Arle needs to hit before he asks for more money? No, because they’re two separate issues, he insists. “Going forward, it’s important for investors old and new to judge Arle on its own merits. It’s not about how it looks relative to Candover; it’s about how it looks relative to other managers in this area of the market.”

So what of the new proposition, then? The smaller, more focused, more operational model certainly looks more compelling – and more in keeping with the times. But Arle is targeting a highly competitive segment here, particularly in the UK and the Nordics, and particularly in services. Arney insists it wants to “hunt away from the pack”, focusing on proprietary deals. But can a London-based firm really beat the EQTs and IKs of this world to a deal in their own backyard? Arney thinks so; others are more sceptical.

Ultimately, it’s hard to know whether Arle will eventually be able to raise a new fund. Much depends on what happens with the old Candover portfolio: a few more examples like CSG clearly wouldn’t hurt. On the other hand, a fund commitment is also a vote of confidence in a GP’s ability to invest money – and even though Arney and co. have some hits in their back catalogue, the Arle team has spent the last four years on portfolio management, not deal-making. That’s why a structure that allows LPs to see the deal before they commit capital seems more likely, at least in the short term.

Arle, like Candover, is a landmark in Hampshire (albeit a river, not a valley). Depending on your point of view, that’s either a discreet and respectful nod to the past – or an acknowledgement that despite its best efforts, Arle will find it hard to leave that past behind entirely. 

Box: A CAPITAL CASE STUDY

When the Arle team inherited Capital Safety Group in July 2009 (its principals were not involved in the original deal), the safety equipment maker was valued at only a little over cost. Less than three years later, in January 2012, it was sold to Kohlberg Kravis Roberts for $1.1 billion, generating €362.3m in proceeds – a 2.7x return.

To the Arle team, CSG represents the perfect example of its active ownership model. They completely overhauled the company’s management: Anders Pettersson (who they’d previously backed at Thule and is now an Arle partner) was installed as CEO, with a new COO, CFO and regional management team recruited underneath him. They made five acquisitions in a year, to supplement the product portfolio and boost growth in emerging markets. They found big savings by improving procurement and stock control. And they managed to push up prices in key markets. The result was that both sales and EBITDA jumped by over 60 percent.

“At Capital Safety we managed to drive a fantastic turnaround in a fairly short time period thanks to very strong leadership from Anders, a really good reworking of the strategy, and selective add-ons in emerging markets,” says Arney.

Was there not a temptation to hold onto the investment a little longer, to generate a bigger return for LPs? “There was, because we could see that growth continuing – but you have to leave some value for the next owner.”

It wasn’t Arle’s first exit from the Candover portfolio – but it was its biggest to date, and more significantly, a much better return than anyone had expected, highlighting the potential upside of its value creation strategy. “That certainly got them a bit of kudos,” says one LP.