Still reeling from the very public failure of Better Capital portfolio company City Link, self-styled private equity maverick Jon Moulton reflects on the past year and the tough environment for turnaround investing.
It's been a rough year for Better Capital. In the last 18 months the turnaround firm and its founder Jon Moulton have been in the headlines for all the wrong reasons.
Last February Better took the decision to sell off magazine publishing company Reader's Digest to venture capitalist Mike Luckwell for just £1, having bought the business out of administration for £14 million back in 2010. That same month the firm announced it would have to write down the value of two companies held in its first fund, office supply company Spicers and aerospace components supplier Gardner Group. Better also committed a further £7.1 million to luxury yacht maker Fairline Boats last year after it suffered another year of tough losses.
But it was the catastrophic – and painfully public – failure of UK parcel delivery business City Link on Christmas Day that really knocked the wind out of Moulton.
“City Link was really pretty tragic,” he says. “The thing failed at Christmas, which is just terrible from a PR viewpoint and terrible on a human level.”
Better acquired City Link from pest control company Rentokil in April 2013 for £1 after the business had endured several years of losses. The firm subsequently ploughed £40 million into the company in an attempt to turn it around, but was thwarted in large part by intense competition on pricing.
Better's efforts to save the business included marketing it for sale, but the last potential buyer pulled out the Monday before Christmas. More than 2,000 City Link employees faced redundancy.
“We couldn't avoid it, we tried everything we could to save the company,” Moulton says.
One of City Links' competitors, Whistl, suspended its household deliveries service in May 2015 which, Moulton says, “rather reinforces the view we had, which was the business was too difficult and we could not sit there long enough and lose enough money to actually see the industry get back into shape.”
As well as losing £20 million of Better's investment, Moulton found himself in front of a joint Scottish Affairs and Department of Business, Innovation and Skills select committee explaining to British parliamentarians what went wrong and defending the turnaround industry.
“It's a change in society, which seeks somebody to blame for things going wrong. It's not realistic that we can get out to people that we tried and it didn't work, and we did do some good,” he says.
“Most of the public doesn't really know what private equity does, let alone the subset of it which is turnaround. So I don't think it's reasonable to assume that the public would really genuinely understand what we do for a living.”
Despite being put through the wringer over City Link, Moulton thinks the environment for turnaround investing in the UK is generally favourable. And as important as it is for governments to support what Better and its peers are trying to do, it is possible for them to be too much in favour, he cautions.
“Turnaround is something which [the government] shouldn't be too overenthusiastic, overzealous, over-religious about,” Moulton says. “All troubled companies do not deserve rescue. It may be better for the economy and for the people in them that the companies are actually allowed to fail and the good people and good assets get out the crumbling business once and for all.”
FIVE TOUGHER YEARS
There's no doubt that Moulton is a successful businessman, both within the private equity world and outside of it. Also an enthusiastic angel investor – which Moulton says has made him “more money than working” – if the latest Times Rich List is to be believed he has amassed a personal fortune of £220 million during the course of his career. More recently, Moulton has definitely been winning less frequently in the turnaround space.
“The last couple of years I've had a higher failure rate than I've historically had in turnaround,” he says. “Roughly speaking over a long period I was able to say something like three-and-a-half times your money in three and a half years. That hasn't been the case for the last five, but was true for the vast majority of my career, which is a very satisfactory rate of return.”
It was just over five years ago – in 2009 – when Moulton left Alchemy Partners, which he had founded in 1997. It also happened to coincide with a dramatic shift in the market.
He says: “Alchemy was literally going nowhere. I was unable to get sufficient control over a team that was not working.” Following Moulton's exit, Alchemy closed a £600 million third fund in March 2014, to make investments in special situations.
A PERFECT STORM
Some of the troubles Better has faced recently are of its own making. Moulton admits the firm has “enough operating errors for us to stick our hands up and say we got that wrong.”
But alongside internal issues, turnaround firms are suffering from a radical depletion in the number of target companies, Moulton says, estimating that the entire UK turnaround industry managed to complete only around £400 million worth of deals last year.
“That's a comparable number to what we'd been doing in the mid-1980s,” he says – and not what he was expecting when he set up Better in 2009 in the aftermath of the crisis.
“Deal flow was better actually pre- the crisis; that's the really odd bit,” Moulton says, explaining that he was expecting a flood of deals as businesses failed to recover from the market crash. The reason that flood never came was because interest rates have been kept at rock bottom.
“What you've got is a situation where the very low interest rates [and] on the whole remarkably compliant banks mean that companies aren't getting into trouble in the way that they used to,” he says. “And perhaps they should. Because, of course, with no effect of pressures like that, weak business models stay in the corporate pool rather than being sifted out by bankruptcy.”
In today's environment, Moulton explains, businesses which are to all intents and purposes dead in the water can “stagger on for a hell of a long time with a balance sheet which is really improbable.”
“If you look at the way that some of the banks, at least, account, they don't take provisions until there's a failure to pay either interest or principle. So if you had a company with £100 million of senior debt and £4 million of EBITDA, in today's world it can pay the interest.”
With the Bank of England promising year after year that interest rates will rise in the near future, all Better can do is hope that will eventually happen.
“We pray for it daily,” Moulton says. “When there is a substantial increase in interest rates, which may occur sometime in the next few years, there's an awful lot stacked up there that really will need a violent restructuring then.”
SEEKING POOR MANAGEMENT
Of course, not all of the businesses that will hurtle toward bankruptcy following a rise in interest rates will be salvageable, and it is up to Moulton and Better's transacting team to identify which companies have a chance of survival. As most of Better's deals are completed “in a matter of days,” according to Moulton, this identification needs to be made swiftly.
“You look for poor management,” Moulton says simply. “You're probably encouraged if the existing management are awful, because at least it gives you something that you know you can do better. Whereas if the management team you're looking at actually seem to be quite good and the company's losing money, you've got to question what you're doing there.”
Extensive due diligence is not often feasible. In any case, sometimes detailed scrutiny of financial records leaves the firm none the wiser.
“In turnaround, it is really quite rare for the financial reporting to be accurate. It's quite common that it's fraudulent,” Moulton says. “So you're desperately trying to get something you can hold onto and believe in. You try and work out a picture of where the company should be rather than where it is. You try and work out the steps that get between them.”
Once Better acquires a company, it sends in operating partners full time – the number dependent on the amount of work that needs to be done. As well as four full-time operating partners, Better has another 20 or so operating experts with whom it works on a regular basis.
“Companies arrive at us with everything from being in reasonable shape with a management team that arrived three months earlier and already have made progress in sorting it out to being in total collapse run by a bunch of idiots, possibly crooked ones. So clearly you have to respond differently to those different situations.”
The operating team assesses every aspect of the business and the capacity of the management team, whether new or retained, to implement the necessary changes as quickly as possible.
“Sometimes it's all into the accounting system, sometimes it's all into sorting out the customer base,” Moulton says. “Actually most of the time it's all of the things you can imagine, everything needs some degree of review and action.”
A CASE IN POINT
Despite the write-down last year, Moulton champions aerospace components supplier Gardner -Better's first acquisition – as a very promising asset. Better acquired the company's debt for around £15 million in 2010 from HSBC and GE Capital, which had financed a buyout by Carlyle Europe Technology Partners II in 2008 that had subsequently run into trouble during the financial crisis.
When Better took it on, Gardner was “over-levered, [with a] very optimistic business plan, and not a terrible management team but certainly a weak management team, underinvested, actually suffering in a way you often read about but don't often see from excess leverage.”
“One of the factories featured a three-storey manufacturing setup, the floors for which were made out of World War II ammunition boxes,” Moulton says. “So what we did was put in new kit, new buildings, new factories, very much not the things that you associate with turnaround. Put in new management, put in a proper costing system, did a huge amount of continuous improvement stuff, and the company statistics have improved throughout our ownership.”
Last year Gardner returned £7 million to Fund I, according to Better's 2014 interim financial report, and is expected to outperform its budget for Q1 2015.
When it comes to selling the business, as well as looking to private equity there are a number of active trade buyers in the aerospace engineering field, meaning the business will likely be sought-after.
“At the moment the asset's obviously doing very well, we're getting very regular approaches for the asset,” Moulton says.
ROAD LESS TRAVELED
Moulton's career in private equity spans more than three decades. One of the most famous men in the UK private equity industry, he has nevertheless for the most part shunned the mainstream. He describes himself as “very much an individualistic sort of soul”.
“I do like things to be right, rather than generally accepted. And 'right' is, of course, my definition of right, and not necessarily everybody else's,” he says. “I've done several things in my career, and moved on when things don't seem to be much fun anymore or much point to doing it.”
Since he started out with Citicorp Venture Capital, now known as CVC Capital Partners, back in 1980 the industry has changed beyond all recognition, he says.
“You stuck your flag up as an MBO guy in the early 1980s and you could make a lot of money even if you made a lot of mistakes. Nowadays you really do have to work for a living.”
With the majority of deals today completed through an auction process, firms can no longer rely on making money through the buying alone; it's imperative to add value during ownership.
For those starting out in the industry today, Moulton thinks it's less fun than it used to be.
“Because actually there's not much fun in spending days poking your way around in electronic data and doing analyses which your seniors will probably never read and which really will have very little relevance to where the deal actually ends up. And if you work for a mega fund at the junior level, you might spend two years working on projects which never happen, whereas in the early 1980s we used to work on the idea that we could get four deals per human per year done. And we did it.”
Back in the here and now, for the rest of 2015 the priority for Moulton and Better is to secure a much-needed exit. The firm's second cell has around £100 million left, enough for two to three deals, which must be deployed by the end of 2016. After City Link, Moulton admits Better will give potential bad PR and its adverse effects rather more weight when deciding whether to invest in a particular company.
As to whether Moulton will seek to raise another cell in the near future, that remains to be seen.
“Before we go out to raise more money we really need to generate some more record on exit,” he says. “That we hope will be occurring over the next 12 months.”
It's hard to think of Better without Moulton; you scarcely ever read one name without the other. This, Moulton insists, is unintentional on his part. In fact, when he set up the firm he committed to working just 100 days a year with Better. He is confident that the firm can survive – and even thrive – without him at the helm.
Moulton turns 65 in the autumn, and acknowledges that as much as he enjoys his work there will come a time when he must step back.
“At some stage nature will tell me to slow down regardless of what I want to do,” he says, although he suspects he'll be “hanging around the flanks of the industry for quite a few years to come”.
“I'm gradually going to taper out over the years ahead, and I'm hoping people will just pick it up and run with it properly,” he says. “I've got a chief executive, a head of portfolios, a very talented transacting team. There are several people in the organisation who could probably do better than I can.”
Among the blooms and sculptures of his idyllic clifftop garden in Guernsey, it's not hard to believe Moulton when he says he's satisfied with the hand he's been dealt.
“I've managed to keep going for a very long time,” he says. “I've enjoyed what I've done. I'm not really looking for anything much more than that.”