Privately Speaking: Justin King on rebuilding Terra Firma

It seems odd to sit across the table from someone other than its founder, Guy Hands, to discuss the future of Terra Firma. Yet as the firm finally consigns the EMI debacle to history, it clearly wants to demonstrate the revitalised and reinforced team it has assembled as it returns to investment mode.

And there is certainly substance to that team. Sitting on the other side of the table is Justin King, the former CEO of British supermarket giant J Sainsbury.

King is a genuine corporate veteran. He held senior positions at Marks & Spencer and Asda before joining Sainsbury’s in 2004 and is credited with driving a significant turnaround of the supermarket during his 10-year tenure at its helm. When he stepped down at the age of 53, he was still below the average age of his FTSE 100 CEO peers.

In September 2015 he joined Terra Firma as its vice-chairman and head of portfolio businesses.

While the job title – vice-chairman – sounds a little “non-executive”, it is without doubt a full-time position, which sees King splitting his working week between portfolio company site visits – involving travel to Europe, North America and Australia – and Terra Firma’s London and Guernsey offices.

On leaving the corporate world, King – with a highly credible track record – must have had options.

Many of his peers from the world of retail had made the leap from publicly listed retail management to private equity. Sir Terry Leahy, who led Tesco during its period of dramatic expansion between 1997 and 2010, has gone on to advise Clayton Dubilier & Rice, as well as chairing its portfolio company B&M Retail. Former CEO of Asda Tony De Nunzio is now a senior advisor to KKR and holds non-executive roles at a number of the firm’s notable retail portfolio companies. Sir Stuart Rose, of M&S fame, is now an advisor to Bridgepoint and Richard Baker, who was at the helm of Alliance Boots when it was taken private by KKR in 2007, now chairs Advent International-backed furniture retailer DFS.

There must have been plenty of blue-chip private equity firms willing to pay for King’s skills. So why did he choose Terra Firma, a firm which due to its infamous investment loss relating to EMI – and the subsequent legal battle – has been unable to raise a conventional buyout fund since 2006?

“I wanted a big day job,” says King, speaking days before Terra Firma dropped its case against Citi over its investment in EMI.

His youth relative to other former CEOs meant the chance to get stuck into running a pre-existing portfolio of nine investments, as well as feeding into future investment decisions, contrasted favourably with the less expansive option of advising a buyout firm on individual assets.

“I had lots of discussions about working with individual assets, but the Terra Firma opportunity meant sitting alongside Guy and taking responsibility for the investments we have. The number one value creation opportunity we have is the businesses we already own.”

King did not avoid the media limelight when leading Sainsbury’s and clearly part of his role at Terra Firma is to take some of that limelight from Hands and represent the firm to the media and the wider business community. He comes to our meeting fresh from an appointment at talk radio station LBC, where he has been talking “Brexit” with pugnacious presenter Nick Ferrari. Part of the attraction of Terra Firma compared with other private equity firms was, he says, its attitude to communication.

“It may be pushing it to say it’s unique, but it gives meaningful information on portfolio companies in a way which is more like a FTSE 250 company than a private equity firm.”

There was also clearly a broader meeting of minds between King and Hands, who had – until the former’s appointment – retained 100 percent of the ownership of Terra Firma and had been synonymous with the firm. While King’s appointment – and inclusion in the equity ownership of the firm – was not intended as a succession plan as such (the two men are of similar ages), it has created a clearer picture of how the firm will look in the future.

“Our succession ambition,” says King, “is that between us we will create a new Terra Firma, with longevity and embedded succession plans.”

And that new Terra Firma has now taken shape.

Around the same time as King’s appointment, Terra Firma brought in Peter Miholich as managing director. Miholich, a veteran of the credit space, was, until 2012, global head of strategic equity and head of structuring at Royal Bank of Scotland and latterly responsible for the principal credit business of Nomura.

Earlier this year, the firm added three further managing directors to its bench. Alex Williams joined from energy specialist First Reserve, Jyrki Lee Korhonen joined from northern European firm Triton Advisers and Michele Russo, a veteran of both Doughty Hanson and Lazard, joined having previously established his own GP in Milan, Opera Private Equity, to execute direct secondaries transactions.

The recent spate of hires has provided a welcome reversal following a number of senior departures in the last two years. Among these was renewable energy head Damien Darragh, who left in 2014 as the firm was trying to raise a dedicated renewable energy fund, which is now off the agenda. King frames the departures in the context of generational change: “If you look back at the departures, they left having made a tremendous amount of money as a result of the success of the business over many, many years.”

Other senior team members on the operational side have moved onward and upward to advisory roles at portfolio companies, such as Robbie Barr, who was recently appointed as chairman of Four Seasons Healthcare, or Ingmar Wilhelm, who is chairman of Italian solar energy business, RTR.?

What the firm is doing now, says King, is “recruiting people who want to be with us for the next 10 years”. So is the team complete? “As we start to do new deals, we’ll need more operating partners; so there is still some building to do. If we are successful in growing this business, we will always be recruiting.

“As I have started to talk to people about the opportunity, it’s clear that other people see what I see in terms of the uniqueness of the opportunity versus other private equity houses.”

On the topic of new investments, Terra Firma has been quiet since 2012, when it made the final investment from Terra Firma Capital Partners III in Wyevale Garden Centres.
In February 2015, Hands announced that following a string of successful exits, Terra Firma had €1 billion of “discretionary capital available for new transactions”. This is Terra Firma’s own money to invest; why has it not put any of it to work? Partly because of the market, and partly because the team was not yet in place to do so, says King: “We’ve not been alone in expressing concern at the inflated prices being paid for some assets.”

On the shape of the team, King says: “Look back 18 months and what Terra Firma has become today was just a twinkle in Guy’s eye. We now have the bench strength to be able to start looking [for investments]. We have the balance sheet capital to invest and the opportunity to start having a conversation with our LPs based on new opportunities.”

SUPPORT CAPITAL

Terra Firma will still do conventional private equity deals, but the firm has been busy building its capability to attack two new areas: direct lending and direct secondaries.
What is internally labelled “Support Capital” is what Miholich – with his background in credit – was brought in to develop. It was an idea born, says King, from Terra Firma’s own experiences with ageing private equity funds and assets in need of further capital.

He points specifically to cinema chain Odeon, which was acquired in 2004 by Terra Firma’s second fund and remains in the portfolio (albeit partially realised). “Late in its ownership with us it still had fantastic development potential, but we were past the investment cycle for [Fund II].”

Terra Firma was faced with stopping the execution of its business plan – which essentially revolved around creating the environment for “a great night out” rather than just delivering movies to consumers – because the business was not generating enough cash to fund its own capex requirements.

“We worked hard to find that funding and were successful in doing so,” says King, “But it was clear the price for debt in such circumstances is high, and the equity we would have to give up for an equity investment would dilute our returns on our ultimate exit.”

This experience persuaded the firm that there must be many other Odeons out there: tail-end investments with operational potential, but without the financial headroom to finance plans. So it brought in Miholich to work on a direct lending proposition. “You see this huge field of play – GPs across the whole of Europe – where they have businesses which they don’t yet want to sell because they see a significant value creation opportunity, but have no ability to support the execution of the business plan,” says King.

Support Capital will provide the finance that sits between pure debt and pure equity, says King. “You might call it ‘last in – first out’ equity, or ‘first-call’ debt.”

While direct lending is a departure for Terra Firma, it is by no means virgin territory. For example, 17Capital, which has been operating since 2008, provides flexible preferred equity financing for private equity funds as an alternative to debt or a secondary sale and is currently investing its third fund.

King is confident, however, that Terra Firma’s operational nous – specifically its ability to assess the viability of a business plan and, if needs be, step in to take control – will give the firm a competitive edge in direct lending.

“We are uniquely well placed to do this,” says King, “because if you are going to be a debt provider to a business like that, you are going to have to take a view on how executable the operational plan is.”

This confidence will allow it to offer more favourable terms, he says: “Often the kind of debt provider you would be talking to at that stage in the life cycle of the business would be someone looking for a very high coupon, some really quite tight constraints on the debt with very little room for manoeuvre. We’ll try to make them covenant-lite, to give the management room to move.”

DIRECT SECONDARIES

If the arrival of Miholich gave a clue as to Terra Firma’s foray into direct lending, then the arrival of Michele Russo – a man who recently established a business to acquire portfolios of companies from funds at the end of their life – suggests a foray into direct secondaries. This is exactly what Russo is working on.

“The simple idea is that if you have individual investments trapped in funds that are end-of-life, then you will also most likely have portfolios of investments similarly trapped,” says King.

“This will be very attractive because you have a mutual trap: businesses are trapped with owners who can’t support their business plans. The owners are trapped because they can’t support the business plan and don’t want to exit, as they see themselves selling a lot of potential value. The GP is trapped because they are no longer collecting fees because the fund life has finished. Finally, LPs want liquidity.

“Michele has done that before and we think we are similarly well positioned to step in and take that GP role.”

The two new investment strategies – lending to cash starved portfolio companies and buying up portfolios of assets – both represent moves into markets that could be described as segments of the private equity secondaries market. They are both market segments that are still in their formative stages.

It is not hard to imagine, therefore, a firm with Terra Firma’s infrastructure and €1 billion of capital making a significant splash in either one.

In terms of transaction bite size, the individual loans, says King, will be “in the small numbers of tens of millions”, although the enterprise value of the business could be substantial: “in the hundreds of millions”.

For the portfolio transactions, he is not drawn on how much the firm could invest: “We have a billion to invest; we are not going to invest it all in one idea, but we do have the capacity to make significant investment behind specific ideas.”

“We are not constrained by our own resources,” he continues. “We have LPs on whom we can call.”

Which brings us on to the question of funds and fundraising. Terra Firma will make initial investments directly with its own capital in the first instance – “as clearly we have the ability to do that” – and will then invite others to co-invest alongside it on a deal-by-deal basis. It does not plan to try to raise a blind-pool fund in the near future.

If Terra Firma is to successfully rebuild its reputation as a significant force in private equity, it will do so with two senior figures at its helm, rather than Hands alone. It will also do so by being nimble and moving into nascent markets alongside the world of conventional private equity. It will also do so slowly: one deal at a time.