Sir Robert Smith has gone full circle. Last month, the former dealmaker was appointed non-executive director at London-listed global private equity provider 3i Plc, in effect returning to the industry in which he made his name.
Smith ranks as one of the founding fathers of the UK buyout market. While in charge of Charterhouse Development Capital and later at the helm of Morgan Grenfell Private Equity (MGPE), Smith led some of the biggest and boldest buyouts of the 1980s and early to mid-1990s. The returns he delivered, a no-nonsense management style and a natural way with the media made him a star in an industry that had only just begun to move from obscurity into the mainstream of (then still genuinely British) corporate finance.
At the time, Smith was having a ball. When, in 1996, he left the industry in order to take charge of Deutsche Bank's asset management business, it was a move that surprised many. He was, after all, thought of by many as king of the hill of UK private equity. As a former colleague puts it: “Back then he was the UK's Henry Kravis.”
3i's invitation to sit on its board also takes Smith even further back, right to the origins of his career. He first joined 3i, then trading as the Industrial and Commercial Finance Corporation (ICFC), on 2 September 1968, one day after qualifying as a chartered accountant.
Walking along the corridors of 3i's corporate headquarters on London's Waterloo Road today, Smith will be acutely aware that it's not just the company's offices that have changed since he first arrived in London on an overnight train from his native Glasgow 36 years ago. “It was obviously a slightly different animal back then,” he says with deliberate understatement.
THE BRIGHTON YEARS
We meet in the still empty bar of a Holborn hotel early one morning in mid-September. Smith has stopped on his way from Scotland to a first proper heart-to-heart with Philip Yea, 3i's recently appointed new chief executive whose board he will be serving on. What better way of warming up for that meeting than discussing where UK private equity came from and where it is going? Smith first confirms that that really is what I expect him to talk about. Then he gets going and stays on the subject for a packed 90 minutes. Talking to journalists is obviously still fun.
Smith starts right at the beginning: ICFC in the lat€1960s. He describes the still relatively small, though rapidly expanding, quasigovernmental organisation set up immediately after World War II in 1945. ICFC was founded to help plug the then-existing funding gap that was constraining the growth of small and mediumsized businesses in Britain. “Quasi-governmental” may not conjure up images of a particularly dynamic, entrepreneurial environment. To Smith, however, with its sprawling branch network that already reached into every regional hub of corporate Britain, and with a commitment to encouraging talent to show initiative and take responsibility right from the start, ICFC was just the place.
During his accountancy training, he tells me, he'd taken a paper titled “Investigation and valuation”, which dealt with mergers, takeovers and acquisitions. “I don't know why, but I just ate that paper. It fired my imagination.” Audits and accountancy he was enjoying much less – no surprise there – and upon reading an ICFC advertisement in an accountancy magazine that asked, “Are you big enough to advise small companies?”, Smith decided here was a group he wanted to be part of.
He joined an organisation that was making a multitude of often small equity investments all over the country, at times providing development capital in chunks as small as £5,000. UK venture capital was in its infancy. Buyouts were unheard off altogether. Unlike ([A-z]+)-based investors Gresham Trust and Charterhouse Development Capital, ICFC wasn't just a commercially driven entity at the time: “We were on a social mission. There was always this feeling that we were genuinely helping small businesses.”
After stints in Reading as a trainee, London, Glasgow and the Channel Islands, Smith became head of ICFC's Brighton Office, coordinating investment across Surrey and Kent at the tender age of 28. It was a baptism of fire: “They blooded you early, they trusted you, allowed you to get out and take risk.”
Smith's coming of age as an investor was a £60,000 investment that went bust within a year. “I was on £1,600 a year then. If you lose the equivalent of 40 years of your salary, the lessons are deeply seared into your soul. My mentors took me through everything that had gone wrong with the investment, but they also said to me: “If you go risk-averse now, you'll be no good to us”. They told me to go out there, keep taking risk and get back the money I lost.”
THINGS LIKE CARRY
And so he did, helping to make ICFC an important driver of the development of corporate Britain. Many years later, in 1983, he left the organisation and joined The Royal Bank of Scotland as general manager of corporate finance in London. Soon after, the Edinburgh-based bank acquired London rival Charterhouse, and Smith insisted that with his background, he should run that bank's already existing development capital business.
This was the time when Smith and a small number of London-based professionals were beginning to get their arms around a revolutionary new investing technique: management buyouts.
Visits to America had opened Smith's eyes to how private equity investment worked in the States – “we found they had a thing called “carry”” – and a number of other UK financiers had got that same message as well. In addition, US and Japanese capital was pushing into London, eager to back people willing to pioneer buyouts in Britain.
Much of the early US money came from foundations and private trust, and Smith recalls raising capital from the likes of Pittsburgh-based industrialist Henry Hillman as well as KKR co-founders Henry Kravis and George Roberts, who both invested from their own pockets. These were exciting times for everyone: “I remember Henry looking at our numbers going, “how can you be making money from these crappy little companies?” He was doing RJR Nabisco. We were doing Bristow Helicopters.” When I tell him of his former colleague comparing him to Kravis, Smith replies he is flattered, but also insists that the Wall Street trailblazer has always played in a different league.
With the first dedicated funds ready to invest in the early 1980s, UK buyouts started to roll. Of course there were obstacles, regulations for example: Section 54 of the UK's Companies Act prevented businesses from acquiring their own shares, which made buyouts difficult to structure. “Section 54 was a very tough test. We used to have to hive down assets, liquidate companies and reconstitute them. The technology involved was unbelievable.”
Eventually the rules changed, but only after, as Smith puts it, “people realised that no one was out to rip off creditors or shareholders, and that buyouts were in fact legitimate.”
As the market evolved, Smith and the Charterhouse team invested in a diverse range of UK. In 1987 came a genuine groundbreaker. Smith led the £715 million buyout of furniture maker MFI, a deal that for its time was simply enormous. “MFI was four times the size of anything that had been done before. Nobody had ever raised £200 million of private equity and £500 million of debt for a buyout, and even we didn't know whether the market could take it. When it was all done, [MFI chief executive] Derek Hunt said to me, “We thought you knew what you were doing, Robert, but you clearly you haven't done anything like this either!”,” he laughs.
If UK private equity had been on an upward trajectory already, MFI was the deal to really drive the market forward. Smith himself became hot property as well, as new players were itching to get involved and saw this Scotsman as a key rainmaker. He says: “I came to a wee bit of notice then. Head hunter characters came to me because funds started to spring up everywhere now.” In 1989, UK merchant bank Morgan Grenfell came along with an offer that he couldn't refuse.
Smith doesn't beat around the bush when explaining why he agreed to move to a firm to which private equity would be a whole new ball game. “They said to me, ‘start with a blank piece of paper, hire your own guys, whoever you want, and we will give you a percentage of the equity. At Charterhouse, we weren't getting any carry, so this was obviously significant.”
Wasn't there also an upfront personal sweetener for Smith himself? I ask the question reluctantly, expecting him to be guarded about the personal terms of the deal. As it turns out, he likes to talk about that too: “Oh yes, the legendary golden hello,” he beams. “It's actually true. £1 million, absolutely unheard of. I mean, corporate finance types were getting the occasional golden hello, but private equity?”
Sir Robert Smith
The business had clearly started to come of age, and dealmakers were getting more aggressive. Six months on gardening leave prior to being able to join Morgan Grenfell meant Smith was sidelined during the bidding for Gateway, the supermarket chain later known as Isosceles, the heavily geared buyout that today is remembered as one of the UK's greatest private equity disasters ever. “I remember sitting at home thinking, “I should be involved in this”, but it was probably a case of the gods looking down and keeping me out of a market that by then was getting too toppy.”
Under Smith's stewardship, Deutsche Bank-owned MGPE flourished. Then, in 1996, Deutsche's asset management business hit trouble after it was discovered that fund manager Peter Young had been bending the rules. Smith was asked to investigate, a number of individuals lost their jobs, and after the dust had settled, Deutsche asked him to run the whole of DeAM.
Why did he accept? Smith says that at 52 years old, he liked the idea of a new challenge. Any regrets? None, he says: “Venture capital was my life, and backing a small company and watching it grow was very exciting. But here was an opportunity to manage a global business with several thousand employees. And I'd been doing venture almost since I was straight out of school. You do move on to other things.”
As vice chairman of the asset management business, Smith continued to have ultimate management responsibility for MGPE. But DeAM took up most of his time. The founder of the business was no longer actively involved.
Smith doesn't dwell on the asset management chapter, which lasted until he retired from Deutsche in 2002. A year before that, the bank had asked him one more time to be its trouble-shooter. MGPE was in tatters after the now infamous investment in SLEC, the company owning the rights to Formula One, fell over. Smith moved in and took over as interim CEO.
A management-led buyout was considered one way in which the situation could be resolved, an option that one source close to the situation says Smith was keen on at the time. Smith says: “I looked at every possibility including a buyout and discussed it with the troops. But at that time, the buyout was probably not on. And I would have had to make a commitment of five to ten years, which would have been personally difficult for me.”
In the end, the MGPE name was scrapped, the team dissolved, and the remaining assets were rolled into the portfolio of investments that was later acquired by the managers of DB Capital Partners, who in February 2003 spun out of Deutsche to set up MidOcean Partners.
With tales of these and other battles Smith has fought in his career in mind, I put it to him that people who worked with him remember both as charming and aggressive individual. One former colleague said to me before the interview: “Robert has a magnetic personality, but don't let that mislead you. He also scares a lot of people.”
Smith doesn't mind that. “Scared? I can be aggressive in negotiations, and I use bad language a lot, but I don't think I've ever done anyone down. I will fight my corner, sure I'll fight my corner. But I hope I don't have too many enemies out there. I think of myself as a fairly amusing character to work with.”
He tells how during the MFI buyout, he crossed swords with a senior lawyer sat across the negotiating table. As Smith became aggravated, the lawyer stayed unnervingly calm. ““Thank you for making this concession” he'd say. I said, “look, it's NOT a concession.” But the guy wouldn't blink: “Thank you for conceding the point”.” Smith was beside himself. “I was furious, because I was losing points that I knew I shouldn't be losing. But he was so overbearing, just playing with me. I nearly went round the table and hit him.”
After the deal was done, the two shook hands and talked about the showdown. “I told him I wasn't often defeated in negotiations, but that I just hadn't been able to deal with his calm. He replied, “Robert, I can confess to you now that on several occasions, I was physically frightened”.” Smith visibly enjoys the anecdote: “A lot of it was just play acting, to get what you wanted. But I'm glad to hear some people were a wee bit terrified,” he laughs.
BEATING ASSETS INTO SHAPE
After Smith's move into asset management in 1996, the buyout market shifted gear yet again: ever larger funds were raised, US firms arrived in droves and, together with their UK peers, began the push into continental Europe. Smith says that after him came people who took the industry way beyond what he had done, or even could have foreseen. “The growth of this industry is an astonishing story, absolutely astonishing,” he concludes.
He's also aware that some of those who succeeded him made bigger fortunes. Any regrets there? Smith insists not. “Of course, I could have made more money. But I'm not poor.” And that is that.
Sir Robert Smith
Neither does he accept that operating in the more institutionalised and crowded environment that has emerged since he left might have been be less fulfilling – let alone less profitable. He dismisses the idea that today's market is excessively competitive. “It's always been difficult to find deals. The key is still to persuade vendors to take a solution to a problem they didn't even know they had. Whenever you thought that the last buyout had been done, the market moved on. Take buy-ins for instance. In the early days, we never thought of changing management. If management didn't seem good enough, you'd tiptoe away. Then, suddenly, you had management teams going round asking us to find them businesses they could run.”
Smith has seen this kind of strategic transformation of the business many times. The industry's ability to innovate is one reason why he remains a firm believer in private equity. Another is its ability to generate superior returns. He says the asset class remains fundamentally attractive. “This business is about people who can identify the right management team to take an asset behind the bicycle sheds for three year, beat the merry hell out of the thing, bring it back and say, look at the shape this is in now. You can't do that easily with a listed company. Private equity is a far superior process to transform an asset, and if you are a pension plan or a life company, you absolutely need it as part of your portfolio.”
THOUGHTS ON 3I
Smith also applies the same optimism to 3i. The group has had well-documented difficulties in recent years. Along with the rest of the market, it suffered from overly enthusiastic early-stage bets placed during the technology boom. The UK office network, so fundamental to the company's modus operandi in Smith's youth, has now been decimated. A recent effort to raise fresh third-party capital for buyouts in Europe failed to reach target And, a number of senior investment professionals have left the group.
Smith agrees that there are challenges facing the group. “3i has changed. The social mission isn't quite there the way it was.” However, discussing how it should go about its business in the future is not for today's conversation: “I haven't even been to a board meeting yet.”
Smith is one of those individuals whose retirement seems largely nominal: his diary is still jam-packed. He serves as National Governor on Scotland on the board of the BBC, which he says takes up two and a half days of his week alone. He is to step down from the board later this year. In addition, he is chairman of Scottish companies The Weir Group and Southern Energy. Other interests include work on corporate governance reform – from 1997 to 2000 he was a member of the Financial Services Authority and in 2003 oversaw the publication of The Smith Report – and, away from the markets, Britain's museums. Smith has spent nearly 20 years actively supporting museums in Scotland and England, work for which he was given his knighthood.
Despite the full agenda, he clearly is keen to get back to working with 3i. “The firm is run by very talented people,” he says. “It's a very international board, [chairman] Baroness Hogg is an absolutely exceptional person, and Philip Yea, who isn't a 3i lifer and comes in with a new perspective, is an inspired appointment.”
With that, he's off to see the new man in charge of his old turf. Expect 3i to benefit from Smith's hands-on input and enthusiasm.