Legend under scrutiny

Christopher Flowers should be making hay. But at the outset of an historic buying opportunity, why are some of his firm's limited partners running for cover? Matt Levin and David Snow investigate

For Christopher Flowers, this should be his moment in the sun.

The most severe credit crisis in 80 years has left the financial services landscape on both sides of the Atlantic littered with broken banks, busted brokerages and crippled insurance companies in desperate need of capital and expertise.

For one of the most widely respected financial services investors in private equity, all this low-hanging fruit should appear ripe for the picking.

But at present, for Flowers and his eponymous firm, the fruit tastes surprisingly bitter.

The firm faces considerable uncertainty in raising its third fund, according to multiple market sources. Some LPs in JC Flowers's troubled $7 billion second fund are looking to trade out amid plummeting portfolio company values. This is despite Flowers himself remaining something of a star – if a reluctant one – with many GPs and LPs eager to do deals with this highly connected and knowledgeable financial whiz.

It often seems that Flowers pops up anywhere in the world where there is a troubled financial institution to be saved. Most recently his low-profile firm, New York-based JC Flowers, was among seven equity investors in the $13.9 billion acquisition of IndyMac Bank, a failed US lender.

When the first rumblings of the credit crisis felled Bear Stearns in spring of last year, JC Flowers was there, reportedly offering to pay $3 billion for a 90 percent stake in the now-defunct investment bank.

When a more severe wave of financial tumult rocked the global credit markets in the autumn, the firm was splitting its time between a last-ditch bid for flailing insurance giant AIG and serving as financial adviser to Bank of America in its $50 billion all-stock acquisition of Merrill Lynch.

JC Flowers's place at the epicentre of finance surprises no one familiar with the man or the firm. But what has many industry veterans scratching their heads is that despite Flowers's reputation for opportunistic brilliance, his firm is increasingly looking like the victim of a classic mistake in private equity: investing too much, too soon.

The struggles have prompted some investors in the firm's second fund, which closed last year on $7 billion, to seek a way out. According to two secondaries specialists familiar with the fund, at least 10 limited partners have explored selling their stakes on the secondaries market. At the time of writing there existed virtually no buyer's market for those stakes, according to the sources.

One LP says that, according to third-quarter 2008 performance figures from JC Flowers's second fund, the capital put to work has already been written down by approximately 50 percent. This investor, who stresses the interim nature of the results and the fund's recent vintage, says he expects the fourth-quarter numbers to look worse. Flowers himself declined to comment for this article.

Late last year, JC Flowers informed its limited partners that it would seek to raise a third fund in the early part of 2009. The vehicle faces an uncertain reception from investors. According to one current LP, committing to the next fund would be “a tough sell. I'd have to go before an investment council and explain why, given the performance of the previous fund, I want to commit to the next”.

Polite and serious; thin and bespectacled; reputed chess aficionado. Graduated from Harvard University in 1979 magna cum laude with a degree in applied mathematics (he is still a major donor to the university and endowed a professorship in his parents' honour in 2003). Hired by Goldman Sachs, where he ultimately became managing director of the firm's financial institutions group. The CV is striking, but compared to many other well educated general partners, it is by no means extraordinary. What really set Flowers off from his brethren and earned him the mantle he enjoys today was the lucrative turnaround of Long Term Credit Bank of Japan (LTCBJ).

After leaving Goldman in 1998, Flowers teamed with Ripplewood Holdings founder Tim Collins in 2000 to lead a consortium of investors in a $1.2 billion turnaround investment in LTCBJ, which had been saddled with bad debts and had needed repeated government bailouts. Flowers and Collins helped assemble a bevy of talented banking pros to assist with the restructuring, including former Federal Reserve chairman Paul Volcker and former Paine Webber Group chief executive Don Marron.

“He saw early on how you could work with the Japanese government, and he had the patience that it took to get the deal done,” says Marron, now chief executive at New York financial services buyout firm Light year Capital.

In a well-documented restructuring involving the reshaping of divisions and job shedding, Flowers and Collins famously steered the rebranded Shinsei – literally, “new day” in Japanese – to a $2.5 billion public float in 2004. That IPO yielded Flowers and his partners a 6x return on committed capital, and the deal was widely lauded as one of the most successful in private equity history.

Shinsei was for Flowers what Continental Airlines was for TPG founder David Bonderman – a reputation maker. Springboarding from the Shinsei deal, Flowers was able to firmly establish JC Flowers and Company and close a $900 million debut fund followed by a $7 billion second fund.

Along the way, Flowers won admirers as well as many well capitalised co-investors.

One adviser says a GP once told him that Flowers is the one person with which he would do a deal, “no questions asked”. The source adds: Flowers “can see both the macro and micro. He's able to see the forest and the trees at the same time”.

JC Flowers rapidly deployed capital from its two post-Shinsei funds, including a new investment in Shinsei in 2007.Many of these investments are now underwater.

According to one current LP, committing to the next fund would be “a tough sell”

Most notable among these is Hypo Real Estate Holding, in which a consortium including Flowers, Shinsei and real estate private equity firm Grove International Partners invested €1.1 billion last June.

The consortium paid €22.50 per share for a roughly 24 percent stake in the Munich-based commercial real estate lender. Not only were Hypo's shares trading at €3 at the time of writing, but the lender has received upwards of €50 billion in bailout money from the German government to stave off insolvency.

Flowers's investments in publicly listed German bank HSH Nordbank and Bermuda-based brokerage house MF Global Limited are also trading well below the original per share investment price. Flowers was involved in a $1.6 billion investment for a 24 percent stake in Nordbank in 2006, and agreed to invest a minimum of $150 million in MF Global in May 2008.

It is difficult to analyse the performance of investments Flowers has made into private companies over the last two years, and it is possible that these are performing considerably better than their public counterparts. Those investments include stakes in Indian financial services conglomerate State Industrial Corporation of Maharashtra; Italian wealth manager Euromobiliare; and a carve-out of the life insurance unit of BISYS Insurance Services.

Several financial services investors and limited partners say off the record that a case could be made that Flowers was a victim of unprecedented turbulence in the sector in which he invests, and that he's far from alone among financial services investors in suffering now.

But others are less generous. One LP says he declined to invest with Flowers because it seemed like his firm was “run like a one-man show”.

But, for many investors, Flowers remains the go-to guy for financial services. From Don Marron's perspective, he would partner up with Flowers without hesitation.

“You can do a deal with him [Flowers] on a handshake. That's a very important thing in our world. He's very hands-on, so he knows exactly what's going on and he's a brilliant guy.”