From its headquarters at 2 More London Riverside by the banks of the River Thames, the HgCapital team is able to enjoy a stunning view. On this day in particular, that view takes a lot of beating: the sun is shining, the sky is blue and pedestrians are ambling sedately past rows of decorative fountains. Despite gloomy news coverage of everything from economic woe to potential flu pandemics, it's possible to believe for a moment that all is well in the world.
Gazing out at this benign scene from the large glass window of a meeting room is a quartet of European mid-market investment specialist HgCapital's key personnel: chairman Ian Armitage, chief executive and head of the TMT sector team Nic Humphries, client service and fundraising head Craig Donaldson and head of portfolio management Lisa Stone. To imagine that the assembled group is equally as carefree as those strolling beneath the window might be stretching credibility. After all, we are – lest we forget – in the middle of what Armitage goes on to describe as “the mother and father of all recessions”.
But despite this being what is often delicately described as a “changed world”, some of the optimism generated by the spring warmth is clearly shared within these walls. A sense of relish evident, Armitage insists that current market conditions – bleak as they may be in many ways – nonetheless represent “a great buying opportunity”.
Such an opportunity last arose, Armitage continues, in the early 1990s – and he recalls with regret that it was one the firm missed. At the time, Hg predecessor Mercury Development Capital (MDC) was part of UK fund management company Mercury Asset Management (MAM). The firm raised its first institutional fund in 1987, but the momentum was not destined to last.
“By 1989,” says Armitage, “it was clear that we had made a poor start. I took over [as chief executive] in 1990 and the fund was in bad shape. With Frances Jacob [current Hg Capital chief investment officer], we dug it out of a ditch. But we missed a period around 91/92 where it was a great time to invest. The proverbial monkey with a typewriter could have made money at that time.” One indication of the hard work involved in turning round the fund was the fact that the next fund was not closed until 1997 – some ten years after the raising of the prior vehicle.
FREE AT LAST
It was in the same year as the 1997 fund closed that investment bank Merrill Lynch acquired MAM. Three years later the Mercury team had the opportunity to spin out and, in 2000, the independent HgCapital was born. Armitage says he now felt free from constraints. As a captive firm “there had been budgetary controls [meaning an inability to invest more in a resource-based approach], a lack of carried interest and the consequent difficulty of hiring the best people”.
We missed a period around 91/92 where it was a great time to invest. The proverbial monkey with a typewriter could have made money at that time
In fact, Hg had managed to lure a few key professionals prior to 2001 based “on the potential for a spinout”. The skills being sought were the result of soul-searching by Armitage and others as to the type of firm they wanted HgCapital to be – as a consequence, some key decisions were made. The firm would, for example, remain focused on the European mid-market and have a sector-based approach. Other conclusions were equally as critical – and explain the presence of two people gathered round the table today. Stone joined in 1999 from UK motor parts firm LucasVarity, where she had been director of strategy and business planning, to spearhead portfolio management. The following year, Donaldson was brought into the fold from Prudential Global Asset Management in the US – where he had marketed alternatives funds to non-US institutions – because it was decided the firm should have a dedicated in-house fundraising resource. Going forward, “portfolio management” – as it's now commonly known – would be fundamental to the HgCapital philosophy. At the time of Stone's arrival, however, it was a function that didn't have a label. Stone recalls it arose from the belief that “within mid-market companies there were many things you could do to improve performance by working closely with them to maximise sales, improve operating margins and strengthen management teams.”
What followed was an attempt to have portfolio management professionals working in harmony with the firm's deal-makers. It was, in effect, an acknowledgement that private equity professionals are most productive when playing to their strengths rather than attempting to be all-rounders. Says Donaldson: “The private equity process has six key aspects: you decide the type of business you want to buy; you originate the opportunity; you evaluate how to create value; you win the deal; you deliver portfolio support; and you make sure you are a disciplined and effective seller. If you do all that well, there's a danger of making good money. But the rub is I've never met anyone who has all those different skill sets and personality traits.”
Hg's recent results would suggest that the firm's strategic approach has served it well. Since raising its last fund in June 2005, the firm has realised 30 investments, including 16 since the onset of the credit crunch, at an average multiple of 2.7 times cost. It is now relatively under-invested compared with its peers and is arguably therefore well placed to take advantage of lower prices.
With a dedicated team of seven at the time of writing – and plans afoot to recruit one more – it's clear that this is one GP viewing portfolio management very seriously at a time when such skills are in high demand. It is also clear that the firm views effective integration of the portfolio and deal teams as crucial. “Culturally, going down the road we've gone down is a huge shift [for a private equity firm to make],” reflects Stone. “There are different models in relation to portfolio management. It's common to have it separately labelled and separately remunerated. Ours is totally integrated – and that includes same pay, same remuneration structure and same status. It's difficult to have cultural parity without economic parity.”
This commitment to integration is also apparent in the way HgCapital sources and executes its deals. It would be easy to assume that a kind of “passing of the baton” occurs whereby deal professionals execute transactions and then colleagues in portfolio management look after acquired companies once they are residing in the Hg stable. In fact, Stone says the portfolio management team is involved from very early in the deal-doing process, with a member of the team providing input at investment committee level. This allows the team, she says, to “see what's coming down the track and buy into the plan rather than just taking a handover of someone else's deal.”
It's also the point at which serious consideration is given to three areas relating to any new business proposal: is there a “clearly articulated” commercial hypothesis; are there operational measures that can be taken to deliver on the hypothesis; and can the current management deliver? Stone is quick to point out that these questions do not cease to be asked once a deal has been done. “It's our ongoing responsibility to address these issues,” she says. She also highlights that she or a colleague in portfolio management will always have a seat on the board of portfolio companies, alongside a second seat taken by a deal professional. When it comes to planning exits from investments: “We're working on the story, we're helping management teams with their presentations and we' reworking the M&A angles.”
If all that sounds like hard work, how much more daunting is the prospect of integrating 61 bolt-on acquisitions? That, nonetheless, is what Stone and colleagues have achieved on behalf of portfolio companies in Hg's last two funds. Donaldson says: “Having a portfolio team to help integrate these companies has been very helpful. But these demands highlight that you can't just switch to portfolio management overnight – it took us four years to really start seeing the benefits.” Humphries takes up the theme: “There are two portfolio management models that we don't subscribe to. One involves bringing a bunch of external consultants in-house and the other is going out and hiring lots of ex-chief executives. There's some merit to the latter approach but they may be at a point in their careers where they don't really want full-time roles. Alternatively, they may still think they should be in charge.” Humphries himself has now taken the reins at Hg. Having joined from US-based venture capital firm Geocapital Partners in 2001, he became chief executive – while continuing as head of the TMT sector team – in August 2007.
Just prior to Humphries' arrival, the firm had begun to undertake a review of its activities – something it does every three or four years. Humphries says: “It was seven years after the spinout and the competition were doing a lot of exciting things like opening overseas offices and launching debt funds. There was a lot of expansion going on and we wondered whether we were missing the boat.”
LESS CAN BE MORE
In the end, Humphries continues, the partnership reached “a dull and slow conclusion”. He explains: “We asked ourselves whether we should try and build teams in places like Warsaw, Mumbai or Shenzhen or whether we should put all of our resource into the things we were already focused on and getting pretty good at. We concluded that less really can be more and that there was a great opportunity for us to focus on our core strengths.”
This is not to say, however, that HgCapital is resistant to change. In February this year, the firm closed its consumer and leisure sector teams in order to concentrate its efforts on healthcare, business services, technology and industrials. Explains Humphries: “We had six teams and each was a bit small. We thought it was better to have four larger teams than six smaller ones. We wanted six or seven people in each team. Healthcare, TMT, industrials and services together cover about 70 to 75 percent of the economy and they are complementary.”
At the same time, the firm announced it was closing its Amsterdam office (only two professionals were based there) – leaving in place just the two existing strongholds of London and Munich. From here, HgCapital targets opportunities across Northern Europe. Humphries insists that being without an office in the Benelux region – and indeed the Nordic region, where the firm has been highly active – has not been a hindrance. “People said you can't fly in and out of Scandinavia if you're not one of the established local players, but you can if you have a lot of experience, good networks and sector expertise.”
We had six teams and each was a bit small. We thought it was better to have four larger teams than six smaller ones
Donaldson makes the point that the firm “is not interested in planting flags around the world”, but rather identifying opportunities in specific sub-sectors and then executing deals wherever the opportunities exist. He cites the example of Visma, a Norway-based accountancy software business which HgCapital acquired in a public-to-private transaction in 2006, and whose organic sales have doubled under Hg's ownership, according to Donaldson. Armed with prior experience of backing similar businesses such as Iris Software in the UK and Addison in Germany (which was sold to Dutch publisher Wolters Kluwer for a 3.7 times return last year), he says Hg was confident in its ability to identify the best management teams within that particular area.
Developing sector expertise is something the firm places great stall by. One of its boldest moves was the launch in 2004 of a renewable energy team headed by Tom Murley. “Initially, people thought we must be muesli-eating sandal-wearers,” quips Armitage. “But clients said, ‘okay, we'll support it – so we built a dedicated team and started making investments.” The firm raised a €300 million first-time fund for investment in renewable energy projects in 2006 – billed on the firm's website as “the largest fund for European renewable power projects”. The firm waited two years before raising its fund in order to make sure the model was tested and proved.
Having already marked itself out as a house committed to the fledgling renewable energy sector, HgCapital believes that reaping the benefits will take time – but will be worth it in the end. Says Humphries: “You've got to decide you're in it for the long term. Everyone piled into debt funds a few years back. It was seen as instant money, but it turns out to have been rather more difficult than that. Renewable energy is hard work. You get one or two people in and you build a team around them. Then you get a flywheel effect.”
The flywheel effect is what happens when something that has been given momentum by an external force finally generates its own independent momentum. It seems a good analogy not just for HgCapital's renewable energy business but for the business as a whole since its spinout in 2000. Despite the economic headwinds, this is a firm continuing to move forward steadily and relentlessly. If that sounds a little unsexy, it's a quality many investors admire in these volatile times.
HGCAPITAL AT A GLANCE