Put yourself in this position. Your company is divesting one of itsl finance works fast, spends billions, re-packages cashflows and remains coolly focused on his margins. divisions – perhaps a non-core business that isn’t performing well or is diverting management attention from more profitable activities.
You are looking for a way out. You consider the main options – a trade sale or a management buy-out.
Both threaten the prospect of months of gruelling negotiations, haggling over price, terms and methods of financing. With a trade sale, cunning competitors posing as buyers could filch your trade secrets. With a management buy-out, senior executives could use the threat of resignation to get you over a barrel and beat down the asking price.
You seek advice from investment bankers. Most start on a lengthy – and, for them, very profitable – merry-go-round of meetings and financing studies.
Then one of them comes along, cuts through the kerfuffle and offers you straight cash. No wonder that is an offer that seems too attractive to refuse.
In the last two years, Guy Hands has beaten the more ponderous investment bankers with his simple cash-on-the-table approach – the investor buy-out (IBO). He first used it when he bought 1,800 pubs from Grand Metropolitan and Fosters in August 1995, creating Phoenix Inns. But his approach really hit the headlines three months later when he financed the purchase of a third of British Rail’s rolling stock, creating Angel Train Contracts.
He beat off 104 competitors with a cash offer that was #700m, #100m above the nearest contender.
Since then, Hands’s Principal Finance Group at Nomura International has snapped up 57,000 Ministry of Defence houses, AT&T’s equipment leasing company in the US and the William Hill betting shop chain. This latest deal finally brought to an end George Walker’s debt-laden corporate empire, which hit the buffers. Now, other investment banks have started to imitate the principal finance approach – where the banker buys the investment, then lays off the risk through a mixture of restructuring, bond financing and asset sales.
So is this an easy exit route for any business wanting to get rid of a troublesome business? Well, not quite. Principal finance only works for certain kinds of assets. Hands himself describes them succinctly as “cashflow assets in boring industries”. So unexciting but reliable lease revenues from trains, rents from public houses, cashflows from equipment rentals are all in. Not on the table are growth businesses, firms in unpredictable markets, companies that rely on bringing the fruit of complex R&D to market and anything that might pose an unusual or creative business and marketing challenge.
Hands says he is not interested in looking at assets or businesses worth less than #300m. Around 20 propositions a week come into Nomura’s offices at the City’s St Martin-Le-Grand. The bulk of those don’t bear much more than a cusory look. But a few make it to the serious negotiations stage.
In short, principal finance is most at home with big, sturdy, stolid businesses that are growing old gracefully. Chris Hemmings, corporate finance partner at Price Waterhouse in London, reckons there are a “finite number” of businesses that lend themselves to the principal finance approach.
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Hands, a former Eurobond trader, can reasonably lay claim to introducing the concept of principal finance to Britain. For years, investment bankers have arranged the sale of bonds secured against assets. Hands introduced a novel twist into this by taking the asset onto the bank’s own books before securitising it by the sale of bonds.
Moreover, by focusing on the quality of the cashflow from the assets, Hands has often been able to securitise it by issuing triple-A-rated bonds, reducing the cost of financing over alternative approaches. By focusing on the cost of re-financing the asset – and keeping that cost as low as possible – he has often been able to offer a higher price than other bidders, as he demonstrated with the Angel Trains Contract.
What Hands has done is to turn principal finance into something of a financial art form. First, you pay cash for the asset. Next, you securitise the cashflows by issuing bonds. Then you restructure the company, introduce new management disciplines – and sometimes new management – and run it more efficiently in its own right. Finally, you sell it at an enhanced value to a third party. You hope.
Yet this world of leveraged buy-outs has some discordant echoes of the US junk bond activity on the 1980s, some of which ended in tears. But Hemmings points to a critical difference: “Nomura is basically parceling up cashflows, lending against those cashflows, then securitising and selling off bonds with a very high credit rating against them. You could argue that a junk bond is just the same thing but underpinned with much lower quality cashflows.”
Of course, there are huge risks in this approach and while Hands boasts of bringing in $13bn of deals in little over two years – to much applause from the investment banking community – one or two clouds have started to appear on the horizon. First, Hands paid top-dollar for his investments at a time when markets were high – near record levels, in fact. If there is a bear market for the next couple of years – by no means certain, but not impossible – the prices paid could begin to look over-generous.
As Ken Robbie, deputy director at the Centre for Management Buy-out Research at Nottingham University, says: “In investor buy-outs you are going in at a higher entry p/e ratio so that if things do go wrong you may be left with a bit of a lame duck. I think there are a few IBOs which are believed to be in trouble, but that hasn’t really filtered through to published accounts.”
Another straw in the wind is news that Nomura is preparing a #200m junk bond issue to refinance part of its #700m acquisition of William Hill betting shops. The junk bonds will not achieve the triple-A rating Hands has preferred for most of his securitisations. As they represent a higher credit risk, they pay bigger yields to investors at the expense of Nomura’s margin on the deal.
Indeed, the William Hill deal illustrates just how vulnerable principal finance is to both sudden moves in stockmarket valuations and the price paid for assets. Hands was unlucky enough to conclude the deal before world stockmarkets went into free-fall. Although the main markets have recovered some of their lost value, the price paid still looks generous.
One analyst describes the junk bond issue as a “blow” for Nomura which was believed to want to raise more debt on the business. Now it is said to be putting in more than #150m of its own cash.
A key part of Hands’ approach is to securitise the debt as soon as possible.
As a result, his deal-makers are often looking at both sides of the equation at the same time: acquiring the asset and laying off the risk through a bond issue. Despite this, Hands reckons he consummates deals light-years faster than conventional investment bankers. For example, his purchase of pubs from Inntrepreneur was completed in three weeks. The William Hill deal took just eight days. It is certainly not unusual in more traditional investment banking to be still pushing paperwork around a year after the first conversations started.
Nomura Principal Finance moves fast but it is thorough. It gets its hands all over a company, even into those intimate little places which others might regard as too personal to examine. FDs are sometimes surprised by the amount of detail that a Nomura team collects and the thoroughness of its evaluation. When Nomura acquired AT&T Capital, Nomura’s team spent weeks in New Jersey hotel rooms building detailed cashflow models of the business and performing due diligence exercises on the leases.
Hands knows that if he is to offer a top price, he can’t afford any nasty surprises when the assets have fallen into his hands. Even so, he will still pay for assets which many others wouldn’t touch. He bought into Inntrepreneur and Spring Inns pubs despite a string of outstanding legal actions from aggrieved pub tenants.
Traditionally, venture capital used to be all about backing the management.
Hands has turned that logic on its head, but that does not mean he is not concerned about the quality of the management. The value of the assets comes first and the cost of financing second in his calculations but the quality of management runs a respectable third place.
Indeed, on the whole he has retained the management in most of the businesses he has acquired. In some cases, managers find the infusion of investment banking chutzpa reinvigorates their own performance. “I think quite often we can give ideas to management about alternative ways of thinking about the business,” says Hands. “But, at the end of the day, it is the managers who determine the success of the business.” Where they don’t, they take their leave swiftly and unceremoniously.
Hands makes the point that Nomura does not interfere in the day-to-day running of the individual businesses. Indeed, with a small central management team it simply doesn’t have the resources. Nor could it possibly develop the expertise to run companies as diverse as pubs, railway rolling stock and betting shops.
Yet there is no doubt that Nomura’s central team keeps a close eye on what is happening. Nomura managers on the board is common. Hands says: “We review what management of each business does.” Most of his focus is on financial results. “We are looking at how the cashflow is going to perform over a long period of time,” he says. “The reason for that is the fact that it will clearly affect what economically the value of the business will be.”
The main rationale behind Hands’ approach is being able to finance deals more cheaply than rivals. As more move into compete, margins will narrow.
Will that make it more difficult to be competitive? “Yes,” he responds coolly.
How will he tackle sharper competition? One way is to look for more innovative, and cheaper ways, to finance deals. Another is to add value to the management of the companies that shelter under Nomura’s umbrella. “One of the most effective ways of doing that is simply by making the review process of their results as demanding as possible,” he says. That means focusing on financial measures other than short-term profit.
Hands says the Principal Finance Group has already turned a profit for Nomura. But the real profit on each deal can only be calculated when Nomura starts making exits as it gradually turns over its multibillion dollar portfolio.
Even as a boy, it is said Guy Hands would scan the pages of Exchange & Mart looking for profitable opportunities to buy and sell. But it was at Mansfield College, Oxford, that he first made his mark as an entrepreneur.
While other students lived in college or rented rooms in the town, Hands bought his own house from which he ran thriving business ventures. One of his ventures was a door-to-door scheme selling silk-screen pictures.
Hands recruited hard-up students eager to earn a few pounds to supplement their grants.
One such student was William Hague, already a rising young star in the Conservative party. Hands was also active in the University Conservative Association and was said by one contemporary to be “virtually Hague’s political godfather”.
After Oxford, Hands moved effortlessly to Goldman Sachs where he worked at first as a floating rate note trader. It was the early 1980s – the high-tide of Thatcherism. Successful traders demanded – and received – telephone number salaries. Within four years, Hands was head of Eurobond trading at a time when the market was surfing a boom.
Hands is said to have developed the idea of principal finance in the early 1990s, partly by studying the way in which Nomura Securities International was securitising real estate in the US. The door-step salesman, who had peddled pictures in the Thames Valley, had little difficulty persuading Nomura to buy his idea.
by Peter Bartram.