Crash of Kravis-Inspired Candover Shows Woes of Buyout Industry
The leaders of a prestigious European private-equity firm and one of its companies were celebrating at a pair of parties on the French Riviera. It was Sept. 13, 2008. Gerry Grimstone, chairman of Candover Investments Plc (CDI), sipped cocktails and reviewed strategy with executives of the firm’s leveraged-buyout unit on a yacht in Monaco harbor. Two months before, Candover Partners Ltd. had won a bidding war to purchase oil services company Expro International Group Plc for 2 billion pounds ($3.19 billion), then the largest LBO in Europe that year.
That same evening, just a short cruise southwest along the coast, Ferretti SpA was showing off one of its luxury vessels at the Cannes Yacht Festival. As models wearing Bulgari jewelry promenaded on board Ferretti’s new Altura 840 yacht, the Italian boatmaker had reason to cheer. The Candover-controlled company had just received a new order from Dubai for 24 yachts, and it was planning an initial public offering by the end of 2008, Bloomberg Markets magazine reports in its January issue.
Two days later, the collapse of Lehman Brothers Holdings Inc. pushed the global economy into a recession and set in motion a chain of events that led to Candover’s implosion. The buyout unit shut its 2008 fund and is selling assets and fighting for survival. It’s also negotiating to break free from Candover Investments, its publicly traded, London-based parent. And Candover Investments says it will no longer invest in its buyout unit’s funds.
“Candover was a mythical name in the private-equity industry,” says Antoine Drean, founder of Triago, a Paris-based company that finds investors for buyout funds. “Its disappearance is a shock. It shows that even the stars are vulnerable.”
Candover’s saga -- the biggest private-equity blowup since the losses at Hicks, Muse, Tate & Furst Inc. in the U.S. a decade ago -- is emblematic of the industry’s rise and fall since 2005. Dealmakers worldwide deployed unprecedented levels of debt to buy companies at skyrocketing prices, capped by the record $43.2 billion purchase, including assumed debt, of power producer TXU Corp. in 2007 by Kohlberg Kravis Roberts & Co. (KKR), TPG Capital and other buyers. Private-equity firms are now struggling to sell many of these companies for a profit, with stock markets in the MSCI World Index in November trading 27 percent below their 2007 highs.
Returns have been crushed. Half of the private-equity funds worldwide that started investing in 2006 through 2009 were posting a loss of at least 4 percent as of the end of June, according to data compiled by London researcher Preqin Ltd. Investors, also hurt by stock market declines, are cutting their commitments to funds.
In December 2008, Fort Worth, Texas-based TPG Capital let investors scale back pledges by as much as 10 percent in its $20 billion fund. A year later, Paris-based PAI Partners, which managed continental Europe’s largest buyout fund, slashed its 5.4 billion euro ($7.3 billion) fund by 50 percent after its chief executive officer and one of his successors departed, scaring away investors.
More firms may unravel in Europe and the U.S. as part of a consolidation of the industry, says Jon Moulton, chairman of Better Capital LLP, a London-based buyout firm. With many companies in danger of defaulting, interest-rate hikes would spark carnage, Moulton says.
“There are a very large number of leveraged buyouts where, if interest rates rise, there will be massive failures,” he says.
Candover founder Roger Brooke, 79, who studied classics at the University of Oxford, had no experience in leveraged buyouts when he started the firm in 1980. A decade later, Candover Partners produced some of the highest private-equity returns in the world, according to Preqin data.
Candover then veered out of control in the mid-2000s as part of the global buyout frenzy. Its Ferretti deal in 2006 valued the yachtmaker at 12.7 times earnings before interest, taxes, depreciation and amortization, while buyouts in Europe were priced at an average of 8.8 times Ebitda that year, according to Standard & Poor’s data. Burdened with debt, Ferretti defaulted in 2009 as customers rushed to cancel orders. In addition to squandering its entire investment in the yachtmaker and another company during the financial crisis, Candover Partners wrote down the value of three others to zero.
“They lost their souls chasing large and pricey deals in competitive auctions,” says Cyrille Chevrillon, a former managing director at Candover Partners and a limited partner through his own investment firm in Paris.
1 Billion Euro Commitment
Candover Investments stoked its buyout unit’s ambition to grow, pledging 1 billion euros in 2008 to a new fund. The commitment to the fund, which aimed to raise a record of more than 5 billion euros, stirred controversy inside Candover. While Chairman Grimstone, 61, supported the pledge, his predecessor, Stephen Curran, opposed it.
“I wasn’t in favor of the 1 billion euro commitment, which I considered too big compared to the firm’s assets and therefore too risky,” says Curran, a director at the time.
Curran, 67, turned out to be right. The collapse of the stock and credit markets in late 2008 made it almost impossible for the buyout firm to sell companies, which denied Candover Investments the profits it needed to meet its pledge.
So shareholders were already fleeing the parent company when it canceled the commitment in March 2009, causing the stock to be hammered again. The shares plummeted 96 percent to 82.75 pence from Sept. 16, 2008, to April 1, 2009. And the limited partners who had already committed 2 billion euros to the 2008 fund demanded and got their money back.
Offers to Resign
“The commitment of 1 billion euros to a new fund which they couldn’t then honor was a fatal error,” says Brooke, who retired as Candover Investments’ chairman in 1999. “It’s not a particularly happy situation for me where, having started the business, it’s going apart.”
On a morning in late October, Candover’s fifth-floor office on London’s Old Bailey street is almost deserted. During Candover’s heyday in the middle of the decade, its payroll swelled to more than 100 managers and staff spread among five European offices in London, Paris, Milan, Madrid and Duesseldorf. Grimstone leans back in his chair in a sparsely furnished meeting room and says the weeks after Candover’s blowup were some of the most difficult times of his life. He offered to resign to shareholders.
“They said, ‘No, you’re in the hot seat; we like you to be in the hot seat,’” says Grimstone, who’s also chairman of U.K. insurance group Standard Life Plc. (SL/)
Brooke owes his start in private equity to a 1980 meeting with Henry Kravis, co-founder of KKR, whose $30 billion takeover of RJR Nabisco Inc. in 1989 would put LBOs on the map. Brooke says he met Kravis in New York on behalf of his friend, Michael Stoddart, the founder of Electra Investment Trust, one of the first U.K. investment firms focused on private equity. Stoddart was considering investing in a fund raised by KKR, then a four-year-old company that was pioneering the growth of private equity in the U.S.
Brooke says he knew little about buyouts back then. After serving in the British Foreign Office for 11 years, he became in the 1970s an executive or board member of a string of companies, including book publisher Penguin and the Financial Times newspaper, both subsidiaries of London-based Pearson Plc. (PSON) Brooke says talking with Kravis about LBOs sparked his idea of starting a firm.
“Kravis gave me a full rundown on how leveraged buyouts worked,” he says. Kravis explained that large companies were sometimes willing to sell their noncore units. “If you could raise the finances, you could get a substantial share in the company and incentivize the managers of those units,” Brooke says.
Shortly after returning to London in 1980, Brooke started Candover, naming it after a rural valley in the southern English county of Hampshire near where he still lives. The U.K. was in the beginning of a two-year recession, which was driving down asset prices and making buyouts more attractive. Brooke started the firm with 2 million pounds, raising some of the money from state-owned British Rail’s pension fund, BP Plc (BP/), 3i Group Plc (III) and Stoddart’s Electra.
The former diplomat drew on his contacts from his City career to find investors and deals as the firm got going, says Joe Scott Plummer, a Candover director from 1985 to 2003. “Roger was the front man, developing the business,” he says. “He knew how to open doors.”
Candover had to compete with only a handful of U.K. private-equity firms in the early 1980s, including Apax Partners LLP and Cinven Ltd. Brooke hired Curran in 1981 from then-four-year-old Cinven, where he worked as an investment manager. The following year, he appointed Curran deputy CEO, with a seat on the board. Curran, who had previously worked at Coopers & Lybrand, a U.K. accounting and management advisory firm, provided analytical rigor to Candover’s dealmaking, former colleagues at the firm say.
“Roger and Stephen complemented each other,” says Antony Hichens, a director of Candover Investments from 1989 to 2010. “Roger was a charming, ebullient buccaneer, while Stephen was the most scrupulous manager who was always dotting i’s and crossing t’s.”
In 1984, Brooke says, he converted Candover Investments into a publicly traded trust, with Candover Partners remaining its subsidiary, to take advantage of U.K. tax rules that limited the amount of capital gains tax paid by trusts on the sale of assets by subsidiaries. The trust would also invest in its unit’s funds, which accounted for about 12 to 14 percent of total capital raised in the 1980s and 1990s.
Early on, U.K. buyout firms grew more slowly than their U.S. counterparts. British managers mostly confined their dealmaking to their home country in the 1980s and 1990s, making smaller acquisitions than the Americans, who had a larger market to exploit. Candover Partners bought a range of U.K. companies, from Cavenham Foods’ confectionary unit, for about 8 million pounds, to Shepperton Studios. Candover paid about 12 million pounds for Shepperton in 1995 and sold it for 35 million pounds six years later, a very profitable deal for its 1994 fund. The 307.5 million pound fund delivered an annual net return of 42 percent -- still the firm’s best performance to date and among the top 25 percent of returns from funds of that year worldwide, according to Preqin.
Deal Goes Bust
In 1999, Curran succeeded the retiring Brooke as executive chairman, giving him command of both the trust and Candover Partners. The buyout firm began losing its way after 2001 as it moved into continental Europe. Curran led the European expansion, opening the firm’s first stand-alone office outside Britain in Paris, a block east of the Arc de Triomphe. The buyout firm raised 2.7 billion euros for its 2001 fund and scoured Europe for larger deals, increasing the size of loans to finance the acquisitions.
In one such deal that went bust, Candover acquired Ontex NV, a Belgian diaper manufacturer, for about 1 billion euros in 2003, raising 660 million euros in loans for the purchase. It was the largest LBO in Belgium at the time. Candover sold Ontex in 2010, taking a 30 percent loss. The firm’s 2001 fund was delivering a 17.6 percent annual return as of March 31, according to data from the California Public Employees’ Retirement System. Half of the funds of that year worldwide are making more than 28 percent, according to Preqin.
Riding the Boom
By 2006, Candover Partners was riding the buyout boom, executing deals that would help crush it. Armed with a 3.5 billion euro fund for 2005 -- Europe’s sixth biggest at the time -- managers went on a high-priced shopping spree. In 2006, Candover bought 60 percent of Ferretti, whose clients included Sean Connery, Brigitte Bardot and King Hussein of Jordan. The deal valued the yachtmaker at 1.5 billion euros.
“Candover stretched its commitments too far, paying high prices for companies like Ferretti and borrowing too much to finance the deals,” says Per Olofsson, manager of alternative investments at AP7, a pension fund firm in Sweden that owns almost 5 percent of Candover Investments.
After 25 years at Candover, Curran stepped down as executive chairman in 2006 and became a director. The trust’s board appointed Grimstone, then a director, to replace Curran as a nonexecutive chairman. In contrast to Curran, Grimstone says, he didn’t directly manage the buyout firm. Marek Gumienny and Colin Buffin, who had worked for Curran at Candover Partners, were appointed co-heads of the firm.
Grimstone was eager to increase the leverage on Candover’s balance sheet to fund its growth, says Iain Scouller, an analyst who covers the company at Oriel Securities Ltd. Before arriving at the trust in 1999, Grimstone served as a senior civil servant at the U.K. Treasury in the 1980s and then rose to vice chairman of global investment banking at London-based Schroders Plc. (SDR) At Candover in November 2007, Grimstone raised 150 million pounds from a U.S. bond issue, a move cheered by the trust’s shareholders, as the buyout firm began to explore possible deals in Poland, Russia and Asia.
“When a company’s old guard leaves, there’s a natural desire for people taking over to change things and expand,” Curran says. “And if you expand too much too quickly, you can lose control.”
Gumienny, 51, and Buffin, 52, made more room for their growing staff by renovating office space at Candover’s Old Bailey headquarters. The firm redecorated the premises, hanging abstract modernist paintings on the freshly painted brilliant white walls.
“They tarted the whole place up,” Brooke says.
As new investment executives joined, the quality of the team deteriorated, says Chevrillon, who resigned as managing director in 2006.
“When you push for a deal and are enthusiastic about it because it’s your deal, the others have to be able to throw cold water on it,” he says. Buffin could not be reached for comment, and Gumienny declined to comment for this story.
Curran’s resignation from the board in December 2007 meant that Candover lost a meticulous executive who set an example for the rest of the firm, says Doug Fairservice, deputy chairman to Curran from 1999 to 2004. Curran departed as the board was leaning toward making the pledge of 1 billion euros, or about 20 percent of the 2008 fund. Curran, who as chairman oversaw contributions of about 14 percent to two funds, says he viewed the larger commitment to the 2008 fund as dangerous.
“Stephen was a hands-on manager, as indeed was I,” Fairservice says. “We were hands-on managers of the companies we owned but also, more importantly, of Candover itself. Some of the later guys at Candover were not.”
Reneging on the Pledge
The board decided to make the funding pledge in March 2008 as credit markets were tightening and Bear Stearns Cos. was collapsing. Four months later, Candover Partners did its biggest deal ever. The firm was part of a consortium that won a bidding war against Halliburton Co. (HAL) for oil services company Expro International and managed to secure 1.4 billion pounds of loans to fund the transaction.
By early 2009, Candover began to crumble under the weight of its deals and the 150 million pound bond issue, which Grimstone now calls a mistake. As Candover wrote down Ferretti and other assets and as prospects for selling companies vanished with the crisis, the trust risked breaching its bond covenants if it funded the pledge.
Two months after Candover reneged on the commitment, sending its stock into a nosedive, Grimstone confronted angry shareholders at the company’s annual meeting. The May gathering was held near Candover’s head office at Founders Hall, a wood-paneled assembly room with paintings of City dignitaries on the wall. A humbled Grimstone apologized.
‘Deeply Regret This’
“Clearly, Candover is not in good shape at present, and both I and your board deeply regret this,” he told his audience in a written statement.
Candover Investments is now winding down. The trust says it’s selling assets to return cash to shareholders.
“We don’t actually have the capacity to anchor a fund,” Malcolm Fallen, the recently appointed CEO of Candover Investments, told reporters in August.
Candover Partners is negotiating with the trust with the goal of spinning itself off by the end of December, people familiar with the talks say. The future of the firm and its 13 remaining buyout executives hangs on whether they can sell their remaining 12 companies at a good profit and restore investors’ confidence, Oriel Securities’ Scouller says.
26.4 Percent Annual Loss
Candover Partners lost its investment in U.K. food tester Alcontrol Group Holdings Ltd. and suffered a 40 percent loss on its investment in U.K. betting shop operator Gala Coral Group Ltd. after debt restructurings. The buyout firm also wrote down the value of Swedish bedmaker Hilding Anders AB and two other companies to zero.
Candover managers hope to boost returns with some of their profitable investments, such as French defense company Qioptiq. The buyout firm’s 2005 fund is posting a 26.4 percent annual loss as of March 31, according to Calpers. Funds of the same vintage are showing a median 1.6 percent annual loss, according to London researcher Preqin.
“The real issue of this firm has been poor investment performance,” Grimstone says.
John Arney, 42, who now heads Candover Partners after Buffin stepped down and Gumienny became chairman in 2009, is one of the firm’s best dealmakers. Arney, who joined in 2002 after working for buyout firms 3i and JPMorgan Partners LLC, led the acquisition of Houston-based Vetco Gray Inc. in 2004. Candover and other investors sold the oil-drilling-equipment firm to General Electric Co. (GE) for $1.9 billion in 2007, quadrupling their initial investment. Arney declined to comment for the story.
‘Chance to Survive’
“If Candover comes back to its original strategy of medium-sized U.K. deals, it has a chance to survive,” Chevrillon says.
Candover Partners will compete in a shrinking industry. Firms will make smaller acquisitions using less leverage, says Peter Morris, author of a 2010 report on private equity published by the Centre for the Study of Financial Innovation, a research group in London.
In 2007, firms led $717 billion of leveraged buyouts, according to data compiled by Bloomberg. The deals in the U.S. and Europe were valued at about 9.7 times Ebitda on average, according to Standard & Poor’s. And managers used debt to fund about two-thirds of the price, S&P says. In the first 10 months of 2010, firms led $173 billion of LBOs worldwide as banks resumed lending. Deals in the U.S. were valued at 7.7 times Ebitda in 2009, and debt funded about half of the price.
“Some buyout firms will go out of business, and some may merge,” Morris says.
Exactly two years after Lehman Brothers’ failure, leaders of the buyout industry were back on the French Riviera. On Sept. 15, about 300 fund managers and investors gathered in Monaco for the industry’s annual Capital Creation conference at Monte Carlo’s Meridien Beach Plaza Hotel. On the agenda were such topics as “What do general partners need to do to survive the next 5 to 10 years?”
In 2008, on the same stretch of the Riviera, Candover executives had toasted their own good fortune. This time around, they didn’t show up. After two years of watching their companies tumble and investors flee, they weren’t in a mood to celebrate.