In the 67 years since it was established by the Bank of England and the major British banks to provide long-term investment funding for small and medium-sized enterprises, London private equity house 3i Group plc has recovered from many mistakes and regularly redefined its business.
Yet the venerable, listed firm stands accused once again by shareholders of having lost its way and is being punished accordingly. Its stock has spent the last year trading at a 30%-40% discount to net asset value, and activist investor Laxey Partners Ltd. is agitating to have the company freeze investments and start selling assets until the gap closes.
Even the May 17 appointment of a new CEO, former Greenhill & Co. International LLP chairman Simon Borrows, failed to boost the share price. The stock simply continued its slide, uninterrupted, as the week drew to a close.
Analysts at J.P. Morgan Securities Ltd. gloomily argued that Borrows will find it difficult to fix the company's problems overnight and downgraded the stock from overweight to neutral. In the media, some commentators have called for 3i to distribute its 34% stake in separately listed 3i Infrastructure plc among its own long-suffering investors as a prelude to breaking up the company. The infrastructure and debt management businesses are seen as rare bright spots in 3i's crepuscular outlook.
Could the pessimism be overdone? Borrows certainly has his work cut out to change investor mood, given the wider context of recession-hit Britain and a crisis-stricken euro zone in which he has to work. But the company hardly seems a lost cause.
Having joined the company six months ago as chief investment officer, the new CEO has had time to identify the areas he plans to shake up and revitalize. He has already begun work on improving investment discipline and managing existing assets. His next task will be to ask -- and answer -- more fundamental questions about the firm's private equity business. Is the network too ambitious, for instance? Are there too many offices spread across too many geographies? While Brazil, which outgoing CEO Michael Queen poured resources into last year, remains exciting, other emerging-markets operations may not repay the additional investment they would require to grow.
Borrows says he has not yet "done the granular exercise to verify those views," and he won't elaborate on his current ideas about operations in China, India or other parts of the Far East. But by the time he puts the new strategy to the annual general meeting of investors at the end of June, that homework will be done. Rethinking the firm's strategy in China, for instance, could be fruitful. The market has become increasingly competitive, and there are worrying questions about economic bubbles and the speed of future growth.
Borrows also wants to cut costs across the 3i network and is keen to reduce the firm's £1.6 billion ($2.5 billion) gross debt and its similarly sized liquidity pool, much of which is cash. The new chief executive argues that both far exceed what a private equity firm requires to do business, even though 3i has traditionally invested off its balance sheet and cannot rely solely on limited partner funds to make acquisitions.
Reforming a business the size of 3i will take time. Poor investments in Southern Europe will need to be managed patiently, as will exits from whichever geographies Borrows decides to give up. Success will depend in good measure on Borrows' skill in presenting himself to investors as a different kind of leader from the conservative Queen, ready to abandon some of his predecessor's most cherished projects.
But he will also be building on reforms already begun by the outgoing CEO. It was Queen's readiness to slash the debt left behind by his own predecessor Philip Yea that saved 3i from collapse in the credit crunch. It was Queen who agreed to return regular cash to shareholders but fought to ensure dividends and distributions do not take leverage above 20%. Queen restructured the private equity business, replacing the top people at the London office. And it was Queen who built up the successful debt management unit while ending Yea's experiment in investing in listed companies.
Borrows is starting from a better place than investors acknowledge. At once more radical than Queen and more of a dealmaker than a career manager like Yea, he has a chance to restore the old firm's reputation. No wonder analyst Iain Scouller of Oriel Securities Ltd. takes the opposite view from J.P. Morgan. He sees value in 3i and is keeping the stock as a buy.