Nothing to hide

When Sir David Walker’s report on transparency and disclosure first came out, it was met with scepticism by a large segment of the media and the political community. The levels of disclosure were too low, the skeptics cried, bring in regulation!
Yet even the asset class’ strongest critics are unlikely to challenge Terra Firma Capital Partners’ approach to transparency. Going far beyond Walker’s prescriptions, the London firm provides more details in its first annual report than many public companies.
The much-vaunted UK transparency initiative drawn up by the ex-Morgan Stanley chairman limited the reach of its voluntary guidelines to companies with 50 percent of their revenues in the UK and 1000 UK employees. Companies bought in non-public to private bids with an enterprise value of more than £500 million (€660 million; $993 million)will be expected to comply; while companies bought in take-private bids should have a market capitalisation of £300 million.
Under this ruling, Terra Firma would be required to report on EMI, its music business portfolio company, Odeon/UCI, the cinema chain, and Annington, a property company. Yet the company chose to report on its entire European portfolio, disclosing profits for companies smaller than the Walker threshold and those which have the majority of their revenues outside the UK.
The firm’s founder Guy Hands said at the time: “The simple truth is we have nothing to hide. Private equity should not be clouded in secrecy, but explained… This role as a catalyst for change is private equity’s most useful economic and social function. We believe that only when firms become open and transparent will people appreciate this.”
The annual report showed that firm paid £15.2 million in corporation tax, income tax and national insurance to the UK Treasury on income of £46 million and profits of £3 million. More than £200 million of interest was paid by Terra Firma’s UK businesses to UK banks in the year and they paid £78 million to advisors based in the UK.
Terra Firma also disclosed the remuneration of its staff, a level of disclosure explicitly ruled out by Walker as a detail for a firm’s limited partners alone. The firm disclosed that it paid its senior management of 15 an average of £665,053 or a total of £8,978,216 in salaries and bonuses in 2007. Hands, characteristically, used the report to make his views known on the UK government’s decision this year to raise capital gains tax on carried interest at a higher rate of 18 percent, above the present 10 percent rate.
The report said: “Taxing long-term capital gains more like annual income will encourage businesses to be less long term in their approach.” He warned: “Such trends in UK taxation, making the UK a less competitive financial centre than it was, have caused us to review our UK activities and may result in future growth being pursued through our other European offices.”
This move would please a number of staff that are already foreign nationals and who have expressed a desire to be located outside the UK.. Yet currently Terra Firma staff based in the UK pay UK taxes.
A spokesman said Hands’ firm would stay in the UK and continue to be a UK private equity firm.
The message from the firm was clear. It showed willingness to reveal more than was asked for about the firm’s activities, in what could become a new benchmark for private equity firm disclosure.
Yet it also asked private equity’s critics in government and the media to consider further steps on taxation carefully in recognition of the competitive globalised world.

The price of transparency
The firm put money where its mouth is investing “approximately €325,000 and around 2,000 hours in making information on Terra Firma and its businesses more accessible.” The cost in time and money highlights why smaller firms were keen to stay outside of the scope of Walker’s report and why other firms may be chagrined to see Hands widen Terra Firma’s reporting to include its entire portfolio.
Peter Cornell, Terra Firma’s managing director for stakeholder relationships, says of the cost of the report: “It was a significant sum, but we didn’t spend it begrudgingly. We wanted to get out on the front foot and do much more than pay lip service to Walker. We saw it as an opportunity to tell people what we are doing.” The firm says it will continue to report with the same level of disclosure over the coming years. “It’s early days but there’s nothing that startled us. I’m sure there will be things we’ll tweak but we won’t change the general approach,” says Cornell.
This may begin to raise issues for the firm in the coming years as the world enters an increasingly hostile economic environment. But Cornell is nonchalant about people scouring through the report to publicize the firm’s problems. “What it is is what it is. As long as we’re telling it correctly, the fact it may be more gloomy is less important.”
Cornell says it does not matter that the firm has put many of the details of the company on display. “With the information given out there, if people want to dig deep they can. Everyone [in the team] was adamant we should be transparent the way we have been from the middle of last year when the draft Walker report came out.”
The argument is something which an advocate of transparency must put forward, but in a world where appearance is highly important, one can understand reticence from Terra Firma’s peers are accustomed to doing business in private. As yet, the firm has disclosed more than most of its competitors who have filed Walker-compliant annual reports, including Bridgepoint, Cinven, Doughty Hanson, Montagu Private Equity and Permira. The firms with companies under the Walker criteria have also begun to issue specific portfolio company reports.
Terra Firma has gone to such measures because it would prefer reporting standards to remain voluntary.
“The point about the voluntary stuff is it is the right way forward. In order to preserve it we need to make sure most people do a decent report,” he says. The people Cornell has spoken to from larger buyout houses are convinced it is worthwhile conforming to the Walker Report, making him confident the voluntary approach will be adopted wholeheartedly.
Transparency may be expensive and potentially inconvenient, but it is preferable to actual legislation.
Arguably, through voluntary compliance the industry can turn the system of reporting into persuasive public relations, and nothing speaks to this better than the positive reception Terra Firma’s report has received within the media and in the business community.

Teamwork
Despite the report’s high costs, much of the labor was taken on by Terra Firma’s own team. Cornell says: “The design work was outsourced, but most of the crafting had to come from the team. It was quite time-consuming for our own people because of the way we approached it. [With outsourcing] I don’t think it would be much more expensive to go beyond what we did. If you just comply with Walker it may cost less.”
The key individuals on the project included Cornell, as well as Cormac O’Haire, a finance director at Terra Firma, and Michael Hewett, head of investor relations. Cornell was formerly global managing partner of Clifford Chance, a global law firm, O’Haire was chief financial officer at Dresdner Kleinwort, a German bank, and Hewett was principal and director at Atlantic-Pacific Capital, a placement agent.
The firm was keen to include a high level of detail, but keep the report accessible. “We wanted to be transparent and to make it user friendly. We didn’t want to hide behind any jargon so you can look at the report and understand the portfolio,” Cornell says.
The firm also used the report to demonstrate its commitment to its people and emphasize its wider role in the community, Cornell says. A move that is arguably necessary in the case of Terra Firma, which is linked within both the private equity community and with the wider public to the mercurial figure of Hands. Terra Firma’s founder is a high profile figure in the City of London, having set up the firm for Nomura in 1994, before leading its spin out to become Terra Firma in 2002.
Yet a glance at the firm’s report reveals not only the successful executive experience of the team, but humanizing touches. We are told Hands has an interest in photography, gardens and spending time with his family. Cornell enjoys skiing, surfing, golf and tennis, while Mike Clasper, one of the firm’s operational managing directors and former chief executive of BAA, the UK airport company, supports Sunderland Football Club, an underdog in the world of English football.
The firm donated more than £500,000 in 2007 to various channels including the Prince’s Trust, a charity set up by the UK’s Prince Charles, the PE Foundation, the private equity industry’s charity, and 10 percent of profits generated in 2006 and 2007 towards the Terra Firma Charitable Trust. The latter trust has backed The Unicorn Theatre, a professional theatre for children in the UK, Create, which uses the creative arts to improve the lives of disadvantaged and vulnerable people, and Bloomfield Learning Centre, which provides diagnoses and tuition for children with learning difficulties.

Facing the music and dancing
It is fitting that Terra Firma is one of the most transparent nonpublic private equity firms as in one of its latest investments it has thrust it into the media limelight, perhaps more so than any other firm in the UK. The €5.9 billion buyout of EMI closed just as the problems in the credit markets finally became apparent last summer.
Due to the declining fortunes of the worldwide music industry the firm’s attempts to turnaround the struggling company are likely to be challenging.
Yet rather than retreat from the limelight, Terra Firma has decided to conduct its turnaround in the public eye. The firm is cutting between 1,500 and 2,000 jobs at the company and targeting a £200 million ($392.6 million) per year cost reduction drive. As this goes on, high profile spats have dominated the magazine supplements and music sections, as music acts like Radiohead have left the label while Terra Firma’s cost-cutting takes effect.
The success of the deal is of importance to Terra Firma’s returns. The firm has invested close to 30 percent of both its €2.1 billion second fund and its €5.4 billion third fund in the transaction, according to a source close to the company.
But it would seem in today’s changing markets the transaction is unattractive to debt investors. Citi solely underwrote the transaction, and it reportedly failed to syndicate £2.4 billion of the debt related to the deal during its attempts to sell on $12.5 billion loans to a private equity consortium, according to Financial Times. This is arguably related to debt investor risk aversion in current markets, rather than any specific problem at the company.
Despite the difficulties, Terra Firma has recruited a crack management team, including Douglas Merrill, former Google chief information officer, and Nick Gatfield, the artists and repertoire specialist, who among other successes at Universal and Island Records, helped sell Amy Winehouse, the highly popular UK singer.
The firm has undertaken reputable turnarounds in the past such as Angel Trains and Le Meridien, underlining its track record to achieve in the EMI deal. The success of the firm in the ambitious project would lead to a fixed music industry, according to Hands.
Many in the markets are skeptical that even a firm as successful as Terra Firma at turnarounds will be able to pull the feat off. But if it does manage to do so the firm is likely to bring credit on the whole industry for fixing a company that many feel was in decline.
Given the firm’s open approach to disclosure, transparency’s champions in the industry will be hoping that the deal goes well for Terra Firma. Should other firms see Terra Firma continue to receive positive comments for its open approach, more will presumably follow suit as a public relations move. Should EMI falter, the poster child of transparency may look less appealing to those who remain wary of baring all.