By remote control

By Alistair Blair, 03 March 2010

There's a lot to admire about Guy Hands and his private equity operation Terra Firma even if, like me, you're inclined to attribute a lot of the success of private equity to two decades of gearing in a bull market. Although private equity has carried this off with some élan, the fact is that a large element of its success is due to taking risks which its investors ignored at the time, but which may yet come home to roost as the sector's gargantuan borrowings fall to be refinanced about two to three years from now. It is a sign of what is to come that 3i has lost three investments in 10 days, writing off £400m.

But if you read the Terra Firma annual report, it's tempting to see in its investments some grander and longer-term design than in the average private equity portfolio. Indeed, the report itself is quite laudable. Although signally failing to answer many important questions about Terra Firma (for example, what returns it has made, how much debt there is and when it falls due), it stands leagues ahead of those of most rival private equity operators.

Mr Hands has also made some endearing comments about the recent financial madness. He recently told the New York Times that, because private equity funds grew so large, their 2 per cent annual fee - arrived at two decades ago as a way for the small original private equity firms to cover their working expenses - "had become an entirely unwarranted windfall - as important as the 20 per cent" - the 20 per cent being the profit share that was the original incentive for private equity managers back in the old days. Two per cent of a £5bn fund is £100m a year. It does not cost anything like this sum to run a private equity manager, unless everyone is ridiculously overpaid.

Guy Hands, as the sole owner of Terra Firma Capital Partners, would appear to be in a unique position to do something about this. He may have cause to do so very soon. Every three months, Terra Firma's biggest investment - EMI - has to demonstrate to Citibank that its cash profits exceed a certain percentage of its debt (of around $4bn). If it looks like failing the test, Terra Firma can put some cash into EMI to ensure a pass and it has done this several times already. But most onlookers have now arrived at the judgement that EMI will struggle ever to repay its borrowings in full. So there's probably no longer any point in Terra Firma putting more money into EMI unless Citi takes a haircut. And Citi is adamant that it won't - at least, not one as severe as sought by Mr Hands.

This process has triggered several events and disclosures which are decimating Guy Hands' reputation. The first is his spectacular lawsuit alleging he was tricked into buying EMI by a senior Citibanker advising EMI, who convinced him that he had to pay £2.4bn in the closing moments of an auction. Whereas, according to Mr Hands, the other bidder had dropped out. Countless City auctions have been concluded by over-representations of the strength of the seller's position. Caveat emptor. The idea that such a powerful player was a mere jessie in the EMI auction would be an interesting one for a jury to consider.

Last year Guy Hands quit these shores for low-tax Guernsey. This was well known. But in an effort to persuade the New York courts to hear his case, rather than the London courts, Mr Hands has spelt out how his tax exile is an absolute: he has not set foot in the UK since last April and will not to do so for a further two years except in the event of a compelling personal or family emergency. From this it follows that, although most of the significant action in Terra Firma and many of its investee companies occurs in London where the great majority of Terra Firma's 100 employees are based, whenever any of them or anybody else in its portfolio of companies needs to meet Guy Hands, they have to fly out to his new home in Guernsey.

If Guy Hands was merely the sole owner of Terra Firma Capital Partners that might be fair enough. But in that role he is responsible for around €10bn of equity, most of it ultimately provided by ordinary pension savers and policyholders. Many of these would ask themselves whether Mr Hands can properly fulfil his responsibilities if he insists on removing himself from the action.

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