Happy to be captive

Earlier this year, Chris Masterson succeeded Ian Forrest as head of HSBC Private Equity.

In Europe, HSBC Private Equity manages GBP1.2 billion of funds, one third of which is bank money. In Asia, the private equity business manages $1 billion in funds, perhaps 10 per cent of which is bank money the Asian business developed independently during the 1980s and has a classical LP structure, whereas the European business is a Partnership Scheme’ effectively a series of co-investment arrangements. The Latin American private equity business, based in Buenos Aires, currently handles funds of $100 million through the HSBC Tower Fund and is currently fund raising to boost that total to $400 million.

In conversation with EVCJ, Chris Masterson outlined his take on private equity and plans for taking the firm forward.

What attracted you a) to private equity and b) to HSBC?

I’ve been doing private equity since leaving Manchester business school in the early 1980s and joining 3i. I think the reason I joined then is that it struck me as being like doing business school case studies with real money. I soon found out that private equity wasn’t like that at all, but it is a business where one gets a significant degree of responsibility finds oneself at the sharp end very quickly. That can be quite scary at 23 if you aren’t sure what you’re doing. But, if you are in business at all, private equity is not a bad job to be doing, because it involves constant exposure to all aspects of business, finance, strategy, marketing, operations and constant involvement, unlike corporate finance, where one takes a fee and moves on. That type of total immersion is very rewarding.

Following my time at 3i, I worked at Castleforth Fund Managers, which ran Business Expansion Scheme (BES) funds. The BES reached the natural end of its product life cycle towards the end of the 1980s when legislative changes made it very difficult to invest the funds in the way originally intended. In 1991, with its main raison d’tre gone, Castleforth merged into what was to become Royal Bank Development Capital, and I joined what was then Midland Montagu Ventures (MMV), which was looking to recruit a new team.

The attractions of joining a good organisation with a strong market position that is also facing succession issues are self-evident. And, when HSBC took over Midland Montagu shortly afterwards, it couldn’t happen soon enough for our liking we were excited about the possibilities that the HSBC brand could open up for the private equity business. We wanted that label, and the concomitant credibility as soon as possible: the HSBC name effectively gives the entree to any boardroom on the globe and that, of course, is hugely valuable.

We didn’t actually get the name for some time, going through an interim period under the Montagu Private Equity label before rebranding as HSBC Private Equity in 1994. And that label has been of tremendous assistance to us.

How has HSBC PE evolved during your time with the firm?

It has changed a lot. In the early 1990s, although not exactly passive, MMV didn’t lead deals very often it was much more a participant. During the mid- and later 1990s, the firm worked to build a position as a deal leader, and was relatively innovative in the deals it led. We undertook 19 privatisations during the 1990s, including three ports and five bus companies, and structured early public-to-private’ deals of public sector operations.

The view we took then, and still take now, is: “If we can find a competent management team, we’ll find a way of financing them on a profitable basis, whatever form that may take”. We were in a position to benefit from the restructuring of the UK market, which at the time was the focus for some 90 per cent of our business. The forces at play were clearly beneficial to private equity: following the UK’s ejection from the ERM in 1992, there was a broadly upward economic trend and presuming you didn’t actually go out of your way to shoot yourself in the foot private equity players, particularly those using leverage, could not fail to benefit.

At that stage we were operating in the mid-market, looking at enterprises values in the range of GBP10 million to GBP80 million or so: GBP100 million would have been a huge deal then. We were quite aggressive in terms of going out and doing business and quadrupled our investment rate to GBP100 million per annum from 1992 to 1996. At the same time, we produced very good returns.

Is HSBC PE still firmly rooted in the UK or are you genuinely pan-European?

From 1996 onwards, HSBC Private Equity has undergone big changes in structure and strategy, inasmuch as it is meaningful to talk in grandiose terms about strategy’ in the context of private equity, which is essentially an opportunistic business. The biggest change was the decision to raise external capital and thus give ourselves the ability to do control deals without having either to find a partner or to sell down. The other major project has been to ensure that we developed as more than a UK-centric operation, to be able to capitalise on the same economic forces that had benefited us in the UK as they came in to play albeit perhaps less strongly in France and Germany. We established offices in France and Germany, together with an operation in Sweden. Those are the three main markets where we have focused our efforts (faring better so far in Germany than in France) and we have also enjoyed some success in Switzerland with deals like Schaffner, which netted us four times our money. In France, we have really done just a handful of deals, but they have been profitable: Manoir Industries is a good example.

In Germany, one transaction of particularly note was Evotec, which returned nine times cost on its Neuer Markt listing. Evotec was an early-stage biotech deal, and to be honest, we hadn’t really cracked the German LBO market until earlier this year with BBA. That transaction has woken up a lot of people, and HSBC is now recognised as being a serious group in the German private equity market place.

The HSBC subsidiary in Germany, HSBC Trinkaus and Burkhardt, works closely with HSBC Private Equity and has begun to pay real dividends. Both our visibility and the degree of interaction we enjoy in the German market have increased immensely.

Is it significant that the firm closed its largest deal months after you stepped into the driving seat?

Probably half of the transactions we seriously consider come to us courtesy of HSBC’s footprint. Capital is, after all, a commodity, and all private equity firms have teams of bright people, so the differentiating key is quality deal flow. HSBC as a global bank contains a vast number of people interacting with a vast number of corporations, and in consequence, a vast number of potential opportunities for us are sitting on their desks. The question is finding them, harnessing that resource within the group.

BBA came to us via that route: an individual within the bank had lunch with the head of BBA’s frictional materials division and called us to say that the business was potentially for sale. That kind of lead is like gold dust. I want to make sure that that individual’s contribution is recognised, and that it is known elsewhere within the bank, to ensure that there is a focus on private equity opportunities across the board. That is a huge and on-going internal marketing job.

Many investors now seem to prefer independents to

semi-captives. Do you think this will affect you at all?

There seem, broadly, to be two strategic models for private equity. There are former captives that have spun out of commercial banks, something you see most in the UK and Germany. In the US, while there are obviously many independents, there are also some very successful captives operating as an integral part of financial parents, such as DLJ and Chase. These groups demonstrate that you don’t have to be independent to be successful and I feel strongly that the very opposite is true. As long as a private equity house’s relationship with its parent is not dysfunctional, and it can efficiently harness deal flow channelled through its parent, then it is in a very strong position.

Investors are naturally concerned as to whether a captive private equity player’s principal driver is returns on the capital invested or fee-earning for its parent. I don’t think that stands up to scrutiny. In our own case, the bank invests one third of the capital we deploy in Europe and the other two thirds is external money. Our rewards as a team are based entirely on returns. HSBC expects to put GBP500 million of its own money into European private equity over the next four years or so, and a sum like that is clearly not a loss leader.

Having said that, the HSBC group does compete always at arm’s length with other candidates to provide other services to companies in the private equity portfolio. I would never give soft work’ to other groups within the bank, because all I would reap from that would be disbenefits.

Like some of the major US investment banks, HSBC sees private equity as part of its core offering as well as being a highly profitable business in its own right.

We are vigorously pursuing a strategy of integration and trying to leverage on the opportunities offered by our proprietary deal flow and to avoid it leaking’ to other groups. That is the biggest challenge I face but there will be a huge payoff if I get it only a quarter right. And if I don’t, I won’t be here! Traditionally, around half of deals originate within the broader HSBC group, and that is our competitive edge.

Is there any new area where HSBC PE is planning to make its mark?

HSBC is a global business with private equity structures in place in three regions: Asia, Europe and Latin America. Five years ago, these businesses were run as independent silos of expertise, and didn’t really interact. Today, the three work as a coherent unit with reporting and management structures that encourage us to talk to each other. That opens up another field of opportunity. We now have weekly conferences, and you’d be amazed by what comes up sometimes, especially on the technology front.

Given that both our investor base and our investees are operating global businesses, we obviously need to adopt a similar perspective. In the European and Asian markets, we are targeting business with an enterprise value of between GBP50 million and GBP400 million: with a very few exceptions, these businesses will not be purely domestic operators, and many of them are genuinely global. Our investors, meanwhile, want to invest where the returns are, irrespective of geography. It is therefore nonsensical to think purely in UK, or even European, terms.

Wherever HSBC Group has a significant geographical presence and a sufficient footprint to interact with a significant proportion of the corporate population, is where HSBC Private Equity wants to do business.

The acquisition of CCF in France is a case in point. CCF has an excellent network of corporate and private client relationships if we can make them work for us. We are already looking at two or three very interesting details that have come to us via the CCF network.

How would you describe your investment philosophy?

At the early board meetings in the course of a private equity investment, it is common for there to be an atmosphere of “freeing the slaves”. At the very first board meeting, whether the company in question is a privatisation or whether it is a spin-out from a larger corporation, we say that we are not going to be discussing anything that is not involved with making money or, perhaps more broadly, increasing the value of the business. Instead, we ask the managers how they are going to turn the company into something of ten times the value in the next five years and remind them that, if they can do that, then they will make more money than they may ever have dreamed of.

We tell managers to clear their minds of inessentials and to focus on creating value. And that’s a formula that works everywhere from deepest China to Sao Paulo. We want them to become proprietors as well as managers in their outlook.

What, for you, is HSBC PE’s most memorable deal?

Speaking personally, it is Innovex. The company, which provided support services to pharmaceutical groups, was founded by Barrie Haigh around 1980. We invested in 1993 to support Innovex’s acquisition of a business from Boehringer Ingelheim in Germany. The company grew very quickly thereafter and HSBC provided a further funding round in 1996. The business ultimately merged with Quintiles, a US clinical research services operator, at a valuation of around $600 million. Not only did the deal provide us with a stellar financial return but it also allowed the chance for me to sit on a company’s board during a three- to four-year period during which it transformed itself from being a domestic supplier of sales and marketing services to being a global provider of sales and marketing, clinical research and statistical analysis services, with a leading US market position in certain of its fields. It was an amazing process to observe in terms of realisation of a successful strategy and the consequent creation of value.

If you could choose one thing to be the legacy of your tenure at HSBC PE, what would it be?

That when they think of HSBC Private Equity, they think of a business that is a successful and influential player in every market globally where the HSBC group has a significant presence.

If you look at where HSBC Private Equity has made its money over the last ten years, then Europe is prominent.

Another legacy might be the harnessing of the internal deal flow and incentivising people to ensure that the bank’s presence works for us in an integrated fashion.

Our message to our investors is always: “If you invest with us and remember, HSBC itself is always the biggest investor in each deal then you will have access to an excellent proprietary deal flow that you won’t see anywhere else”.