3i suffers as turmoil cuts net asset value

The UK’s biggest listed private equity group, 3i, reported its first negative returns for five years on Thursday as a sharp rise in provisions for potential investment losses and a drop in valuations took their toll.

The credit crunch has triggered a sharp deterioration in conditions for private equity groups, which use investors’ capital and bank debt to buy companies, cutting the value of investments and limiting banks’ willingness to lend them new money.

While 3i is viewed as one of the more defensive private equity groups because of its strong mid-market focus and wide geographic diversification, it has ultimately proved to be vulnerable to the financial crisis.

In the six months to September, 3i said its total return to shareholders was a loss of £182m against a profit of £512m in the year-ago period. Shares in 3i, which have lost almost half their value in a year, fell 10.5 per cent to 529½p.

It is the first time 3i’s returns have turned negative since 2003, the year before Philip Yea took over as chief executive at a time when the group was still suffering from the bursting of the dotcom bubble.

The group said it still managed to make a profit of £190m from disposals. But this was outweighed by a drop in its remaining portfolio, which was hit by falling valuation multiples, reflecting the stock market decline, and provisions for potential losses.

Mr Yea defended the performance as “resilient”. He argued that, while 3i made a negative return of 4.5 per cent in the year to September, the FTSE 100 fell 24 per cent in the same period.

Net asset value – a key indicator of private equity performance – fell for the first time in five years from £10.77 per share in March to £10.19 in September.

Mr Yea said a further fall was likely in net asset value for the six months to March. “We do believe that in the second half we are seeing a weaker position,” he said.

Provisions for potential bad investments jumped to £248m in the period, as Mr Yea said the group had adopted a more conservative valuation technique, using forecast earnings rather than historical figures for a third of investments.

One rare piece of good news was that operating costs, minus fees from external funds, fell 13 per cent to £93m in the first half, within a whisker of 3i’s target for costs to be 3 per cent of total portfolio value.

3i has cut its headcount by 34 to 738 and last month announced the closure of its Menlo Park office in California, as part of its exit from venture capital.

Investment and realisation levels both fell by almost half. Mr Yea said 3i was looking at several potential deals but stressed that “the hurdles that any deal has to clear are extraordinarily high”.