12th May 2005 07:01
3i Group PLC12 May 2005 12 May 2005 3i Group plc announces intention to return £500 million of capitalto shareholders on back of strong performance • Total return on opening shareholders' funds of £512 million • Realisation proceeds of £1.3 billion • Proposal to return £500 million of capital to shareholders Preliminary results for year ended 31 March 2005 Total return on opening shareholders' funds 15.9%Net asset value per share 603pFinal dividend 9.3pRealised profits on disposal of investments £260mNew investment £755m- Including co-investment funds £962mRealisation proceeds £1.3bn- Including co-investment funds £1.7bn Highlights • A total return of £512 million representing a return of 15.9% on opening shareholders' funds. • Realisation proceeds on the sale of assets of £1.3 billion generating realised capital profits of £260 million. Equity realisations were made at an uplift of 40% over opening values. • Investment in the year of £755 million (£962 million including co-investment funds). • Full year dividend of 14.6p, up 4.3%. • Announcement of intention to return £500 million to shareholders through: - a special dividend of approximately £250 million and - an on-market share buyback programme of approximately £250 million. Baroness Hogg, Chairman of 3i Group plc, said: "Our last financial year was ayear of progress on many fronts. The results for the Company are a good financial performance and strong cash flow, an enhanced competitive position and opportunities to grow value for shareholders in the years ahead. Our very high level of realisations has afforded the opportunity to return £500 million to shareholders, thus improving our capital efficiency." 3i's Chief Executive, Philip Yea, said: "I believe we have made good progress inthe acceleration of 3i's development as a truly international private equityfirm. Our returns have been such that it makes sense to propose a return ofcapital to shareholders." Commenting on the outlook, he added: "Despite the hesitancy apparent in thefinancial markets I intend to report good progress towards our performance andstrategic goals in the year ahead." Return of capital to shareholders3i is focused on delivering a strong performance in terms of return on equity.In this context, the Board has carefully assessed 3i's capital base and intendsto return £500 million to shareholders. The Board proposes to pay a specialdividend of 40.7p per share (approximately £250 million). This dividend is to belinked to a consolidation of shares and, if the consolidation is approved byshareholders, the dividend is expected to be paid in July. The Board also proposes that, subject to shareholder approval, the balance of about £250 million (representing approximately 6% of 3i's issued share capital at 3i's current share price) will be returned through a programme of on-market purchases of 3i shares commencing in July. On the basis of current market conditions, it is likely that these purchases will be executed at prices which exceed 3i's latest published net asset value per share. It is intended that shareholder approval for these proposals will be sought atan extraordinary general meeting to take place immediately following the AGM on6 July. A circular convening the EGM and giving more information and detail onthe proposals is expected to be sent to shareholders in June. - ends - For further information, please contact: Philip Yea, Chief Executive Tel: 020 7975 33863i Group plcSimon Ball, Finance Director Tel: 020 7975 33563i Group plcPatrick Dunne, Group Communications Director Tel: 020 7975 32833i Group plcIssued by: Philip Gawith Tel: 020 7379 5151The Maitland Consultancy For further information regarding the announcement of 3i's annual results to 31March 2005, including video interviews with Philip Yea and Simon Ball (available7.15am) and a live webcast of the results presentation (at 10.00am, available on demand from 2.00pm), please see www.3igroup.com. Notes to editors3i is a world leader in private equity and venture capital. We focus on buyouts,growth capital and venture capital and invest across Europe, in the UnitedStates and in Asia. Our competitive advantage comes from our international network and the strengthand breadth of our relationships in business. These underpin the value that wedeliver to our portfolio and to our shareholders. Chairman's statement 3i's business, balance sheet and board have all developed considerably thisyear. The results for the Company are a good financial performance and strongcash flow, an enhanced competitive position and opportunities to grow value forshareholders in the years ahead. In summary, a year of progress on many fronts. Our very high level of realisations has afforded the opportunity to return £500million to our shareholders, thus improving our capital efficiency, withoutcompromising our ability to grow. Each of our Buyout, Growth Capital and Venture Capital businesses has improvedits competitive position in the year. Our strategy of developing the businessinternationally has progressed well and some 48% of 3i's portfolio value is nowoutside the UK. A total return of £512 million for the 12 months to 31 March 2005 represents a15.9% return on opening shareholders' funds, marginally better than both theFTSE All-Share (15.6%) and the FTSE 100 (15.4%) total return indices in the sameperiod, and ahead of 3i's share price. The Board is recommending a final ordinary dividend of 9.3p, making a totalordinary dividend of 14.6p, an increase of 4.3% from 14.0p last year. Looking forward, the Board intends to achieve the return of an additional £500million to shareholders through a combination of special dividend and sharerepurchases. The Board therefore proposes to pay a special dividend of 40.7pper share (approximately £250 million) as soon as practicable after the AnnualGeneral Meeting on 6 July. The Board also proposes that the balance of about £250 million be returned to shareholders through a programme of on-market share buybacks beginning in July. Resolutions relating to both the special dividend and buyback proposals will be put to shareholders at an Extraordinary General Meeting we plan to hold immediately following the Annual General Meeting. In my interim report to you I noted that the appointment of Philip Yea as ChiefExecutive in July 2004 was widely welcomed and that Philip had made a number oforganisational changes in the autumn of 2004. These changes have positioned thebusiness for growth, enhancing the linkage between our business lines andgeographic markets and ensuring that 3i continues to attract, retain and developthe best talent. Simon Ball joined 3i in February and succeeded Michael Queen as Finance Directoron 1 April 2005, the date when Michael formally became responsible for 3i'sGrowth Capital business. Rod Perry, who has done a tremendous job with ourVenture Capital business since he became responsible for it in 2001, retiresfrom the Board at our Annual General Meeting in July at the age of 60. He willbe succeeded by Jo Taylor, who will join our Executive Committee in July. Rod'sHuman Resources responsibilities have been taken on by Denise Collis, who joined3i and the Executive Committee in November. I was also delighted to welcome Sir Robert Smith and Dr Peter Mihatsch asnon-executive Directors to the Board in September 2004. Sir Robert brings awealth of experience from the City and industry and has substantial privateequity experience. Peter brings an extensive knowledge of German business aswell as insights gained from growing a major international telecommunicationsbusiness. 3i now has non-executives from the US, France and Germany, allcountries where we have significant interests. As ever, the macroeconomic prospects are complicated by global imbalances andshifts in the pattern of growth. 3i is, however, well placed to take advantageof these. We are already securing access to growth capital opportunities inIndia and China and our Venture Capital business is able to exploit its networkin the US, Asia and Europe. Meanwhile, the pace of restructuring in Europe isaccelerating. A year of such good progress at 3i is the result of a team effort and I wouldlike to pay tribute to three groups of people in particular. First, our teamsaround the world, who have worked with skill and determination to deliver theseresults. Second, the managers of our portfolio companies, who are the ultimatedrivers of 3i's value, and third, the many people who work with 3i around theworld to find, invest and grow businesses with us. Baroness HoggChairman11 May 2005 Chief Executive's statement My role as Chief Executive is to deliver performance from the present businesswhile building for the future. I am pleased to report a strong set of results and good progress in theacceleration of 3i's development as a truly international private equity firm.Total return for the year was 15.9% on restated opening shareholders' funds.Both Buyouts and Growth Capital performed well, with gross portfolio returns of22% and 24% respectively, and Venture Capital showed an improved performancewith a gross return for the year of 11%. Although, during the year, investment conditions were competitive for Buyouts,with increased funds flowing into European private equity and the highavailability of debt, our teams invested £532 million, of which £338 million wasfrom 3i's own resources. Growth Capital had a slower year in terms of the amountof investment (£263 million) but the pipeline going forward is encouraging. OurVenture Capital business continues to be selective and disciplined in itsinvestment approach and invested £143 million. Realisation proceeds were £1.3 billion and these were generated at good upliftsto carrying value. The portfolio performed well and health remains sound,reflecting both improved investment processes and the relatively benign economicbackdrop. To assist understanding of our current business model, we have decided to reportseparately the returns from our SMI portfolio which, in fact, has been run by adedicated team since 2001. This team continues to make excellent progress inrealising value from this part of the portfolio. At the time of our interims in November, I spoke of the opportunities I saw forthe Group to continue to improve our returns but also to increase the level ofour investment. In view of the opportunities within our Growth Capital businessto invest at a larger deal size, which quite often involves investing incompanies with cross-border ambitions, we have decided to operate this businessline on a more integrated international basis. We are accelerating the development of our Asian business by opening an officein Shanghai and starting the recruitment of a high quality team to develop abusiness in India. We are also actively building relationships to access themarket for infrastructure investment in the UK and the rest of Europe. These steps are the prelude to achieving a higher level of investment over the next few years without diluting our returns. In his new role as Head of Group Markets, Chris Rowlands has taken a number ofimportant steps to improve the agility with which we bring our resources to bearin the market. Our central sector group of industrialists has been strengthened to support thegreater emphasis being given to sector specialisation in the origination ofinvestments. We have also taken specific opportunities to add to the quality ofour existing teams by bringing in fresh, relevant experience from outside,including Managing Directors for our German speaking and Indian businesses andour Group Marketing Director. The creation of partnership style structures within each of our business lineshas been supported in recent years by the introduction of carried interestschemes. These reward our teams for successful realisations. The continuedsuccess of our business line model within our international network iscritically dependent upon the quality of our people and how well we deliverpartnership models across the Group as a whole. Denise Collis, who joined ourExecutive Committee as Human Resources Director in November, is having a majorimpact on how we further improve our employment proposition and progress thedevelopment of our people to deliver a true culture of partnership across theGroup as a whole. As we develop our resources in new markets, we anticipate a modest increase inour cost base but, over the medium term, would expect our costs as a proportionof our gross returns to decline. Following Michael Queen's move from Finance Director to head up our GrowthCapital business, and the appointment of Simon Ball as his successor, theannouncement in January that Jo Taylor would succeed Rod Perry in heading ourVenture business has completed the series of changes required to implement ourimmediate plans. Rod has made a major contribution to the Group in this andother roles and I have asked him to continue his association with us by headingup an international advisory board for our Venture business. At the interims, we took the step of making public the gross cash to cashreturns that we are targeting for each of our business lines, as well as thevolatilities that we expect to experience over given time periods. At themid-point of these ranges and with an appropriate level of leverage to ourequity base, we would expect to achieve an average return on equity of 20%. The good returns we are achieving, and particularly the high level ofrealisation proceeds we have generated over the past two years, have given riseto a higher level of financial resources than we can profitably reinvest in thenear term. By reference to the level of gearing we believe is appropriate forthe business and, having reviewed our medium-term projections of cash flows, wehave decided to take immediate steps to return capital to shareholders. Although we intend to increase the amounts we invest, particularly throughaccelerating investment in growth capital opportunities and expanding ourbusiness lines and geographic footprint, we are committed to maintainingfinancial efficiency by returning cash when it is surplus to our investmentneeds. Our strategic opportunities are clear and much change is under way to acceleratetheir delivery. At the same time, our teams are maintaining their focus oncontinuing to deliver high quality investment opportunities. Despite thehesitancy apparent in the financial markets, I intend to report further goodprogress towards our performance and strategic goals in the year ahead. Philip YeaChief Executive11 May 2005 Operating and financial review This review includes a description of 3i's business and strategy and comments on3i's performance during the year in the context of the economic and marketenvironment and other influences. It also discusses 3i's financial position,including changes to its capital structure, and comments on the main risksinherent in 3i's business and the framework used to manage them. 3i's business and strategy 3i's businessThe focus of 3i's business continues to be to invest in buyouts, growth capitaland venture capital. Buyouts represent 36% of our portfolio by value at 31 March2005, with Growth Capital at 29% and Venture Capital at 17%. Geographically,most of our investment is in businesses based in Europe, although 3i does havegrowing investment operations in the US and in Asia. BuyoutsThis business line invests in European mid-market buyout transactions with avalue up to €1 billion and targets between 15 and 25 transactions per year.These investments typically involve 3i together with co-investment funds managedby 3i holding the majority of the equity of a portfolio company. The vendors of businesses acquired through a buyout are typically largecorporates disposing of non-core activities, private groups with successionissues or, in the case of a secondary buyout, other private equity investors. 3i targets the mid-market because that is where we believe we can create themost value. There is also less competition for transactions in this market thanfor larger deals and price is less likely to be the sole or key criterion in"winning the deal". The nature and size of businesses in this market are suchthat we are more able to add value through strategic, operational and managementinput; and, in this segment, the underlying businesses will generally havesignificant growth potential and be attractive acquisition targets for a numberof strategic purchasers. We anticipate growing this business broadly in linewith the European mid-market. Growth Capital3i's Growth Capital business line targets investments of between €10 million and€100 million, across a broad range of sectors, business sizes and funding needs,investing in 20 to 30 transactions per year. These investments typically involve3i acquiring minority stakes in substantial privately-owned businesses at keypoints of change. Growth capital can be invested to accelerate organic growth,to fund acquisitions or to acquire shares from existing shareholders to resolvea succession or other ownership issue. With such minority positions, we seek toensure a high level of influence to create value for all shareholders. 3i's Growth Capital business is primarily focused on the European and Asianmarkets where we see excellent opportunities to grow investment by around 15%per annum. Success in Growth Capital is increasingly driven by sector-focused marketing andthe ability to add value to companies expanding internationally through givingthem access to 3i's network. These factors, combined with 3i's traditionalstrength in managing relationships with regional businesses and intermediaries,gives 3i significant competitive advantage. In addition, because 3i's funding, unlike that of most of the private equityindustry, is not constrained by being fixed-life or closed-end in nature, we areable to be more flexible regarding the investment holding period. During the year, we commenced the recruitment of a team to develop a growthcapital business in India, and announced our intention to open an office inShanghai. In addition, we have also made commitments to invest in a centralEuropean growth capital fund and a Chinese growth capital fund. Theseinvestments will increase our understanding and capabilities in these developingmarkets. 3i will continue to target opportunities to invest in infrastructure, a segmentof the market where we have historically made a number of successfulinvestments. Also included within this business line is our investment activity in smallerbuyouts in Europe and Asia. These transactions typically have a value of lessthan €25 million. This activity is managed as part of Growth Capital as itgenerally involves 3i and its co-investment funds together taking only minorityequity stakes. The financial analysis provided in this review, of returns, by business line includes smaller buyouts within Growth Capital. This represents a change from the basis used in prior years where they were included within Buyouts. For ease of comparison, the 2004 figures have been restated on this new basis. Venture Capital3i's Venture Capital business is targeted at four key sub-sectors - healthcare,communications, software and ESAT (Electronics, Semiconductors and AdvancedTechnologies). The main geographic focus is Europe and the US, though thebusiness also makes venture investments in Asia. As venture businesses competeglobally, each investment opportunity is reviewed by reference to the relevantglobal sub-sector's competitive landscape. Investment in venture capital takes the form of participation in a series of"funding rounds" and we therefore separate out "first investments" (those inbusinesses where 3i is not already invested) and "further investments". 3itypically invests between €2 million and €10 million in each new opportunityand, depending on circumstances and market conditions, we expect to investbetween £150 million and £200 million per annum in venture capital. 3i's strategyConsistent with our vision, we will continue to build our businessinternationally in markets where we believe we can generate market-beatingreturns. This will include extending business lines and building thecapabilities necessary to deliver our targeted returns. Integral to 3i's strategy is the ability to use our network to generatemarket-beating returns at each stage of the investment lifecycle - originationof the investment opportunity, developing and validating the business case,structuring and making the investment, implementing the operational plan for thebusiness, and exit. The main elements of our network are as follows: Business line teamsOur specialist teams of investment executives in each of our Buyout, GrowthCapital and Venture Capital business lines. 3i's scale and structure also allowus to utilise specialist skills in a number of other areas, including portfoliomanagement, restructuring and turnarounds, and exits and initial publicofferings ("IPOs") of companies from 3i's portfolio. Sector specialisationOur sector teams and the relationships that they have around the world providemarket access, insight to investment judgment and the capability to add value.These sector teams are drawn from our investment and portfolio managementexecutives and 3i's Sector Group, which comprises around 20 experienced seniorindustry specialists. Local presenceThe relationships that 3i has across the world with entrepreneurs, businessleaders, corporates, universities, research organisations and intermediaries. Relationships with corporatesAnother benefit of 3i's scale, international reach and membership of the FTSE100, is that we have developed valuable relationships with many of the leadingcorporates in each of the geographies and sectors in which we operate.Furthermore, 3i's ability to make effective business introductions across arange of geographies and sectors is increasingly a critical factor in ourability to "win deals" and provides 3i with a distinctive source of valuecreation. Boards and management teamsThe "People Programmes" 3i runs for chairmen, chief executives, chief financialofficers and independent directors provide an excellent resource for buildingand strengthening boards and operational management; and are also a strongsource of both investment opportunities and due diligence capability. Sharing knowledge and relationshipsHaving invested in building such a significant network, it is imperative that 3imaximises its value through having the systems, processes and, most importantly,culture, to enable this to happen. An important tool is the 3i portal. Thisweb-based knowledge system provides everyone at 3i with instant access to thecombined knowledge and relationships of the Group. Organisation and office networkA number of changes to the management and organisation of our investmentbusiness were announced during the year. Chris Rowlands was appointed as Head ofGroup Markets, with responsibility for further developing the benefits of 3i'sgeographic network and our sector and business relationships. Michael Queen wasappointed to succeed Chris Rowlands as Head of Growth Capital. These changestook effect from 1 April 2005. In addition, we announced that Rod Perry would beretiring as Head of Venture Capital in July and would be succeeded by Jo Taylor,who has run 3i's UK Venture Capital team since 1999. Jonathan Russell continuesto lead our Buyouts business line. Within each business line, a panel of 3i's most experienced investors ensuresrigorous application of our investment processes. These panels also seek toensure, on a case-by-case basis, that we assemble "the best team for the job"from our regional, sector and business line specialists. The investment and divestment approval functions for larger transactions arecarried out by two Investment Committees, addressing technology andnon-technology investments respectively. The membership of these InvestmentCommittees is drawn from 3i's Executive Committee. 3i's SMI initiative, which was established in 2001, continues to be successfulin generating returns from some of the older and lower-growth investments. At 31March 2005, £762 million of value (18% of 3i's total portfolio) and 807investments (54% by number of 3i's total portfolio) were managed by the SMIteam. It is our objective to continue to realise the SMI portfolio over themedium term. As noted above, we have started the recruitment of a team for India and intendto open an office in Shanghai to complement our team based in Hong Kong. Duringthe year, we closed a number of our smaller offices, in Padua, Nantes and Vienna. As of 31 March, we had a total of 28 offices (24 across Europe and two each inthe US and Asia). Since 31 March 2005, with a view to focusing our new business activity in the UKand Germany in fewer locations, we have communicated the decision to close ouroffices in central Birmingham, Reading and Dusseldorf. Following these closures,we will have eight offices in the UK, of which four (Aberdeen, Cambridge, Londonand Manchester) will focus on new business, with the other four (Birmingham -Trinity Park, Bristol, Glasgow and Leeds) being solely focused on portfoliomanagement. Operating review Macroeconomic and market conditionsOverall, the macroeconomic environment in the geographies where 3i operatesremained supportive during the year, though conditions within the differentregions and sectors in which our portfolio companies operate were variable.Broadly, the year was one of economic growth with low levels of inflation andinterest rates, which helped to keep business sentiment and consumer confidencepositive throughout. In currency terms, sterling strengthened slightly againstthe US dollar and a number of Asian currencies, and weakened slightly againstthe euro, giving rise to a modest negative impact on the competitive positionsof some of our European and UK portfolio companies. Stock market indices rose over the year as a whole, after a relatively subduedfirst half, though technology indices and markets did less well, experiencingeither flat or moderately negative performances. The strong overall growthreflects improving confidence in underlying economic growth and prospects forcorporate earnings. Mergers and acquisitions ("M&A") volumes, a key driver ofactivity in our Buyouts business, remained relatively subdued, both in Europe and globally, as corporates remained cautious despite improved balance sheets. The private equity markets in which 3i operates experienced increased levels ofactivity. Market statistics for calendar year 2004 show that total privateequity investment in Europe increased by 18% compared with 2003, with buyoutinvestment up by 15%, growth capital up by 61% (from a particularly low level in2003) and venture capital up by 16%. The level of investment in 2004 representedthe second highest year on record after 2000 (the height of the "technologybubble"). Market statistics for the venture capital market in the US show that investmentin 2004 was up 11% on 2003; and statistics for the same period for Asia showoverall private equity investment also up 11% on 2003. Conditions for realisations improved, with the return of corporate buyers to themarket and the IPO window reopening to some extent. Market statistics for Europeshow a 53% rise in the number of divestments in 2004 compared with 2003.Secondary buyouts (sales of private equity-backed businesses to other privateequity-backed teams or businesses) have become an increasing feature of themarketplace, providing a significant alternative realisation route. In 2004 theyaccounted for 28% of total buyout investment in Europe. In addition, 2004 sawincreasing amounts of debt available, which led to an increase in refinancingactivity across the industry. The European mid-market for buyouts saw increased levels of competition duringthe year, driven by a combination of the high availability of debt at aggressiveprices and the large amounts of cash in the hands of private equity investors.Rising leverage ratios enabled private equity buyers to outbid trade buyers. Within growth capital, the level of competition remained at much lower levelsthan for buyouts, with relatively few private equity players pursuing thesetransactions. The market itself is much less well-defined and understood thanbuyouts, but we have noted a growing acceptance in some of the less matureprivate equity markets in Europe of the role of external equity funding inenabling businesses to grow. We continue to believe that the use of privateequity to facilitate cross-border expansion within the European market is a keydriver of investment opportunity. For venture capital, 2004 saw a number of positives, including signs ofincreasing technology expenditure by corporates, greater willingness on the partof the stock markets to absorb venture-backed companies, especially within thebiotechnology sector, and the return of trade buyers in greater numbers,particularly from the US. The fundraising environment in Europe remained slowand difficult throughout 2004, influencing the choice of syndicate partners for3i. Total return3i achieved a total return of £512 million for the financial year, which equatesto 15.9% on restated opening shareholders' funds. This compares with returns onthe FTSE All-Share, FTSE 100 and FTSE SmallCap (ex investment companies) totalreturn indices of 15.6%, 15.4% and 11.4% respectively. The main drivers of the total return were a good level of profitablerealisations, strong levels of income and steady growth in the value of theportfolio. Our Buyouts and Growth Capital business lines delivered strong returns for thesecond successive year, and Venture Capital continues to demonstrate improvedperformance. We have decided this year to disclose separately the returns, amount investedand realisation proceeds of the SMI portfolio, in order to provide greatervisibility on trends in our three ongoing business lines. In prior years, theSMI figures were included within those of the business line to which individualassets previously related. For ease of comparison, we have adjusted the 2004figures to show them on the same basis as those for 2005. For Buyouts, the gross return of 22% was underpinned by a high level ofprofitable realisations and the continuing strong performance of the portfolio.The Growth Capital business line achieved a 24% gross return, mainly as a resultof strong realisation profits and good "first-time uplifts" on a number ofrecent investments. Venture Capital made a gross return of 11%, reflecting agood level of realised profits and a number of valuation increases arising as aresult of portfolio companies raising funds from new investors at increasedvalues. Across each of the business lines, we have seen the portfolio's healthimproving and the level of provisions falling. The gross portfolio return from the SMI portfolio was £70 million (7%), whichcomprises £86 million of income receipts, realised profits of £2 million and anet unrealised valuation reduction of £18 million. Investment3i invested a total of £755 million (£962 million including investment on behalfof co-investment funds), which is marginally lower than the prior year and lowerthan our expected run-rate over the cycle. This reflects two main factors.First, within Buyouts, as noted previously, competition has been intense andprice levels high, and we have sought to remain selective and disciplined in ourapproach. Second, in Growth Capital, as we have moved to a larger average dealsize, investment levels are less evenly spread. Buyouts represented 45% of total investment, Growth Capital 35% and VentureCapital 19%. Of the amount invested in Venture Capital, 59% was furtherinvestment into existing portfolio companies. Continental European investment represented 45% of the total invested, the US 7%and Asia 4%. The share of investment represented by continental Europe reflectsour focus on the relatively less mature private equity markets there comparedwith those in the UK. 3i's ability to access and execute deals across Europethrough our regional presence and ability to resource transactions on apan-European basis has also driven investment growth. Realisations3i generated realisation proceeds of £1,302 million (2004: £923 million) duringthe financial year, reflecting a profit over 31 March 2004 values of £260million (25%), compared with £228 million (33%) in the prior year. The upliftover 31 March 2004 values on realisations of equity investments was 40% (2004:58%). The reduced uplift percentage relative to last year is largely due to thehigh level of realisations achieved in the earlier months of the year. Theseassets were realised for amounts similar to their carrying value at 31 March2004 as they were then valued on an imminent sale basis. Realised profits are stated net of write-offs, which amounted to £37 million(2004: £50 million). Overall, 24% of the opening portfolio (by value) wasrealised during the year (2004: 18%), including sales and redemptions of loansand fixed income shares. Realisations were strong across all business lines, but most significantlywithin Buyouts, where advantage was taken of the high level of secondary buyoutactivity. Geographically, the UK was particularly active, generating 69% oftotal proceeds. Although most of our realisation proceeds continue to come from sales ofportfolio businesses to trade and financial purchasers, 12 portfolio companiesachieved IPOs during the year on 6 different markets. The IPOs of PinewoodShepperton, the film and TV studios business, in May 2004 and E2V Holdings, asupplier of switching, sensing and imaging components, in June 2004 were notablein providing 3i with a 100% cash realisation on IPO. Significant individual contributions to our realisation proceeds for the yearwere Yellow Brick Road, the telephone directories group, where we achievedinterim realisation proceeds of £61 million through a merger and refinancingcompleted in April 2004; and the sale in October 2004 of Westminster HealthCare, the care homes operator, which generated realisation proceeds of £155million at an uplift of £97 million over its 31 March 2004 valuation. As noted in the market commentary above, sales of businesses to financialpurchasers, through secondary buyouts, were a feature of the market during theyear. Realisation proceeds of £182 million arose through such sales of portfoliobusinesses. In addition, conditions were favourable for refinancing businessesand we were able to generate realisation proceeds of over £100 million throughrefinancings, with the merger and refinancing of Yellow Brick Road being theprime example. Sales of quoted equity benefited from the general rise in equity markets and amore active realisation strategy by 3i, with proceeds of £134 million and aprofit of £28 million (26%) over 31 March 2004 valuations. Unrealised value movementThe unrealised profit on the revaluation of investments was £270 million (2004:£336 million). The weighted average earnings multiple applied to investments valued on anearnings basis was 12.0 at both the end and the start of the year. However, forthose investments valued on an earnings basis at both dates, the weightedaverage earnings multiple rose from 11.7 to 12.3 over the year, giving rise to avalue increase of £40 million (2004: £287 million). In the prior year, largelybecause of the general rise in equity markets, the weighted average earningsmultiple increased from 8.1 to 12.0 over the year. The aggregate attributable earnings of investments valued on an earnings basisat both the start and the end of the year increased by approximately 3%, givingrise to a £20 million value increase. A number of strongly-performing Buyoutsand Growth Capital assets contributed significantly to this increase. It shouldbe noted that the value movement relating to first-time uplifts includes £74million which is due to earnings growth and that there is a net £3 million valuation increase in respect of investments that moved between a net assets and an earnings basis of valuation. The net value movement due to earnings growth is therefore a £97 million increase. The net valuation impact arising on investments being valued on a basis otherthan cost for the first time ("first-time uplifts") was £149 million (2004: £238million). This is a reflection of the quality of investments made in recentyears and also of the general increase in price levels over the period. Provisions against the carrying value of investments in businesses which mayfail totalled £66 million (2004: £143 million), representing 1.5% of the openingportfolio value and a significant improvement over levels in recent periods. There was a net £36 million valuation increase (2004: £70 million decrease) as aresult of investee companies raising funds from new investors at increasedvalues (£56 million), net of value reductions (£20 million) relating to theapplication of 3i's downround valuation methodology and fair value adjustmentsto our Venture Capital portfolio. Other movements on unquoted investments include valuation increases totalling£101 million on investments being revalued on an imminent sale basis. Thisincludes £52 million in respect of the announced sale of Travelex, the foreigncurrency services business, which is due to complete in the summer. The quoted investments held at the end of the year increased in value by anaggregate £12 million over the year, largely reflecting the rise in equitymarkets. Carried interest and investment performance plansMarket practice in the private equity industry is to offer investment staff theopportunity to participate in returns from successful investments through"carried interest" or similar arrangements. The charge in the year of £66million (2004: £40 million) reflects both profitable realisations and strongvalue growth on a number of recent investments. Amounts payable under such arrangements on the successful realisation ofinvestments in the year totalled £30 million (2004: £8 million). A further £36million (2004: £32 million) has been accrued in respect of amounts that would bepayable under such arrangements if assets were ultimately realised at their 31March 2005 carrying values. Income and costsTotal portfolio income was £232 million (2004: £199 million). The increase whencompared with the prior year is due mainly to the receipt of several largespecial dividends arising on the sale of investments, an increase in the levelof interest income and a rise in deal-related fees (net of abort costs). Management expenses of £172 million (2004: £163 million) were 6% higher than inthe prior year, during a period in which our staff headcount fell slightly, from771 at the start of the year to 740 at the end. The increase reflects the costsassociated with "upskilling" our investment teams and the costs associated withchanges in senior management. Net interest payable decreased relative to last year, reflecting both thereduced level of net borrowings and the lower average rate of interest followingthe €550 million convertible bond issue in August 2003. The portfolioThe number of investments in the portfolio fell from 1,878 (of which SMI was1,079) at the start of the year to 1,502 (of which SMI was 807) at the end,reflecting the high level of realisations. We would expect this trend tocontinue over the medium term, as a result of our SMI initiative and partly alsoof our strategy of making a smaller number of higher value investments than inthe past. At the year end, 36% of the portfolio was represented by Buyouts, 29% by GrowthCapital investments and 17% by Venture Capital investments. Geographically, 52%was in the UK, 39% in continental Europe, 7% in the US and 2% in Asia. Although the number of investments in 3i's portfolio has reduced, 3i still has,in contrast to many others in the private equity industry, relatively lowexposure to individual company risk. The top 10 investments represented 15% ofportfolio value at the year end and the top 50 investments 40%. Fund management activitiesConsistent with our announcement last July, we have ceased managing quoted fundsand our fund management activities now comprise solely the management of privateequity funds. These funds are primarily co-invested alongside 3i's own capital when financingbuyouts, enabling an investment to be made without 3i holding a majorityinterest. During the year, 3i earned fee income of £27 million (2004: £31million) from the management of private equity funds. In addition, 3i receivescarried interest in respect of third-party funds under management. At 31 March2005, the invested portfolio managed on behalf of private equity fund investorswas valued at £1,260 million (2004: £1,324 million), excluding undrawncommitments. The final closing of Eurofund IV, our latest fund targeted atpan-European mid-market buyouts, took place in June 2004 with 25 investors. Wesubsequently placed further commitments with an additional 15 investors, takingtotal third party commitments to €1.1 billion. At 31 March 2005, Eurofund IV was44% committed, with investments in 30 companies. As noted above, we have ceased managing quoted funds and have closed our 3iAsset Management operation. Fees earned from quoted fund management amounted to£3 million (2004: £4 million) and total third party quoted funds undermanagement at 31 March 2005 were £nil (2004: £600 million). Net costs incurredin closing the 3i Asset Management operation were not material. Accounting policies and valuation ValuationThe valuation guidelines of the British Venture Capital Association weresuperseded with effect from 1 January 2005 by "International private equity andventure capital valuation guidelines", issued and endorsed by the BVCA, theEuropean Private Equity and Venture Capital Association and the French nationalassociation, AFIC. These new guidelines effectively incorporate, withoutsubstantial change, the superseded guidelines of the BVCA and have not resultedin any changes to 3i's valuation methodology. Changes to accounting policiesFinancial Reporting Standard 17 "Retirement Benefits" was implemented in fullfor the first time during the year. Additionally, the recommendations of UrgentIssues Task Force Abstract 38 "Accounting for ESOP Trusts" were implemented andthe presentation of comparatives changed accordingly. Introduction of International Financial Reporting Standards ("IFRS")Work to comply with the requirements of IFRS in the year to 31 March 2006 isadvancing to plan. Differences have been identified, revised accounting policiesare being finalised and systems changes have been implemented. We are confidentthat 3i will be able to meet requirements for financial reporting during theyear to 31 March 2006. The first financial statements prepared on an IFRS basiswill be those for the six months to 30 September 2005. Financial review Cash flowsThe key cash flows during the year were the aggregate cash outflow of £719million (2004: £756 million) in respect of investment and cash inflows totalling£1,287 million (2004: £913 million) in respect of proceeds received on realisinginvestments. Net cash inflow for the year was £433 million (2004: £45 million),reducing net borrowings at the year end to £526 million (2004: £936 million).The level of gearing fell from 28% at 31 March 2004 to 14% at 31 March 2005. Capital structure3i's capital structure comprises a combination of shareholders' funds, long-termborrowing, short-term borrowing and liquid treasury assets and cash. There wereno significant changes in 3i's capital structure during the year, other than thegrowth in shareholders' funds and the strong cash inflow. Long-term borrowing at 31 March 2005 is £1,623 million and is repayable asfollows: £154 million between one and two years, £818 million between two andfive years and £651 million after five years. In addition, at the year end, 3ihad committed and undrawn borrowing facilities amounting to £579 million andcash and other liquid assets totalling £1,199 million. We are confident we havein place adequate funding for foreseeable investment needs. 3i Group plc currently has credit ratings with Moody's and Standard & Poor's ofAa3/stable and A+/stable respectively. Proposal to return capital to shareholdersAs indicated in the Chairman's statement, it is intended that £500 million willbe returned to shareholders through a combination of a special dividend and aprogramme of on-market share buy-backs. The pro-forma level of gearing at 31 March 2005, based on flowing through intonet borrowings the impact of this £500 million proposed return of capital andthe proposed final dividend of £56 million, is 34%. This represents a moreefficient level of balance sheet leverage for our shareholders, whilstmaintaining the funding we require to achieve our medium-term investment plans. Risk management Introduction3i has a comprehensive framework to manage the risks that are inherent in itsbusiness. This framework includes a risk committee whose purpose is to monitorthe identification, assessment and management of key risks across the business.The main risks comprise economic risk, treasury and funding risk, investmentrisk and operational risk. Economic risk3i invests mainly in European companies and continues to develop its operationsin the US and Asia. However, the majority of the portfolio by value (52%) isstill in UK companies and there is an element of exposure to the UK economiccycle. To mitigate this, 3i has invested in different sectors of the UK economywith different economic cycles. In addition, an increasing proportion of assetsis invested in continental Europe, in the US and in Asia, which may be subjectto different economic cycles. Treasury and funding riskThe overall funding objective continues to be that each category of investmentasset is broadly matched with liabilities and shareholders' funds, withcorresponding characteristics in terms of risk and maturity, and that fundingneeds are met ahead of planned investment. This objective continued to be metduring the year ended 31 March 2005. All assets and liabilities are held for non-trading purposes and, as a result,3i does not have a trading book. 3i does not trade in derivatives and does notenter into transactions of either a speculative nature or unrelated to 3i'sinvestment activities. Derivatives are used to manage the risks arising from3i's investment activities. The main funding risks faced by 3i are interest rate risk and exchange raterisk. The level of these risks is mitigated by the overall funding objective andthe Board regularly reviews and approves policies on the approach to each ofthese risks. 3i is currently in the process of implementing a new policy for foreign exchangerisk management. The policy is designed to eliminate, as far as possible, theexposure of assets denominated in foreign currencies to movements in theexchange rates between sterling and the respective currencies. Foreign currencyborrowings and swaps will be used to effect the hedges. Day-to-day management of treasury activities is delegated to executive Directorsand the Group Treasurer. Regular reports on 3i's funding position have beenconsidered during the year by the Board. There has been no change during theyear or since the year end to the major funding risks faced by 3i, or to 3i'sapproach to such risks. Investment riskThis includes investing in companies that may not perform as expected, beingover exposed to one sector of the economy and the portfolio valuation beingpartly based on stock market valuations. Investment levels are set, allocated and monitored by business line andgeography. Within this framework, 3i invests in all sectors of the economy,except those, such as property, where the opportunity to invest in privateequity-backed businesses meeting 3i's investment criteria is limited. Managementperiodically reviews the portfolio, which is well diversified by industrysector, to ensure that there is no undue exposure to any one sector. 3i's investment criteria focus on management ability and market potential.Investment appraisal and due diligence is undertaken in a rigorous manner bydrawing on our international network and experts in individual industry sectors.In general, proposed investments over £5 million are presented to 3i'sInvestment Committee or Technology Investment Committee, which are committees ofsenior management including executive Directors. The valuation of a large proportion of 3i's equity portfolio is based on stockmarket valuations for the relevant industry sector. Quoted investments arevalued using the closing mid-market price at the balance sheet date. 39% of theunquoted portfolio is valued using stock market earnings multiples for therelevant industry sector discounted for non marketability. Accordingly, stockmarket valuations for individual sectors are an important factor in determiningthe valuation of 3i's portfolio and the total return. There are regular reviews of holdings in quoted companies and exposure toindividual sectors in order to monitor the level of risk and mitigate exposurewhere appropriate. In particular, the level of future funding of technologycompanies is kept under review. However, it is not possible to protect againstthe risks of a downturn in stock markets generally or in any specific sector.Accordingly, the valuation of 3i's portfolio and opportunities for realisationdepend on stock market conditions and the buoyancy of the wider mergers andacquisitions market. Operational riskThis includes operational events such as human resources risks, legal andregulatory risks, IT systems problems, business disruption and shortcomings ininternal controls. Line management at all levels is responsible for identifying, assessing,controlling and reporting operational risks. This is supported by a framework ofcore values, standards and controls, a code of business conduct and delegatedauthorities. The ability to recruit, develop and retain capable people is of fundamentalimportance to achieving 3i's strategic objectives. We operate in a competitiveindustry and aim to remunerate our staff in line with market practice and toprovide superior development opportunities. A group-wide business continuity strategy is in place. This strategy has beenassessed against a detailed business impact analysis and independentlybenchmarked against best practice. Total return-------------------------------------------------------------------------------- 2005 2004 (as restated) £m £m--------------------------------------------------------------------------------Realised profits on disposal of investments 260 228Unrealised profits on revaluation ofinvestments 270 336Portfolio income 232 199 --------------------------------------------------------------------------------Gross portfolio return 762 763Fund management fee income 30 35 --------------------------------------------------------------------------------Total income 792 798Carried interest and investment performance plans (66) (40)Administrative expenses (172) (163)-------------------------------------------------------------------------------Net portfolio return 554 595Net interest payable (36) (60)Other (6) (11) --------------------------------------------------------------------------------Total return 512 524-------------------------------------------------------------------------------- Return by business line (£m) -------------------------------------------------------------------------------- Buyouts Growth Venture SMI Total Capital Capital -------------------------------------------------------------------------------- 2005 2004 2005 2004 2005 2004 2005 2004 2005 2004 (as restated) --------------------------------------------------------------------------------Grossportfolioreturn 332 291 286 258 74 32 70 182 762 763--------------------------------------------------------------------------------Return as% ofopeningportfolio 22% 25% 24% 23% 11% 5% 7% 17% 18% 19%--------------------------------------------------------------------------------Net portfolioreturn 554 595--------------------------------------------------------------------------------Return as% ofopeningportfolio 13% 15%--------------------------------------------------------------------------------Total return 512 524 --------------------------------------------------------------------------------Total returnas % ofopeningshareholders' funds 15.9% 18.8%-------------------------------------------------------------------------------- Consolidated statement of total returnfor the year to 31 March 2005-------------------------------------------------------------------------------- Revenue Capital Total Revenue Capital Total 2005 2005 2005 2004 2004 2004 (as restated)* (as restated)* (as restated)* £m £m £m £m £m £m------------------------------------------------------------------------------- Capital profitsRealised profits ondisposal ofinvestments 260 260 228 228Unrealisedprofitson revaluationof investments 270 270 336 336------------------------------------------------------------------------------- 530 530 564 564Carried interestand investmentperformance plans (66) (66) (40) (40)------------------------------------------------------------------------------- 464 464 524 524Total operatingincome beforeinterest payable 290 18 308 262 5 267Interestpayable (57) (25) (82) (51) (42) (93)------------------------------------------------------------------------------- 233 457 690 211 487 698Administrativeexpenses (78) (94) (172) (72) (91) (163)Other financeincome/(costs)on pension plan 1 - 1 (3) - (3)Actuarial (losses) on pension plan - (1) (1) - (4) (4)-------------------------------------------------------------------------------Return beforetax and currencytranslationadjustment 156 362 518 136 392 528Tax (22) 19 (3) (29) 25 (4)-------------------------------------------------------------------------------Return for the yearbefore currencytranslationadjustment 134 381 515 107 417 524Currencytranslationadjustment (1) (2) (3) 24 (24) ---------------------------------------------------------------------------------Total return 133 379 512 131 393 524-------------------------------------------------------------------------------Total return per shareBasic (pence) 22.1p 62.8p 84.9p 21.8p 65.2p 87.0pDiluted (pence) 21.3p 60.7p 82.0p 21.2p 63.8p 85.0p------------------------------------------------------------------------------- * As restated to reflect the adoption of FRS 17 - Retirement Benefits and UITF38 - Accounting for ESOP Trusts. See note 1. The cumulative effects of the prior year adjustments are explained in note 4. Reconciliation of movement in shareholders' funds-------------------------------------------------------------------------------- 2005 2004 (as restated)* £m £m--------------------------------------------------------------------------------Opening balance 3,395 2,936-------------------------------------------------------------------------------- Prior year adjustment (165) (147)--------------------------------------------------------------------------------Opening balance as restated 3,230 2,789-------------------------------------------------------------------------------- Revenue return 133 131Capital return 379 393--------------------------------------------------------------------------------Total return 512 524Dividends (88) (84)Proceeds of issues of shares 5 12Own shares (22) (11)--------------------------------------------------------------------------------Related Shares:
3i Group