Milan Pavlovic, having graduated from LSE with a masters in finance and private equity, has recently completed the analyst programme at private equity firm Terra Firma.
What do private equity firms do?
Private equity firms raise money from institutional investors (pension funds, insurance firms, and so on). This money is then invested into a fund that Terra Firma manage by using it to buy out businesses in need of investment and major transformation.
We provide a return for our investors by increasing the value of the businesses and selling them on. Each fund usually has a ten-year lifespan, with all money returned to investors by the end of this lifespan. The cycle of raising money, investing, harvesting, and then exiting investments occurs repeatedly.
How is private equity different from investment banking?
Although there are similarities in the work you do at a junior level, the mindset is totally different. In private equity, you're thinking about acquiring and managing a business, which carries a lot more risk than just advising on transactions. If people are interested in growing and developing businesses, private equity is where they need to be.
What makes Terra Firma stand out?
Terra Firma is defined by its clear investment strategy and operational focus. We have an in-house team of operational managing directors who look after the businesses we acquire.
We like to think of ourselves as contrarian investors, meaning we look at neglected assets and industries. Although we target a broad range of businesses, the ones we decide to pursue must have three major characteristics: they need to be in essential industries, they need to be asset-backed (e.g. have real estate), and they need to be in need of transformational change.
Once we acquire a business, we look to create value by changing the strategy, strengthening management, developing through further investment (capital expenditure), building through add-on acquisitions and lowering the cost of capital.
The analyst programme
Analysts rotate around Terra Firma's various teams over a period of three years.
Deal team (one year)
This is the transactional team responsible for finding deals, negotiating with the vendors, carrying out due diligence and finally completing the acquisitions.
Other teams (one year)
This part of the programme is split into several rotations, with analysts spending a few months with each.
Investor relations: Involves fundraising, meeting investors, answering their queries and reporting back to them about acquired businesses.
Finance: Produces valuations of all Terra Firma's businesses and prepares quarterly and annual reports for investors.
Chairman and Chief Investment Officer: Analysts spend a rotation based in Guernsey, working directly for Terra Firma's Chairman and Chief Investment Officer Guy Hands.
Portfolio business (one year)
In a recent addition to the analyst programme, Terra Firma gives analysts a year of experience working directly with a business in its portfolio, helping it to achieve the transformational goals set by Terra Firma.
How did you find the analyst programme?
The Terra Firma programme is special as not many private equity firms have an analyst intake. You won't get similar exposure to the industry elsewhere as this programme allows you to experience how private equity operates from every angle.
My first full rotation was in the deal team, where I worked on looking for investments and going through the process of acquiring a business. Once you acquire the business, you start working on the strategy for the business going forward, and you remain involved on future decisions such as add-on acquisitions.
Understanding debt finance
When purchasing a business, private equity firms use a combination of money from investors (equity finance) with borrowed money (debt finance), in a process known as leverage. Leverage is used for two reasons.
The first is that a fund might not have enough equity available to invest in a particular deal without debt. Every fund has a limit on how much equity can be put into a single deal, in order to minimise risk. If only 10 per cent of a £5 billion fund can be allocated to one deal, investment is limited to £500 million. If a company costs more than that, leverage is needed to help finance the transaction.
The other reason leverage is used is it helps increase the return on investment.
What are the risks of using leverage?
Taking on more debt means higher interest payments so the cash flows generated by the business must be sufficient to cover the interest. In a downturn, there's a risk the business will start earning less money which causes problems. In the buildup to the financial crisis, people were doing deals where up to 90 per cent of the acquisition was funded by debt finance, however the downturn caused leverage levels to come down to more conservative levels of around 50 per cent.
Case study: The Garden Centre Group
The highlight of my first year was a deal involving The Garden Centre Group, the largest chain of UK garden centres. After Terra Firma acquired the business, the first thing we did was to professionalise and centralise the operations. As the business had been built through acquiring various independent shops around the country, it had been run as an amalgamation of various brands. All 130 sites had never been properly integrated, which isn't ideal for a big business.
Our second task was to look at weatherproofing the business, as the garden centre trade is very seasonal. We developed the restaurant and concessions segment of the stores, expanding the business into less weather-dependent areas and developing the sites into small out-of-town retail centres.
I was involved in the financial modeling and coming up with financial projections. We had to analyse the whole 130 site estate site by site, looking at the trading performance by region, by size or by type of store, and try to understand why some sites were outperforming others.