Business review Growth Capital

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Business model

The Growth Capital business, which has a team of over 100 investment professionals in Europe, Asia and the US, targets cash-to-cash IRR returns of 20% through the cycle. These returns are achieved through a mix of dividend and interest income, returns of capital and capital realisation upon exit. A highly-selective approach to investment is taken with 20 to 30 minority transactions completed each year, investing typically €10 million to €250 million from 3i's own balance sheet in each situation. The purpose of the investment may include supporting organic growth, funding for acquisitions, to resolve succession issues or simply to reduce gearing.

Another key element of the business model is to have a portfolio which is diversified by region, sector, investment type and size of business. Aligning interests between 3i and the majority owners of the company, who are typically the management, underpins the delivery of targeted returns.

The Growth Capital business line also manages some third-party funds which include pre-Eurofund IV buyout co-investment funds which had a mandate to make growth capital investments.

In recognition of the increased significance and potential of infrastructure as a separate asset class, a new business line "Infrastructure" was established during the year. Prior to this, the Growth Capital business line also managed 3i's infrastructure investing activity. Accordingly, whilst all of the performance data for the year to 31 March 2007 regarding gross portfolio return, investment and realisations excludes Infrastructure, comparatives have not been restated. In addition, long-term performance IRRs exclude those assets which formed part of the Infrastructure portfolio at 1 April 2006. Information on the performance of the new Infrastructure business line can be found in Business review Infrastructure.

Strategy

Our strategy is to capitalise on 3i's competitive advantages in this market which are principally our track record, experience, global network and the flexibility afforded to us by investing from our own balance sheet.

Over the last five years we have increased the average size of each investment significantly (2007: £26 million, 2003: £6 million), targeting larger companies which are more likely to have international operations or aspirations.

3i's expansion in Asia and the US has increased the opportunity to leverage our network, People Programmes and sector expertise for the benefit of the companies in which we invest. For each opportunity, we assemble the "best team for the job" with the most relevant geographical, sector and transactional experience drawn from the global team.

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Marketplace

The market in the last year has both grown and become more competitive. Global market statistics are somewhat inconsistent but the general consensus is that the market for growth capital investments grew by around 20% in terms of value.

Although the mandates of many private equity funds preclude them from making minority investments and few competitors can currently access permanent capital to fund their investments, competition has increased in several regions due to new entrants. These include US growth specialists entering the European market, hedge funds starting to take minority positions in private rather than public companies and mezzanine funds moving towards private equity as mainstream banks encroach on their traditional markets.

In Asia, general economic development has driven opportunity, especially in consumer-related sectors. Competition varies from market to market, with India being the most competitive.

Investment and realisations

Our strategy is to accelerate the development of the business in Asia and to increase the average size of investment globally. At £258 million (2006: £91 million) Asia represented 54% of the £482 million (2006: £497 million) invested in the year. Excluding infrastructure investment (£89 million) from the 2006 total, Growth Capital investment grew by 18%.

The average size of the 21 Growth Capital investments (2006: 18) made during the year was £26 million (2006: £21 million), with the two largest being Singapore-based ACR Limited at £105 million and Spanish-based STEN at £78 million. Both of these investments, together with our two largest realisations (SeLoger in France and Alimak in Sweden) and our next largest portfolio company DIAB, also from Sweden, are profiled in more detail in the Case studies section.

Realisation performance was once again strong with total realisations of £691 million (2006: £855 million), delivering realised profits of £235 million (2006: £232 million). The majority of proceeds arose from the sale of portfolio companies to trade buyers. In addition, four companies achieved an IPO. The largest of these was SeLoger, a £41 million 2005 investment which achieved a listing on the Paris Stock Exchange in December 2006 since when 3i has realised £98 million.

Gross portfolio return

The Growth Capital business line generated a gross portfolio return of £569 million in the year to 31 March 2007 (2006: £341 million). As can be seen from the Gross portfolio return chart, this represents a return of 48% (2006: 26%) on opening portfolio value.

Realised profits, which were up 1% to £235 million, produced 41% of gross portfolio return. The unrealised value movement of £269 million (2006: £60 million) included £129 million of uplifts to imminent sale on assets, of which £60 million has been realised since the year end.

Post 2002 vintages have performed particularly strongly, contributing 57% of gross portfolio return in the period, demonstrating the effectiveness of our business model.

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Portfolio health

A favourable macroeconomic environment, the focus on a smaller number of higher-value investments, together with a global approach to assessing opportunities and more international deal and portfolio management teams, have led to a significant reduction in the level of portfolio write-downs over the last two years. Provisions of £1 million were made in the year, the lowest level for a number of years. As at 31 March 2007, 92% of our investments were classified as healthy, against a three year rolling average of 81% (2006: 84%, and 74%).

Long-term IRRs

The long-term vintage IRRs from this business line have been above target in recent years and the younger vintages, which are of greater size, are already showing encouraging signs. Indeed, returns from the investments made in the year to 31 March 2006 have already achieved a 35% return, ahead of our expectations at this stage in the evolution of the vintage.

Management

In November 2006 we announced that Guy Zarzavatdjian would succeed Michael Queen as Managing Partner, Growth Capital in April 2008. This was to allow Michael to become full-time Managing Partner of 3i's Infrastructure business line. To facilitate this transition, Guy became responsible for Growth Capital in Europe on 1 January 2007, reporting to Michael.