Boardroom blitz: What happens when private equity gets it wrong?

As Guy Hands prepares to do battle with Citigroup over his ill-fated purchase of EMI, Stephen Foley argues that for the deals inked before the credit bubble burst, things are about to get very ugly

Monday 11 October 2010 00:00

Guy Hands's secret code name for the deal was Project Dice. Not, presumably, as in "roll of the..." Nor as in, one assumes, "...with death". In hindsight, though, either phrase might appropriately have been behind the name. A lot of mad things happened back in 2007, on the distended skin of a credit bubble about to pop, but among the maddest was Project Dice.

The deal was the takeover by Hands' private-equity firm Terra Firma of the British music icon EMI – historic home of the Beatles, with a roster of blockbuster acts from Coldplay to Kylie and upcoming talent like Lily Allen and Hot Chip. The sum paid for EMI was £3.2bn.

Sure, private equity was in clover, using borrowed billions to buy up some of the world's biggest corporations, but EMI was a company in crisis in an industry in chaos – and debt can be dangerous. It looked dicey even at the time it was unveiled to the public that May. Under Terra Firma's ownership, EMI would be loaded with £2.6bn of debt from the US financial giant Citigroup. With that burden, it might be just one chart flop away from being unable to meet its obligations to the bank – and so it has turned out.

Now, Project Dice is hardly the only deal signed in 2007 that failed to turn out the way it was planned. Hundreds of billions of pounds of wealth simply evaporated as the credit crisis ripped first through financial markets and then through the wider economy. In courthouses everywhere, deals signed, sealed and delivered during the boom years are being reopened. Losers are resorting to the courts as a kind of retroactive negotiating position. Some of these losers were actually the victims of fraud or negligence. Many are genuinely aggrieved. Lots are too embarrassed to admit they made a foolish investment. All have made a business calculation that money spent on expensive lawyers and expensive lawsuits will be money well spent. After the Bubble Years, now we have the Litigation Years.

A lot of vicious things are happening in courthouses this year, but undoubtedly the most vicious is the case scheduled to begin next week in a grey federal building in downtown Manhattan. On the docket it says "Terra Firma vs Citigroup". In fact, it is more personal than that. It is Guy Hands vs David Wormsley. The private-equity millionaire vs the banker he befriended and trusted for more than a decade, with whom he had worked on deals worth a total of more than £35bn, with whom he shared nights at the opera and clay-pigeon shooting trips, whose wife's 40th birthday party he had hosted at his Italian vineyard – and who Hands now claims betrayed him over Project Dice.

It takes a certain sort of arrogance to decide, in 2007, with music piracy assailing the recording industry, that buying EMI would be a good idea. It is the sort of arrogance that comes from having made a personal fortune estimated at £100m by buying companies that the rest of the world likewise thought were duds. Investing, £100m proves you're smarter than those guys.

And there is no doubting that Guy Hands is smart. The son of a Kent solicitor, he worked relentlessly to overcome severe dyslexia and gain a place at Oxford University, where one good friend, William Hague, thought Hands might be prime minister one day. Hands tapped Hague to be best man at his marriage to Julia, the childhood sweetheart with whom he has two sons and two daughters.

A slightly shambolic air, largely the result of a refusal to tidy his hair, disguises a a single-minded determination to make money. He has taken the same approach to personal finance as he does to deal finance: when he decided that Labour had taken taxes too high, he decamped to the Channel Island haven of Guernsey. For the past year and a half he has been forgoing visits to his family and to the Sevenoaks home that used to belong to Winston Churchill, staying instead at a newly built mansion near the Guernsey capital St Peter Port. It was the most expensive house ever purchased on the island.

In a variety of ways, Hands is a creator and creature of the credit bubble. After trading bonds for Goldman Sachs in the City of London, he moved to Nomura, a Japanese wannabe. There he pioneered the use in the UK of securitisation, a new form of debt got up by allowing companies to sell future revenues. Enterprises no one had previously thought should be taking on mountains of debt suddenly could do so.

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Thanks to Hands, Nomura was briefly the biggest pub landlord in Britain, as the Japanese investment bank bought thousands of local boozers, securitised their revenues, and sold them on for a profit. By the time he branched out into his own private-equity operation with Terra Firma in 2002, banks were clamouring to make cheap loans and investors to buy bonds, even with low interest rates. Private-equity firms the world over were happy to take their money, over and over again.

As the bubble reached its height, private equity was treating major companies in the same way that individuals were treating their houses – as cash machines that would pay out every time the mortgage got refinanced. And like homebuyers, private-equity firms were willing to pay crazy prices to get in on the racket. Many of the excesses of the credit boom were hidden from view, deep in arcane financial markets, where exotic derivatives with impossible acronyms traded between anonymous banks and hedge funds. But what was happening in private equity did attract attention, and opposition.

British trade unions led the charge, denouncing the sector's megadeals as an outrage: a financial scam multiplied by a tax dodge. They demonised Hands and his peers for the riches they reaped. Protestors from the GMB union turned up with a stuffed camel outside the Clapham church attended by Damon Buffini, whose firm Permira owned Birds Eye and the AA in the UK (the allusion was to eyes of needles). Private-equity owners of productive companies cut jobs to meet interest payments on all that debt, the unions said. The camel got into the newspapers, but the boom continued. As late as mid-2007, Chuck Prince, the chief executive of Citigroup, said that banks like his knew the party would end, but "as long as the music is playing, you've got to get up and dance. We're still dancing."

It was about the same time that Guy Hands bought his record label – and the music stopped.

It hadn't even got off on the right note. Within days of taking over, Hands had read the riot act to EMI's roster of stars. "While many [stars] spend huge amounts of time working with their label to promote, perfect and endorse their music, some unfortunately simply focus on negotiating for the maximum advance," he wrote in an explosive memo. "Advances which are often never repaid. There is no reason why we should not be more selective in whom we choose to work with."

Immediately, the music industry scoffed. Hands may be famous for making money, but what did he know about making records? This is a man who boasts one of the largest collections of karaoke records in the world.

Hands insisted he was injecting a dose of business reality. Of the 14,000 artists in the EMI stable, just 200 accounted for half the company's sales, he said.

Radiohead walked out after Hands offered only a fraction of what they wanted for their next deal. Sir Paul McCartney and the Rolling Stones followed them out the door. Robbie Williams threatened to go on strike.

Lily Allen put it most succinctly: "It's really sad for EMI. I hate Terra Firma," she told The Word magazine. "They're wankers and they don't know what they're doing. They will fail." Meanwhile, CD sales were crashing, and early hopes for revenue fromdigital downloads had proved wildly optimistic.

EMI slumped to a £1.6bn loss in its worst year, the 12 months to March 2009, and was still in the red a year later. Some 2,000 job cuts hadn't relieved the pressure of all that debt. Terra Firma has had to give EMI repeated cash infusions to stop it from defaulting on its obligations to the bank, something that would mean control of the company would fall to Citigroup. And that is what Hands wants to avoid – at all costs.


It is no coincidence that Terra Firma filed its lawsuit against Citigroup last winter just a few weeks after Citigroup spurned a deal to renegotiate EMI's debts. The bank had never wanted to keep all that debt in the first place. It had hoped to package it up and parcel it out to other investors. But the first rumbles of the credit crisis had begun, and Citigroup has been stuck with it ever since.

Last November, Hands had offered to put in another £1bn from himself and Terra Firma's co-investors, but only if Citigroup wrote off about £1bn of its loans. It said no. And that's when Hands went public with an allegation that stunned the City of London: David Wormsley lied to me.

Wormsley's nickname, "The Worm", tells you more about the prep-school humour of the City than it does about him. At 50, one year Mr Hands's junior, he is Citigroup's UK banking chairman and one of the most respected deal-doers in British finance. His reputation as an honest broker has been his calling card.

"Terra Firma v Citigroup" hinges on the contents of three alleged phone calls between the two men the weekend before Hands put in his final bid for EMI, including one call that the private equity millionaire took at Guernsey airport near midnight. Hands claims Wormsley told him another firm, New York-based Cerberus Capital Management, was still in the running, and that he must therefore bid 265p per EMI share to be sure of winning the auction the next day. Cerberus had, in fact, pulled out hours before.

Hands duly bid up for his hot potato. Citigroup earned £6m in fees for advice it provided to EMI, and £80m from Terra Firma, for underwriting loans for the deal. In an internal email, one Citigroup executive said: "We got paid on both sides." Terra Firma claims that EMI's debt load would have been much lighter if it had not been misled into overpaying for the record company, and wants compensation. Citigroup points out that Hands hardly had a gun to his head when he decided to sign the cheque, says the suit has no merit, and promises to fight it vigorously.

For his part, Wormsley says the conversations were not as portrayed by Hands, and that in any case he didn't know whether Cerberus was still in the auction or not. Such is the importance of the calls, the two sides will use flight logs from Hands's private jet and telephone records to try to reconstruct what might and might not, and what could and could not, have been said, and when.

That Terra Firma should have delivered an aggressive lawsuit is no surprise. Hands has enlisted as attorney David Boies, who The New York Times once described as being to the legal profession "what Bono is to arena rock".

Boies, like Hands a dyslexic and workaholic, turns up all over the legal soundtrack to the past two decades. He represented then vice-president Al Gore in "Gore v Bush" at the Supreme Court following the disputed 2000 election in the US. He represented the Clinton administration as it fought to break up Microsoft for its abuse of a monopoly in personal computers. When Enron collapsed, Sotheby's and Christie's were accused of price-fixing and the New York Yankees wanted more money out of Major League Baseball, Boies was on the scene.

By attacking Wormsley's honesty, the very fact of the lawsuit hits him where it hurts most. By accusing the bank of being riddled with conflicts of interest, it hits Citigroup where it hurts the most, too.

And this is, of course, the point.

There's an old lawyers' joke. What's the difference between justice and law? Justice is when you get what you deserve. The law is when you get what you pay for.

The complexities of the financial deals inked during the credit boom have provided a playground for expensive lawyers. Suits against the major investment banks are coming in at a rate of about one a week from such supposedly sophisticated investors as European banks and US hedge funds, who say they were misled into buying ultimately disastrous mortgage derivatives. This despite the fact that the Securities and Exchange Commission, the US government's newly emboldened Wall Street watchdog, could find only one derivative deal on which to charge Goldman Sachs, and even then by presenting a civil, rather than criminal, case.

However Goldman paid a record $550m to settle those charges, without admitting liability, and that is an important lesson.

Legal actions, with complaint and answer filed for all to see, are only the public face of a process that more often than not ends in a private financial settlement. The more aggressive and embarrassing the lawsuit you launch, the greater your power in negotiations. Reputational damage to a company ends up costing it real money. Defence lawyers cost real money. Juries are unpredictable. Sometimes the maths just comes out at "settle". In other words, a lawsuit is just part of the weaponry of modern financial deal-doing. They are scripts for plays whose actors rarely have an interest in performing for a jury.

As for "Terra Firma vs Citigroup", undoubtedly the stakes are high. A triumph for Terra Firma would bring in significant cash compensation to prop up EMI, while a victory for Citigroup would make it vastly more likely that the music firm and all its stars will fall under the bank's control. Much of whatever value a restored and refinanced EMI creates in the future will fall to the winner of a courtroom fight.

But there is still a week to curtain up, seven days for the two sides to reach a behind-the-scenes deal. The City of London, and Wall Street for that matter, are agog that the actors have even brought things this far.

Citigroup's defence argues not only that Terra Firma didn't suffer any injustice, but that the private-equity firm does not, in fact, feel aggrieved. Hands and Wormsley were working happily together on a proposed acquisition of Gatwick Airport in early 2009, it points out. The banker kept getting his invites to the annual clay-pigeon shoot. Ah yes, Terra Firma retorted in its most recent court filing, but did the pair actually talk to each other on the shoot?

Let's see if Hands and Wormsley really do take the stage. If they do, they will be playing to a packed house.

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