Kate Bulkley, Media Analyst.

Mr. Newcastle Out in the Cold as 3i Boss retreats

By Kate Bulkley

The Independent on Sunday

Jan 6, 2002

With a history dating from the end of the Second World War and a large number of investments across a variety of industries, Europe's largest venture capital company 3i, has developed a unique personality. But it's one that some now think is under threat.

After absorbing a 23% fall in the value of its portfolio of investments late last year, 3I's CEO Brian Larcombe took unprecedented steps to cut costs, including laying off a fifth of its workforce, closing several satellite offices and trimming its investment strategy going forward. This was a new approach for Mr. Larcombe, 48, who as the company's CEO for the last five years has been piloting an expansionary course, including ramping up investments in technology-related companies to unprecedented levels and opening up an office in the US, the world's biggest and most competitive market for venture capital and buyouts. Although no one seems to think Mr. Larcombe's job is under threat, how he steers this next course is critical both to him and to 3i's future.

Mr. Larcombe casts a penetrating and defiant gaze over questions about the timing and size of the cutbacks. First of all he doesnít like the word cuts, believing that the exercise was more in the way of part of a long-term restructuring. "I was thinking in the summer (of 2001) that this (slowdown) wasnít going to be over in 18 months," says Mr. Larcombe. As the company's former finance director before taking her top job in 1997, Mr. Larcombe is also prickly about criticisms related to the 3i's balance sheet. "We have a balanced business both in early and late stage (companies) and both a technology and a non-technology business. Nothing has fundementally changed in the portfolio," he says. "Our strength is in our balance sheet, in having the best network and the best teams. If we are coming through difficult times then the market leaders tend to come out on top. "

But clearly tumbling stock markets have had a big impact on 3i, both in its venture capital and buy-out businesses, where the number of deals has gone down and the cost of finance has gone up.

On the VC side, 3i had expanded its venture capital business on the Continent and ramped up its investments in technology-related companies, like internet hosting company Telecity and optical components companies Kymata and Bookham Technolgies. This looked fine in the run-up of values spurred on by the dot com craze, but this exposure hit hard when values started to plummet. At one point, over 50% of 3i's portfolio was in companies quoted on the public markets, the lionshare in technology-related businesses. Nick Corke, head of sales at Credit Lyonnais Securities, says that he is "skeptical" about the technology bent to 3i's portfolio. "We think that there is still plenty of potential for blood in their portfolio because it could be ten years before you see the kind of values for tech companies that we had in the TMT (telecoms, media and technology) bubble."

Not only did 3i keep investing in technology even after many had started to realise the boom in those markets had peaked, but the company failed to sell some of its quoted stocks as their values were rising, instead, taking all the pain of the falls on the chin. Part of the problem was timing, says Iain Scouller, an equities analyst at UBS Warburg. Once the process of investing in a company begins, it is difficult, especially for a large group like 3i, to suddenly change course. Another part of the problem is strict stock lock-up rules that prevent investors from selling for a certain period of time, which can really hurt when booming stock markets are compressing the natural growth cycle of a company from start-up to FTSE 100 in a matter of months. Bottom line, Scouller believes that 3i was "complacent on the technology investing front and got caught."

A veteran of 3i of 27 years, Mr. Larcombe says says there is "not a huge amount I regret about" the investments the company made in technology, reminding critics that technology is still the biggest growth driver in business. But Mr. Larcombe admits that the whole capital expenditure cycle has been decimated by the market's recent falls and the general business slowdown. 3iís own research shows that earnings expected from 3i companies in continental Europe in the fourth quarter are at the lowest level since the company started keeping track of such things in 1998. With caution reminiscent of his tenure as 3i's chief finance officer, Mr. Larcombe hesitates to hazard a guess when the recovery might begin. "Tell me where we are in the cycle and Iíll tell you the answer to that," he says. "You have to say today that there is a lot of uncertainty around. Anyone who says differently is just silly."

With a certain ferocity, Mr. Larcombe also defends the recent job cuts, which some see as cutting the very heart and soul out of 3i. 3i made its name by making lots of smaller investments in a wide variety of firms and today the company still counts more than 2,700 investments and 36 offices in 16 countries. The value of its portfolio at September 30, 2001 was just over £5 billion.

The recent cuts closed four offices in smaller UK cities as well as three on the continent. "Ten years ago we would have a Mr. Newcastle who knew everything about that regional area, but today we need to work in teams," says Mr. Larcomb. "We need bigger teams with an industry sector focus and not just a sector like telecoms, but, for example, optical networking. And not tightly-defined geographical areas but across Europe and beyond."

Itís the US business that has been attracting the most attention of late. While other big US venture capital companies have been licking their wounds in the wake of problem investments, 3iís late re-entry into the US market in mid-1999, means it has been able to be more active recently. To date the US arm of 3i has invested some $400 million in 55 or so young companies across the US, and the amiable chief executive of the US business Martin Gagen is now also considering launching a specialist US technology fund. Mr. Larcombe says with some pride that 3i is now the fifth most active V.C. on the West Coast of the US, but 3i is still a very UK-oriented company, with some 70% of its investments still in the U.K

In the dot com upswing, 3i's limited US exposure means that it didnít catch the same amount of downside as many of its Silicon Valley rivals. This may have created an unexpected benefit, a springboard for 3iís next stage of growth in what is undeniably the biggest VC and buy-out market in the world. However, at the moment some analysts wonder if Mr. Larcomb's reining back on new investments is more the former finance director talking than someone willing to capitalise on falling prices for deals. With a with a high profile, media-friendly counterpart in the US in Mr. Gagan, the more guarded Mr. Larcombe may have an internal battle on his hands if he wants to continue to lead 3i into that future.


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