3I SEEKS TO SHAKE OFF TECH SECTOR HANGOVER

Robert Cole launches The Times's authoritative weekly profile of Britain's top 100 companies

THE investment trust 3i has several unique qualities not shared by its FTSE 100 brethren. It is the only one to begin its name with a number. It is the only one with a woman chairman. It is also the only such trust in the index.

But 3i is also representative of the peer group. Its interests lie across all industrial sectors occupied by its fellows in the index of the UK's largest companies. The company is also a global business, so it reflects the international activities of Britain's biggest firms.

A close association with technology also means 3i has shared in probably the most powerful trend to have affected British business in the past decade. Few companies did not try to hitch themselves to the dot-com bandwagon in the late 1990s. Many are enduring the hangover after the bust.

Investments in companies such as Telecity, Bookham Technology and Morse gave 3i status as a proxy for the tech sector. Senior 3i managers are annoyed that the firm is tarnished by association with tech stocks. Given the chance, they point out that 3i has still made handsome returns out of its technology companies.

Take Telecity. The market value of the firm -of which 3i has 44 per cent – soared to Pounds 1.6 billion in the spring of 2000. The company is now worth a paltry Pounds 30 million, yet 3i's shares are worth more than the Pounds 10 million it put into Telecity since 1998. 3i also sold Telecity shares worth Pounds 40 million. Normally an investor who conjured fourfold rises in value over four years would be thought remarkable.

The challenge for 3i is to convince the market that it can move on from its association with tech stocks. It faces another big task in coping with the changing nature of the venture capital market. The above-average investment returns generated by 3i and its ilk mean that money has flooded into the sector. Increased availability of finance has raised competitive pressures and the levels at which venture capitalists can expect to buy investments.

Peter Webb, manager of the Eaglet Investment Trust, a smaller companies fund, levelled another criticism at the venture capital industry -or the "private equity" sector. He said: "I have always believed that the so-called added value of private equity specialists is more about financial engineering than a superior knowledge of industry."

At the same time, sellers of businesses have become more wary about venture capital, especially in the buyout business. Big companies have too often seen venture capitalists buy subsidiaries and then sell them on at huge premiums.

Sellers are also driving harder bargains just as the economic backdrop means the investment risks for venture capitalists have risen.

However, if any venture capital company is to rise to the challenges, it is a fair bet that 3i will be among the leaders. In providing much of the finance for the buyout of Go, the low-cost airline founded by British Airways, 3i signalled that it is about more than technology.

Tech investments make up a large part of its portfolio, but, at a third, they still represent a minority.

If 3i does bounce back, its network of offices will play a key role, as they have throughout its history. The network is most developed in the UK and Europe, but its global reach gives 3i knowledge of local markets where smaller companies are based or where they transact business. Crucially, it gives 3i access to deals.

That strength justifies the premium at which 3i shares trade when compared with net asset value. Stock can be worth more than the sum of the parts if there is confidence that 3i will be worth more in future. That value can be delivered if the network continues to generate investment ideas.

The staff of 3i are usually graduates, often taken on in their mid-twenties after a few years of commercial working experience. "We rarely recruit from merchant banks," one insider says. The company likes to hire people with nonfinancial expertise as well. Specialist scientific qualifications are respected.

People tend to stay for a few years, or for life. Former employees include Paul Barber, finance director of Capita, the support services business, and Bernard Jenkin, Shadow Defence spokesman. Lifers include Brian Larcombe, who rose to chief executive.

3i is described as being more grammar school than public school. People are worked hard, but it is not the kind of place where it is thought necessary to be seen in the office for long hours. The intention is to admire what its people do rather than how long it takes them to undertake projects.

The way last year's redundancies were organised suggests there is a gritty edge to human resource management. No talk of voluntary redundancies; people were paid off whether they liked it or not.

The Times verdict

Social responsibility 4/10 Fat-cat quotient 7/10 Financial record
6/10 Share performance 7/10 Attitude to employees 7/10 Strength of brand
8/10 Innovation 6/10 Annual report 6/10 City star rating 5/10 Future

prospects 8/10 Total 64/100 Social responsibility is evaluated by PIRC. The fat-cat quotient, in which best boardroom pay practice scores highest, is provided by CEBR.

How we reached our decision

THE TIMES scoring system provides a ready reckoner of companies' strengths and weaknesses.

Two categories are judged by outside consultants. PIRC, the shareholder activist group, calculates social responsibility ratings. Of 3i, Stuart Bell, PIRC research director, says: "At board level and below, individuals are identified with responsibility for community, employment, environmental and human rights issues. While environmental risk is factored into investment strategy, performance indicators are poorly developed, apart from those reflecting community involvement. Stakeholders are identified, but do not appear to have a role in influencing policy."

Our "fat-cat quotient" is calculated by the Centre for Economics and Business Research. Doug McWilliams, the CEBR chief executive, says: "By and large, 3i carries out the remuneration process well, with the right structures and independence. The remuneration report is slightly opaque in the way it treats pensions and the management equity investment plan. Brian Larcombe, the chief executive, is paid in line with what we calculate to be appropriate, but the overall remuneration of the six-executive board is on the generous side."

Financial record is judged by studying profit, cashflow and dividend history; share performance by reference to absolute and relative returns over one, three and five years. City rating is based on analysts' recommendations. The rest are judged by specialist writers compiling the profiles.

Who's who in the boardroom

The non-executive chairman, Baroness Hogg, is a governor of the BBC, and a non-executive director of P&O Princess Cruises and GKN, the engineer. She is the former journalist Sarah Hogg, who was head of the Downing Street policy unit between 1990 and 1995.

She is a former non-executive director at National Provident Institution, and is non-executive chairman of the Foreign & Colonial Smaller Companies fund and a non-executive director of the Martin Currie Portfolio Investment Trust.

Brian Larcombe, chief executive, has been with 3i since 1974, taking the top job in 1997. Former chairman of the British Venture Capital Association.

Michael Queen is the finance director. Other executives are: Martin Gagen, in charge of the US side; Rod Perry, responsible for investments in the Asia Pacific region; Richard Summers, also a director of 3i Bioscience Investment Trust and 3i European Technology Trust, who oversees the continental interests; and Peter Williams, who is head of UK operations.

Oliver Stocken is non-executive deputy chairman and chairman of the remuneration committee. Also chairman of Stanhope and Lupus Capital, and a director of Great Universal Stores, Novar, and Pilkington. He is a former finance director of Barclays Bank.

Other non-executive directors: Lord Camoys, the former Lord Chamberlain of the Queen's Household, and a former director of Barclays Bank, Sotheby's and National Provident Institution.

John Forrest is chairman of the UK Government Spectrum Advisory Group. Former chief executive of NTL, the cable telecoms group. Used to be technical director of Marconi Defence Systems and Professor of Electronic Engineering at University College London.

Danny Rosenkrantz, the former BOC chief executive. He is also a director of Vetsfriend.

The company in detail

3i SITS uneasily beside its investment trust cousins. It is more like an asset management company than a run-of-the-mill trust. But it retains the status of an investment trust because it confers useful tax advantages.

Its focus is unquoted companies and it makes efforts to identify its own opportunities. Most investment is in start-ups or buyouts of subsidiaries. Only about 10 per cent of 3i's portfolio is in listed entities. Staff give first-hand advice to companies in which 3i invests and will often serve as a director.

3i has 1,000 staff; most are graduates. The head count was cut by 16 per cent last autumn in a reaction to the less-buoyant climate. That apart, annualised staff turnover for the past five years runs at 9 per cent.

3i's net asset value per share, at September 30, was 631p, or Pounds 3.8 billion. Shares trade at a premium to NAV; it has been as high as 75 per cent but now sits at 17 per cent. 3i manages funds for three 3i-branded trusts and for other unrelated investors. Funds under management total Pounds 7 billion. The dividend for last year was 13p. In the first half of this year it was an unchanged 4.9p.

History

3i IS the grandfather of the British venture capital industry. It traces its roots back to 1929 when a committee chaired by Harold Macmillan, who was later Chancellor of the Exchequer, Foreign Secretary and Prime Minister, identified the paucity of opportunities for small and medium-sized companies to raise finance.

In 1945 the Bank of England and the UK clearing banks founded a firm called the Industrial and Commercial Finance Corporation (ICFC), which was charged with finding financing solutions for what became known as the Macmillan Gap. At the same time, the Finance Corporation for Industry (FCI), whose aim was to channel funds into larger enterprises, came into being.

In 1973 the ICFC and the FCI merged to create Finance for Industry. In 1982 this body was renamed Investors in Industry, and it is from this title that the 3i monicker derives.

3i's banking community owners sold 3i to private and institutional investors in 1994 in one of the largest flotations of that year. The company joined the London Stock Exchange with an initial market capitalisation of Pounds 1.5 billion. It touched a peak value of Pounds 10.5 billion in September 2000.

3i and its predecessors have made investments in about 15,000 companies over the past 55 years. It helped to finance British Caledonian, the airline; Dunlop, the tyre manufacturer; Travellers Fare, the railway platform cafe operator; and Derwent Valley Foods, the maker of Phileas Fogg snacks. Waterstone's bookshops also grew with backing from 3i. So did Allders, Geest, Laura Ashley, Leyland DAF, MORI, Tibbett & Britten and Prontaprint.

Go, the low-cost carrier formerly owned by British Airways, counts among 3i's more recent ventures. Go, into which 3i injected Pounds 58 million last June, is also the largest of the firm's current investments.

(c) Times Newspapers Ltd, 2002