CREDIT OPINION 3i Group plc Update following the publication of first-half 2018 financial results Update Summary credit rationale 3i Group plc (3i) is a UK-based private equity firm to which we assign a senior unsecured debt rating of Baa1 with a stable outlook, under our Investment Holding Companies and Conglomerates rating methodology. Analyst Contacts Andrea Usai 44-20-7772-1058 Senior Vice President andrea.usai@moodys.com Maxwell Price 44-20-7772-1778 Associate Analyst maxwell.price@moodys.com Laurie Mayers 44-20-7772-5582 Associate Managing Director laurie.mayers@moodys.com Nick Hill MD-Banking nick.hill@moodys.com 33-1-5330-1029 3i's baa1 senior unsecured debt rating is supported by the firm's (1) limited amount of outstanding debt, (2) conservative financial and investment policies, and proven asset management and investment realisation track record; and, (3) moderate net debt position, following the payment of dividends and higher reinvestment compared to realisations in the period. The rating also takes into account our expectation of reduced cash operating inflows, following the sale of the debt management business in October 2016 (completed in March 2017), which will lag cash outflows from expenses over the next 12-18 months. We also expect the firm to maintain its disciplined investment process, which has thus far supported good value creation within its investment portfolio. With the sale of the debt management business to Investcorp for 270 million, the firm's activity has refocused on private equity and infrastructure investments. Americas 1-212-553-1653 3i continues to benefit from a robust operating environment despite uncertainties stemming from still low, albeit improving, economic growth in Europe and heightened uncertainty as the United Kingdom (Aa2 stable) prepares to leave the European Union. This has supported the value and performance of the majority of the 3i's investments, as well as its investment realisation activity. Asia Pacific 852-3551-3077 Credit strengths CLIENT SERVICES Japan 81-3-5408-4100 EMEA 44-20-7772-5454» Solid mid-market private equity franchise in the UK, US and Northern Europe.» Reduced leverage following the reduction in outstanding gross debt.» Strong track record of asset management and investment realisation activities, which supports strong profitability levels.» Conservative financial and investment policies, supporting good-quality investments. Credit challenges» We expect lower cash operating inflows than outflows from expenses, following the sale of the debt management business, over the outlook period.
» High asset prices reduce the scope for profitable investment opportunities in the current competitive investment environment, constraining 3i's investment activity. Rating outlook The outlook on 3i's Baa1 senior unsecured rating is stable, indicating that we do not expect material changes in the firm's credit profile over the next 12-18 months. The stable outlook already incorporates our expectation of (1) an overall supportive operating environment, and (2) 3i management's commitment to shareholders to maintain a strong financial position and adequate liquidity to support the firm's investments, if required. Factors that could lead to an upgrade The stable outlook indicates that rating upgrades are unlikely over the next 12-18 months. However, an increase in the quality of the investment portfolio could lead to a rating upgrade. Factors that could lead to a downgrade A rating downgrade could result from (1) a significant increase in the firm s leverage, (2) a reduction in its liquid resources, or (3) a material deterioration in the quality of its investment portfolio. A structural decline in cash inflows, reducing materially the firm's operating cash generation, would also be negative for the rating. Key indicators Exhibit 1 3i Group plc Financial Year Sep-17 2017 [1,4] 2016 [1] 2015 [1] 2014 [1] KEY DATA Investment portfolio for own account [2] 6,584 5,675 4,497 3,877 3,565 Total assets 7,816 7,279 5,863 5,076 4,544 Total financial debt to Moody's norms [3] Net financial debt to Moody's norms [3] Shareholders' funds [2] 597 597 857 840 873 67-397 -145-24 174 6,320 5,836 4,455 3,806 3,308 Net profit 658 1,523 830 673 467 Net financial debt /equity, % 1.1-6.8-3.3-0.6 5.3 Net financial debt / non-cash assets, % 0.9-6.3-3.0-0.6 4.5 Net financial debt / portfolio, % 1.0-7.0-3.2-0.6 4.9 [1] Financial years ending 31 March, GBP million [2] Fair-value accounted [3] Taking into account retirement benefit obligations [4] 2017 Net Profit excludes profit from discontinued operations Source: Moody's Investors Service based on 3i Group annual reports Detailed credit considerations Unless noted otherwise, data in this report is sourced from company reports. Please see the "Note on data" section for further details. Solid mid-market private equity franchise in the UK, US and Northern Europe 3i invests on its own account and on behalf of third parties in private equity and infrastructure assets. In recent years, the firm has been reducing the number of private equity investments, which comprised 39 investments as of the end of September 2017 (end of first-half 2018), down from 53 a year earlier (see Exhibit 2). Two of the firm's current investments are listed companies. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history. 2
Exhibit 2 Number of 3i's private equity investments 90 80 70 60 50 40 30 20 10 0 2014 2015 2016 2017 1H 2018 Note: excludes quoted investments. Source: 3i Group annual reports. We consider 3i's investment portfolio to be fairly diversified by sector, taking into account the firm's size and its target market, despite some sectoral concentration, which has increased following recent investment disposals. The firm's top 20 investments accounted for 82% of the total portfolio as at the end of September 2017, compared with 77% as at 31 March 2017. The portfolio is mostly exposed to the UK, US and Northern Europe (see Exhibit 3), which benefit from strong macroeconomic fundamentals. Exhibit 3 Geographic composition of 3i's investment portfolio 7% 5% 10% UK Benelux France 27% Germany 47% North America Rest of Wrold 3% Source: 3i Group interim report 2017. Over the last few years, 3i has improved its earnings from its private equity investment portfolio through (1) the sale of lower-quality investments, and (2) the enhancement of its internal controls and asset management process. The firm has also strengthened its investment policies, which we expect to lead to lower earnings volatility, going forward. 3
Improved leverage following the reduction in outstanding gross debt As part of its strategic plan, 3i has utilised in recent years cash from its investment realisation activity to reduce its outstanding gross debt, which accounted for 575 million as of end-september 2017, down from 1.6 billion as of end-march 2012. A lower debt stock has strengthened the firm's financial position and halved its funding costs. The firm's cash position decreased by 467 million to 527 million in the six-month period ending 30 September 2017 due to dividend payments ( 178 million) and new investments ( 289 million). This has led to 3i reaching a net debt position (gross debt minus cash) of 48 million as at end-september 2017, from a net cash position of 419 million at end-march 2017, indicating a worsened liquidity position. However, we expect 3i's liquidity position to rebound during the second half of the current financial year, due to investment realisation and portfolio income. The reduction in outstanding gross debt has improved the firm's leverage, as illustrated by gross debt/ebitda of 0.41x at end-september 2017 from 1.65x in 2014 (see Exhibit 3). 3i's improved financial position mitigates some of the financial risks within its private equity portfolio, which comprises investments with an average leverage of c.3.1x debt/ebitda, as of end-september 2017. Exhibit 4 3i's private equity portfolio leverage and group leverage 3.5 Portfolio leverage 3i leverage 3 2.5 2 1.5 1 0.5 0 2014 2015 2016 2017 1H 2018 Source: 3i Group annual reports and Moody's Investors Service calculations. Strong track record of asset management and investment realisation activities supports strong profitability levels 3i has increased its assets under management (AUMs) across its two business lines in recent years, owing to both higher investment values and fund-raising. AUMs in private equity totaled 9.1 billion at end-september 2017, up from 8.1 billion as at 31 March 2017, whereas AUMs in infrastructure rose to 3.6 billion from 2.9 billion over the same period. In May 2016, 3iN, an infrastructure investment company in which 3i has a 34% stake, announced a 385 million capital increase, which 3iN's management subsequently deployed to expand its investments in two existing companies (Wireless Infrastructure Group and TCR). 3i has fully participated in this equity-raising initiative with a contribution of 108 million, after taking into account dividend proceeds that 3iN paid to its shareholders, including 3i. 3i has been a net realiser of investments in recent years, particularly through the disposal of some lower-quality assets, which has allowed management to focus on maximising the value of existing larger investments. The increased concentration within the firm's private equity portfolio could, however, lead to less granular income streams from investment realisation in the future. 3i has guided to a desired number of investments of around 30-40, although availability of investment opportunities and changes in market conditions could lead the firm to diverge from this figure. 3i's largest private equity investment is a Northern European discount retailer (Action), which the firm values at around 2 billion, corresponding to around 35% of its total private equity portfolio. Action's value increase resulted from a refinement to 3i s valuation methodology. 3i used Action s run rate earnings to the closest period end to its own, rather than the run rate earnings to the quarter end preceding the reporting period, to reflect Action s consistent financial delivery. Action's good investment performance is illustrated by its ability to pay dividends to 3i, which accounted for 187 million over the last year, bringing the total cash distribution to the firm to 526 million, since its initial investment in 2011. 4
3i's investment realisation totaled 374 million during the 6 months ending 30 September 2017, down from 666 million in the same period the previous year. Conservative financial and investment policies have proven to support good-quality investments 3i had a total of 486 million in short-term investments as of end-september 2017, largely in Aaa-rated money market funds and bank deposits, and representing 6% of its total assets, as of the same reporting date. Similar to other asset managers, 3i holds large cash balances to support the business during periods of high market volatility. The firm also has access to 350 million committed liquidity lines (undrawn as of end-march 2017) provided by well-rated banks. These funding arrangements were renegotiated in 2014 and have allowed 3i to benefit from lower running costs and an extended maturity to September 2021. 3i's strong liquidity profile should allow the firm to withstand unexpected market shocks, in our view. The firm has changed its dividend policy, consisting of paying a base dividend of 16 pence per year, and a variable amount, which depends on the realisation achieved in the previous year and on the outlook for future realisations, investments and balance-sheet liquidity. This variable amount will only be paid if gearing remains below 20% and gross debt stays below 1 billion. In 2017, total dividend paid was 26.5 pence, up from 22 pence in the previous year. A divergence from the current dividend policy, which would result in cash distributions to shareholders at the expense of the firm's strong liquidity position, would be a negative development for its creditors. Reduced cash flow from the debt management business sale will lag cash expenses over the outlook period 3i's cash flow will decline following the completion of the sale of its debt management business in 2017 and, as such, we expect cash operating income to remain lower than expenses, over the next 12-18 months. However, the firm's available liquidity should allow it to cover any mismatches during this period. The firm has lowered its operating expenses in recent years, through headcount reductions and office closures. In the half year ended 30 September 2017, operating expenses were 58 million, which, although higher than 54 million in the same period a year earlier, were much lower than in 2012. We expect the firm to have limited ability to reduce its operating costs further. High asset prices reduce the scope for profitable investment opportunities in the current competitive investment environment, constraining 3i's investment activity We view 3i's investment policies and processes as conservative. Management is seeking investment opportunities that can provide high potential returns. In the 6 months ended 30 September 2017, 3i's proprietary investments totaled 572 million. Although higher than in the same 6-month period a year earlier, 3i has used cash held to make these additional investments. Finally, we understand that 3i's focus on middle-market transactions in niche business sectors has allowed the firm to take advantage of investment opportunities outside auction-driven acquisitions, which tend to be larger in value and more expensive, reducing the expected return. Note on data Unless noted otherwise, data in this report is sourced from company reports. All figures are based on our own chart of account, and are adjusted for analytical purposes. For the year ended 31 March 2014, 3i adopted International Financial Reporting Standards 10, a new accounting standard, in reporting its annual results. For the purposes of our analysis, we have used the investment basis set of financial statements, which are prepared on a similar basis to prior year's financial statements. In our view, the investment basis allows for relatively better transparency with 3i's portfolio performance and comparability with prior year's results. Please refer to the document entitled Financial Statement Adjustments in the Analysis of Financial Institutions published on 13 June 2017. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on http://www.moodys.com for the most updated credit rating action information and rating history. 5
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CLIENT SERVICES 7 Americas 1-212-553-1653 Asia Pacific 852-3551-3077 Japan 81-3-5408-4100 EMEA 44-20-7772-5454