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Wagamama, Paperchase and GAME have one thing in common: Graphite Capital. Managing partner Rod Richards talks about how the firm has helped build market-leading consumer brands.

It’s Blue Monday, the day that is supposed to be the most depressing of the year, but inside his pristine Mayfair office Rod Richards is looking cheerful. Granted, his upbeat demeanour is tempered with a large dose of realism, but that’s more to do with his personal style than the gravity of the downturn sending him into a tailspin.

‘I was quite conservative when everyone was getting carried away, and I’m not nearly as negative now when everyone’s gloomy,’ he explains.

But this is private equity, and a measured outlook only gets you so far. You have to take risks, or ‘play the game’ in Richards’ phrase. And some of those risks look pretty brave.

There was the £100 million buy-out, in December 2007, of recruitment company Alexander Mann Solutions, followed closely by the acquisition of shoe retailer Kurt Geiger for £95 million last February. These were Graphite’s last two major investments, though the firm did contribute to a £53 million financing package for care home group Willowbrook in October.

Richards concedes that recruitment and retail are vulnerable sectors in a downturn. But he says Kurt Geiger, which sells through departments in Harrods and Selfridges as well as its own outlets, has grown both sales and profits, not just over 2008 as a whole, but also in its year-on-year figures for December. Expansion into the Middle East has helped, as well as a white-label agreement designing shoes for a major retail chain.

Meanwhile, Alexander Mann has suffered as ‘some of their clients are taking on a lot less people than before’. But Richards points out the company has won five major new clients and made an acquisition since Graphite’s investment.

‘If you come out of a downturn with big global clients, it’s almost not that important how much money you make every year – as long as the company doesn’t go backwards,’ he says.

‘If we could have had the option of keeping the core business intact with no new clients, I would say that would be a worse outcome.’

Naturally, there are ups and downs within every investment. Richards emphasises that private equity is meant to be a ‘long-term game’ with investors judged on what they deliver over the typical five-year lifespan of a fund.

Growing pains
The year ahead presents a number of problems for all private equity firms. There are still opportunities, but it is more difficult and costly to arrange debt for buy-outs. Decent exits are few and far between, admits Richards, because ‘if companies are doing well, you don’t want to sell them against this background and if they aren’t, you definitely don’t’. That means you have to hang on to portfolio companies longer, which hits your internal rate of return (IRR) ‘almost by definition, because you have to wait longer to get the price you need’.

The firm has two things on its side: first, there is about £500 million left to invest from a fund raised in May 2007, and second, he’s been through this before. Since joining what became Graphite Capital in 1986 he’s navigated portfolio companies through the recession of the early 1990s and the dotcom-led crash at the turn of the century.

‘Our 1988 fund didn’t look good in 1990, but we returned cost and a bit more. Our 1994 fund didn’t look too spectacular for a while but we sold [noodle chain] Wagamama at ten times cost and the others at two to three times cost,’ he says. ‘So you could be really gloomy about the current situation, but I don’t believe the outcome will be as bad as some people expect.’

Strikes and sideburns
When Richards graduated from Oxford with a first-class degree in politics, philosophy and economics, Britain was still reeling from the recession of the mid-1970s. The top rate of personal tax was 83 per cent, people were scared of losing their jobs and a career in the Civil Service was seen as the safest and most prestigious option.

Richards, though, had other ideas, as did his mother. She flatly stated he could do whatever he liked with his life so long as he didn’t become a solicitor – his father’s profession. He dutifully obeyed and, after a spell working in marketing for an American company, completed an MBA at INSEAD. He then worked briefly at consultancy firm McKinsey, intending to put in ‘the standard two years’ before branching out in a new direction. He lasted four months.

‘I didn’t want, long term, to be a consultant. I didn’t suit that very rigid type of corporate culture,’ he explains. Instead, he joined asset management firm F&C, which had a few years earlier raised £20 million to invest in unquoted companies worldwide. ‘It was an opportunity to get into a business that was tiny, which was both incredibly interesting and, if it did well, offered a huge opportunity,’ he recalls.

That opportunity paid off as F&C’s private equity business mushroomed during the 1990s on the strength of impressive investment returns. In 2001, when F&C was sold to insurance group Eureko, Richards and his team bought out the business and named it Graphite Capital.

‘We just liked the idea of owning our own business rather than being owned by somebody else,’ says Richards. ‘Investors in our funds perceived our being independent as a big advantage, as we couldn’t be manipulated by a large group.’

Eye for a deal
Graphite claims an average IRR of more than 40 per cent for realised investments made since 1991, and a cost multiple of more than three. It has £1.2 billion under management and has helped build household names such as Maplin Electronics, Paperchase and GAME.

Richards has no regrets about going into private equity, but he will not necessarily be recommending the career to his university-age children. ‘I would have reservations,’ he says. ‘There is a danger in going into whatever is the glamorous sector of the moment, because by then it is probably too late. That’s what happened with stockbroking, investment banking, hedge funds – the people who got in there early did very well, the others not so well.’

That doesn’t mean he believes the party’s over for private equity. ‘This industry does not have a record of generating big losses. The big wins will pay for some losers,’ he maintains.

A lot of private equity’s current problems can be attributed to the banking sector, which made credit too readily available, driving up company valuations to unsustainable multiples, Richards argues.

‘Our industry has been tainted completely by the excesses of the banks. With the availability of bank debt being what it was, you could either go along with it or you didn’t play. It’s like what happened in the housing market: because banks made mortgages available at six or seven times salary, you either over-borrowed or you were out of the market.’

But weren’t the banks in competition with each other to meet the demands of dealmakers? ‘That is true whatever sector you’re talking about,’ Richards counters.
‘If you were running a bank and one of the other banks was involved in sub-prime mortgages, it is actually quite dangerous for you not to take part.’

Out of the ashes
Despite his criticism of the banks, Richards says the credit crunch will create ‘the best buying opportunity for 17 years’, which he expects to emerge towards the end of 2009 and continue for two years after that.

As for his existing investments, he remains philosophical. ‘In private equity, we all run portfolios. We might have some zeros, but we’ll also have some doubles. And if you roll forward a few years you might find some of the companies that look like zeros end up being worth a lot more than that.’

He cites the example of GAME, the video game retailer. ‘The company ran out of money one Christmas. The new Sony Playstation was due to launch, and was delayed, and there was nothing to replace it. On any basis, the business was technically bust. But we put more money in and made eight or nine times our investment two years later.’

Now there’s a story to take the gloom out of Blue Monday.