SIGB.L Regulatory News (SIGB)

Sherborne Investors (Guernsey) B Limited

16 October 2015

Sherborne Investors (Guernsey) B Limited

Letter to Shareholders of Electra Private Equity plc

Sherborne Investors Management (Guernsey) LLC ("Sherborne Investors"), the investment manager of SIGB, LP, has notified the board of Sherborne Investors (Guernsey) B Limited that Sherborne Investors is today sending to Electra Private Equity plc ("Electra") shareholders a letter regarding the upcoming general meeting of Electra urging them to vote IN FAVOUR OF all of the resolutions to be tabled at the general meeting of Electra to be held on Thursday 5 November 2015.

Highlights

· Two out of eight directors is not control

Adding a minority of two highly qualified nominees to a board of eight would add skills and oversight while retaining six incumbent directors. It does not begin to approach "control."

· Board independence is compromised

Electra's corporate governance is deficient. The board has, to all intents, conceded that it is not fully independent of its investment manager, Electra Partners, which effectively controls board nominations and opposes additional board oversight.

· Inconsistent board stance

By abandoning its prior refusal to agree to a review, the board clearly acknowledged the validity and seriousness of points raised by Sherborne Investors that it had previously dismissed.

· Electra underperformed until Sherborne Investors acquired shares

The board highlights Electra's share price performance since 12 October 2006. Electra underperformed the FTSE 250 by 14% from then until January 2014 when Sherborne Investors started buying its 30% shareholding.

· Continuing opportunity to increase value for all shareholders

The Chairman's review, which was poorly received, ignored areas for improvement suggested by Sherborne Investors which the whole board should consider. These include:

- Corporate financial risk

- Portfolio risk

- Clarity and consistency of disclosures

- Pay for performance

- Portfolio operating performance.

Edward Bramson, a partner in Sherborne Investors, said:

"The hostile reactions of the investment manager and the board seem disproportionate to a proposal by a long-term shareholder to nominate a small minority of qualified directors to Electra's board. Our nominees are exclusively aligned with the interests of all shareholders and their independence from the investment manager would not affect their desire to work collaboratively and constructively with the board and with Electra Partners.

"Independence from management and constructive engagement are core principles of effective corporate governance and the board is wrong to suggest that reasonable questioning equates to disruptiveness.

"Electra is a public company and the benefits of public capital come with additional duties and levels of oversight which are currently lacking. Our requisition is a last resort, having acted in accordance with the UK Stewardship Code and after exhausting all other avenues available. We continue to hope that the directors will reconsider their unwarranted opposition to our nominees."

Letter to Shareholders

Dear Fellow Shareholder,

We are writing to you to ask for your support of all the resolutions to be proposed at the forthcoming shareholder meeting of Electra Private Equity plc ("Electra" or the "Company") to be held on 5 November 2015, which has been convened by Electra following our requisition. This letter explains why we believe the appointment of our two directors to the board of the Company would be positive for all Electra shareholders as it would improve corporate governance, increase awareness of risk, and help to promote long-term increases in shareholder value.

The board of directors of Electra, to which the shareholder resolutions relate, sets the strategy for the investment of the Company's funds and manages its relationship with Electra Partners LLP, a separate entity to which Electra has delegated substantially all of its activities ("Electra Partners" or the "Investment Manager").

Sherborne Investors has been a shareholder in Electra for almost two years and is Electra's largest shareholder with approximately 30%. Over the past year we have increased our shareholding in Electra and we have a long-term investment perspective.

Over the last 15 months we have tried to reach an agreement with the board to add two highly qualified directors. These two directors would be a minority of an eight member board.

As an indication of good faith, we have compromised our proposals on various occasions to respond to Electra's concerns. Although there have been hints of flexibility, the board has not made any compromises. Having exhausted all options set out in the UK Stewardship Code we are left with no other choice than to requisition a meeting of shareholders.

We recognise that there may be legitimate differences of opinion between us and the directors, but have been surprised by the extraordinary measures they have taken to block the appointment of a small number of new, well qualified directors who are able to bring a fresh outlook. The following are a few examples of their behaviour.

The board's confrontational behaviour

· Before we made any request for board representation, Electra wrote to certain of its shareholders threatening retribution if they were supporting us.

· During the same period Electra attempted, unsuccessfully, to hinder our regulatory approvals. Had these approvals been denied, we could have been compelled to divest our Electra shares at a loss.

· In order to persuade us to drop our request to nominate directors, the board suggested that Sherborne Investors should make a proposal to become the Alternative Investment Fund Manager of Electra's assets. We rejected this proposal outright in our letter to Electra of 11 May 2015.

· The board has consistently refused to consider any of the opportunities and risks that we have suggested for review.

"The Board of Directors of Electra sees no requirement for a further strategic review to be undertaken by either Mr. Bramson and Mr. Brindle or any other party." (I)

· When it became clear to the board that the only way to avoid the appointment of our director nominees was to reverse its position and agree to a review we, as the largest shareholder, were not consulted or even informed prior to the announcement of the change of stance immediately after the announcement of the October 2014 shareholder vote results. We were, in fact, deliberately excluded.

"As a result of discussions with shareholders over recent weeks, the Board of Directors is announcing that it will launch a review covering the fee arrangements with Electra Partners LLP as well as the capital structure and distribution policy of the Company. The Board of Directors of the Company recognises that these are topics of particular focus for all shareholders and that a review of them is appropriate at the present time." (II)

The results of the review by Electra's chairman, Roger Yates, were described as the result of consultation with shareholders. Again, despite being the largest shareholder in Electra, Sherborne Investors was not consulted before or during the review process.

Chairman's review

By its about-face on its earlier stance, the board acknowledged the validity and seriousness of points raised by Sherborne Investors that it had previously dismissed out of hand. The board now had a chance to demonstrate its grasp of the issues we had raised and to set out its own plans to increase shareholder value.

Mr. Yates' review did not offer any effective plans to increase shareholder value and fell significantly short of market expectations on most of the points that it had sought to address.

· The revised fee structure is unlikely to reduce costs in the medium-term, but encourages greater near-term risk-taking by the Investment Manager.

· The review's increase in borrowing facilities actually amplified the riskiness of Electra's capital structure rather than reducing it as we suggested.

· Introducing a variable return of capital distribution policy, which is effectively tied to market levels, will add to share price losses in a market downturn. The dividend that we would have preferred would have had a more desirable stabilising effect on the share price.

The Chairman's review did not offer any original ideas to increase shareholder value or improve capital allocation at all. Therefore, it should not have been a surprise to the board that Electra's share price fell on the day of the review's announcement, which is unusual in our experience.

Faced with reasonable questioning supported by public data, the board has continued to refuse to consider opportunities to improve shareholder value. The board seemingly believes that there is not the slightest opportunity to improve anything, as if there were the Investment Manager would have done so already.

Unfortunately, Mr. Yates' review confirms our belief that the current directors, on their own, do not have all of the necessary resources or experience to be the exclusive overseers of the Investment Manager or of shareholders' interests.

Board's lack of independence

After many months of discussions with Electra, the directors finally admitted in their letter of 12 August 2015, that the board will not appoint directors who are not acceptable to the Investment Manager as it:

"risks…the relationships at both the Electra Partners and the portfolio company levels."

Electra Partners effectively influences the composition of the board and in this and other ways, exercises effective control over Electra. The board of the Company is, therefore, not independent of management.

We believe that the Investment Manager's fear that new independent directors might ask reasonable questions is based on our earlier exposure of legitimate questions concerning their fees and other practices. Our intentions are entirely constructive so their concerns are misplaced and we expect that they would quickly dissipate in practice.

One of the board's most important responsibilities is to be independent in overseeing the Investment Manager. Oversight cannot be exercised effectively if those whom the board oversees can choose their overseers, and can exclude qualified nominees.

Purpose of the requisition

Sherborne Investors is not proposing to become the investment manager and is nominating only two non-executive directors to a board of eight, six of whom are current members of the board and would continue to be the dominant majority. We are aware of no excuse in the UK Corporate Governance Code or elsewhere for the board's admission of discrimination in its letter to us of 29 September 2015 that:

"[Sherborne Investors'] nominees are being treated differently to any other appointment made to the Electra Board."

Qualified and constructive nominees

Mr. Brindle and Mr. Bramson are committed to working collaboratively with the board as a whole. They are well qualified to broaden the skills, experience and resources behind the board's functions of engagement and oversight and we do not believe that the board or Electra Partners have any basis to discriminate against them. Mr. Brindle and Mr. Bramson are committed to seeking long-term value for all Electra shareholders.

Ian Brindle

Mr. Brindle has been a director of several public companies and was formerly the UK Chairman of PricewaterhouseCoopers and the Deputy Chairman of the Financial Reporting Review Panel. He was also the auditor to the Duchy of Cornwall. Mr. Brindle was given regulatory clearance as an "Approved Person" by the Financial Services Authority (now known as the Financial Conduct Authority) with respect to his non-executive directorship at F&C.

Mr. Brindle has never received any compensation from Sherborne Investors and will not do so in relation to Electra.

Edward Bramson

Mr. Bramson's investment experience started in 1977 when he co-founded New York-based Hillside Capital, one of the first specialist private equity firms in the United States. Mr. Bramson, a partner in Sherborne Investors, has also served as a director and chief executive of public companies in various business sectors, most recently at F&C Asset Management plc, a major asset manager with over £80 billion under management. Mr. Bramson was given regulatory clearance as an "Approved Person" by the Financial Services Authority (now known as the Financial Conduct Authority) with respect to his Chairman and Chief Executive roles at F&C.

We believe that the addition to the board of Messrs. Brindle and Bramson who are independent of the Investment Manager and exclusively aligned with shareholders' interests would bring a healthy and open-minded attitude to the board and would help to develop independence from management.

Areas for improved board oversight

Later in this letter we suggest opportunities the board should explore to increase shareholder value. However, quite separately, we see immediate need for greater board oversight in several critical areas, including:

· Corporate financial risk

· Portfolio risk

· Clarity and consistency of disclosures

· Pay for performance

Corporate financial risk

The Company increased its borrowing facilities in February 2015 to £275 million (23% of net asset value ("NAV")). The borrowing facilities allow Electra Partners to require the Company to borrow money to be invested in portfolio companies that it controls. Electra itself has no significant sources of net cash flow and cannot direct a sale of assets or return of cash by the Investment Manager. Its independent ability to repay maturing loans may therefore, in some instances, be jeopardised.

Without appropriate controls and oversight, this arrangement subjects shareholders to substantial risks, including insolvency. This is a basic corporate finance principle and Sherborne Investors drew attention to it prior to Mr. Yates' review. It is worrying that, as a result of the review, these committed borrowings were increased by £80 million. We believe that corporate financial risk is an area in which more expertise and independent oversight is needed.

Portfolio risk

Although portfolio management is "wholly and exclusively" outsourced to the Investment Manager, the board is responsible for independently reviewing risk levels and, if necessary, setting risk parameters for the Investment Manager.

In recent years the senior investment team at Electra Partners has changed significantly and it has adopted, as Mr. Cullinan, an Electra director, describes it "modern style private equity" to replace the investment approach of the previous investment team.

This change has coincided with a major increase in portfolio concentration by sector and by size of individual investment. Additionally, a recent rush of new investments at relatively high market price levels has eroded Electra's more consistent vintage discipline of the past and has increased the exposure of the portfolio to a market decline.

Clarity and consistency of disclosures

Shareholders, directors and managers depend on meaningful presentations of data to support effective decision making. We believe that the usefulness of financial presentations by the Company and by Electra Partners could be improved and should be subjected to greater independent oversight. Mr. Brindle, who served as Deputy Chairman of the Financial Reporting Council and as the UK Chairman of PricewaterhouseCoopers is particularly well qualified to contribute in this area.

For example, Electra frequently cites "weighted average" measures as, to be fair, do many of its peers. When used to characterise performance or to justify decisions, "weighted average" calculations often appear reasonable but can be misleading. "Weighted" figures skew the apparent performance of a portfolio towards successful companies with growing earnings and minimise the impact of those with declining earnings. A "weighted" portfolio can, therefore, appear to have only "winners," while "losers" can be effectively buried.

An example of the distorting effect of this technique is the statement in Electra's recent financial results presentation that "weighted average" earnings grew by a double-digit figure. We have attached to this letter a slide taken directly from this presentation which can be viewed here (III) These data, which are aggregated and not "weighted average," show a picture at odds with the performance implied by the board's and Electra Partners' statements.

We have also observed instances of operating or financial data that cannot be reconciled to public sources without detail that is not provided by the Company or Electra Partners. Recent announcements concerning the sale of Nuaire are a case in point.

Pay for performance

We take no comfort from the board's comparison of Electra's performance to the Morningstar Private Equity Index, as the index's long-term returns have been dreadful.

The Company's recent circular refers to share price returns using its preferred starting date of 12 October 2006. This shows that Electra's share price return lagged the FTSE 250 index from that date to 20 January 2014, when Sherborne Investors began to purchase 30% of Electra's shares. Since our buying began, the share price has beaten the index and this period accounts for more than all of Electra's claimed share price outperformance from October 2006 to-date. Electra's NAV performance follows a similar pattern, so the board's self-congratulation may be misplaced.

We suggest an alternative method of measuring performance that is simple and easy to understand: a comparison to a relevant index, adjusted for gearing. Electra uses considerable financial gearing in its investments which can increase returns in rising markets at the risk of greater losses when conditions are unfavourable. Electra's assets are predominantly illiquid, so the risk from financial gearing is particularly high.

The Company's recent financial presentations indicate that Electra depends on gearing for as much as 50% of its diluted NAV per share growth.

Electra uses the FTSE 250 index, of which it is a constituent, to value its portfolio investments. A comparison of Electra's returns to this index, when corrected for differences in gearing, shows that at the equivalent level of overall risk Electra consistently produces lower returns than the index. For example, over the last five years Electra has produced a return 39% below the index. Sadly, as is often the case in asset management, active management of the fund is not, at present, generating excess risk-adjusted returns ("alpha"). A passive indexing strategy has higher returns and lower expenses.

During the last five years, the Company has accrued more than £250 million of investment management expenses for Electra Partners during a period when Electra's returns, adjusted for gearing, lagged the FTSE 250 by 39%. Typical expenses for an index tracking fund over this period would have been much less, most likely less than £10 million in total.

We believe that Electra and its shareholders should be prepared to pay handsomely for excess risk-adjusted returns; however, the current performance scheme is essentially "pay for gearing" rather than "pay for performance." A more independent board could usefully review the metrics used to measure performance and perhaps include other factors to incentivise the Investment Manager to produce better risk-adjusted returns.

We have also discovered from public sources that Electra Partners receives fees of various kinds from Electra's portfolio companies over and above its investment management compensation. Our nominees would encourage the board to examine how these fees relate to pay for risk-adjusted performance and to disclose them clearly to shareholders. At present, the board does not disclose or even refer to these payments in its financial statements. This topic has become a regulatory focus in the private equity field and, if not addressed, poses the risk of reputational and other damage to the Company.

Operating improvement opportunities

Our previous letter to Electra's shareholders of 17 September 2014 contained information on a number of issues, including operating performance, which, for brevity, we have not repeated. The full text of our September 2014 letter is available for review at www.sherborneinvestorsguernseyb.com.

Our September 2014 letter laid out the reasons for our suggestion that a board review of opportunities to improve shareholder value was justified by data on the operating performance of companies in the Electra portfolio at that time, which was justified by the data included in our letter. Updating the operating performance data in last year's letter has not changed our conclusion that a review is warranted. We now have more information, so the proportion of the value of Electra's Direct Unlisted portfolio for which we have public data is now up to 79%.

In the aggregate, i.e. on an actual rather than "weighted average" basis, the companies in Electra's portfolio have somewhat lower operating profit margins and higher fixed costs than companies that we have typically found to be good candidates for operating improvement. Electra Partners might prefer it if the board did not ask probing questions about the operations of the portfolio. The data supporting the observations in our letter are available to any diligent analyst, director or shareholder who makes the effort to find them. In our view, an independent board should be keen to explore opportunities to improve shareholder value with the Investment Manager, rather than to vilify a major shareholder for raising legitimate questions.

The board has made no direct attempt to refute the observations we made in September 2014. The directors' response ignored the Company's current investments that we had mentioned and instead focused on different portfolio companies that Electra no longer owned, arguing that some of the constituents of this different group had exhibited signs of growth in EBITDA. However, even this barely relevant conclusion was based on data that were, as usual, "weighted average" and disclosures that were, at best, incomplete. We consider the following quotation from the board's response to be essentially meaningless, as it excludes data to which Electra must have access, and it exemplifies why we have concerns about Electra's disclosure policies.

"Analysis based upon a pool of 11 direct unlisted investments which account for 75% of realisations of direct unlisted investments in the five years to 31 March 2014." (IV)

We believe that the opportunities we have pointed out should have been considered in a serious manner and not dismissed without proper investigation. A more independent board might have chosen to react more thoughtfully and with more concern for shareholders than for management.

"Open dialogue"

The board constantly highlights its policy of "open dialogue" with shareholders. However, it was only after 13 months of discussion that it finally admitted that their real reason for opposing our board nominees was concern that Electra Partners had objected to our presence. Prior to this, a variety of insubstantial reasons were put forward instead. For example, Mr. Yates told us that the contract with Electra Partners contained provisions that precluded our nominees from joining the board. The board refused to show us the relevant investment management agreement sections even though the agreement had been on public display in the past. The board subsequently abandoned this claim and other diversionary regulatory and procedural obstacles that they had raised, leaving the Investment Manager's control of the board's nominating process as their only substantial issue.

Conclusion

Shareholders have the right to point out, and directors have the obligation to investigate, opportunities to mitigate risk and increase shareholder value. There is no requirement in the UK Corporate Governance Code, or in logic, for a proposed director to submit a "plan" as a condition for joining the board. If this were the case, none of Electra's directors could have joined the board as they have admitted that they submitted no plans.

In some circumstances it might be reasonable to expect a "plan" to be presented, prior to the appointment of a new investment manager, for example. We reiterate that our requested involvement with Electra would simply be as non-executive members of the board and not as the investment manager. Accordingly, we cannot see how any requirement for a "plan" is justified.

The board has confirmed that Sherborne Investors' "nominees are being treated differently to any other appointments to the Electra board." We see no business principle and no support in the UK Corporate Governance Code for discrimination against Mr. Brindle or Mr. Bramson. We believe that our nominees are fully qualified to serve on the board of Electra and to add value to the board's oversight and engagement functions.

We believe the Investment Manager exerts inappropriate influence by deciding who is or is not suitable to join the board of Electra. It is impossible for a board to act independently in asking reasonable questions or making appropriate decisions in these circumstances. Our nominees would help to establish a better balance on the board.

Our nominees would work collaboratively with the existing board to create long-term value. We are simply proposing to retain the six current directors who are "wholly independent of shareholders" and to add two experienced and qualified directors who are wholly independent of management.

We believe the addition of Mr. Brindle and Mr. Bramson would add a fresh, balanced approach that is lacking from the board and create a much better long-term investment for all shareholders.

We respectfully ask you to vote IN FAVOUR OF all of the resolutions.

Yours faithfully,

Sherborne Investors

HOW TO VOTE

By now you should have received a notice of general meeting of Electra ("GM") to be held at 11.00a.m. (London time) on Thursday 5 November 2015 at Allen & Overy LLP, One Bishops Square, London E1 6AD ("Notice of GM").

By Post

You will find enclosed with the Notice of GM, a form of proxy for use at the GM ("Form of Proxy"). Whether or not you intend to attend the GM, Sherborne would urge you to complete the Form of Proxy to vote IN FAVOUR OF all of the resolutions and to appoint Edward Bramson as your proxy for the GM.

The Form of Proxy must be completed and signed and sent or delivered, together with any power of attorney or other authority (if any) under which it is signed, so as to reach Electra's registrars, Equiniti Limited, at Aspect House, Spencer Road, Lancing, BN99 6DA, United Kingdom as soon as possible but in any event no later than 11.00 a.m. (London time) on Tuesday 3 November 2015. The return of the completed Form of Proxy will not prevent you from attending the GM and voting in person if you wish to do so.

Via CREST

CREST members may also appoint a proxy or proxies through the CREST electronic proxy appointment service by utilising the procedures described in the CREST Manual. CREST Personal Members or other CREST Sponsored Members, and those CREST members who have appointed (a) voting service provider(s), should refer to their CREST sponsor or voting service provider(s), who will be able to take the appropriate action on their behalf.

If you need assistance voting you shares or have any related questions, please contact Sherborne Investors' proxy solicitor, D.F. King & Co., Inc.:

European Investors

Direct: +44 (0)20 7920 9700

US Investors

Toll Free: +1 (800) 821-8781

Direct: +1 (212) 269-5550

Email: electra@dfking.com

OTHER INFORMATION

If you are in any doubt about the action you should take, you are recommended to seek your own independent financial advice immediately from your stockbroker, bank manager, solicitor, accountant or other independent financial adviser duly authorised under the Financial Services and Markets Act 2000, as amended, if you are resident in the United Kingdom or, if not, from another appropriately authorised independent financial adviser.

The contents of this document should not be construed as legal, investment or tax advice, nor should it be construed as an invitation to purchase or sell any of your shares in Electra. This document is being circulated to shareholders of Electra by Sherborne Investors for the purpose of supporting resolutions proposed by Pershing Nominees Limited (for and on behalf of Sherborne Investors) as a member of Electra pursuant to section 303(2)(a) of the Companies Act 2006.

Sherborne Investors believes that certain statements in this document may constitute "forward-looking statements". Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and risks, many of which are subject to change. As a consequence, current plans, anticipated actions and future financial condition and results may differ from those expressed in any forward-looking statements made by or on behalf of Sherborne Investors. Additionally, forward-looking statements speak only as of the date they are made and Sherborne Investors undertakes no obligation to release publicly the results of any future revisions or updates it may make to forward-looking statements to reflect new information or circumstances after the date of this document or to reflect the occurrence of future events.

-Ends-

Enquiries: 

(I) Source: Electra circular dated 11 September 2014

(II) Source: Electra RNS dated 6 October 2014

(III) Source: Electra Half Year Results Presentation May 2015

(IV) Source: Footnote 4 of Electra circular dated 22 September 2014