Market Report: Debt and portfolio worries strike at 3i

Mounting concern about debt and the outlook for its portfolio depressed the private equity group 3i, which closed at the bottom of the Footsie for the second session in a row.

There were worries that the group may have to offload some of its investments owing to the relatively high levels of leverage on its balance sheet and the leverage in the underlying portfolio. There was also concern about the valuation of the portfolio and the group's funding requirements, sending the stock to 243p, down 12.75 per cent, or 35.5p, despite some supportive comment from Cazenove.

The broker said that the underperformance was not justified given the levels of portfolio declines implied by the current valuation. "Very roughly, a 50 per cent decline in the overall portfolio [from the end of September] would take its net asset value down to the current share price. This would be approximately equivalent to writing off all the Growth Capital and Buyout portfolio investments on a cost or an earnings basis," Cazenove analyst Christopher Brown said, calling the implication "harsh".

"There is clearly a risk that 3i – like any geared company – could go bust if current conditions persist for several years and refinancing is no longer possible, but we believe the most likely scenario is that the company survives and its net asset value recovers from the low point it has yet to reach," he added, recommending that the group realise assets where it can do so at the right prices. "It is not a forced seller, but clearly lower net debt would improve the stock's rating," Mr Brown said, sticking to his positive "outperform" recommendation.

Overall, it was another light session as traders prepared for the Christmas and New Year holidays. Volumes were low and the FTSE 100 edged up 31.52 points to 4,309.08 while the FTSE 250 crept up to 6,251.05, up 46.16 points.

Tullow Oil, the strongest stock on the benchmark index, gained 8.49 per cent, or 48.5p, to 620p after announcing a significant oil discovery at the Heritage Oil-operated well in Uganda. FTSE 250-listed Heritage, which also stands to gain from the discovery, was up 6.7 per cent or 1,4.75p at 235p. Tullow and Heritage were also supported by the oil price, which firmed up on hopes that the Opec cartel would unveil substantial productions cuts when it meets in Algeria this week.

In the wider sector, Cairn Energy was up 2.13 per cent or 40p to 1916p.

Among banks, HSBC retreated to 715p, down 1.24 per cent, or 9p, amid talk that it may have to raise as much as $14bn (£9bn) to make its capital base more solid. The concerns were provoked by analysts at CLSA Asia Pacific Markets in Asia, which highlighted the possibility in a note to clients.

Man, the London-based hedge fund that last week confirmed exposure to Bernard Madoff's securities firm, remained on the back foot, losing 5.42 per cent, or 13.75p, to 240p. Merrill Lynch, which maintains a "buy" rating on the stock, said that although the group would outperform its peers this year, the alleged $50bn fraud would impact sentiment towards institutional investment in the hedge industry. "In the current febrile environment, we see the risk of higher outflows than we had previously expected," said Merrill.

On the second tier, PartyGaming, up 27.21 per cent, or 37.75p, at 176.5p, surged ahead after saying it was making progress in discussions with the United States Department Justice over its operations in the US before legislation banned foreign gambling websites.

The troubled housing sector was firm after Cazenove said that some recovery potential was emerging. "The newsflow for housebuilders has been awful and is likely to remain so, but there are unlikely to be any surprises and that cannot be said for most other sectors," the broker said, singling out Persimmon, up 0.5p at 239.5p, and Bellway, up 1.5p at 571.5p, as its tops picks.

Also on the upside, Imperial Energy gained 1.18 per cent, or 11.5p, to 990p after batting down recent market speculation that possible holdings by the erstwhile Lehman Brothers investment bank may pose an obstacle to ONGC Videsh's bid. Imperial poured cold water on the rumours, saying that Lehman has a de minims holding of about of 0.01 per cent.

Among smaller companies, Private & Commercial Finance, the AIM-listed independent finance house, climbed to 13.5p, up 17.39 per cent, or 2p, after posting a 15 per cent hike in interim pre-tax profits and 36 per cent increase in turnover.

Elsewhere, Vitec gained 14.12 per cent, or 24.75p, to 200p after Goldman Sachs switch its stance on the stock to "buy" from "neutral", citing the weakness in the share price since September.