Raising the cash was the easy bit – now what to invest it in?
“Private-equity funds [are raising] money at the quickest pace since 2006,” read a recent Financial Times headline. Although its chart suggested that the amount raised this year was falling behind 2017’s near-$250bn, the private-equity (PE) industry still has an estimated $2trn in cash to invest, it said.
This is both good and bad news for investors in PE funds. The good news is that competition for assets is driving up the prices on disposals; the bad news is that finding attractively priced deals in which to invest the proceeds is a growing challenge.
No such thing as a free lunch
Although PE funds have mostly done well this year, there are a few laggards. Hg Capital (LSE: HGT) returned 9.5% in the first half from its investments in technology and tech-enabled services. It sold nine businesses for £180m in the half year, each for significantly more than book value, and invested £146m in six new investments. With an internal rate of return (a way of calculating the profitability of an investment) of 18% on the disposals, momentum is strong.
Pantheon (LSE: PIN) also returned 9%, helped by a restructuring in 2017. The net asset value (NAV – the value of the underlying portfolio – is always a few months out of date (due to the time it takes to collect valuation data on the funds it invests in), and thus understated in a rising market. Yet even using this understated NAV, the shares trade on a near-15% discount.
That said, discounts to NAV are not always a good guide to value. Apax Global Alpha (LSE: APAX) also trades at a discount of 15%, but its performance since its initial offering three years ago has been a bit disappointing, given the reputation of the group. Still, the dividend yield of above 6% is appealing.
On a similar topic, note that investing in a fund that is committed to a wind-up (that is, selling all of its investments and returning the cash to shareholders) at a significant discount tends not to be as much of a free lunch as it sounds. Wind-ups can take a long time and investments with a “for sale” tag often perform poorly. For example, Candover Investment’s asset value evaporated as it was run down, and the two Better Capital funds (LSE: BC12 and LSE: BCAP) are struggling, hence discounts of 45% and 40%.
Electra Private Equity’s (LSE: ELTA) 15% discount might look attractive given that 23% of NAV is in cash, but two of the remaining investments, Hotter Shoes and restaurant chain TGI Friday, are performing poorly.
What might prove better bets? Christopher Brown of broker Cazenove likes the 23% discount of Harbourvest (LSE: HVPE), given its consistently good performance. Simon Elliott of Winterflood likes Standard Life Private Equity (LSE: SLPE) – it offers strong long-term performance, a portfolio focused on European buy-outs, a 3.7% yield, and a 14% discount – although the last six months have been dull.
Too soon to sell
The star performer is 3i (LSE: III), which has persistently traded at a significant premium to a NAV that has proved to be cautiously valued. The problem now is that Action, the hugely successful European discount retailer, makes up 30% of its assets. When the chain reaches maturity, the valuation multiple is likely to drop. Also, if it is sold, reinvesting the proceeds will be tough. 3i has a good pipeline of opportunities, but at its current rate of investment it would take over two years to reinvest the proceeds, given Action’s £2bn-plus valuation. So 3i’s recent dull performance looks set to continue.
Overall, while the cycle for PE is increasingly mature, the excesses seen at the peak of past cycles are nowhere to be found. With the exception of 3i, most funds trade at discounts to conservatively stated NAVs. It’s too soon to sell.
Activist watch
Shares in Vodafone Group rose by 4% this week on reports that activist investor Elliott Management had bought a stake in the group, says Kim McLaughlin in Bloomberg. Elliott Advisors, the European arm of the New York-based fund, is “pressing for changes” at Vodafone – the world’s second-largest mobile operator – although the actual details are not yet known, reports news service DealReporter. Vodafone reported a 1.3% decline in European quarterly sales last week. As a result, incoming chief executive Nick Read is under pressure to confront mounting competition in southern Europe and to make a success of Vodafone’s $22bn takeover of Liberty Global’s German and eastern European businesses, says McLaughlin.
Short positions… the Winklevii foiled again
► The US financial regulator, the Securities and Exchange Commission (SEC), has rejected a request to list an exchange-traded fund (ETF) run by Cameron and Tyler Winklevoss (pictured) – the “Winklevii” twins famous for suing Mark Zuckerberg for allegedly stealing the idea for Facebook, but also for becoming the first bitcoin billionaires. The SEC remains sceptical that the bitcoin market is sufficiently free of abuse to bring trading to the masses, says Benjamin Bain in Bloomberg, noting that Cboe Global Markets, which would have listed the ETF, failed to show that the underlying market was “resistant to manipulation”. This is the second time in 18 months the SEC has rejected Cboe’s bitcoin ETF. Bitcoin is now trading at around $7,500 a coin, well off the high of $19,511 reached in December last year.
► The asset manager behind the £850m British Empire investment trust plans to launch a new trust investing in small and mid-cap Japanese equities, says Jayna Rayna in Investment Week. The AVI Japan Opportunity Trust will be managed by Joe Bauernfreund, who has run British Empire since October 2015. British Empire has more than a fifth of its assets in Japan, but as a global fund there is a “natural limit to what it can put into one area”, says Bauernfreund. “Japan warrants its own dedicated fund.” The new trust, which launches in mid-October, will focus on companies trading at discounts to asset value, and which have a substantial chunk of their market capitalisation in surplus net cash. The fee should be around 1%.