The Private Equity investment company sector was hit hard by the credit crunch, with the average discount widening out to 51% at the end of 2008.
Whilst this has affected the Private Equity sector’s previously strong longer-term performance figures, over the shorter-term the sector has bounced back and is up 62% over the last three years to 30 April 2012 compared to 43% for the wider investment company sector.
Tim Spence, Finance Director, Graphite Capital Management LLP demonstrates that the listed Private Equity sector has come a long way since then, and balance sheets are in general much more robust. He would not expect to see such a severe reaction in the event of further financial crises. But with the average discount for the Private Equity sector at 24% at the end of April 2012 – more than half the level at the end of 2008 – have discount opportunists missed the boat? And what is the outlook for the sector? The Association of Investment Companies (AIC) today hosted a press roundtable lunch on the prospects for private equity with JZ Capital Partners and Graphite Enterprise Trust PLC, and have also collated other manager views.
Managers see scope for further discount narrowing, and are finding a steady stream of opportunities amidst the downturn, particularly in Europe. Interestingly, Hamish Mair, Manager, F&C Private Equity Investment Trust believes that there is a need now, more than ever, for the skills that private equity managers have in order to work with investee companies.
Do discount opportunities still exist?
Jock Green-Armytage of JZ Capital Partners said: “Investors certainly haven’t missed the boat – they can still buy high quality assets at a discount of up to 40%. It’s certainly worth remembering that those who invested in listed private equity when they were trading at even greater discounts in 2008-2009 have made significant returns – we could be in a similar position today. Despite the challenging economic climate, investors are showing signs of returning to listed private equity. This is due to the sector’s renewed focus on enhancing shareholder value and the opportunity to access this unique area of the market at a discount. In addition, we are starting to see an increased level of M&A which is providing better exits and improved valuations. The outlook is positive.”
Tim Spence, Finance Director, Graphite Capital Management LLP said: “Discounts of 60% or more, which were briefly available in late 2008 and early 2009, will probably not be seen again for a long time. Investment company discounts, particularly in the Private Equity sector, are cyclical. Looking back over the last 20 years, companies have traded at premiums, then discounts and back and forth again as investor sentiment has changed. The current discounts of around 30% remain higher than long term averages of between 10% and 20% and we believe at this level pricing is attractive.”
Hamish Mair, Manager, F&C Private Equity echoes this: “Looking at the long term historical standards, we see scope for a further narrowing of discounts in the Private Equity investment company sector. Pronounced buying opportunities still remain; asset performance has generally been good, and valuations can be verified by the price at which companies are sold, but the share price performance has failed to fully reflect this. It took courage to invest in the Private Equity sector in 2009, and those who did were well rewarded. We believe there remains an excellent opportunity for those investing now for the medium and longer term. Investors have definitely not missed the boat.”
Does recession still equal buying opportunities?
Far from being deterred by the global financial crisis many private equity managers are finding opportunities. Nic Humphries CEO, HgCapital Trust said: “It is true that periods of economic recession usually coincide with more attractive buying periods and better long-run returns – that’s why HgCapital sold over 65% of our investments in the period 2005-2007 and then re-invested heavily in 2009 and 2010. We don’t think the current double-dip will produce exceptional value opportunities, but we do think that it will mean that good growth companies looking for patient equity capital to back them over the medium to long term will be acquired or take on-board new investors at reasonable prices.”
Tim Spence, Finance Director, Graphite Capital Management LLP added: “This downturn has been interesting in that there has been far less company distress than perhaps we expected, in particular because interest rates have remained very low. While banks have taken control of some underperforming companies, they have not yet started in earnest to sell these stakes. Both of these factors could change, which would create more opportunities, although we think low interest rates will probably prevail for some time.
“So we, like other private equity managers, have been focusing on businesses which have performed well through the downturn because they have a service or product for which demand has grown despite the economic cycle. At Graphite we have identified and invested in a number of such companies since the beginning of the downturn.”
Hamish Mair, Manager, F&C Private Equity said: “In the aftermath of a recession or stock market crash, private equity funds are usually able to buy well, and this remains the case; it’s a buyer’s market. This cyclical opportunity will continue to exist for the next two or three years. We are also finding opportunities across Europe, and further afield, where the use of private equity to finance the growth of smaller and medium-sized companies is growing. The mid-market of Europe presents a longer term secular buying opportunity and this is being enhanced by the stage we’re at in the economic cycle.”
Jock Green-Armytage of JZ Capital Partners said: “The current economic climate is providing the industry with plenty of fruitful investment opportunities and at JZCP we’ve been applying our value orientated investment approach beyond our core US micro-cap market. Distressed prices in Europe – particularly Spain – and the exceptionally positive demographics across Latin America have provided us with interesting opportunities.
“Furthermore, our track record of investing in credit and the current dislocation in the real estate market has also led us to some quality investment opportunities in secondary mortgage loans. These assets have the potential to provide a high yield and capital appreciation, so fit nicely within our risk reward profile.”
Outlook for the sector
Interestingly, Hamish Mair, Manager, F&C Private Equity believes the private equity skills are more crucial than ever: “There is a need now, more than ever, for the skill sets private equity managers have in working with investee companies. In particular, we are seeing a definite shift in the emphasis from financial engineering to operational management input, which will be beneficial for investors in private equity industry. This, along with the current background of gradual economic recovery from a cyclical low, is providing buying opportunities for skilled private equity investors.”
Nic Humphries CEO, HgCapital Trust believes that the Private Equity sector will continue to polarise, as it has done over the last 3-4 years since the 2008/9 recession. Nic Humphries said: “Those firms that can use their knowledge and expertise to find fundamental growth despite the economy (HgCapital uses 10 – 15 years of deep sector expertise to do this) will continue to do well, whereas those firms stuck with an old-fashioned private equity model of buying slow growth companies, applying gearing and perhaps cutting costs will struggle to generate real value and will then further struggle to exit such highly indebted and margin maximised ‘zombie companies’.”
Tim Spence, Finance Director, Graphite Capital Management LLP said: “In a low growth world, with apparently significant downside risks from the Eurozone crisis, investors are rightly asking themselves what a leveraged equity play such as private equity has to offer. The evidence of the past few years is perhaps counter-intuitive: the performance of private equity portfolios has been surprisingly robust through the downturn. Graphite Enterprise’s portfolio illustrates this: in the year to December 2011, the largest 30 companies grew EBITDA by 14% on average. This compares very favourably with the aggregate of the FTSE 250 for the same period, for which EBITDA did not grow at all.
“What this tells us is that the private equity model has been working: the structural benefits such as alignment of interests, incredibly detailed pre-investment due diligence and controlling interests have resulted in stronger performance. So in our view the outlook for private equity is good – the sector is not reliant on GDP growth or leverage to produce strong returns.”
Annabel Brodie-Smith, Communications Director, Association of Investment Companies (AIC) said: “It has been a turbulent few years for the Private Equity investment company sector, but it is worth remembering that with the potential for higher risk also comes the potential for high reward. For investors prepared to take a long term view, the private equity investment company sector gives investors the opportunity to access this unique sector for the price of a share. Active management does not come more active than the Private Equity sector who often take positions on the Boards of investee companies, and provide strategic direction as well as funding. From mid-market, through to the larger management buy outs, from fund of funds through to direct investment in companies, there is a great diversity in the sector.”
