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Investment Trust Watch: 3i leads private equity charge

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Investment Trust Watch: 3i leads private equity charge

It’s been a big but mixed week for private equity with three trusts among the big movers in response to news and analyst upgrades.

This could be a sign that even after last year’s impressive gains – with an average 12-month total shareholder return of 54.5% on the back of a 36% rise in portfolio valuations following the corporate activity at Electra (ELTA) and SVG Capital (SVG) – private equity remains one of the most undervalued investment trust sectors with average discounts of 14%, if you exclude the massive premium on 3i (III).

Does 3i own the next Inditex?

3i, the £7 billion market leader, this week saw its heady premium to net asset value rise 4.7% to 33.2% after Morgan Stanley upgraded the stock from ‘equal weight’ to ‘overweight’ and hiked its target price to 823p from 710p.

Analysts at the investment bank believe 3i’s highly successful investment in Action, the rapidly expanding Dutch discount retailer, is undervalued using a conventional multiple of earnings method. That’s quite a claim given that at the end of last year Action accounted for around a third of 3i’s private equity portfolio after a five-fold increase in its original investment in 2011.

‘We feel that this does not fully capture Action’s long-term growth potential or its unusual level of cash generation,’ wrote the analysts in a note on Tuesday. ‘Using a DCF [discounted cash flow analysis], with undemanding assumptions, we believe that Action could be worth in excess of €10 billion, implying that 3i’s stake could be worth more than 250p per 3i share.’ Its previous estimate for 3i’s stake was 160p per share. The shares jumped from 699p to 739p.

3i’s premium rating is unique among its private equity peers. Even in its own terms the shares are beginning to look expensive, unless of course you agree with Morgan Stanley that Action could be the next Inditex.

The current premium is well above the 19% average of the past 12 months giving 3i a Z-score of 1.6, according to Numis Securities.

Just to recap a Z-score is a measure used by analysts to indicate whether a trust’s valuation is outside its normal range. Roughly speaking a Z-score of 2 or more is considered ‘dear’ while a score of -2 or below is getting cheap.

More outperformance at FPEO

F&C Private Equity (FPEO) was the week’s biggest riser, jumping 4.6% to 314p at yesterday’s close after Stifel analysts upgraded the high yielding fund of funds to ‘buy’ from ‘hold’ in response to strong annual results published last Friday. A 23% increase in net asset value to 351p per share at the end of 2106 was surprisingly good, said Stifel’s Iain Scouller and Maarten Freeriks, reflecting the big returns made on selling Skyscanner, the flight booking website, and Park Holidays, as well as the boost to overseas income from the weak pound.

The results earned the managers a £2 million performance fee, the fourth year in a row they have done so, which either suggests they are very good or that the hurdle – beating an annual internal return of 8% over three years – is too low.

The move in the share price did not reflect the full rise in the quarterly NAV meaning the discount on the shares widened to 10.6% from 6%, giving them a Z-score of 0.3, according to Numis.

‘Our fair valuation increases to 325p from 290p, which is based on a discount of 5% to 10% to 31/12/16 NAV and this is 8% above the current price,’ the Stifel analysts noted on 24 March. ‘In addition the shares have a yield of 4.2%, which gives a combined potential return of 12.5%. We upgraded to “buy”,’ they added.

Better Capital is not better

The only fly in the private equity ointment is Better Capital 2012 (BC12), which features at the bottom of our ‘expensive’ trusts (see second table) after a partial narrowing in its very wide discount left it with a 2.1 Z-score.

It’s unlikely to stay there for long after the shares plunged 4.35p, or 13.5%, to 27.9p today after the least successful of Jon Moulton’s private equity funds sold struggling fashion retailer Jaeger for £7 million and had to write off £23 million (7.2p per share) off its carrying value. It is left with just three investments in Spot, the office supplier, Everest, the double glazing manufacturer, and Northern Aerospace.

Cheap trustsShare price premium (- discount) to net asset value %12-month average premium (- discount) %Z-score
Aurelius Equity Opportunities (AR4)3.736.9-3.7
Keystone IT (KIT)-12.6-10.0-2.2
City Merchants High Yield (CMHY)-0.31.4-2.1
Drum Income Plus REIT (DRIP)2.810.0-2.0
BBGI (BBGI)6.114.2-2.0
Terra Capital (TCA)-19.6-15.3-2.0
Edinburgh (EDIN)-6.8-2.8-2.0
Ecofin Global Utilities & Infrastructure (EGL)-17.3-12.6-1.8
Vietnam Infrastructure (VNI)-42.4-18.9-1.8
Reconstruction Capital II (RC2)-45.1-33.6-1.7
BlackRock Commodities Income (BRCI)-8.0-1.9-1.7
BlackRock North American Income (BRNA)-8.7-4.6-1.7
Ranger Direct Lending C (RDLC)-1.40.7-1.7
Qannas Investments (QIL)-4.1-1.0-1.6
Aberdeen Latin American Income (ALAI)-14.8-12.6-1.6

Source: Numis Securities 30/3/17

First quarter winners

It’s a been a good first three months of the year for Macau Property Opportunities (MPO) with shares in the investor in the gambling haven soaring over 47% to 120.75p to appear in our second table (see below). Fears over the impact of China’s crackdown on corruption have evidently receded with the discount narrowing from a low of 58% to 26%, which although still wide gives it a dear Z-score of 2.7.

Industrial Multi-Property Trust (IMPT) is up nearly 37% to 304.5p following the agreed bid from Hansteen, although shareholder Alpha Real Trust is objecting.

India Capital Growth (IGC), whose 2016 results we looked at this week, has also done well with a 21.6% gain that leave its on an 18% discount and a 0.7 Z-score.

The cheap seats

Turning to our first table of ‘cheap’ trusts, Keystone (KIT) continues to drift on a wide 12.6% discount following the decision of Invesco Perpetual’s Mark Barnett to step back from the UK equity income fund.

Sticking with the same group, City Merchants High Yield (CMHY) dipped to a very small discount this week as the high yield bond fund published full-year results. This puts it on a Z-score of -2.1, which might be an attractive point to access Invesco’s experienced bond investors Paul Causer and Paul Read.

Infrastructure fund BBGI (BBGI) saw its premium dip to just above 6% as it announced a share placing to professional investors.

Expensive trustsShare price premium (- discount) to net asset value %12-month average premium (- discount) %Z-score
DeA Capital (DEA)-24.6-42.53.9
Threadneedle UK Select (UKT)-3.2-12.63.4
Honeycomb IT (HONY)
Macau Property Opportunities (MPO)-26.3-44.22.7
Fidelity Asian Values (FAS)-3.2-10.12.6
Apax Global Alpha (APAX)-2.8-14.92.6
Chenavari Capital Solutions (CCSL)-1.1-8.82.5
Henderson European Focus (HEFT)1.9-6.82.5
Shires Income (SHRS)-9.4-12.02.5
Kubera Cross-Border (KUBC)-46.9-62.52.4
Manchester & London (MNL)-12.3-20.32.4
TR European Growth (TRG)-9.8-14.72.3
NB Private Equity (NBPE)-13.3-23.02.3
Henderson Opportunities (HOT)-11.3-17.52.1
Better Capital 2012 (BC12)-41.5-61.82.1

Source: Numis Securities 30/3/17

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