Last week, Marten & Co held its listed private equity conference and it reinforced my view that, despite decent performance, many are still attractively valued.
I like the private equity sector but, when talking to investors about the conference, it was surprising to me how many are lukewarm about it.
The experience of the credit crunch, when a few overleveraged and/or overcommitted funds were caught out, seems to have put some people off the sector. However, I would recommend thinking again about this area.
There is little doubt that the years following the credit crunch were difficult ones for the industry. It got much harder to get finance for new deals and refinancing, the initial public offering (IPO) window shut and distressed sellers of assets drove down valuations.
The last 12 months were a year of recovery though. Figures from Deloitte show a dramatic uptick in IPO activity and in all forms of realisations. Graphite Enterprise said in October it reckoned its disposals for the year would top £100 million for the first time since 2007.
For the industry as a whole, the surge in realisations has not been accompanied by an equivalent surge in capital calls and many funds are cash-rich.
For funds-of-funds that commit money to limited partnerships that is then drawn down over a number of years, cash drag can be a real problem.
Overcommitting themselves – making binding promises to invest in LPs beyond your present ability to pay for these – is a necessity and should not be seen as a potential problem unless the manager is overdoing it.
Graphite Enterprise, with a market cap of just over £400 million, is one of the largest UK listed private equity fund-of-funds. It invests in a mixture of external funds investing in Europe and in-house funds investing in the UK.
For the most part these are primary deals, but it does also buy secondary interests and puts some money into co-investments. The asset allocation is set by manager Graphite Capital and about 40% of the portfolio is invested in its funds or co-investments.
Graphite has about £1.6 billion under management, most of which is in UK mid-market buyouts. Graphite Enterprise is a cornerstone investor in Graphite Capital’s funds.
For a fund-of-funds, Graphite Enterprise has more day-to-day control over its portfolio than most, and its portfolio is probably also more concentrated than the average, with the top 30 holdings at 45% of the portfolio.
Graphite ran through a couple of examples of recent transactions at the meeting. In its recent acquisition of City & County Healthcare, a provider of home care services, the fund committed £14 million towards a £110 million secondary buyout.
The manager thinks there is ample scope to consolidate the home care market – the 50 largest operators currently account for just 25%. City & County ranks fourth.
Graphite also highlighted the sale of Vue Cinemas by Doughty Hanson. This was a deal it got exposure to through a primary investment in Doughty Hanson V, added to via a co-investment and topped up via a secondary purchase of the LP.
Vue was bought for £450 million in December 2010 and sold for £935 million in June 2013. Graphite wrote up the value of its investment by 68% following the disposal announcement.
That last point is an important one. Private equity firms are usually very conservative when valuing their investments. The 30 disposals Graphite made in the first three quarters of 2013 generated, on average, an uplift of 39% over their prior valuation.
Graphite Enterprise has always been careful to avoid developing an overcommitment problem. Although it has a £100 million borrowing facility, it has no plans to use it except for short-term liquidity. At the end of October 2013, Graphite was about 18% overcommitted.
Graphite Enterprise is sitting on an 18% discount versus its net asset value (NAV) at the end of October 2013. That NAV will have contained quite a few valuations for underlying investments that were made at the end of September or June.
You will get a better handle on the NAV when results are published on 27 March. Using that October figure, Graphite is the best performing fund in its peer group over most time periods.
I think it might be worth you having a closer look at it. I will write something on the other funds over the coming weeks.
James Carthew is a director at Marten & Co