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Trust Insider: what does Sherborne want from Electra?

Trust Insider: what does Sherborne want from Electra?

This week I thought I might have a look at Electra. This is something I have been meaning to do for ages but I thought I would sit back for a bit while we waited to find out what Sherborne Investors were up to (they have been building a stake in the company). There has been no news on that front, however, so here goes.

Electra has been around since 1976, which makes it one of the oldest funds in the listed private equity sector. With a market cap approaching £1 billion and gross assets in excess of £1.3 billion, Electra is also a large liquid company. This makes it a useful vehicle for institutional fund managers looking to get exposure to private equity.

At the moment, Electra is trading fairly close to asset value. Its share price jumped when Sherborne’s stake building was disclosed but its rating wasn’t particularly out of line with its peer group beforehand.

The average directly invested private equity fund trades on a discount of 7%. Investors might reasonably wonder whether Electra is expensive today – much depends on the latent value within its portfolio.

Despite the rerating of the private equity sector, I wonder whether there is not still some lingering antipathy towards it: a legacy of the events of the credit crunch when many funds over-extended themselves and some were forced into rights issues or selling assets at the bottom of the cycle.

At the nadir, Electra’s discount was in the high 60s but, in retrospect, that was a stunning buying opportunity as the shares have risen by 260% over the past five years. Bear in mind, though, that comparing funds on their performance since the depths of the crisis is misleading in my view and is not a good guide to the quality of the funds or their managers.

In this case, past performance is definitely not a guide to future performance since other funds may have done better in price terms, but this is usually just a factor of their having reached even wider discounts in the depths of the crisis. A similar factor is at work even in the NAV performance numbers as many poor quality funds also overconcentrated their portfolios in highly leveraged companies that were written down in the crisis and have been written up again since, flattering medium-term performance.

Electra does not pay a dividend; the sector is not really designed to produce high yielding funds. Private equity funds do not tend to throw off much income unless they have investments in mezzanine debt or similar parts of the capital structure.

Early stage investments

Most underlying investments are either at an early stage and consuming capital to grow or their balance sheets have been geared up to maximise equity returns. Some private equity funds pay dividends out of capital but I think the jury is out as to whether this attracts many investors.

Electra is a split capital trust; it has convertible unsecured loan stock and zero dividend preference (ZDP) shares in addition to its ordinary shares. The ZDPs had an initial redemption yield of 6.5%, mature on 5 August 2016 and have a final capital entitlement of 155.41p. The £100 million convertible issue was completed in December 2010.

The bonds have a seven-year life, maturing on 29 December 2017 and, if not previously converted, pay a coupon of 5% per annum. They can be converted into ordinary shares at a price of £20.50 (so, with Electra currently trading at £26.60, they are well in-the-money; at the time the convertibles were issued, Electra was trading at £16.05).

Electra can make holders of the convertibles convert if its share price trades at or above 130% of the conversion price (ie, £26.65, coincidentally around today’s share price) for 20 consecutive days before the 29 December 2015. This caps the capital upside on the convertibles and limits the dilution for ordinary shareholders.

One thing people have picked up on is how busy Electra has been recently and they have speculated this is in response to Sherborne’s presence on the register.

Electra has announced quite a few deals over the last few weeks. It has invested £40 million in the secondary buyout of Innovia (a company that makes packaging films and the substrate for polymer bank notes including the planned £5 and £10 notes).

Other investments include Treetops Nurseries. Electra is funding its expansion plans as it snaps up nursery schools in the South East of England; a £15 million injection in CALA Homes, the luxury housebuilder, to allow it to acquire Banner Homes; £14 million for Calrec – the manufacturer of audio mixing consoles; an £83 million investment in Ogier Financial Services; and £85 million for Hotter Shoes.

All the deals though will have been thoroughly researched by Electra’s team and I expect they would have been working on some of them for months.

My hunch would be that this flurry of deals is more reflective of a more upbeat UK economy than some mad dash to invest their cash pile before anyone else can get their hands on it.

If things are picking up a bit, that bodes well for portfolio realisations and this could help push the net asset value higher over time.

Sherborne’s last announcement was that it had indirect interest in 19% of Electra and maybe it will stick around hoping that Electra will perform well from here.

My best guess however is that Sherborne will quietly sell its stock in the market, having made a reasonable (if unspectacular) profit simply by announcing its presence on the register.

James Carthew is a director at Marten & Co

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