HgCapital 22 September 2023
Disclosure – Independent Investment Research
This is independent research issued by Kepler Partners LLP. The analyst who has prepared this research is not aware of Kepler Partners LLP having a relationship with the company covered in this research report and/or a conflict of interest which is likely to impair the objectivity of the research and this report should accordingly be viewed as independent.
To provide shareholders with consistent long-term returns in excess of the FTSE All-Share Index by investing predominantly in unquoted companies where value can be created through strategic and operational change.
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HgCapital Trust (HGT) has been a long-running, and leading, constituent of London’s listed private-equity universe. It is highly differentiated from its peers, in that Hg, the managers of HGT, focus only on private European technology companies. In terms of size, it sits behind 3i, but HGT is otherwise the largest directly investing private-equity trust listed on the LSE.
Hg claim to be the biggest private-equity firm in Europe. They aim to turn this to their advantage, not only in terms of the support they are able to give to investee companies, but also due to the knowledge network that the team can leverage. Hg call it the ‘Power of the Portfolio’, which essentially means using all of the lessons they have learnt over the last 25 years on a relatively narrow segment of the private-equity market, not to mention the resources they have in managing $65bn of assets under management. Hg believe their experience and resources gives them a “systematic engine for value delivery” in the portfolio.
In what has been a highly uncertain time economically, HGT’s top 20 underlying companies, accounting for 76% of the portfolio, continued to show strong revenue growth of 29% over the 12 months to 30/06/2023. EBITDA growth improved to 30%, over the same timescale, from the prior 12 months’ 26%. Profitability remains as robust, with the top 20 companies reporting an average EBITDA margin of 30%.
As we discuss in the Discount section, HGT has traded consistently at a premium to peers, which we attribute to the strong track record, the focus on software and the relative paucity within the peer group of ‘directly investing’ LPE alternatives. The current discount stands at 16%, as at 18/09/2023.
As we discuss in the Portfolio section, HGT’s portfolio remains relatively concentrated. That said, the exposure to the top two holdings has reduced, following the sale and reinvestment of the largest holding, Access Group. The resilient financial performance reported in the interims to 30/06/2023 should provide reassurance, given the relatively high multiples that HGT’s portfolio is valued at. As at 30/06/2023, HGT’s portfolio (top twenty holdings) was valued at 26.2x on an EV/EBITDA basis. This might be seen as relatively high in absolute terms, which could be a risk if earnings falter or realisation activity remains muted.
Realisations traditionally provide confirmation that valuations are not too far out of line with reality. In this regard, HGT has seen a relatively low level of activity so far during 2023. That said, top ten holding Transporeon was sold (signed in late 2022) at an uplift of 18% and, since the end of June 2023, partial exit deals have been announced for TeamSystem and Azets, as well as a full exit of Commify. These transactions represented significant uplifts to carrying value of 68%,16% and 32% respectively, providing a vote of confidence on valuations and potentially representing signs of green shoots of a recovery in activity.
Despite the shares continuing to trade at a discount, we would not expect buybacks unless the discount widens significantly. Whilst HGT’s underlying companies’ fundamentals have been defensive this year, there are clearly risks. However, if companies’ earnings prove resilient, then we believe the market will gain more confidence in HGT and, as we discuss in the Discount section, there is clear potential for the discount to narrow from these levels.
- Narrow sector focus gives managers significant edge to add value
- High-growth companies provide differentiated exposure to UK and European indices
- Shares trading on a material discount to NAV
- Portfolio is illiquid, meaning shares could remain on a wide discount to NAV for a considerable time
- Highly concentrated portfolio means fortunes of the trust are arguably hostage to a relatively narrow group of businesses
- HGT, as have all private-equity trusts, has relatively high charges, especially the KID RIY figure