UK Edition
Questor: 3i is thriving in the spotlight vacated by its rival ‘locusts’
3i: 771p
Questor says BUY
The public pain of the private equity industry was something to behold. It is a decade since the so-called “locusts” were called to explain themselves before parliamentary select committees, accused of financial engineering and asset stripping to feather their own nests.
So long in the memory does such scrutiny linger that those hearings were a topic of conversation once again at the industry’s recent BVCA annual dinner, even though most buy-out firms have long ago withdrawn back to the shadows.
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One private equity firm that has little choice but to remain highly visible is 3i, a FTSE 100 member with a £7.3bn market value.
Yet its misfiring past – a miserable share price and a long tail of underperforming investments – has been consigned to history during the five-year reign of chief executive Simon Borrows. So much so that the collapse into administration last month of lingerie chain Agent Provocateur, at an estimated cost to 3i of £45m, was an uncharacteristic flop.
Sold to a company part-owned by Mike Ashley’s Sports Direct, tempers frayed like a cheap thong over suggestions that 3i could have done more to revive the retailer.
But knowing its fate is immaterial to the firm’s investment case, its shareholders have moved swiftly on. After sharply outperforming the FTSE 100 in 2016, the stock is now trading at levels not seen since 2008.
Part of the reason is another retailer. The City is switching on to the attraction of Action, the Dutch discount retailer that 3i invested £114m in six years ago. Morgan Stanley recently said 3i’s stake could be worth more than 250p a share, compared to the 142p or £1.4bn the company values it at.
Action’s slogan, “surprisingly comprehensive, amazingly affordable”, might sound snappier in German, but it sums up the constantly changing product range that has powered expansion to more than 200 stores across the Continent.
Borrows’ team has already recouped five times its original investment from cash distributions alone, including £187m from a refinancing in the third quarter. This time next year Action could account for 40pc of 3i’s entire private equity portfolio.
Given the length of time the group typically holds investments, an exit could realise some of that value within a year or two. Stand by for clues when Action holds a capital markets day on May 30.
There has also been a flurry of exits this spring. 3i has offloaded its stakes in builders’ merchant MKM; Lekolar, a maker of school furniture and educational supplies; and testing and inspection firm ESG.
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Its debt management operation was sold to Investcorp. All this activity is expected to add up to £1.3bn of proceeds for the year, plus £250m that will fall in the new financial year.
3i is expected to be a net seller of assets while the macroeconomic outlook remains tough – good news for the dividend.
But it also has plenty of dry powder after raising a £700m infrastructure fund and sitting on net cash of £348m at the end of the last quarter. Believing it can enhance businesses not squeeze them, recent investments include £122m for Ponroy Santé, a French manufacturer of natural cosmetics, and Belfast City Airport.
One common complaint of listed private equity firms has been that they always trade at a discount to net asset value.
Such vulnerability might explain why SVG agreed last autumn to sell its investment portfolio to HarbourVest, and why Electra Private Equity is currently being shaken up by activist investor Edward Bramson.
When Borrows was recruited to 3i, its shares were trading at a 20pc discount. Now they are at a 30pc premium. Bill Barnard at Canaccord Genuity recently marked up his net asset value forecasts to 640p from 620p for this year and to 700p from 670p in 2019 – as well as setting a new price target of 875p.
One theory is that 3i is conservatively capping some of the valuation multiples of its investments. In practice, it is proving to be more than the sum of its parts.
If you must operate in the spotlight your rivals can easily avoid, it is better to under-promise and over-deliver.
After delivering an average return on equity of 20pc since former Barings banker Borrows’ turnaround began, 3i is getting used to that. Don’t bet against it continuing to outperform.
Buy.