ICG Enterprise Trust Analyst Q&A: Resilience of PE (LON:ICGT)

Hardman & Co

ICG Enterprise plc (LON:ICGT) is the topic of conversation when Hardman and Co’s Financial Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.

Q1: Your recent report on ICG Enterprise Trust sits behind a disclaimer. What can you tell us about that?

A1: It is just the standard disclaimer that many investment companies have. In essence, for regulatory reasons, there are some countries (like the US) where the report should not be read. In the UK, because private equity is not a simple asset class, and it should only be looked at by professional / qualified investors. P2 of the report gives all the details.

Q2: Can you give us your brief summary of the 63-page report?

A2: ICGT is a 39-year listed private equity (PE) investor, which has delivered a total NAV return of 178% over the past 10 years (comparable FTSE All Share return 61%). Since Intermediate Capital became the manager in 2016, the company has earned mid-teen p.a. underlying returns every year. Investors get liquid access to the attractive PE market combined with incremental manager-specific synergies. It has a concentrated portfolio of “high-conviction” investments (19% p.a. average returns over five years, 42% of portfolio, defensive growth focus) and a diversified third-party PE funds book. ICGT manages over-commitment tightly. The discount to NAV is slightly above PE peers.

Q3: You say PE is an attractive market? How does it add value?

A3: We believe PE adds value for shareholders in four key areas: i) strategic development – PE-backed businesses can adopt a long-term focus; ii) performance enhancement –  operational improvements from adopting sector-wide best practice, the active management of capital structures/finances and the strengthening of management teams; iii) valuation opportunity –  PE can buy low and sell high; and iv) corporate governance – PE has the resources to consider Environmental, Social and Governance (ESG) issues, when a standalone company may not.

Q4: How does ICGT add value to this attractive market?

A4: ICGT adds value through portfolio creation, with a careful balance between i) a concentrated book of high-return, high-conviction ideas, which are directly chosen/managed by the manager, and ii) a well-diversified, third-party PE fund portfolio. ICGT’s skill in selecting investments has resulted its top 30 companies having 12% revenue and 17% EBITDA annual growth, as at December 2019. Additionally, there are incremental benefits in having ICG as the manager, including economies of scale, market intelligence, experienced investment oversight and access to technical skills. We note by way of example that the expansion of the US elements of the book have been materially enabled by having ICG as the manager. Since 2016, when ICG became the manager, ICGT had generated mid-teen underlying annual returns, as it has managed its over-commitment closer to the market level, reducing the return drag from excess cash, and broadened its geographical diversity.

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Q5: Your heading, “Outperformance through every stage of cycle” may come as a surprise to some of our listeners as many people think of PE as increasing debt and so being risky in a downturn? Why will it outperform in a recession?

A5: We believe that PE providing more certain access to capital is a key factor in considering a COVID-19 or any other recession outperformance. Its companies have access to capital and liquidity that other companies simply do not have. Furthermore, there is operational support PE backers can offer in terms of expertise, scale and operational improvements. Academic research, which we summarise in our report, confirms our view of the resilience of PE. In terms of hard numbers, you can see it in the modest NAV falls that PE funds and funds of funds have recently reported. Looking company-specific, their investment focus has been on defensive growth, which means that investments are considered that benefit from long-term structural trends, rather than relying on cyclical economic growth. This, and an analysis of performance through the last downturn, typically leads to a focus on larger, well-established businesses, rather than early-stage companies with, unlike many peers, no exposure to venture stage business.

Q6: And the risks?

A6: PE is an above-average cost model, but post-expense returns are market-beating. Even though actual experience has been continued NAV outperformance in economic downturns, sentiment is likely to be adverse. ICG Enterprise Trust’s permanent capital structure is right for unquoted and illiquid assets but again sentiment for this type of asset can be an issue.

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