Oakley Capital Investments Limited (LON:OCI) is the topic of conversation when Hardman and Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: Your recent report on Oakley Capital Investments 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, private equity (PE) is not a simple asset class, and it should only be looked at by professional/qualified investors. Page 2 of the report gives all the details.
Q2: You called your recent piece ‘Evolution of the high-growth drivers in 2023’. What can you tell us about that?
A2: In this note, we explored the factors that have driven the market-beating 22% YTD 2022 NAV growth, the 15% growth we expect in 2023 and the 35% NAV discount. In addition to fuelling returns, further exits with uplifts to carrying value (long-run average 50%) should reinforce confidence that portfolio valuations are conservative. Cash realisations from the portfolio give additional comfort – as do the £302m of liquidity and £474m of investments held for more than three years – that investment commitments will be delivered.
We highlight the resilience of the portfolio in the past, and note the incremental value added in downturns, with Oakley backing resilient, profitable businesses with sticky revenues.
Q3: Sounds good. So taking your first point, how can we trust the valuations?
A3: The key point here is that Oakley, on average, sees a 52% premium on exits. It mainly sells its business to other PE houses, and, after they have done all of their due diligence and taking into account that they want to make returns on their investments, they are still willing to pay significantly higher ratings than the level at which Oakley had valued the businesses in its books.
Now part of that is the synergies and opportunities that the new PE backer will bring to the table, but it also gives great confidence that Oakley valuations are conservative.
Our note also highlights i) that it is value-driven by EBITDA growth, not rating, ii) the low PEG ratio, iii) the low, stable price earnings ratio, iv) the uplift in the price earnings ratio ratings only significant at exit, v) growth sectors, but not in ratings, vi) no incentive to inflate ratings, and vii) independent checks – but the real test is what others pay for the assets, and that is well above the carrying value in OCI’s books.
Q4: And your second point – can OCI meet its £979m commitments?
A4: The key point here is that OCI has £302m of liquidity and £474m of investments held for over three years, which are thus in harvesting phase and likely to be sold at the uplift I have just mentioned. The commitments are spread over many years, and potentially £250m of them will never be called in any case.
Our note also highlights the important practical point that Oakley Capital controls the calls from the funds, and it would be improbable that it would do anything to stretch OCI’s financial position
Q5: And your third point – how will the underlying portfolio companies cope with recession?
A5: The key point here is that Oakley backs resilient, profitable business with sticky revenues. Our note goes into some detail looking at this.
Understanding the EBITDA growth in underlying companies is core to understanding OCI’s resilience. It is focused in structural growth sectors with recurring income streams, where Oakley Capital provides active operational, strategic and financial support, and expertise, to its investee companies. OCI’s entrepreneurial network helps them grow, transform their models and pick the right people. Many of their investments offer customers low-cost alternatives in an environment where customers are looking to save costs or provide mission- critical services. The financial gearing has been very stable over the past five years, and OCI’s own liquidity and commitments are tightly controlled.
The bottom line is that, if you look at the NAV performance through COVID-19, OCI delivered market-beating resilience, and we are expecting mid-teen NAV growth in 2023.
Q6: And the risks?
A6: Rising interest rates appear likely to have a modest, impact with relatively conservative leverage (net debt/EBITDA 3.9x) and with Oakley Capital Investments’ treasury expertise supporting investee companies. While demand for some companies could be affected, such as the price-comparison websites, it appears modest relative to the structural growth opportunity.
Rising inflation could affect up to 40% of the portfolio, with wage inflation/energy bills and falling consumer demand. Offsetting factors include i) many portfolio companies provide low-cost products, which may see market share gains, ii) technologies and applications can provide cost savings to customers, such as price-comparison sites, iii) many companies can pass on cost increases, and iv) many companies are proving to be mission-critical services, with low input costs.