Pantheon International plc (LON:PIN) 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 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 seen as a complex investment, and the report is targeted at professional/qualified investors.
Q2: So, you called your note “FY’22 results: It is not just lionesses that roar”. What can you tell us about it?
A2: FY’22 was a record year for Pantheon International in terms of NAV growth, cash generation and investment activity. The period saw valuation gains of 24.4%, nearly double the 10-year average. Combined with positive forex (7.2%) and a small buyback benefit, the 31% NAV growth was more than double the 10-year average, and this was achieved net of all fees.
PIN saw its largest-ever single company exit, and uplifts on exit averaged 42%. This performance followed outperformance over the previous 34 years through multiple cycles. Despite this, PIN, and the rest of the PE sector, are trading at near-record discounts to NAV.
The strategic message is PIP is 35 years old and has been through numerous cycles, the most recent of which is COVID. The portfolio has been actively managed, has evolved over that time and is now positioned in more resilient sectors, powered by long-term secular trends. Over the 35 years, PIP has delivered an impressive 12.4% average annual NAV growth compared with the FTSE All-Share total return of just 7.3% and MSCI World Index total return in sterling of 8.2%.
Q3: Your note highlights the resilience of the portfolio. Can you tell us more about that?
A3: This has been a theme of ours in several previous pieces, including ‘Returns, resilience and responsibility’, ‘Just look at PIP’s underlying company resilience’, and ‘2020 results: positioned for sustained growth’, so it is not new. It reflects both what is happening in PE and what PIN has been doing.
Looking at PE, PE-backed companies are more resilient than non-backed ones because they have access to committed capital and creditors’ knowledge of this support is an important factor, they have strategic optionality for growth both acquisitive and organic, PE backers may provide expertise in downturns to help investee companies operationally and strategically, and to manage their finances, and there is clear manager alignment with PE backers, with investors making commitments over the long term, through economic cycles. In recent years, there has been a fundamental shift in repositioning PE portfolios into more defensive, sectors driven by secular growth trends. Despite some people focusing on gearing, multiple academic research supports resilience of PE-backed companies.
Additionally, PIN has incrementally reduced risk through its stress tests, manager and investment due diligence and selection, and its own sector, sub-sector and market focus. All of this saw material outperformance by PE and PIN through COVID and previous downturns.
Q4: So, they had record results, and your analysis indicates a very resilient outlook in what are uncertain terms. Why is Pantheon International, and the entire listed PE space, trading at such large discounts to NAV?
A4: It is rather anomalous that after such a performance last year and outperformance through COVID-19 that the whole sector should be at the near-record discount levels. So, what is going on?
By having such a discount, the market is saying either that the current NAV is not a fair reflection of the real value of the private companies or that it is not a sustainable number going forward. The sustainability issue reflects the uncertain world we live in, and as PE delivers the returns, this uncertainty should abate. Our previous notes said returns would be sustainable and they were and we expect the same again from a diverse portfolio, significantly invested in resilient sectors, powered by long-term secular trends. In terms of the current valuation of the portfolio, our notes goes into great detail on this. I think about it in terms of lines of defence.
The first line of defence is that PIN receives valuations from GPs that it has taken a lot of due diligence reviewing before investing with. Equally importantly, the GPs have no incentive to inflate valuations as their performance fees are paid on exit not interim valuations.
The second line of defence is PIN’s independent valuation committee, which comprises experienced PE valuation professionals and financial staff, and can draw on the expertise across the Pantheon group, so can see where one GP is out of line with others.
The third line of defence is the external auditors and board. Critically, PIN has a conservative culture and, in policy terms, has in the past couple of years alone on three occasions over-ridden GP valuations (with a COVID-19 manager’s provision, writing down Russian exposure to nil, and in the treatment of listed exposure).
The critical test is what someone else pays for the business and, on exit, every year since FY’12 when it has started to be measured, there has been an uplift on sale, which, on annual average, has been 31% and never been below 20% in any year. The PEG ratio in FY’22 is just 0.66x, nearly a fifth below the long-run average.
Overall, the uplift on exit is the critical evidence that the valuation approach is conservative.