Gresham House — ESG specialist manager delivering its strategy

Gresham House is a specialist asset manager with an emphasis on private assets and sustainability. Its five investment strategies are split between Strategic Equity (public and private equity) and Real Assets (forestry, new energy and sustainable infrastructure, and real estate). The group is the UK’s largest commercial forestry asset manager, manages Europe’s largest battery storage investment company and is the second largest venture capital trust (VCT) manager in the UK. With expertise across these mainly specialist areas, it can claim to be differentiated from many asset managers. The structural shift towards sustainable investing creates a favourable market background that should persist through fluctuations in market sentiment supplementing the company’s own initiatives to continue the strong growth it has already recorded. Gresham House indicates that its shares may qualify for Business Relief for Inheritance Tax.

The 2021 results, reported in March, showed assets under management (AUM) up 65%, net core income 51% ahead and adjusted operating profit and the dividend both increased by 67%. The end-2021 balance sheet was strong with no debt, cash and realisable assets of over £78m and a revolving credit facility of £20m, leaving it well placed to pursue its near-term plans to invest to support AUM growth and to meet deferred acquisition payments.

As for other asset managers, there will be some sensitivity to equity market movements, but this is significantly modified by the group’s exposure to real assets and private equity where valuations are either uncorrelated with equity markets or much less volatile because of the lags inherent in private market valuations. The length of management contracts reduces exposure to volatility in flows. Other potential areas of sensitivity include key person, acquisition execution, changes in regulation, changes in rules relating to VCTs and maintenance of in house and investment process sustainability standards.

The chart below shows the range of values implied when we put Gresham House shares on peer group multiples for 2022e, those implied by transactions involving comparator companies and finally the range indicated by our discounted cash flow (DCF) model, assuming a 3% long-term growth rate and discount rates between 8% and 17%.

Gresham House has a long history dating back to its incorporation in 1857 and was on the Official List from 1950 to 2014, operating as an investment trust from 1966. A management buy-in team led by Tony Dalwood initiated a new direction for the company in December 2014, aiming to develop the company organically and through acquisition as an asset management business managing and investing in relatively differentiated, specialist or illiquid assets. In conjunction with the change in direction the company transferred to AIM.

As a starting point the company established a strategic equity investment team to manage funds using an approach Tony Dalwood had employed previously, including during his period managing Strategic Equity Capital from its launch in 2005. This involved applying private equity techniques in managing public equity investments and Gresham House won its first mandate in July 2015 for Spark Ventures (which became Gresham House Strategic).

In 2015 Gresham House also acquired Aitchesse, giving it an entry into real assets and forestry asset management. By the end of 2021 forestry was to account for 45% of group AUM at nearly £3bn.

Growth from 2015 proceeded through a combination of organic development and acquisitions. The acquisition history is set out below, with the purchases adding capabilities and geographical reach, providing the basis for further organic growth. The weighted average EBITDA/profit multiple for the acquisitions was 6.0x and the percentage of AUM 3.5%.

Looking at how the acquisitions contributed to the development of Gresham House, we would add the following points. The Hazel Capital acquisition introduced expertise in new energy, including battery storage, which enabled the subsequent launch and initial public offering (IPO) of the Gresham House Energy Storage Fund (GRID: follow link to Edison research). FIM added substantially to the forestry management business and Livingbridge gave access to the VCT market under the Baronsmead brand, which also includes micro-cap and multi-cap income funds. TradeRisks brought management of affordable housing (within the real estate segment of real assets) to the product list including management of Residential Secure Income (ReSI REIT). This activity has recently extended to Ireland through the Burlington acquisition. Appian was another acquisition in Ireland adding to the list of public equity funds within Strategic Equity and giving the group an EU-based alternative investment fund manager (AIFM). Also in 2021, the private equity capability was strengthened through the purchase of Mobeus, which added four VCTs taking the total AUM in this area to nearly £0.9m.

In the period since 2015 the group pursued an organic growth strategy involving marketing, additional fund-raising and new fund launches to build on the growing capabilities and capacity of the asset management team. Exhibit 3 shows some highlights in this process.

In the last five years organic AUM growth (net fund flows, fund launches and performance) has ranged between 55% and 23%, with 2021 seeing a 50% increase (see chart below).

The next table gives a view of the substantial growth in the business resulting from the organic and M&A steps highlighted above. Accompanying the growth in AUM, staff numbers have risen to an average of 173 in 2021 with the implied management fee rate and fee income per person broadly stable since 2018. Following the initial build up phase following the management buy-in, the business moved into adjusted operating profit in 2018 and reported operating profit in 2020. The adjusted operating profit margin has been close to or above 30% since 2018.

Exhibit 6 gives an overview of the make-up of Gresham House’s AUM at end 2021, with an analysis of management fee and operating profit contributions together with fee rates. Below this is the split of client and fund types. Real assets account for over 70% of AUM but a lower proportion of management fees and adjusted operating profit, reflecting the lower average fee rate that applies in this segment and relatively higher costs in managing these assets. The higher average fee rate for Strategic Equity is driven by the private equity/VCT component. The result is that this segment contributed 42% of profit compared with 29% of AUM.

Wholesale/retail and institutional clients each account for 41% of AUM while the fund type analysis underlines the long-term nature of the mandates held by Gresham House. Open-ended funds only account for 12% of AUM with the remainder closed-ended or listed. The average contract life of limited partnership funds was 14 years. There is therefore a good level of revenue visibility.

Next we give a brief outline of the investment approaches taken in Gresham House’s funds, which are divided into two divisions and five strategies.

Strategic Equity

Real Assets

In March 2020 Gresham House set out its five-year strategy, GH25, which includes strategic goals and specific financial targets. The six strategic goals are as follows:

The group set four financial targets aiming to double shareholder value over five years. The targets do not assume further acquisitions. Our estimates suggest the group is on track to reach some of these targets ahead of schedule:

Management sees the potential for further significant growth beyond the end of GH25 given investor appetite for sustainable funds and capacity for investment within the existing strategies (this is outlined in the Background and Outlook section). Therefore, our expectations for 2024 are set on the assumption that Gresham House will still be bearing the costs of continuing investment in people and systems to support further growth but will have seen the benefits of operating leverage, allowing it to reach the 40% target operating margin.

Members of the management and investment committees (see Exhibit 7) bring together substantial collective experience of financial markets and management. Tony Dalwood highlights the benefits that this experience continues to bring, particularly given the relatively recent relaunch of the business following the management buy-in and the role that acquisitions have played since then. In the case of Rupert Robinson and Samee Khan, Tony Dalwood worked with them in previous roles, while other members of the team have now worked together for a number of years, strengthening communication and coordination. On the investment committee, the input from independent voices (Bruce-Carnegie Brown and Simon Stilwell, who is also on the group board as a non-executive director) is valued highly. In addition the group board includes other non-executive directors with significant City, financial and business experience: Anthony Townsend (chairman), Rachel Beagles, Sarah Ing (to be appointed following the 2022 AGM), Richard Chadwick (to retire following the AGM) and Gareth Davis.

During 2021 AUM increased by 65% to £6.5bn with growth including strong net inflows of nearly £1.2bn (29% of opening AUM) across its strategies, while performance added approaching £0.8bn (+20% overall, including 29% in forestry) and acquisitions £0.6bn (Appian in Strategic Equity and Real Estate and the Mobeus VCT business). Within the total increase in AUM of £2.6bn, organic growth was £1.9bn (c 50%).

Exhibit 8 gives an analysis of the 2021 P&L compared with the prior two years. Gross core income increased by just over 50% in line with the increase in average AUM. Administrative overheads rose by 43% including a 49% increase in staff costs. The year-end full time equivalent headcount stood at 185 compared with 122 in 2020. The increase in costs was partly due to the acquisitions of Appian and Mobeus and higher office costs. This left adjusted operating profit at £20.2m (up 67%) and the adjusted operating margin increased from 29.6% to 32.7%. Net performance fees of £1.7m and £1.8m of net realised gains resulted in an 81% increase in adjusted operating profits including these items.

After amortisation and depreciation, acquisition related share-based payments, exceptional items, net gains on investments and other items (a total net deduction of £7.3m), reported operating profit before tax was £16.3m compared with £1.9m. Reported diluted EPS increased from 1.8p to 32.6p while the adjusted diluted EPS was up 50% at 49.3p.

Reflecting the strong results and a confident outlook, the group announced a 67% increase in the dividend to 10p.

The growing trend towards allocation to alternative investments and sustainable funds is well established, reflecting a combination of many factors. These include regulation, greater ESG disclosure, increasing concern over climate change, a realisation that there may be no performance penalty in pursuing a sustainable investment strategy (rather the reverse) together with a desire to have a positive impact for the greater good. This has driven a rapidly accelerating appetite from both retail/wholesale and institutional investors and is illustrated by the trends in AUM and flows into global sustainable funds.

Forecasts from a range of data providers and consultancies point to further significant growth over the medium to longer term. In one example, a Bloomberg report suggested that global ESG assets could rise from $37.8tn in the current year to $53tn by 2025 based on a growth rate of 15%, half the rate of the prior five years. PwC Luxembourg has been reported as looking for European ESG assets to account for between 41% and 57% of total mutual fund assets, up from 15% in 2019. In a press release on its 2022 global alternatives report, Preqin indicated that it expects alternative managers’ AUM will rise from $13tn to $23.2tn by the end of 2026, noting that ESG factors have become increasingly important among alternative assets.

While these data points may not read across directly to the product set that Gresham House offers, they do indicate the broad growth in alternative and sustainable investment and tend to confirm that it is operating in a segment of the market that is seeing strong growth. As noted earlier, the group has strong positions in areas such as forestry, battery storage and, within private equity, VCTs.

The next question to ask is whether there is scope to increase scale in the areas these strategies address. Gresham House has set out the size of some of the opportunities within the existing strategies (see table below), which indicate substantial room to increase overall AUM.

The group acknowledges that the war in Ukraine1 will cause risk premia to rise, which will affect valuations, but notes that (outside public equity) its asset classes have long-term time frames and that the growing demand for its products should be sustained. The board therefore expresses confidence in delivering further growth in the current year and beyond.

We do see some risk to nearer-term fund-raising as investors deal with heightened uncertainty surrounding the Ukraine war, sharply rising inflation and rising policy rates (see charts above showing relatively modest recent weakness in the European State Street Investor Confidence Index and, unsurprisingly, a sharp spike in the Economic Policy Uncertainty Index Europe). However, on a medium-term view the positive trend in sustainable investing highlighted above and the specific alternative asset management capabilities that Gresham House has brought together do seem to support the group’s positive stance. As we set out in the next section, we have assumed in our estimates that the group does continue to generate good AUM growth.

We set out our key estimate assumptions in Exhibit 14. Starting with AUM, our estimates are for total growth of between 14% and 15% for 2022–24. This is equivalent to an average increase of just below £1bn per annum, excluding this year’s acquisition of Burlington, which compares with average organic growth of £1.4bn for 2020–21. Within this we assume that net flows account for 10–11% per annum and performance 4%.

In terms of mix we have assumed faster growth for Real Assets than Strategic Equity at 16% compound annual growth versus 11% reflecting the respective growth opportunities in each area. This explains a reduction in the average asset management fee rate from 125bps (2021) to 102bps (2024e). This flows through to 15% compound annual growth in net core income and 21% for adjusted operating profit. Adjusted operating profit margin increases from the 33% recorded in FY21 to 40% in FY24, meeting the GH25 target.

We have not assumed any performance fees or realised gains in our estimates and these could create added value over the long-term. Likewise, in estimating reported profit (see the lower section of table) we do not include any exceptional items or net gains or losses on investments.

Further details of our estimates are shown in the financial summary (Exhibit 22) including our assumed dividend payments for the next three years, with cover in 2024 matching the group’s 3x objective (using adjusted earnings).

The next table gives a summary of cash flows over the last five years, which provides a useful overview of how the group’s growth has been financed over this period. Our comments here relate to the five-year total figures unless stated. Operating cash flow moved from an outflow in 2017 to significant inflows in 2020–21 as the group expanded and benefited from operational leverage. Over the period shown the net operating cash inflow was nearly £44m.

Cash elements of initial and deferred acquisition payments and a management contract purchase totalled £54.5m. The net £5.4m investment in DevCo projects reflects investment in battery storage projects, which form part of the investment pipeline of GRID. The sale of these projects generated investment gains for the group. The sale of investment properties (raising £12.9m) represented the final unwinding of the legacy assets from Gresham House’s days as an investment trust. The overall net outflow from investing activities was £53m.

Equity and warrant issuance is the main item within financing cash flows at nearly £77m, partly offset by share-based payment settlements of £17.7m and dividend and other payments of £6.3m. This left cash flow from financing at £53m and a net cash inflow over the period of £43m.

Turning next to the balance sheet: at the end of 2021 the group had cash of just over £40m, no debt and investments of £38m. The investments figure includes net investment in battery projects and investments in securities and is adjusted to show the group’s investment exposure rather than the consolidated IFRS 10 basis reported on the balance sheet. On the adjusted basis the group had net realisable cash and investments of £78.3m, compared with £45.1m in 2020. Subsequently it has sold its stake in Rockwood (formerly Gresham House Strategic) generating a substantial total return with a circa 2x money multiple and an IRR well above its 15% target. The sale released £7.6m in cash net of the purchase of a co-investment from Rockwood. The group also has a rolling credit facility of £20m and therefore has headroom to support further AUM growth.

On this point the group has identified the potential to make balance-sheet investments of up to £40m, including: £23–28m in battery and other renewable projects and a climate transition product; £5–7m to warehouse forestry assets; £2m in general partner commitments for new housing investments; £5m as part of its commitment to Strategic Equity Capital; and £5m to demonstrate alignment in a potential private equity mandate. All these investments have been or will be subject to review and challenge by the investment committee with a requirement that they should be compatible with the group’s medium-term 20% return on capital target. Note that we have not included these potential investments or returns from them in our profit and loss and cash flow estimates. We have estimated cash outflows of c £16m for deferred consideration over the 2022–24 period.

In this section we consider the valuation of Gresham House shares with reference to a peer group comparison, selected transaction metrics and the outputs from our DCF model.

Starting with our peer group comparison, this includes a selection of specialist and alternative fund managers with different profiles and market capitalisations ranging from sub-£0.5m (Gresham House and Foresight) to over £22bn (Partners). For Gresham House we have used our estimated adjusted EPS and EBITDA numbers2 as the basis for multiples, while the comparator multiples are derived from consensus estimates. Gresham House P/E multiples are below the European peer average and above the North American average. The EV/EBITDA multiple for 2022 is noticeably below both peer groups. The rating on both measures is noticeably above the more conventional/larger UK peers, a differential that can be attributed to expected growth rates.

Our next two charts look more closely at two enterprise value (EV)-based valuation measures. Exhibit 17 charts EV/AUM against the management fee margins. Apart from Impax, all the peers have a management fee close to or above 100 basis points, reflecting their provision of private equity and/or real asset management services. Impax is an established specialist but its weighted average fee margin of 47 basis points reflects its exposure to listed company investment and to third-party mandates. Gresham House features a significantly below-average EV/AUM valuation and an above-average management fee margin.

Exhibit 18 compares EV/EBITDA multiples (these are based on last reported figures) with compound annual growth in AUM since 2016. The first point to make here is that all the companies have recorded very strong growth in this period, with an average value of c 30% per annum. Acquisitions and performance have contributed to this to varying degrees, but this level of growth also tends to support the argument that the specialist/alternative areas are attracting relatively strong allocations. Gresham House stands out even more clearly in this chart, trading on a below-average multiple while achieving very strong growth. The starting point for the comparison is at a relatively early stage in Gresham House’s development, but the compound annual growth in AUM since 2018 is a still-strong 42% compared with the average for these companies over the same period of 27%.

Our transaction table below shows valuation measures for a selection of transactions in the alternative asset management sector since late 2019. The rationale for the acquisitions follows the broad theme that the buyers were looking to enhance their capabilities in specialist areas and in some cases to extend their geographical reach. There is quite a wide range of valuations, but on average there is a similarity between the transaction averages and the average for the European peer group shown above.

We have prepared a DCF model and a range of outputs are shown below. The model includes our explicit forecasts to 2024 and then allows for an intermediate period of three years in which operating cash flow grows at a rate of 8%. The central assumptions in the table for discount rate and long-term growth are 10% and 3% respectively. Given the other assumptions, the table shows that, on our estimates, you would have to assume a discount rate of over 17% and long-term growth of 2–3% to match the current share price.

In our final valuation table we have collated the values that are given if we apply the range of earnings and EBITDA multiples for the North American and European peer groups and transactions to Gresham House. For convenience we have also shown the DCF value range using the 3% long-term growth assumption. We have not included the UK asset manager multiples which we included the average in Exhibit 16 given their different profile; using their multiples would produce figures at or below the low end of the range shown in the table below. Within the figures included in the table there is a large range, reflecting the variation in the circumstances of the peers. Taking the average values does narrow the range somewhat to 830p to 1,620p, giving a framework for considering the current valuation in conjunction with the DCF sensitivity table above.