Investment process: Active involvement to drive growth
Hg’s area of expertise (the manager’s ‘sweet spot’) represent buyouts of defensive tech growth companies operating in one of eight core end markets: tax and accounting; ERP and payroll; legal and compliance; automotive; insurance; SME tech services; capital markets and wealth management IT; and healthcare IT. These companies should display high levels of recurring and contracted revenues generated from products or services that are business critical but typically low spend. This includes solutions delivered in a cloud software-as-a-service (SaaS) setup, with several of HGT’s top portfolio companies already operating in this model (eg Visma, Sovos, IRIS, Access and Allocate Software).
These businesses should be able to use their intellectual property accumulated over several years to generate high margins. Moreover, Hg is looking for companies with a high level of customer loyalty and low sensitivity to market cycles (ie with a defensive profile), as well as low customer penetration (which may be significantly enhanced using a SaaS cloud framework).
Exhibit 2: Hg’s ‘sweet spot’
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|
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Hg prefers companies that constitute a solid investment platform and allow it to implement a ‘buy-and-build’ strategy. It aims at acquiring businesses ranked second to fourth in their respective markets and creating the leading player through add-on acquisitions. Over the last 15 years, Hg has assisted its portfolio companies in conducting more than 200 bolt-on acquisitions. This approach seems particularly compelling in the context of current valuations in the market that are relatively demanding and call for more sophisticated PE strategies than plain financial engineering.
Hg’s key competitive advantage is its strong involvement in the strategic development and value creation of its portfolio holdings. Hg’s active management is executed by its in-house portfolio team (consisting of c 30 professionals), which works with the company’s existing management to develop plans in focus areas around growth, technology & product, analytics, operating model & systems, talent, finance, responsible business, and reporting & communities.
Hg’s high degree of involvement supports its deal-origination process (especially in the lower mid-market segment covered by the Hg Mercury funds), as company founders that are considering selling their business normally display a cautious approach towards PE companies and are not exclusively driven by the price they can get for their stake. It is equally important for them to find an investor who will be able to successfully enhance and expand the company’s operations (someone who will take proper care of their ‘baby’).
The operations group either becomes involved directly in the company’s operations or mentors its senior management. Hg emphasises stimulating collaboration and experience sharing between management teams of its portfolio companies. This includes forums hosted by Hg (over the last year, it has organised c 30 events with more than 1,000 participants) and 15 live online communities with over 1,000 active members in Hg’s trusted environment, Hive.
Current portfolio positioning
HGT’s portfolio at end-September 2019 consisted of investments that the company held as one of the limited partners in Hg funds or as direct co-investments with a total valuation of £869.3m. Moreover, the company holds renewable energy investments through the Asper RPP I and II funds valued at a minor c £1.9m following a partial disposal of its interest in Asper RPP II in October 2019. HGT’s gross cash position at end-September 2019 was £191.7m or c 19% of total NAV, which, after accounting for provision for carried interest and net current liabilities, stands at £1,005.9m. Taking into account the new investment in Argus Media announced in October 2019, HGT’s pro-forma liquid resources stood at £153m or c 15% of NAV reported as at end-September.
Exhibit 3: Portfolio breakdown by sector
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Exhibit 4: Portfolio breakdown by geography
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|
|
Source: HgCapital Trust, Edison Investment Research. Note: Data at 30 September 2019.
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Exhibit 3: Portfolio breakdown by sector
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Exhibit 4: Portfolio breakdown by geography
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Source: HgCapital Trust, Edison Investment Research. Note: Data at 30 September 2019.
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With respect to regional exposures, HGT’s portfolio weighting to the UK has decreased to 31% from 36% at end-December 2018 and increased for Germany to 15% from 11%, respectively. Following the high volume of realisations and new investments in 2016–18 (see Exhibit 5), HGT’s portfolio is relatively young as the 2017–19 vintages represented c 50% of the total portfolio value at end-September 2019.
HGT’s portfolio is also relatively concentrated, with the top 20 investments representing c 79% of NAV. Of this, the five principal holdings constituted c 45% of NAV at end-September 2019, suggesting their performance will be an important driver of HGT’s NAV. Visma alone made up 21.3% of NAV at end-September 2019, up from 16.3% at end-April 2019 partially as a consequence of a £10.9m follow-on investment concluded this year (HGT and other Hg fund investors bought out Cinven’s remaining stake). It is worth noting that the company’s investment policy includes a limit of a single holding on investment at 20% of gross asset value (at cost), which means Visma is currently above the limit. Nevertheless, HGT’s board highlights it has identified several ways to reduce the exposure to 20% in the medium term.
Portfolio companies have continued to deliver solid performance. Value-weighted average LTM sales and EBITDA growth for top 20 holdings (representing 91% of portfolio value) at end-September 2019 were 24% and 35%, respectively (vs 26% each at end-September 2018). According to the company, this translated into an EBITDA margin of 28% at end-September 2019. In valuation terms, the average LTM EV/EBITDA multiple for HGT’s top 20 holdings stood at 19.2x at end-September 2019 vs 17.3x at end-December 2018 and 15.9x at end-December 2017. Four portfolio holdings (representing c 45% of the top 20 investments) were valued at 20x to 22x. Although these multiples are high in absolute terms, they are broadly comparable with multiples for quoted European software companies (average EV/EBITDA multiple of c 20x) and relatively modest compared to US SaaS peers (30–40x) (Exhibits 8 and 9). We would highlight the following factors as support for the valuation:
1.
the high growth delivered by HGT’s portfolio holdings (CAGR of around 10–20% or even more at revenue and earnings levels historically), with a high proportion generated organically;
2.
Hg’s ‘buy-and-build’ strategy, as platform investments may command a valuation premium in the market as discussed above;
3.
the defensive profile of portfolio companies due to a high proportion of recurring revenues generated from business-critical but typically low-spend products, coupled with strong customer loyalty; and
4.
Hg bases the valuation of its portfolio companies on current market multiples based on trailing 12-month earnings, whereas the public market tends to be forward-looking. Given the growth profile of Hg’s companies, it is likely that one-year forward multiples would be lower than those stated above.
However, as the valuation of portfolio holdings is based on observable market multiples of listed peers, a potential significant market downturn would also be reflected in HGT’s NAV. In contrast, strong subsequent EBITDA growth would allow it to restore value in a relatively short timeframe.
Investments and realisations in 2019
HGT has invested c £111m in the first nine months of 2019 (Exhibit 5), with all major transactions conducted in H119, including team.blue (£23.5m), Transporeon (£42.4m including a £6m co-investment), Visma (£10.9m) and Litera Microsystems (£34.3m). Investments in Q319 were relatively minor as HGT deployed c £3.8m into two businesses well known by the manager: Rhapsody (£2.5m) and team.blue (£1.3m). In October 2019, HGT announced a £31.6m new investment in Argus Media, a global provider of energy and commodity price reporting.
Realisations to end-September 2019 reached £104m, including full exit from Foundry (£28m), partial exit from Raet (£10m), and a refinancing at A-Plan (£14m), which we covered in our initiation note in June 2019. In Q319 alone, HGT conducted transactions that returned £39.2m to the company.
Exhibit 5: HGT’s investments and realisations 2006–9M19
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Source: HgCapital Trust, Edison Investment Research
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In September 2019, HGT completed a full exit from Register, a provider of digital services for professionals and SMEs, following its takeover by team.blue, a mass hosting provider offering web enablement solutions to SMEs across Europe. This valued the investment at £26.5m, representing a c 33% uplift from Register’s book value of £19.9m at end-June 2019. team.blue has been HGT’s portfolio company since March 2019 and at end-September (following the takeover of Register) it was HGT’s 12th largest investment holding, representing 2.0% of its NAV. Notably, after the transaction, team.blue became the third largest shared hosting business in Europe with more than two million customers across 10 countries, according to Hg.
Also in September 2019, HGT made a partial exit from Asper RPP II, one of its two renewable energy fund investments. The transaction returned an initial £11m to the company, which compares with total valuation of the two funds at £23.2m as of end-August 2019. The company highlights that additional consideration is deferred and due to HGT on the anniversary of the sale. The Asper funds are run by a specialist team that was formerly part of Hg and moved to a newly created independent investment management company in November 2017. Moreover, HGT completed £10m of refinancings in Q319, including Commify (£9m) and EidosMedia (£1m).
Market background: SaaS market spotlight
To understand HGT, it is helpful to look at the prospects and performance of its underlying markets as well as the top-level track record of the holding company.
As we have mentioned previously, in SaaS terms, the US markets are more mature than the European markets with a far wider universe of pure SaaS businesses. Tracking these has now become easier with the launch of the BVP Nasdaq Emerging Cloud Index, which highlights the performance of a range of 49 US SaaS stocks on an equal weighted basis (rather than weighted by market capitalisation, which would skew the index towards a small number of large constituents).
As can be seen in Exhibit 6, following a sell-off from its peak in late summer, buying interest has now returned to the US SaaS sector with the index climbing steadily back towards its summer peak. At its summer peak, companies on the BVP Nasdaq Emerging Cloud Index were trading at an average of 12x forward revenue (against historical norms closer to 6–8x). Based on Bessemer Ventures data, the index is trading at an average of c 10x forward revenue today, justifiable on the basis of strong sales growth of 30%+.
Supporting these valuations, investors consider that SaaS companies have good defensive characteristics (visible revenue streams, long-term contracts, sticky clients, flexible cost bases) and therefore are expected to perform well in a downturn. Additionally, even on a buy and hold basis, assuming growth rates are sustainable, multiples would fall swiftly as companies continue to grow sales and EBITDA.
Exhibit 6: BVP Nasdaq Emerging Cloud Index
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Source: indexes.nasdaqomx.com/Index/History/EMCLOUD
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As SaaS companies increase in size, adding incremental revenue at sustainably high growth rates becomes more challenging. Late-stage cloud companies are likely to need to thoroughly qualify the opportunities in their pipelines and focus on cross-selling to their existing customer base to sustain revenue growth. Whereas, medium-sized companies are able to focus on managing their pipeline, targeting qualified new customers and paying sensible multiples for acquisitions.
Despite the growing maturity of the SaaS sector, Matt Holleran, general partner at Cloud Apps Capital Partners, still believes there is a period of further growth to come: ‘The horizontal cloud application market is expanding globally across the small, medium, large, and enterprise markets. The vertical cloud business application market is also now a global market across many customer size segments. The global scale of these horizontal and vertical markets is creating the opportunity for more entrepreneurs to build global category leaders that can become public scale companies.’ Although we are at a late stage in the cycle, as Hg recognises, there is still good visibility on continuing growth for the SaaS sector.
In this context, Visma, HGT’s largest holding, does not look out of place. In Q319, Visma reported revenue growth of 28% and EBITDA growth of 21%, with cloud annualised revenue reaching NOK11.2bn, which represents year-on-year growth of 31%. M&A remains a key part of the strategy with Hg characterising Visma as ‘Europe’s leading software M&A machine’ – Visma made six acquisitions during the quarter, three of them driving expansion in the Netherlands as Visma builds out its European footprint.
Framework for valuation of software/SaaS companies
As a framework, the two key factors affecting the valuation of a SaaS business are public market multiples and how fast the business is forecast to grow relative to its peers. Based on a (limited) universe of UK and European software businesses and US SaaS businesses (Exhibits 8 and 9), we have derived a scatter chart (Exhibit 7) setting out the impact of these two key variables, using consensus EV/EBITDA (FY2) multiples against expected sales growth (FY2), with a line of best fit.
Exhibit 7: Prospective EV/EBITDA multiple vs growth for a basket of SaaS businesses
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Source: Refinitiv (at 13 December 2019), Edison Investment Research
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This line of best fit suggests an EV/EBITDA range of 28–34x for sales growth in the 15–20% range. Of course, a true valuation will depend on the specifics of the company and what potential buyers are willing to pay. Hence, one of Hg’s key strategic pillars is to identify potential buyers as part of the initial investment process to ensure strong relationships are established with them as the asset is held and matures in Hg’s portfolio.
Hg also highlights that successful and sustainable ‘buy-and-build’ strategies attract a significant market premium over non-serial acquirors, potentially attracting a 20–30% premium over equivalent market multiples (c 4–6x added to the EBITDA multiple). Both horizontal (broadening the product range) and vertical expansion, integrating new areas of the enterprise software stack, are clear drivers of M&A deals as acquirors see large gains from adding new offerings to their existing marketing channels. The vast majority of Hg’s investments follow an active buy-and-build strategy.
Based on our universe (Exhibits 8 and 9), it is notable that there is a range of pure SaaS businesses listed in the US. However, in the UK and Europe there are no pure SaaS businesses, so we have had to focus on software businesses with partial exposure to SaaS revenues. Looking at high-level valuations, we would identify the persistent higher revenue growth exhibited by the US companies (20–25%) versus their UK (7–15%) and European peers (14–15%) compared to the higher margins in the UK (c 30%) and Europe (c 38%) versus the US (c 22%).
US investors appear to prioritise higher growth over short-term profitability, whereas in the UK and Europe investors favour profitability and are prepared to sacrifice some level of future growth for short-term returns.
Exhibit 8: Basket of US SaaS companies
|
Name |
Quoted ccy |
EV ($m) |
Sales growth 1FY (%) |
Sales growth 2FY (%) |
EBITDA margin 1FY (%) |
EBITDA margin 2FY (%) |
EV/ Sales 1FY (x) |
EV/ Sales 2FY (x) |
EV/ EBITDA 1FY (x) |
EV/ EBITDA 2FY (x) |
P/E 1FY (x) |
P/E 2FY (x) |
CRM.N |
Salesforce.Com Inc |
US$ |
139,616 |
28.0 |
23.0 |
28.9 |
28.4 |
8.2 |
6.7 |
28.5 |
23.5 |
55.6 |
51.9 |
INTU.OQ |
Intuit Inc |
US$ |
65,754 |
10.9 |
10.5 |
36.9 |
36.8 |
8.7 |
7.9 |
23.7 |
21.5 |
34.3 |
30.4 |
NOW.N |
ServiceNow Inc |
US$ |
50,699 |
32.2 |
27.9 |
28.1 |
28.5 |
14.7 |
11.5 |
52.4 |
40.3 |
84.1 |
65.0 |
WDAY.OQ |
Workday Inc |
US$ |
35,819 |
28.1 |
20.4 |
20.7 |
21.3 |
9.9 |
8.2 |
47.8 |
38.6 |
88.9 |
72.7 |
TEAM.OQ |
Atlassian Corporation |
US$ |
28,340 |
29.9 |
26.4 |
25.3 |
25.1 |
18.0 |
14.3 |
71.3 |
56.8 |
118.0 |
93.4 |
PAYC.N |
Paycom Software Inc |
US$ |
14,933 |
29.7 |
23.6 |
42.4 |
42.5 |
20.3 |
16.4 |
47.9 |
38.6 |
75.2 |
60.0 |
OKTA.OQ |
Okta Inc |
US$ |
13,705 |
43.7 |
31.4 |
N/M |
N/M |
23.9 |
18.2 |
N/M |
N/M |
N/M |
N/M |
TWLO.N |
Twilio Inc |
US$ |
12,023 |
71.7 |
31.6 |
3.5 |
5.7 |
10.8 |
8.2 |
N/M |
N/M |
N/M |
N/M |
COUP.OQ |
Coupa Software Inc |
US$ |
8,856 |
46.2 |
27.6 |
9.4 |
11.3 |
23.3 |
18.2 |
N/M |
N/M |
N/M |
N/M |
ZEN.N |
Zendesk Inc |
US$ |
8,540 |
36.0 |
29.9 |
7.4 |
9.7 |
10.5 |
8.1 |
N/M |
N/M |
240.2 |
132.9 |
PCTY.OQ |
Paylocity Holding Corp |
US$ |
6,122 |
21.5 |
20.1 |
29.0 |
29.9 |
10.8 |
9.0 |
37.1 |
30.0 |
66.2 |
54.6 |
PFPT.OQ |
Proofpoint Inc |
US$ |
6,103 |
23.2 |
20.0 |
17.5 |
17.4 |
6.9 |
5.8 |
39.4 |
33.1 |
65.3 |
58.8 |
HUBS.N |
HubSpot Inc |
US$ |
5,853 |
30.5 |
23.9 |
12.7 |
12.7 |
8.7 |
7.1 |
68.8 |
55.4 |
103.5 |
92.9 |
AVLR.N |
Avalara Inc |
US$ |
5,149 |
37.8 |
25.2 |
N/M |
N/M |
13.7 |
11.0 |
N/M |
N/M |
N/M |
N/M |
BLKB.OQ |
Blackbaud Inc |
US$ |
4,328 |
5.7 |
4.6 |
20.6 |
19.0 |
4.8 |
4.6 |
23.4 |
24.2 |
35.1 |
34.8 |
CSOD.OQ |
Cornerstone OnDemand |
US$ |
3,324 |
6.5 |
14.2 |
22.2 |
24.9 |
5.8 |
5.1 |
26.1 |
20.4 |
51.6 |
36.2 |
QLYS.OQ |
Qualys Inc |
US$ |
3,000 |
15.3 |
14.1 |
42.8 |
42.0 |
9.3 |
8.2 |
21.8 |
19.5 |
37.2 |
34.0 |
MIME.oQ |
Mimecast Ltd |
US$ |
2,618 |
24.4 |
20.3 |
17.3 |
19.1 |
6.2 |
5.1 |
35.7 |
26.9 |
94.0 |
64.7 |
BOX.N |
Box Inc |
US$ |
2,503 |
14.1 |
11.4 |
8.3 |
13.0 |
3.6 |
3.2 |
43.5 |
24.9 |
N/M |
58.1 |
LPSN.OQ |
LivePerson Inc |
US$ |
2,475 |
16.6 |
20.6 |
N/M |
2.6 |
8.5 |
7.0 |
N/M |
N/M |
N/M |
N/M |
KXS.TO |
Kinaxis Inc |
C$ |
1,885 |
25.9 |
11.1 |
28.6 |
26.3 |
9.9 |
8.9 |
34.7 |
34.0 |
60.3 |
59.0 |
|
Mean |
|
|
27.6 |
21.3 |
21.9 |
21.7 |
11.3 |
9.2 |
40.5 |
32.4 |
82.1 |
62.7 |
|
Median |
|
|
28.0 |
20.6 |
21.4 |
21.3 |
9.9 |
8.2 |
37.1 |
30.0 |
66.2 |
58.9 |
Source: Refinitiv, Edison Investment Research. Note: Priced at 13 December 2019.
Exhibit 9: Basket of UK and European software businesses
|
Name |
Quoted ccy |
EV ($m) |
Sales Growth 1FY (%) |
Sales Growth 2FY (%) |
EBITDA margin 1FY (%) |
EBITDA margin 2FY (%) |
EV/ Sales 1FY (x) |
EV/ Sales 2FY (x) |
EV/ EBITDA 1FY (x) |
EV/ EBITDA 2FY (x) |
P/E 1FY (x) |
P/E 2FY (x) |
UK |
|
|
|
|
|
|
|
|
|
|
|
|
|
SGE.L |
Sage Group PLC |
GBp |
11,153 |
1.8 |
5.8 |
25.7 |
25.7 |
4.2 |
4.0 |
16.5 |
15.6 |
24.5 |
22.7 |
AVV.L |
AVEVA Group PLC |
GBp |
9,790 |
9.6 |
5.3 |
29.0 |
30.6 |
8.7 |
8.3 |
30.1 |
27.1 |
42.1 |
37.5 |
AVST.L |
Avast PLC |
GBp |
6,906 |
7.8 |
7.0 |
55.0 |
55.1 |
7.9 |
7.4 |
14.4 |
13.5 |
18.8 |
17.2 |
MCRO.L |
Micro Focus International |
GBp |
6,672 |
-29.0 |
-5.3 |
40.5 |
41.6 |
2.0 |
2.1 |
4.9 |
5.0 |
7.3 |
6.9 |
SOPH.L |
Sophos Group PLC |
GBp |
3,750 |
7.1 |
9.5 |
15.5 |
15.8 |
4.9 |
4.5 |
31.8 |
28.4 |
44.4 |
38.7 |
GBGP.L |
GB Group PLC |
GBp |
1,980 |
36.8 |
10.9 |
24.0 |
24.1 |
7.6 |
6.8 |
31.5 |
28.3 |
42.7 |
38.4 |
LTGL.L |
Learning Technologies |
GBp |
1,126 |
38.5 |
8.2 |
33.8 |
34.3 |
6.5 |
6.0 |
19.2 |
17.5 |
27.7 |
25.5 |
EMISG.L |
EMIS Group PLC |
GBp |
901 |
4.8 |
4.4 |
30.0 |
30.1 |
4.3 |
4.1 |
14.4 |
13.7 |
22.4 |
21.3 |
PRSMB.L |
Blue Prism Group PLC |
GBp |
880 |
79.1 |
72.3 |
N/M |
N/M |
6.7 |
3.9 |
|
|
N/M |
N/M |
CRW.L |
Craneware PLC |
GBp |
801 |
7.3 |
8.7 |
32.9 |
32.9 |
10.5 |
9.6 |
31.7 |
29.3 |
48.4 |
45.1 |
ALFAAL.L |
Alfa Financial Software |
GBp |
373 |
-8.6 |
1.8 |
19.4 |
19.5 |
4.3 |
4.2 |
22.3 |
21.7 |
39.5 |
37.6 |
|
Mean |
|
|
14.1 |
11.7 |
30.6 |
31.0 |
6.1 |
5.5 |
21.7 |
20.0 |
31.8 |
29.1 |
|
Median |
|
|
7.3 |
7.0 |
29.5 |
30.4 |
6.5 |
4.5 |
20.8 |
19.6 |
33.6 |
31.5 |
Europe |
|
|
|
|
|
|
|
|
|
|
|
|
|
SAPG.DE |
SAP SE |
€ |
181,586 |
11.7 |
7.4 |
32.8 |
33.9 |
5.9 |
5.5 |
18.1 |
16.3 |
25.0 |
22.9 |
DAST.PA |
Dassault Systemes SE |
€ |
39,031 |
16.5 |
21.8 |
36.2 |
35.3 |
8.7 |
7.1 |
23.9 |
20.1 |
40.0 |
34.5 |
AMA.MC |
Amadeus IT Group SA |
€ |
38,439 |
13.1 |
6.2 |
40.3 |
40.7 |
6.2 |
5.8 |
15.4 |
14.3 |
26.3 |
24.4 |
TEMN.S |
Temenos AG |
CHF |
12,364 |
16.4 |
21.1 |
40.5 |
39.7 |
12.6 |
10.4 |
31.2 |
26.3 |
44.7 |
38.6 |
|
Mean |
|
|
14.4 |
14.1 |
37.4 |
37.4 |
8.4 |
7.2 |
22.1 |
19.3 |
34.0 |
30.1 |
|
Median |
|
|
14.8 |
14.2 |
38.2 |
37.5 |
7.4 |
6.5 |
21.0 |
18.2 |
33.1 |
29.5 |
Source: Refinitiv, Edison Investment Research. Note: Priced at 13 December 2019.
Financial resources: Coverage ratio above past average
HGT’s outstanding investment commitments at end-June 2019 stood at £340.6m (see Exhibit 10), down from £470.8m at end-December 2018, predominantly as a result of the investments in Combell, Transporeon, Visma and Litera Microsystems. The company’s liquid resources amounted to £158.8m and it had an undrawn £80.0m standby facility, which was extended to 2022. Following the £31.6m investment in Argus Media announced on 22 October 2019, commitments have declined further to c £298m and liquid resources amounted to £153m, implying a coverage ratio of 78%. This is visibly ahead of the company’s average levels since 2010. Having said that, the company expects it will announce further commitments to Hg funds in early 2020. HGT’s current commitments should be drawn down over the next 12–18 months and be partially funded by prospective cash inflows from portfolio realisations and refinancing.
Exhibit 10: HGT’s historical coverage ratio
|
|
Source: HgCapital Trust, Edison Investment Research. Note: Last column at end-September 2019 (pro-forma).
|
Importantly, in the case of all of the above-mentioned investment commitments, the board of HGT has negotiated a right to ‘opt out’ without suffering any penalties if it is not able to fund its commitments. However, HGT has not exercised this right so far, as investors could see it as a sign that it is not able to effectively manage its liquidity. It is considered more as ‘disaster insurance’ in order to protect the balance sheet.
Capital structure and fees
HGT pays a priority profit share corresponding to a base management fee that is specific to each of the Hg funds and calculated in respect of either HGT’s commitments to or capital invested alongside the respective Hg fund (see our initiation note for further details). HGT’s LTM priority profit share (between end-June 2018 and end-June 2019) was £11.1m and equalled c 1.4% of HGT’s average NAV in the period (vs £11.7m and 1.5% in FY18, respectively).
HGT is charged a performance fee in the form of carried interest payable to Hg’s investment manager once a certain level of repayments has been made to HGT. The company’s investments alongside Hg Saturn are subject to a carried interest at 12% of aggregate profits after the repayment of capital invested by HGT (and the priority profit share) and a preferred return of 8% per year, which increases to 20% once the fund’s performance surpasses a preferred return of 12% per year (with full catch-up). The company’s investments alongside all remaining Hg funds are subject to a carried interest at 20% of aggregate profits after the repayment of capital invested by HGT (and the priority profit share) and a preferred return of 8% per year. In FY18, the company recognised a net-carried interest charge of £14.4m (equating to c 2% of its average NAV in 2018). In cash terms, HGT paid £55.0m in carried interest in FY18. However, it must be noted this was paid on sizeable realisations (based on several years of accumulated profits), generating £271.8m in gross proceeds (vs a 10-year average value of gross proceeds from realisations at c £108m). Moreover, it is important to highlight the 14.3% NAV total return in FY18 was already net of carried interest.
Neither the priority profit share nor carried interest is applicable to any co-investment made alongside Hg5, Hg6, Hg Mercury, Hg Genesis 7, Hg Mercury 2, Hg Genesis 8 and Hg Saturn in excess of the company’s pro rata commitment. These investments yielded a 1.8x multiple on cost so far and at end-December 2018 represented 14% of HGT’s NAV. It is also important to note that, apart from the administration fee of 0.1% per year on the company’s NAV, there are no separate fees charged at the HGT level. Together with other operating expenses (such as legal and audit expenses or directors’ remuneration), HGT’s LTM total ongoing charges as a percentage of NAV at end-June 2019 were 1.7% compared to 1.9% in FY18 amid broadly stable total operating expenses of c £2.5m coupled with an increase in average NAV.
In terms of leverage, the company had no borrowings at end-June 2019. Last year, HGT extended its £80m multi-currency revolving credit standby facility, which will expire on 30 June 2022 and remained undrawn. The interest rate on the amount drawn from the facility stands at LIBOR plus a margin of 2.15%. HGT pays a commitment fee on the undrawn part of the facility of 0.9% per year. The company may add a further £80m to the facility subject to the bank’s approval.
HGT may make tactical use of the above-mentioned credit facility to fully exploit investment opportunities across the investment cycle. The company anticipates it will enter new commitments at the beginning of FY20. HGT usually applies leverage at its underlying investment level, which is serviced using the entity’s own cash flows. The average net debt to LTM EBITDA ratio across the company’s top 20 holdings was 6.2x at end-September 2019 versus 5.6x at end-2018. The number is somewhat higher than the median (gross) debt to EBITDA ratio for global PE deals in 2018 at 5.5x, according to McKinsey Global Private Markets Review 2019 (based on PitchBook data). It is important to note that the good visibility associated with a high proportion of recurring revenues generated by HGT’s portfolio companies allows for a higher leverage level in comparison to some other sectors where other PE funds invest.
HGT completed a 1:10 share split on 28 May 2019, which resulted in a rise in number of shares by 335.9m from 37.3m at end-December 2018. The aim was to attract more investors and improve the company’s trading volume. Moreover, the company conducted a £63.2m capital increase in June 2019, issuing 29.4m shares at a price of £2.15 each. In November and December 2019, HGT completed five minor share issues at £2.53 per share (issuing of 3.6m shares in total) under its block listing facility, raising gross proceeds of c £9.0m.