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ICG Enterprise: ‘Overhyped’ UK not cheap as our shares!

The UK may be in the middle of a takeover frenzy but private equity fund ICG Enterprise (ICG) manager Oliver Gardey says the tide of investment is ‘overhyped’ and the market ‘isn’t particularly cheap’.
Last weekend, Morrisons (MRW) became the latest gr…

The UK may be in the middle of a takeover frenzy but private equity fund ICG Enterprise (ICG) manager Oliver Gardey says the tide of investment is 'overhyped' and the market 'isn't particularly cheap'. Last weekend, Morrisons (MRW) became the latest group to succumb to private equity bids as US investor CD&R emerged victorious from a GBP7bn for the supermarket, sparking speculation rivals Sainsbury's (SBRY) and Tesco (TSCO) could be the next targets for overseas predators eyeing a comparatively cheap UK market. Nevertheless, Gardey said the 'UK takeovers are overhyped'.

'It's only because of a couple of high-profile companies being bought that it is taking all the oxygen in the market. If Morrisons made widgets you wouldn't have heard [of the takeover,' he said. He added the deal wasn't unusual. 'It is a general trend [to take public companies private], not just in the UK, but in the US and Europe,' said Gardey.

He said regulatory pressure, and investor demands for companies to hit quarterly earnings targets meant being listed company was no longer attractive. 'Companies may not have the time, patience, or capital to fund a 10-year strategic plan,' he said, preferring instead to have the option to run less profitably for a couple of years to be more profitable in future without being 'penalised' by shareholders. The swathe of investors looking to buy British firms has been put down to the huge discount the UK market is trading at as it continues to be hampered by the EU referendum in 2016.

However, Gardey argued that the market 'isn't particularly cheap' and valuations are 'catching up' after the Brexit discount. 'But there is also a lot of risk in [the market],' he said. 'What is the country's status in the world economy, it doesn't have a trading agreement with the US, and so there is substantial risk,' he said. 'It is a good development that capital is coming into the country and not leaving it.

People are obviously excited about the UK.'

High conviction

Having taken over the running of the GBP803m private equity fund-of-funds in July 2019, Gardey has set about increasing exposure to the UK and expanding the number of co-investments the fund makes in the 'high conviction' part of the portfolio. 'We are trying to create a balanced portfolio of 50-50 US and European investments,' he said.

'The reason we want to focus on the US so much is because, from a private equity perspective, it is a very deep market with lots of good companies and the ability to buy private businesses, and the very strong liquidity where you have lots of buyers.' The investment trust is split into two types of investments; half of the portfolio is in third-party funds and the other half is co-investments it makes alongside its 'top tier' fund managers. In the six months to the end of July net asset value (NAV) grew 11.1%, pushing the 12-month return to 37.% and leaving five-year annualised returns from the portfolio at 16%.

Gardey, who started his 25-year career in private equity by buying a bankrupt company after business school and turning it around, said his was 'the best performing asset class'. 'However, there are substantial challenges to private equity, and there is a big dispersion between the top and bottom performers, so to make it work you have to take the risk out of the portfolio,' he said. In order to do this he only invests in company buyouts in the large and mid-sized space and never early-stage venture capital, which has a '60-70% loss rate' compared to the 10-15% loss rate in buyouts.

'Our focus is on making good businesses into better business,' he said. He gave the example of Froneri, a Yorkshire-based ice-cream manufacturer, which supplies well-known brands such as Rowntrees, Oreo, Cadbury and Haagen-Dazs. 'It's a classic example of a company where you know the products without necessarily realising it is the same company,' he said.

In order to expand the 'high conviction' part of the portfolio, Gardey and his team co-invested GBP37m in five new companies in the six-month period. Of this GBP7m went into Digicert, the US online provider of SSL security certificates for websites. 'It's a really interesting business and is benefiting from the growth of online and the need for verification and increase security,' said Colm Walsh, managing director of ICG Enterprise.  

The fund has also put GBP9m into Ivanti, a US business providing IT security softwar needed for 'increasingly complete IT systems'. Another US company, Class Valuation, benefited from a GBP7m investment. 'This is a business that operates in the US although it has plans to expand to Europe,' said Colm. It provides an online portal to track mortgage surveys, or appraisals as they are known in the US, bringing 'transparency with its technology' to a previously analogue industry.

'We look for investment in defensive growth sectors,' said Gardey. 'We do not invest in cyclical companies, we do not have exposure to cyclical revenue drops or increases, our companies have subscription models or strong recurring income. They are market leaders in their space in sectors where there is still growth.'

Deep discount

Despite ICGT's success, with its shares up 34% over one year and having generated a 292% ten-year total return that beats global public equity markets, at yesterday's close of GBP11.44 the trust stood 25% below net asset value of GBP15.17 per share at the end of July.

The deep discount is normal for its private equity peer group, which Gardey said 'can be down to fear of what happened in history and not understanding the industry well enough, or why it is different today'. 'There is a lot of global financial crisis scars from when private equity went belly up' he said. However, he said there is a 'night and day' difference between the performance of the sector during Covid-19 and the 2008 crisis.

'When you look at the global financial crisis, there was a couple of bad eggs that were over-leveraged and over-committed and did not survive, and that scared everyone and gave people in investment trusts a bad experience.

The survivors are very safe and solid.'

Liberum analyst Conor Finn agreed the trust's wide discount was attractive. 'We expect the strong returns to continue, with the company reporting a substantial pipeline of further investment opportunities with a number expected to close in the coming months.'