HgCapital Trust — Seizing ‘buy-and-build’ opportunities

HgT (LSE: HGT)

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Research: Investment Companies

HgCapital Trust — Seizing ‘buy-and-build’ opportunities

HgCapital Trust (HGT) delivered a 4.6% NAV TR in H123, with its performance continuing to be mostly driven by robust trading across its portfolio (with the associated increase in portfolio value in H123 of £203.8m, or 8.3% of end-2022 portfolio value) and a minor positive impact from multiples (£34.1m or 1.4%). Hg was cautious in terms of new platform investments in H123, but saw record high M&A activity across its portfolio, highlighting increasingly attractive pricing and a strong flow of opportunities for smaller bolt-on investments. HGT’s 60% coverage of outstanding investment commitments by its liquid resources makes the trust well positioned for a potential uptick in PE deal activity.

Milosz Papst

Written by

Milosz Papst

Director, Financials

Investment Companies

HgCapital Trust

Seizing ‘buy-and-build’ opportunities

Investment trusts
Private equity funds

22 September 2023

Price

404.5p

Market cap

£1,852m

NAV

£2,166m

NAV per share*

473.1p

Discount to NAV

14.5%

*At end-June 2023.

Yield

1.7%

Shares in issue

458.1m

Code/ISIN

HGT/GB00BJ0LT190

Primary exchange

LSE

AIC sector

Private equity

52-week high/low

416.5p

320.5p

473.1p

443.2p

Gearing

Net gearing at end-H123.

0.0%

Fund objective

HgCapital Trust’s investment objective is to provide shareholders with consistent long-term returns in excess of the UK All-Share Index by investing predominantly in unquoted companies where value can be created through strategic and operational change.

Bull points

Focus on resilient software and services companies with broad client bases.

Portfolio companies continue to deliver both solid top- and bottom-line performance.

Experienced investment team with a strong long-term track record.

Bear points

Investor rotation away from tech could resume in the event of increasing risk aversion.

The impact of a worsening macroeconomic environment on SMEs may result in reduced net client additions across HGT’s portfolio.

High net leverage of portfolio companies (7.4x EBITDA for top 20 holdings on average) but supported by high share of recurring revenues, strong earnings growth and high cash generation.

Analysts

Milosz Papst

+44 (0) 20 3077 5720

Katherine Thomson

+44 (0) 20 3077 5720

HgCapital Trust is a research client of Edison Investment Research Limited

HgCapital Trust (HGT) delivered a 4.6% NAV TR in H123, with its performance continuing to be mostly driven by robust trading across its portfolio (with the associated increase in portfolio value in H123 of £203.8m, or 8.3% of end-2022 portfolio value) and a minor positive impact from multiples (£34.1m or 1.4%). Hg was cautious in terms of new platform investments in H123, but saw record high M&A activity across its portfolio, highlighting increasingly attractive pricing and a strong flow of opportunities for smaller bolt-on investments. HGT’s 60% coverage of outstanding investment commitments by its liquid resources makes the trust well positioned for a potential uptick in PE deal activity.

HGT’s portfolio changes in H123 (£m)

Source: HgCapital Trust

Secular digitalisation trend continues

HGT’s portfolio has benefited from the structural trend towards digitalisation of business processes for many years now, with accelerated adoption following the COVID-19 pandemic. According to Hg’s (HGT’s investment manager’s) head of research, software spending continues to grow significantly, even in advanced economies (where IT spending in relation to GDP is already high versus less developed countries), suggesting that the sector will not reach saturation any time soon. This seems to be confirmed by Gartner’s forecast, released in July 2023, of global software spending growth of 13.7% in 2023 and 14.1% in 2024, as enterprises prioritise spending to capture a competitive edge through increased productivity, automation and other software-driven transformation initiatives.

Consistently delivering top-line and EBITDA growth

Despite the tougher external environment, SaaS companies should continue generating healthy top-line growth of c 15% pa and increasing profitability over the next two years, based on current Refinitiv consensus. HGT is a quality play in the sector, underpinned by the defensive growth profile of its holdings and Hg’s sector expertise, in-house value creation team and buy-and-build strategy. HGT’s historical revenue and EBITDA growth across its top 20 holdings was 20–30% pa at a margin above 25% (H123: 30%). This includes c 10–15% pa organic revenue growth of HGT’s portfolio companies, which is less dependent on new client additions compared to some higher-growth tech businesses, according to Hg.

EBITDA growth and margin at 30%

Revenue and EBITDA growth across its top 20 holdings (76% of end-June 2023 NAV) over the 12 months to end-June 2023 reached 29% and 30%, respectively (see Exhibit 3). Top-line growth was predominantly supported by sales to existing clients (with high renewal rates, as well as cross- and up-sell activity). This is in line with Hg’s earlier expectations of some pressure on sales to new customers as they become more reluctant to commit to new software and services in the current challenging macroeconomic environment. That said, we consider this merely a postponement (rather than an abandoning) of investments in business digitalisation. Average last 12-month (LTM) EBITDA margin to end-June 2023 across HGT’s top 20 holdings remained resilient at 30% (vs 31% LTM to end-June 2022).

Exhibit 3: HGT’s portfolio change waterfall (£m)

  

Source: HgCapital Trust

Given the normalisation of the interest rate environment, it is instructive to look at the interest coverage and debt maturity profile of PE portfolios like HGT’s. Average net debt to LTM EBITDA across HGT’s top 20 holdings was 7.4x at end-June 2023 (down from 8.0x at end-2022), which together with the above-mentioned average EV/EBITDA multiple implies a substantial c 72% equity cushion. The average new-issue loan spreads for a single B issuer in Europe stood at EURIBOR +454bp in Q223 (according to Partners Group’s recent quarterly liquid loan market commentary). For illustrative purposes, if we apply this spread to the current three-month EURIBOR (3.955%), a net debt to EBITDA of 7.4x translates into an EBITDA interest coverage ratio of 1.6x, which leaves some headroom in terms of interest cover, especially for less capital-intensive businesses such as software and services providers.

HGT considers this leverage level as appropriate given the high share of recurring revenues and strong cash generation of its businesses. We also note that c 75% of the debt across the portfolio managed by Hg is hedged for an average two years. Moreover, there are no meaningful maturities across the portfolio until 2025 (with most of the debt maturing in 202729). Hg highlights that the debt structure of its portfolio companies consists of both straight senior debt and junior/payment-in-kind debt to preserve cash for bolt-on acquisitions.

We also note that Hg utilises credit lines to fund portfolio M&A and return cash to investors. These facilities are unsecured and have no recourse to HGT and the underlying Hg private funds HGT invests in. At end-June 2023, the fund level facilities attributable to HGT’s investments stood at £362.0m, which represents c 15% of HGT’s portfolio value (including accrued income but before carried interest and the balance of these facilities) or c 10% of the combined portfolio value and HGT’s outstanding commitments.

Balance sheet allows for seizing new opportunities

Few platform investments in H123, pick-up expected in H223

HGT remained cautious in terms of new investments, with £32.7m deployed in H123 (of which c £17m was in Q223) versus £71m in H122. This includes a c £15.5m new investment in GTreasury (a US-based treasury, payments and risk management software provider) announced in May 2023, as well as several follow-on investments in Howden, Citation, GGW, Rhapsody and Blinqx to support their M&A activity. HGT’s current focus in terms of capital deployment is on bolt-on M&A across its portfolio rather than on new platform investments, with around 300 bolt-on acquisitions across HGT’s portfolio in the 12 months to end-March 2023. A combination of macro headwinds and greater seller motivation allowed for considerable multiples arbitrage on the add-on investments, with acquisition multiples being on average c 40% below the EV/EBITDA multiples at which HGT values the acquirers (its platform investments). Hg notes that Europe is particularly interesting in terms of ‘buy-and-build’ opportunities given differences in market conditions across countries. That said, Hg also highlighted that it sees some indications that conditions for PE deals are more supportive in H223, especially in sectors HGT is invested in. Post balance sheet date, HGT made a £6m new investment in Nomadia, a European SaaS provider of smart mobility solutions that help companies plan and optimise the travel and activity of their mobile workers in real time.

Valuation uplifts on exits consistent with recent years

Meanwhile, £229m was returned to HGT in H123, largely from the full realisation of Transporeon (c £109m, announced in December 2022 and closed in April 2023) and secondary fund transactions (though the latter represent a deferred consideration, see our March update note for details). HGT continued to realise its investments above prior year-end fair value, as illustrated by the transactions agreed post balance sheet date (representing estimated gross proceeds of c £55m): the full realisation of Commify (completed at a 32% uplift), as well as partial exits from Azets (16% uplift) and TeamSystem (68% uplift). Although these are relatively small holdings for HGT (2.3%, 1.2% and 0.7% of end-June 2023 portfolio value, respectively), we consider the average uplift of 39% on these transactions as a positive indicator for HGT’s portfolio valuations. Moreover, it is consistent with HGT’s performance in recent years, as the average uplift on all HGT’s realisations since 2017 was also 39% (average uplift over 10 years was 24%).

Commitment coverage ratio above historical average

HGT’s balance sheet capacity was assisted by recent realisations of individual holdings, as well as other measures introduced earlier this year, including the upsizing of HGT’s credit facility to £350m, the secondary sale of Genesis 8 limited partner (LP) interest and the reduction in Hg Saturn 3 commitment. As a result, Hg estimates that HGT’s total available resources (including the undrawn credit facility) will, after completion of all announced transactions and the interim dividend payment in October 2023 (proposed at 2.0p per share), amount to £657m. This represents a c 60% coverage ratio of HGT’s £1.1bn of total outstanding commitments, slightly above its 201822 average (see Exhibit 4). We note that HGT recently made an additional €50m commitment into Hg Mercury 4 (Hg’s 2023 vintage of its private fund focused on small-cap PE deals), bringing its total commitment to the fund to €175m.

Exhibit 4: HGT’s historical commitment coverage ratio

Source: HgCapital Trust, Edison Investment Research; Note: *Pro forma as at end-August 2023, after completion of all announced transactions and the interim dividend payment in October 2023.

General disclaimer and copyright

This report has been commissioned by HgCapital Trust and prepared and issued by Edison, in consideration of a fee payable by HgCapital Trust. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

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No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2023 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

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Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

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London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

General disclaimer and copyright

This report has been commissioned by HgCapital Trust and prepared and issued by Edison, in consideration of a fee payable by HgCapital Trust. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2023 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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