HgCapital Trust — Improving its commitment coverage ratio

HgT (LSE: HGT)

Last close As at 04/03/2024

GBP4.50

9.50 (2.16%)

Market capitalisation

GBP2,021m

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Research: Investment Companies

HgCapital Trust — Improving its commitment coverage ratio

HgCapital Trust (HGT) posted a 5.4% NAV total return (TR) in FY22, mostly assisted by continued good earnings momentum (revenue and EBITDA across the top 20 holdings increased in 2022 by 30% and 25%, respectively) and the average 28% uplift to end-2021 carrying value achieved on exits. This was only partly offset by lower multiples and higher net debt across HGT’s portfolio (with net debt to last 12-month EBITDA for the top 20 holdings at 8.0x at end-2022). HGT’s recent balance sheet measures strengthen its near- to medium-term liquidity.

Milosz Papst

Written by

Milosz Papst

Director, Financials

Investment Companies

HgCapital Trust

Improving its commitment coverage ratio

Investment trusts
Private equity funds

16 March 2023

Price

336.5p

Market cap

£1,540m

NAV

£2,090m

NAV per share*

456.6p

Discount to NAV

26.3%

*At end-2022.

Yield

2.1%

Shares in issue

458.1m

Code/ISIN

HGT/GB00BJ0LT190

Primary exchange

LSE

AIC sector

Private equity

52-week high/low

454.0p

312.0p

456.6p

433.1p

Gearing

Net gearing at end-2022.

4.1%

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 (8.0x 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) posted a 5.4% NAV total return (TR) in FY22, mostly assisted by continued good earnings momentum (revenue and EBITDA across the top 20 holdings increased in 2022 by 30% and 25%, respectively) and the average 28% uplift to end-2021 carrying value achieved on exits. This was only partly offset by lower multiples and higher net debt across HGT’s portfolio (with net debt to last 12-month EBITDA for the top 20 holdings at 8.0x at end-2022). HGT’s recent balance sheet measures strengthen its near- to medium-term liquidity.

HGT’s coverage ratio moved closer to its historical average

Source: HgCapital Trust, Edison Investment Research. Note: 2022 PF is based on pro forma figures as at 28 February 2023, ie adjusted for the post period-end transactions, upsizing of the credit facility, final dividend to be paid in May and forex changes (as reported by the company).

Why consider investing in HGT now?

HGT is a reliable long-term digitalisation play based on its leading profitable unquoted European mid-market businesses with an international footprint. These offer SME software solutions with a high share of SaaS-based recurring revenues and high customer retention. Their defensive growth profiles make HGT an interesting alternative (or complement) to ‘big tech’ exposure in all phases of the economic cycle. HGT’s appeal is underpinned by Hg’s (its investment manager’s) sector expertise, in-house value creation team and ‘buy-and-build’ strategy. This makes HGT akin to a tech conglomerate in an investment company wrapper, now available at a wide c 26% discount to end-2022 NAV.

The analyst’s view

HGT’s recent upsizing of its credit facility from £250m to £350m, coupled with the agreed 15% reduction in its commitments to Hg Saturn 3 and proceeds from recent transactions have allowed HGT to improve its commitment coverage ratio from 29% at the time of our previous update note in November 2022 to c 55% as at 28 February 2023 on a pro forma basis, which we consider a safe level. This includes the agreed partial secondary sale of its Limited Partnership (LP) interest in Hg Genesis 8 which will provide HGT with liquidity over the medium term. We appreciate these measures given the still muted global M&A activity dampening private equity exit volumes, even if the recent sale of Transporeon is a clear illustration of HGT’s realisation capabilities, also during tough times.

Liquidity measures to address muted M&A activity

As highlighted in our previous update note, HGT’s pro forma coverage ratio at end-September 2022 of 29% was at the lower end of the historical range and below the 2017–21 average of 58%. This was a function of HGT’s commitments to 2022 vintages of Hg Saturn and Hg Genesis (expected to be drawn gradually over 2022–25), but also continued new investments and a lower realisation volume in the second half of 2022. HGT’s total investments in FY22 stood at £527.1m, though we note that this includes c £160.6m related to re-investments in Access, Lyniate and Argus Media (as part of refinancings/recapitalisations). HGT only announced the £9.0m investment in TrustQuay (a technology provider to the global trust, corporate and fund services industry) in Q422.

We believe that listed PE companies should put even greater emphasis on prudent balance sheet management, given the currently muted global M&A volumes, with limited debt availability for buyouts being one of the main factors dampening activity. The US leveraged loan market saw institutional new-issue loan volumes at a mere US$35.7bn in Q422, the second-weakest quarterly level in the past decade, according to Partners Group citing Leveraged Commentary & Data. Similarly, European leveraged loan issue volumes were at a modest €4.5bn in Q422 (down from €7.2bn in Q322) versus €24.8bn in Q321 and €41.3bn in Q221. Nevertheless, as discussed in our previous note, it is worth noting that, except for some of HGT’s largest assets by enterprise value (eg Access, Visma, Howden), the company’s holdings may be largely classified as small- and mid-market buyouts (especially investments through Hg’s Mercury and Genesis funds). Given that private debt funds (which filled in some of the funding gap) mostly focus on this market segment, we believe that it may be somewhat easier for HGT to secure debt for its new investments (and for potential buyers of HGT’s portfolio companies to refinance debt upon acquisition) compared to large/mega buyouts. Moreover, HGT proved that it is able to realise attractive returns by selling assets to trade buyers, who may not be dependent to a similar degree on debt funding than private equity funds.

Credit facility upsized from £250m to £350m

The market conditions remain challenging and HGT has addressed these by improving its balance sheet flexibility and optimising its portfolio structure. As a result of the review of HGT’s facility arrangements, the company upsized its credit facility from £250m to £290m last year and now again to £350m, with the facility remaining fully undrawn as at 28 February 2023. The size of the facility is around 17% of HGT’s end-2022 NAV, therefore broadly in line with its listed peers (c 10% to 25%). Together with its other liquid resources, HGT’s total liquidity as at 28 February 2023 (on a pro forma basis, ie accounting for all announced transactions and the May 2023 dividend payable) stood at £606m.

Partial secondary sale of LP interest in Hg Genesis 8

To further optimise HGT’s portfolio structure and liquidity, HGT decided to sell 25% of HGT’s LP position in Hg Genesis 8 (a 2017 vintage mid-market fund focused on buyouts with an enterprise value between £250m and £1.0bn) in March 2023, with expected proceeds at just over £90m. The fund interest was sold to a secondary fund, an institutional private equity buyer of mature fund interests. Given that Hg Genesis 8 is largely invested, we estimate that the transaction reduces HGT’s outstanding commitments by a minor c £5m.

HGT intends to use the additional liquidity for new co-investments (which are not subject to Hg fees) in potentially more attractive vintages (given moderating valuations). Hg expects these to have a greater return potential than the remaining upside from the Hg Genesis 8 LP interest, which is already valued at a healthy MOIC of 3.2x, higher than the fully realised performance of all Hg’s historical funds (HGT’s average MOIC on realisations over the 10 years to Q322 was 2.6x). It is also well above the median multiple for global buyouts fully realised in 2009–21 with more than US$50m of invested capital at 2.2x, according to Bain & Co. Importantly, the LP interest was priced at 100% end-December 2022, which compares with average pricing of LP buyout portfolios in the secondary market at 87% of NAV in 2022 (according to Jefferies Global Secondary Market Review), providing a further validation of HGT’s portfolio valuations. That said, we note that proceeds will be paid in two instalments on 31 March 2024 and 31 March 2025, rather than collected immediately.

HGT and Hg also agreed to reduce HGT’s outstanding commitments to Hg Saturn 3 (which stood at £612.6m at end-2022) by c 15% given the change in the deal environment since the fund was established, as well as the appreciation of US dollar (in which the commitments are denominated) against sterling. Capital drawn so far will be repaid pro-rata to HGT with no negative impact on HGT’s balance sheet, according to Hg.

As a result of the above measures, HGT’s pro forma coverage ratio as at 28 February 2023 stood at c 55% (more aligned with the historical average); see the chart on the frontpage. As a reminder, HGT has a right to opt-out from any commitments to Hg funds, even if it does not intend to use this right under normal circumstances and considers it as ‘disaster insurance’.

We also note that HGT recently highlighted that there is little to no impact on it from the collapse of Silicon Valley Bank (SVB), with only a small number of underlying portfolio companies having limited deposits with SVB, but no portfolio business is at risk as a result of this.

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

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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