HgCapital Trust — NAV resilient, but near-term outlook uncertain

HgT (LSE: HGT)

Last close As at 20/06/2024

GBP4.87

−3.00 (−0.61%)

Market capitalisation

GBP2,230m

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Research: Investment Companies

HgCapital Trust — NAV resilient, but near-term outlook uncertain

HgCapital Trust (HGT) posted a 2.3% increase in NAV per share total return (TR) in Q322, as positive earnings growth across the portfolio over the last 12 months (LTM) again outweighed multiple contraction. Despite the latter, the average EV/LTM EBITDA across HGT’s top 20 holdings stands at 28.8x vs 27.4x at end-2021 (see our previous note for a discussion on HGT’s valuations). The weaker global economy and tightening credit conditions weigh on both HGT’s near-term portfolio performance outlook and private equity deal activity. Still, the secular digitalisation trend remains intact with, as Gartner forecasted in October 2022, growth in global software and IT services spending of 11.3% and 7.9% in 2023, respectively. HGT’s shares trade at a 18% discount to NAV, while they traded close to NAV in 2021.

Milosz Papst

Written by

Milosz Papst

Director, Financials

Investment Companies

HgCapital Trust

NAV resilient, but near-term outlook uncertain

Investment trusts
Private equity funds

15 November 2022

Price

369p

Market cap

£1,689m

NAV

£2,065m

NAV per share*

450.7p

Discount to NAV

18%

*At end-September 2022.

Yield

2.0%

Shares in issue

457.7m

Code/ISIN

HGT/GB00BJ0LT190

Primary exchange

LSE

AIC sector

Private equity

52-week high/low

454.0p

312.0p

450.7p

414.8p

Gearing

Pro forma gross gearing at end-Q322

7.1%

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 strong long-term track record.

Bear points

Slowdown in deal activity may affect HGT’s level of realisations.

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 (7.5x LTM 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 Thompson

+44 (0)20 3077 5720

HgCapital Trust is a research client of Edison Investment Research Limited

HgCapital Trust (HGT) posted a 2.3% increase in NAV per share total return (TR) in Q322, as positive earnings growth across the portfolio over the last 12 months (LTM) again outweighed multiple contraction. Despite the latter, the average EV/LTM EBITDA across HGT’s top 20 holdings stands at 28.8x vs 27.4x at end-2021 (see our previous note for a discussion on HGT’s valuations). The weaker global economy and tightening credit conditions weigh on both HGT’s near-term portfolio performance outlook and private equity deal activity. Still, the secular digitalisation trend remains intact with, as Gartner forecasted in October 2022, growth in global software and IT services spending of 11.3% and 7.9% in 2023, respectively. HGT’s shares trade at a 18% discount to NAV, while they traded close to NAV in 2021.

HGT’s portfolio has a solid track record of sales and earnings growth

Source: HgCapital Trust. Note: Represents both organic growth and through M&A for top 20 holdings in the respective periods.

Earnings momentum still strong, but may slow down

HGT’s year-to-date NAV TR stands at 4.1%, with a five-year NAV TR of 22.4% pa. LTM sales and EBITDA for the top 20 holdings (representing 78% of HGT’s portfolio value) increased by 31% to £8.9bn and by 27% to £2.6bn, respectively (vs growth of 31% and 26% to end-June 2022 and 27% and 30% in 2021, respectively). Still, the company regards the business environment for its portfolio companies as challenging and likely to deteriorate further in the coming months, as some end-customers may postpone investments in systems and software in the short term.

Closing previously announced investments

HGT closed £221m of new investments in Q322 (mostly related to IFS/Workwave and Ideagen). A further £231m was invested post period-end, though we note that most of it is the refinancing of Access (see our previous note for details) completed in October 2022, which overall resulted in net realisation proceeds (before carried interest) of c £84.0m for HGT. We calculate that HGT’s net investment from the remaining transactions post end-September 2022 was c £66.5m. Except for the £9m investment in TrustQuay, a technology provider to the trust, corporate and fund services industry (completed in October 2022), all the other deals were already made public at the time of the H122 results release in September 2022. Meanwhile, HGT also announced the merger of Ideagen and ProcessMAP, two of its portfolio companies, resulting in a combined uplift of 6% to end-August 2022 valuations.

Lower PE deal activity with a high focus on quality

HGT highlighted that the global economic uncertainty, coupled with lower credit availability, led to a reduction in M&A deal volumes in Q322. We believe that the fact that sellers’ and buyers’ expectations in terms of deal pricing are yet to converge also played a role in the more muted activity across the private equity market. PE deals are at present mostly carried out for high-quality and resilient companies. HGT’s exit activity has also slowed in recent months, as the company has not announced any new exits since July this year. However, we understand that HGT expects several liquidity events from its portfolio in the next 612 months. During Q322, the company did not complete any full exits, though it received distributions of £61m, mostly from the recapitalisation of Visma and the partial sale of Intelerad. In October 2022, the company closed the previously announced full exit from itm8 (at an uplift of 8% to end-2021 carrying value, with £32.7m gross proceeds returned to HGT) and expects to complete a full exit from Medifox Dan (at a 48% uplift to end-2021 value, with £47.0m gross proceeds) in November.

With respect to debt availability, we note that the US leveraged loan market saw institutional new-issue loan volumes of a mere US$21.4bn in Q322 (the weakest level since the post-global financial crisis Q409), which compares to a five-year quarterly average of US$96.8bn, according to Partners Group citing Leveraged Commentary & Data (LCD). This was accompanied by widening average spreads over the Secured Overnight Financing Rate to 491bp for B/B+ rated issuers. Accounting for purchase discounts, this translated into average loan yields of c 9.4% in Q322. Similarly, European leveraged loan issue volumes were at a mere €7.0bn in Q322 (only slightly up from €6.6bn in Q222) compared to €24.8bn in Q321 and €41.3bn in Q221. The high-yield bond markets have also experienced a significant slump in new issuances, hitting a 14-year low in Q322, according to PitchBook citing LCD data.

However, private debt funds (most notably direct lenders) have stepped in and filled in part of the funding gap, gaining market share from the high-yield bond and syndicated loan markets. Global private debt funds have grown in recent years and at end-June 2022 had assets under management of c US$1.24tn (including US$425.1bn of dry powder, of which US$168.7bn was in direct lending strategies) versus US$474.3bn (and US$177.6bn in total dry powder) in 2012, according to PitchBook. Here, we note that small- and mid-market buyouts may overall be better positioned to tap into this source of funding, as private funds more often focus on this private equity market segment (even if some have also been participating in selected large unitranche financings of several billion US dollars for large/mega buyouts). This is illustrated by the average size of European direct lending deals between Q120 and Q222 of c €220m (though €721m in Q222 alone), according to PitchBook citing LCD data.

We note that except for some of HGT’s largest holdings 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). Hence, 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, of the three larger investments mentioned above, Access and Visma were successfully recapitalised this year. Based on our discussion with management, we also understand that HGT sees good opportunities for bolt-on acquisitions.

Despite the negative NAV impact from contracting multiples, HGT’s average EV/EBITDA across its top 20 holdings stood at 28.8x at end-September 2022 vs 27.1x at end-June 2022 and 27.4x at end-2021. The increase during Q322 is largely attributable to the new relatively large platform investments completed by HGT (IFS/Workwave and Ideagen). We note that these multiples are based on historical earnings (LTM) and that HGT normally assumes a multiples contraction in its investment case (even if it has not experienced much of this historically).

Coverage ratio at the lower end of the historical range

HGT’s commitment coverage ratio (calculated as available liquid resources divided by outstanding commitments) declined slightly from 33% at end-August 2022 to a current level (based on pro-forma figures) of 29% (see Exhibit 1 below). This is at the lower end of HGT’s historical coverage ratio and compares to a 2017–2021 average of 58%. Having said that, as already discussed in our previous note, this is partly due to HGT’s recent commitments to 2022 vintages of the Hg Saturn and Hg Genesis funds, which are expected to be drawn gradually over 2022–26 (and by then should be at least partially funded by further realisations). Still, the coverage ratio has also been affected by HGT’s continued new investments and the scarcity of exits in recent months. The board continues to review HGT’s facility arrangements (HGT recently expanded its credit facility from £250m to £290m, of which £143m remains undrawn). Finally, 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 carried out a minor £1.3m share buyback on 13 October.

Exhibit 1: HGT’s historical coverage ratio

Source: HgCapital Trust, Edison Investment Research. Note: Current figures are based on pro forma numbers as at end-September 2022 as reported by the company.

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 2022 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.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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 2022 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.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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