“Edison’s accessible and high-quality research gives us the opportunity to communicate an independent perspective of Tyman to a wide variety of potential stakeholders.”
Currency in GBP
Last close As at 17/03/2023
GBP3.40
▲ 9.50 (2.88%)
Market capitalisation
GBP1,543m
Research: Investment Companies
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.
HgCapital Trust |
NAV resilient, but near-term outlook uncertain |
Investment trusts |
15 November 2022 |
Analysts
|
|||||||||||||||||||||||||||||||||||||||||||||||||||
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 6–12 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. |
|
|
Research: TMT
The Irish regulator has extended the growth cap on European General Purpose Reloadable (GPR) volumes for an additional 12 months to the end of CY23. This limits growth of volumes in Europe (ex-UK) to 10% over the baseline volume in the first nine months of CY22. This restriction could be lifted early, if third-party assurance of ongoing remediation work is finalised before the end of CY23. We have revised our forecasts to reflect slower volume growth in GPR and higher compliance-related overheads.
Get access to the very latest content matched to your personal investment style.
