Princess Private Equity — Portfolio resilient, holding-level liquidity strained

Princess Private Equity Holding (LSE: PEY)

Currency in EUR

Last close As at 03/02/2023

EUR9.33

0.21 (2.30%)

Market capitalisation

EUR631m

Research: Investment Companies

Princess Private Equity — Portfolio resilient, holding-level liquidity strained

Princess Private Equity Holding’s (PEY’s) portfolio has fared quite well in 2022, with the +3.7% NAV total return (TR) in Q322 bringing the 9M22 TR decline to a moderate 4.0%. This was likely assisted by PEY’s sector mix and the temporary allocation of excess funds into senior loans in H221 (gradually redeemed throughout 2022). However, this was overshadowed by PEY’s decision to suspend its second interim dividend amid holding-level liquidity concerns due to high cash outflows for foreign exchange (fx) hedges and subdued M&A markets. This allowed PEY to build a liquidity buffer (c €88m at 18 November) to cushion against potential further headwinds due to a strong US dollar and muted portfolio realisations.

Milosz Papst

Written by

Milosz Papst

Director, Financials

Investment Companies

Princess Private Equity

Portfolio resilient, holding-level liquidity strained

Investment trusts
Private Equity

28 November 2022

Price

€8.94

Price (PEYS)

777p

Market cap

€618m

NAV

€987m

NAV per share*

€14.27

Discount to NAV

37.4%

Yield

4.3%

Shares in issue

69.2m

Code (EUR/GBP quote)

PEY/PEYS

Primary exchange

LSE

AIC sector

Private equity

52-week high/low

€14.8

€7.8

€15.8

€13.8

*At end-September 2022

Gearing

Net gearing at 30 September 2022

9.7%

Fund objective

Princess Private Equity Holding is an investment holding company domiciled in Guernsey that invests in private equity and has a minor private debt position. Its portfolio consists mostly of direct investments but may also include primary and secondary fund investments. It aims to provide shareholders with long-term capital growth and an attractive dividend yield.

Bull points

Focus on building resiliency in portfolio companies and on transformative trends.

High exposure to resilient sectors (eg healthcare).

Available at a wide discount to NAV after recent sell-off.

Bear points

Suspension of interim dividend weighing on investor sentiment.

A persistently weak exit environment may further impact PEY’s new investment activity and liquidity.

Continued US dollar appreciation would trigger further cash outflows for fx hedges.

Analysts

Milosz Papst

+44 (0)20 3077 5720

Michal Mordel

+44 (0)20 3077 5720

Princess Private Equity is a research client of Edison Investment Research Limited

Princess Private Equity Holding’s (PEY’s) portfolio has fared quite well in 2022, with the +3.7% NAV total return (TR) in Q322 bringing the 9M22 TR decline to a moderate 4.0%. This was likely assisted by PEY’s sector mix and the temporary allocation of excess funds into senior loans in H221 (gradually redeemed throughout 2022). However, this was overshadowed by PEY’s decision to suspend its second interim dividend amid holding-level liquidity concerns due to high cash outflows for foreign exchange (fx) hedges and subdued M&A markets. This allowed PEY to build a liquidity buffer (c €88m at 18 November) to cushion against potential further headwinds due to a strong US dollar and muted portfolio realisations.

PEY’s liquidity affected by fx hedges and limited realisations in Q322

Source: Refinitiv, Edison Investment Research. Note: Total returns in sterling.

Why consider Princess Private Equity now?

PEY offers a portfolio of private companies aligned with secular transformative growth themes (eg digitalisation, ageing society/health awareness, automation and sustainability). It delivered last 12-month (LTM) revenue and EBITDA growth (both organic and through M&A) to end-September 2022 of 25.7% and 18.4% respectively (based on a sample covering 75% of portfolio value). PEY offers investors high exposure to the healthcare sector (21% at end-September 2022, including several healthcare service providers) and also a meaningful allocation to IT (12%, mostly enterprise software) and childcare/education (7%). This may help PEY’s portfolio withstand a worsening macroeconomic environment.

The analyst’s view

Following the recent sell-off, PEY’s shares now trade at a 37% discount to NAV (significantly wider than its five-year average of 15%). The dividend suspension has disappointed some investors but we note that PEY now has a meaningful safety margin in terms of liquidity. We also note that its cash and undrawn facility are higher than the outstanding commitments considered by the company as likely to be called (c €35m at end-September 2022). PEY highlighted that it could resume dividend payments as early as June 2023 if fx markets stabilise and M&A activity in private markets resumes. PEY’s near-term liquidity profile could be further assisted by an upsizing of its credit facility or changes to its fx hedging approach. While PEY has stopped any new direct investments for now, it highlighted that its portfolio companies have sufficient resources to continue pursuing add-on acquisitions.

Liquidity situation at holding level tightening in Q322

Impact from fx hedges and low realisation activity

PEY started 2022 with a high liquidity position following the 2021 exits (GlobalLogic in particular), with €135m (or 13% of end-2021 NAV) held in a portfolio of floating rate senior secured loans, which it temporarily invested in back in H221 (as rates on Euro deposits were negative then). Moreover, the company had €55m in undrawn credit at end-2021 (out of the total facility size of €80m). However, as 2022 progressed, PEY’s liquidity became increasingly strained, especially towards the end of Q322, due to a combination of:

The US dollar appreciation versus the euro resulted in c 60m in cash outflows for PEY’s EUR/USD hedges in 9M22 (close to 50% of PEY’s portfolio is denominated in US dollars and c 90% of its fx exposure is hedged to the euro).

Significant weakening of M&A activity in the private equity (PE) market leading to just €8.1m in realisation proceeds (excluding senior loan redemptions) for PEY in Q322 (50.1m in 9M22).

PEY’s relatively high investment activity with 71.6m invested in Q322 (largely agreed in H122), translating into 134.3m in 9M22 (c 13% of opening NAV versus the annual average in 2017–2021 of c 15%).

PEY covered the Q322 liquidity shortfall with senior loan redemptions (€25.4m) and drawdowns on its credit facility (c €58.2m, see exhibit on the front page). However, the remaining senior loan balance declined to €49.5m while PEY’s €110m credit line was 92% utilised at end-September 2022. Consequently, on 2 November PEY’s board announced the suspension of the second interim dividend for FY22 to preserve capital for potential further cash outflows related to fx hedges (as well as PEY’s capital commitments and ongoing charges). Coupled with a pause in capital allocations to new investments starting from July/August, this allowed PEY to amass liquid resources of €88m as at 18 November 2022, including around €50m in cash and €38m in undrawn credit (of a total facility of €110m). PEY has redeemed all of its senior loan investments, which since the initial investment in autumn 2021 have generated a certain capital loss, offset at least in part by coupon income.

Dividend suspension is providing an additional safety margin

PEY’s current liquidity compares with its outstanding undrawn commitments as at end-September 2022 of €103.2m. However, these include €45.3m of commitments to PEY’s investment manager, Partners Group’s direct programmes and third-party funds which are past their investment period (and are thus unlikely to be called). Out of the remaining €57.9m, PEY considers only €35m as likely to be drawn (gradually over the next two to three years). As a result, these commitments are 2.5x covered by PEY’s current liquid resources, although the company needs to put aside some liquidity to cover its ongoing charges (c €8m excluding incentive fee in H122) and interest expense (c €3–4m annualised based on the current Euribor rate and drawn part of the credit line). Importantly, as PEY stopped arranging new direct investments in July/August, there are no immediate capital needs with this respect.

Hence, the dividend suspension has provided PEY with a sizeable safety margin in the event of ongoing US dollar appreciation against the euro (the first interim dividend amounted to €26.3m). Further potential support for PEY’s near-term liquidity could come from measures currently contemplated by Partners Group and board, such as a moderate upsizing of the company’s credit facility or changes to its fx hedging arrangements. We note that PEY’s ratio of current total debt facility (€110m) to NAV is c 11% versus up to c 20% for other listed PE companies.

The company highlighted that its dividend policy of paying 5% of opening NAV per annum remains unchanged and, subject to no further significant US dollar appreciation and a normalisation of the exits environment, it expects to pay the next dividend in June 2023. We believe that the recent decline in M&A activity has been caused by, among other reasons, the uncertain macroeconomic outlook (which makes the pricing of new deals more difficult), as well as lower debt availability.

Near-term debt availability outlook better for small/mid-market buyouts, though still uncertain

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). Similarly, European leveraged loan issue volumes were just €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.

Having said that, debt funding has not dried up completely, as private debt funds (most notably direct lenders) have stepped in and filled 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$1.2tn (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. Private funds more often focus on small- and mid-market buyouts (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 (although the average was €721m in Q222 alone), according to PitchBook citing LCD data. Therefore, we believe that it may be currently somewhat easier for potential buyers to refinance debt upon acquisition in the case of PEY’s small/mid-cap buyouts (54% of PEY’s portfolio at end-September 2022) compared to large/mega buyouts (32% of PEY’s portfolio at end-September 2022). Nevertheless, we acknowledge that a combination of high interest rates and a likely global economic downturn in the coming quarters may put further pressure on M&A deal activity.

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