abrdn Private Equity Opportunities Trust — Resilient NAV and stable balance sheet

APEO’s one-year NAV total return (TR) to end-September 2023 (based on monthly NAV estimates rather than final audited NAV) reached 5.1%, compared to the MSCI Europe Small Cap Index’s 13.3% and the UK All-Share Index’s 13.8%. While the more moderate return is likely due to a muted M&A environment (limiting the contribution from exit uplifts to NAV TR), we also note that the 12-month performance is calculated from end-September 2022, which for public equity markets was close to the local trough following the sell-off throughout most of 2022 (this is also reflected in APEO’s 12-month share price TR to end-September of 11.7%). Meanwhile, APEO’s NAV remained resilient overall (its FY22 NAV TR was 14.1%), hence its subsequent performance did not benefit from the low base effect. We also note that APEO’s performance included some FX headwinds from the strengthening of sterling against the US dollar and euro. We note that all of APEO’s private portfolio valuations (except for new investments) are now based on end-June 2023 values.

The above return allowed APEO to significantly outperform the above-mentioned public indices over three, five and 10 years, with its 10-year NAV TR at 15.0% pa compared to 9.4% and 6.3% pa for the MSCI Europe Small Cap Index and the UK All-Share Index, respectively (see Exhibit 1). APEO also performed broadly in line with its listed private equity (PE) peers (see Exhibit 3), slightly outperforming the peer average and ranking second over 10 years and being marginally below the peer average over five years (ranking third).

Listed PE companies continue to trade at wide discounts to NAV, currently at 44% for APEO (vs its 10-year average of c 23%) and c 40% for its peers. This likely reflects investor concerns in the current uncertain macroeconomic environment around: (1) PE valuations; (2) holding-level liquidity given the muted exit environment; and (3) leverage across portfolio companies. We discussed these points in detail in our listed private equity report published earlier this year.

We note that limited partner (LP) buyout portfolios were traded on average at 90% their NAV (ie only a c 10% discount to NAV, significantly below the current listed PE discounts) in H123 in the secondary market, according to the latest Global Secondary Market Review by Jefferies. This represents a price increase from 84% of NAV in H222 (pricing at the last peak in 2021 was 97%). We acknowledge that these secondary market prices do not reflect any significant volumes of distressed selling. They were likely aided by recovering public markets, which supported private valuations, but also reduced the pressure on LPs coming from the so-called denominator effect (the increase in percentage allocation to private markets due to declining value of listed assets). Another contributing factor was that investors in GP-led transactions prioritised highest-quality assets, according to Jefferies. Finally, a significant number of PE funds focused specifically on the secondary market have been launched recently, boosting the demand side of the market. Jefferies estimates that the ratio of available capital to last 12-month secondary volume increased to 2.3x from 2.1x at end-2022.

That said, APEO’s current discount to NAV is even wider than the 27% discount paid in H123 for very old vintages (2012 or older) across different strategies (buyout, credit, real estate and venture). We note that in contrast, APEO’s vintage profile is quite balanced with 21% of the portfolio aged more than five years, while c 53% is aged three years or less. APEO’s manager said during the interim results call that he could potentially look at opportunistic sales of some of its LP investments if secondary pricing tightens further.

Here, we note the recent partial sale of APEO’s co-investment in Action (see below for details), at a price equating to 100% of the end-June 2023 valuation. Another relevant secondary transaction from the broader listed PE market would be HgCapital Trust (managed by Hg, one of APEO’s ‘core’ GPs), which earlier this year agreed the partial secondary sale of its LP interest in Hg Genesis 8, a 2017 vintage mid-market fund focused on buyouts with an enterprise value between £250m and £1.0bn, in which APEO also holds a position. The LP interest was priced at 100% of end-December 2022 NAV, with proceeds to be paid in two instalments on 31 March 2024 and 31 March 2025.

We note that high-quality PE managers tend to value their holdings conservatively, and consistently delivered an uplift upon exit to previous fair values (in many cases over the last 10 years or longer). In the case of APEO, the average uplift on distributions between end-September 2022 and end-June 2023 was 23% to fair value two quarters prior to exit (consistent with APEO’s average long-term historical uplift of c 25%).

We believe that one of the main potential factors that can contribute to listed PE companies with a significant exposure to fund investments (such as APEO) being traded at wider discounts to NAV than secondary market deals are risks around holding-level liquidity and leverage (especially after the issues of some listed PE companies during the global financial crisis in 2008/09; see our listed private equity report for details). Given the long capital deployment cycle (these commitments are normally drawn over three to five years), it is a common practice of APEO and other listed PE companies with a significant share of primary fund investments to commit more capital than is available for deployment at a given time to facilitate a full investment level. It is also a common practice to use credit facilities to bridge any gap between the timing of realisations and new investments.

Amid the continued muted PE environment, and in line with the investment manager’s earlier expectations, APEO’s last 12-month (LTM) drawdowns to end-September 2023 of c £190.9m outpaced its distributions (£147.5m excluding Action), see Exhibit 4. We note that some of APEO’s drawdowns came from its co-investments (eg £20.6m out of £104.4m in H123 to end-March 2023), which are fully under its investment manager’s control (APEO’s usual ticket size per co-investment is c £5–12m). Co-investments represented c 21% of APEO’s portfolio at end-June 2023 and the manager aims to bring this up to c 29% by June 2025.

It is important to note that APEO’s liquidity was supported by the partial realisation of its co-investment in Action, with total proceeds of €60.6m (more than covering the LTM distribution shortfall), of which it collected €34.6m in October. That said, the investment manager highlighted during APEO’s interim results call in June that the partial realisation of Action was executed not to boost liquidity at the holding level, but primarily for portfolio rebalancing purposes. Action is still the largest underlying individual company in APEO’s portfolio, with the remaining fair value of £24.6m representing 1.9% of end-September 2023 NAV (5.1% at end-September 2022).

APEO has secured a £300m credit facility (upsized in October 2022 from £200m) to bridge potential gaps between distributions and drawdowns. The drawn balance on this facility increased from £62.5m at end-2022 to £102.4m at end-September 2023 (which means it is 34% utilised), but APEO may pay down part of the drawn amount from the Action realisation proceeds collected in October 2023. Adjusting for the latter, we arrive at APEO’s pro forma end-September 2023 liquidity (available resources of c £40m and undrawn credit facility of £197.6m) of c £237m, which translates into a 36% commitment coverage ratio (stable vs 36% at end-2022), as well as an overcommitment ratio (outstanding commitments less cash and equivalents and undrawn credit facility to portfolio NAV) of 33% (vs 39% at end-2022); see Exhibits 5 and 6. APEO’s outstanding commitments declined in FY23 to date from £681.3m at end-September 2022 to £650.0m at end-September 2023. These should be drawn over several years and APEO’s manager considers £94.3m of these commitments unlikely to be drawn. APEO’s total liquidity also represents 5.6x the net capital calls (excess drawdowns over distributions) over the last 12 months. Consequently, we believe that the holding-level liquidity risk remains limited at present and does not justify the current discount to NAV.

A minor part of APEO’s discount may have also been due to investor uncertainty around potential ownership changes. On 16 October 2023, abrdn announced it had agreed to sell its European-headquartered private equity business (including APEO’s investment manager) to Nasdaq-listed Patria Investments, to use the disposal proceeds in abrdn’s core investment businesses. APEO’s board highlighted that it had received assurances from abrdn and Patria that APEO’s investment management team would remain unchanged should the transaction proceed. Moreover, abrdn confirmed that ‘appropriate arrangements will be put in place’ to maintain the existing administration and other third-party services. We note that this announcement follows abrdn’s statement in July 2023 that it had agreed to sell its US private equity and venture capital assets to HighVista Strategies.

APEO invested nearly £200m in FY23 (17% of opening NAV), which is down from £340.3m (33% of opening NAV) in the very active FY22. We also note that the investment volume with reference to NAV is also below the FY17–21 average of 26%. APEO made no new commitments after June 2023 but this may be at least partly due to timing of the fundraising processes of the respective PE funds APEO plans to commit to.

Around £140.8m was invested in H123 (to end-March 2023) across five primary commitments (£121.3m, with capital drawn over time), as well as deals in which APEO’s capital is drawn at closure, including two co-investments (£9.3m), two follow-ons into existing co-investments (£5.6m) and one secondary investment (£4.6m). Subsequently, it entered into three primary deals (c £50m in total). APEO made a commitment in April 2023 to Seidler Equity Partners VIII, focused on the North American lower mid-market, in particular branded consumer products, business services and specialty manufacturing. Moreover, it made two commitments in May 2023 to Montefiore VI and Montefiore Expansion I, which focus on the French services sector, in particular B2B services, digital and IT services, B2C healthcare services, as well as tourism and leisure. Finally, APEO committed €9.0m in June to a continuation vehicle involving HRworks, a provider of Human Capital Management software to SMEs in the DACH region.

The board remains confident in APEO’s liquidity and continues to pursue a progressive dividend policy. APEO’s three interim dividends for FY23 are 4.0p each (the first two already paid and the third one declared), representing a c 11% y-o-y increase. The board highlighted that, in the absence of unforeseen circumstances, its intention is to pay a fourth interim dividend of 4.0p as well. Assuming a total annual distribution of 16.0p per share, APEO’s shares now offer a dividend yield of c 3.7%.