abrdn Private Equity Opportunities Trust — So far so good

abrdn Private Equity Opportunities Trust (LSE: APEO)

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abrdn Private Equity Opportunities Trust — So far so good

abrdn Private Equity Opportunities Trust (APEO) reported a robust 14.1% NAV total return (TR) in FY22 (ended September), as underlying portfolio valuations were up by 10.5% excluding the FX impact (with co-investments particularly strong) and a higher US$/£ rate. Earnings momentum remained high with LTM revenue and EBITDA across APEO’s top 50 holdings at 22.7% and 23.8% in FY22, respectively. This, together with solid exit activity (£210.2m distributions) at an average 20% uplift to carrying values two quarters prior, helped offset lower public valuation multiples.

Milosz Papst

Written by

Milosz Papst

Director, Financials

Investment Companies

abrdn Private Equity Opportunities Trust

So far so good

Investment trusts
Private equity funds

20 February 2023

Price

454p

Market cap

£698m

NAV*

£1,125m

NAV*

731.5p

Discount to NAV

37.9%

Yield

3.2%

Ordinary shares in issue

153.7m

Code/ISIN

APEO/GB0030474687

Primary exchange

LSE

AIC sector

Private Equity

52-week high/low

546.0p

368.0p

NAV high/low

747.2p

651.4p

Gross gearing*

7.5%

Net gearing*

4.5%

*As at end-January 2023

Fund objective

abrdn Private Equity Opportunities Trust’s investment objective is to achieve long-term total returns through holding a diversified portfolio of private equity funds and direct investments into private companies alongside private equity managers (co-investments), a majority of which will have a European focus.

Bull points

Focus on strong relationships with top-performing European private equity managers.

Available at a wider discount to NAV than historical average.

Consistent DPS growth in recent years.

Bear points

Macroeconomic uncertainty and lower debt availability curbing global M&A volumes (and in turn PE exit activity).

Persistently low public equity valuations may weigh on PE carrying values.

Higher interest rates may negatively affect prospective returns of highly leveraged assets such as PE-backed companies.

Analysts

Milosz Papst

+44 (020) 3077 5700

Michal Mordel

+44 (020) 3077 5700

abrdn Private Equity Opportunities Trust is a research client of Edison Investment Research Limited

abrdn Private Equity Opportunities Trust (APEO) reported a robust 14.1% NAV total return (TR) in FY22 (ended September), as underlying portfolio valuations were up by 10.5% excluding the FX impact (with co-investments particularly strong) and a higher US$/£ rate. Earnings momentum remained high with LTM revenue and EBITDA across APEO’s top 50 holdings at 22.7% and 23.8% in FY22, respectively. This, together with solid exit activity (£210.2m distributions) at an average 20% uplift to carrying values two quarters prior, helped offset lower public valuation multiples.

APEO’s discount to NAV remains above average despite narrowing recently

Source: Refinitiv, Edison Investment Research

Why invest in APEO now?

APEO pursues a concentrated, high-conviction strategy of partnering with top-tier European general partners (GPs), with a strong emphasis on sector expertise, an important advantage in the increasingly competitive private equity (PE) space. While the road ahead for the global economy and financial markets remains uncertain, APEO’s investment manager highlights that the trust’s portfolio is skewed towards businesses with lower cyclicality, such as IT (mostly profitable B2B businesses), healthcare (with little exposure to higher-risk biotech) and consumer staples, making up 52% of the end-September 2022 portfolio in total.

The analyst’s view

Since our last update note on APEO in October 2022, the discount to NAV has narrowed slightly from c 42% to 38% on the back of a c 6% share price appreciation. That said, APEO’s current discount is still wider than its 10-year average of c 21%. We believe that this may reflect investor anxiety over a potential decline in portfolio valuations across the PE sector, as these have been marked down modestly so far despite the sell-off in the broader public markets. While PE outperformance relative to listed equities may partly come from its valuation techniques (which make PE portfolio values less volatile in the short term), it is also due to portfolio composition (ie exposure to more resilient sectors). The above-average discount may also reflect investor cautiousness associated with APEO’s overcommitment strategy (which is a standard approach of listed PE with exposure to fund investments). However, we believe that APEO has good balance sheet headroom at present, while its capital calls and distributions were broadly balanced in recent months (despite the slowdown in exit activity across PE markets).

Market outlook

The discussion below is based on our recently published sector note on listed private equity.

Institutional investors continue allocating capital to PE

Private equity has established itself as an important asset class for institutional investors globally. This is likely to continue in the long term, given that most institutional investor groups (insurance companies, private sector pension funds, sovereign wealth funds, endowments and foundations) still remained below their allocation targets at end-2021, according to McKinsey’s Global Private Markets Review 2022. Institutional investors usually target a c 5–15% exposure, depending on the investor type (eg private and public pension funds normally target a 7–8% allocation to PE) and according to Bain & Co’s mid-year 2022 report, PE limited partners (LPs) have consistently signalled that their intent is to maintain or increase PE allocations.

In the short term, the ‘denominator effect’ due to declines in public valuations so far outpacing markdowns on PE investments have increased the latter’s share in LP portfolios and therefore discouraged many institutional investors from making new investment commitments1 to PE recently. That said, US PE fund-raising remained robust in 2022 at US$343.1bn (vs US$362.9bn in 2021), although it slowed down markedly in Europe to €52.8bn versus €106.8bn in 2021, according to PitchBook (see Exhibits 1 and 2). At end-2022, US and European PE dry powder (ie capital committed but not yet invested) as a percentage of total assets under management (AUM) stood at 30% versus a 2012 to 2021 average of 38% in the United States and 39% in Europe, according to our calculations based on PitchBook data. In absolute terms, dry powder has increased markedly in recent years with close to US$790bn in the United States at end-2022 (vs US$612bn in 2017 and US$334bn in 2012) and c €260bn in Europe (vs €230bn in 2017 and €129bn in 2012). Despite the macroeconomic headwinds and denominator effect, 63% of institutional investors surveyed by State Street recently said they anticipate a higher allocation towards PE over the next two to three years (driven by Asia-Pacific and North America).

  1 LPs commit a certain amount of capital that they will invest in a PE fund. Subsequently, they receive capital calls from the fund to deploy the committed capital into PE investments.

Exhibit 1: US PE fund-raising activity

Exhibit 2: European PE fund-raising activity

Source: PitchBook’s 2022 Annual US PE Breakdown. Note: 2022 figures based on data as at end-December 2022.

Source: PitchBook’s 2022 Annual European PE Breakdown. Note: 2022 figures based on data as at end-December 2022.

Exhibit 1: US PE fund-raising activity

Source: PitchBook’s 2022 Annual US PE Breakdown. Note: 2022 figures based on data as at end-December 2022.

Exhibit 2: European PE fund-raising activity

Source: PitchBook’s 2022 Annual European PE Breakdown. Note: 2022 figures based on data as at end-December 2022.

PE leverage is visibly ahead of listed equities on average, but its translation into higher risk is not straightforward

We also note that 69% of the institutions surveyed by State Street believe that higher interest rates will lessen the appeal of highly leveraged private assets. PE-backed portfolio companies are characterised by a relatively high leverage level in terms of net debt to EBITDA compared to listed companies. The global PE entry debt to EBITDA ratio stood at 5.9x in the first nine months of 2022 (9M22) (according to PitchBook citing Leveraged & Commentary Data (LCD) and Morningstar data) versus net debt to last 12-month (LTM) EBITDA for the S&P Small Cap 600 Index and the MSCI ACWI Index at c 2.4x and 1.3x at end-September 2022, respectively, according to Bloomberg data. Higher leverage becomes particularly important in the context of the current sharp spike in interest rates, given that a significant part of the debt of PE-backed companies is floating rate. The higher corporate borrowing costs are for instance illustrated by the considerable increase in the effective yield of the ICE BofA US High Yield Index from 4.35% at end-2021 to 8.40% as at 16 February 2023. PitchBook estimates that at a leverage ratio of 6.0x, a company’s EBITDA interest coverage ratio will decline to just 1.4x in a scenario where benchmark rates are around 4.0% (vs 3.5x for short-term rates at zero).

However, we also note that PE-backed companies tend to perform better in terms of defaults during times of stress than non-sponsored peers, as illustrated by the lower annualised default rate of PE-backed companies in 2008–09 (during the global financial crisis) at 2.8% versus 6.2% for speculative-grade companies, according to Bain & Co’s Global Private Equity Report 2011. Moreover, since 2011, the average default rate of PE-backed leveraged loans tracked by LCD of 1.50% is broadly in line with that of leveraged loans of non-sponsored companies of 1.57% (though the former does not include distressed exchanges).

Firstly, higher indebtedness is in many cases warranted by the private company’s high degree of recurring revenue, strong cash flow generation and high earnings growth. Secondly, part of the leverage is normally attributable to debt-financed strategic M&A (to pursue a ‘buy-and-build’ strategy) aimed at realising synergies that are not immediately reflected in a company’s accounts. Thirdly, PE investment companies are often willing to provide additional funding to support a portfolio company during times of stress (acting as ‘deep-pocket’ investors), potentially warranting the use of more leverage by PE-backed companies. Part of the leverage of PE-backed companies is quite frequently attributable to shareholder loans provided by the PE owner itself. Finally, PE managers have in recent years put more emphasis on higher flexibility of debt structures (ie more covenant-lite debt).

Lower debt availability and macroeconomic uncertainty limiting M&A volumes

The significant interest rate hikes and declining risk appetite of lenders have affected the overall availability of buyout debt funding and PE deal activity in 2022. This is seen across broad M&A markets,2 with US$719bn in transactions being closed in Q422 (according to Bloomberg Law) compared to close to US$1.5tn in Q421. Notably, Q422 was the first Q4 since 2017 where there has been a quarter-on-quarter decline in deal value and count (Q4 usually sees increases due to companies seeking to close transactions before the end of the year). GPs are now forced to use a greater proportion of equity (50% or more) in new leveraged buyouts (also to keep interest expenses at reasonable levels), which we believe could have an impact on prospective returns.

  2 Covering a wide variety of transaction types including minority stake transactions and VC financing rounds.

Most notably, the willingness of banks to provide syndicated loans used to fund large/mega buyouts has deteriorated markedly. 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 LCD. Similarly, European leveraged loan issue volumes were at a modest €4.5bn in Q422 (further down from €7.2bn in Q322) versus €24.8bn in Q321 and €41.3bn in Q221. Collateralised loan obligation issuance also slowed down in the second half of 2022, while high-yield bond markets have experienced a significant slump in new issuances, hitting a 14-year low in Q322, according to PitchBook citing LCD data.

Private debt funds focused on direct lending have generally stepped in to at least partly fill the gap created by low leveraged loan and high-yield bond volumes and have been gaining market share recently. For instance, their share in the US sponsored mid-market increased to 80% in Q322 versus 65% in Q222 and 50% in Q221, according to the CEO of Antares Capital. We believe that PE small/mid-market companies (the market segment APEO focuses on) may find it easier to secure debt financing than mega buyouts, given that many private debt funds reduced their appetite for large deals in 2022.

Valuations more resilient than public equities so far

Historical NAV data of listed PE companies suggest that PE valuations (and in turn NAV TRs reported by listed PE companies) tend to be less volatile than valuations in public equity markets, which may be counterintuitive for some investors given that private markets provide a less liquid exposure to equities. Consequently, we have recently seen a divergence between the harsh sell-off in public markets and the relatively resilient NAVs of listed PE companies. This partly comes from portfolio composition in terms of sectors, and possibly also value-add provided by GPs, translating into higher earnings growth across PE portfolios and in turn greater value resilience. Having said that, the comparatively greater resilience also arises from the choice of methods applied to value private companies, most notably the fact that PE valuations are based on a blend of multiples derived from public equities and private M&A deals (see our recent thematic note on listed PE for details). However, it does not mean that PE valuations are set in an arbitrary way. They are normally performed in accordance with fair value principles such as IFRS 13 and US GAAP Topic 820, and are aligned with the International Private Equity and Venture Capital Valuation (IPEV) guidelines.

While persistent macroeconomic risks, high interest rates, as well as weaker M&A volumes and buyout debt availability could put pressure on PE valuations in the near term, we believe that the entry point for long-term investors in listed PE has become more attractive. Most UK-listed PE companies are trading at 30–40% discounts to their last reported net asset values, well above the historical average of around 20% (see Exhibit 3). And it is worth noting that PE managers tend to value their portfolios conservatively and historically have often realised significant uplifts to previous carrying values upon exits.

Exhibit 3: Average discount/premium to the last reported NAVs of listed PE companies (excluding those that completed or are currently in the process of winding down) over time

Source: Refinitiv, company data, Edison Investment Research. Note: Weighted by prior year-end NAV. Includes the following companies: HgCapital Trust, ICG Enterprise Trust, Pantheon International, CT Private Equity Trust, Princess Private Equity (since January 2007), NB Private Equity (July 2007), Oakley Capital Investments (December 2007), HarbourVest Global Private Equity (January 2008), abrdn Private Equity Opportunities (September 2008), Apax Global Alpha (June 2015).

The fund manager: abrdn PE team

Since its launch in 2001, APEO has been managed by abrdn Capital Partners (renamed on 29 November 2021, formerly SL Capital Partners), a wholly owned subsidiary of abrdn. The manager is one of the largest investors in PE funds and co-investments with a European focus, with more than £11bn in managed assets at end-June 2022. An investment team based in Europe and the United States, with decades of experience and holding over 400 advisory board seats, supported by the broad abrdn resources, is a key advantage in selecting Europe’s top-tier PE funds and sourcing attractive co-investment opportunities, which may be less accessible to the wider market.

APEO is led by Alan Gauld, who is involved in all aspects of investing, including sourcing, appraising and executing investments and portfolio monitoring. He has a strong network and extensive experience in leading PE funds, particularly pan-European, French, Nordic and Iberian GPs. He is supported by Patrick Knechtli, who leads the secondaries team at abrdn, and Mark Nicolson, head of primaries. All three have been working at abrdn Capital Partners for more than 10 years. Overall, APEO’s investment team consists of around 40 investment professionals and its senior management team has an average industry experience of 22 years. APEO highlights that 74% and 65% of its investments by count (as measured by total value to paid in (TVPI) and internal rate of return (IRR), respectively) historically fell within the top or second quartile (based on Burgiss data for 1999–2017 as at end-June 2022).

The manager’s view: Well-positioned to weather the macroeconomic challenges

APEO’s portfolio showed a strong performance in FY22 despite headwinds in the broader financial markets and the uncertain global economic backdrop. The company’s 21-year-old strategy of partnering with a small group of top performing PE firms, focusing on underlying businesses in the mid-market and targeting diversification across a range of resilient sectors continues to position it well. APEO’s new fund commitments are aligned with its long-term strategy of backing PE firms that have a mid-market orientation and have proven expertise within one or more specified sectors. APEO’s manager emphasises the strong deployment in co-investments in FY22 and the good balance in deployment across key sectors. While secondary deployment in the year was modest relative to primary and co-investment, the manager sees a window of strong secondary opportunities emerging as we move through the first half of the new financial year.

Looking ahead, the manager does not expect the challenging conditions arising from higher inflation, interest rate rises and the war in Ukraine to abate in the immediate short term. Specifically, the manager believes that the full impact of high inflation has not been felt by economies and underlying companies yet, and that the first half of 2023 will be instructive in this regard. Deal flow levels across PE slowed down as buyers and sellers attempted to reconcile differing price expectations and current access to debt financing is more difficult than in recent years. That will have implications on cash flows going forward, with less short-term distributions coming in but less money being drawn too. It will also have valuation implications, as PE investments typically sell at an uplift to carrying value, which helps drive APEO’s NAV in normal times. The manager expects the deal flow to pick up again soon, given the record levels of dry powder in PE, but he expects that the next 12 months might see a slower pace compared to recent years.

While the road ahead appears to be more challenging in terms of financial markets and the global economy, APEO’s manager takes comfort in its PE governance model, the quality of APEO’s current portfolio and its set of core managers, and the opportunity to make attractive new investments during this period of greater uncertainty.

Exhibit 4: Investing in the PE mid-market by Alan Gauld, investment manager of APEO

Source: Edison Investment Research

Performance: Assisted by earnings momentum and exits at an uplift to last carrying value in FY22

APEO posted a robust NAV TR of 14.1% in FY22, driven by a 10.5% increase in the underlying portfolio valuations during the period (excluding FX impact), as well as positive foreign exchange effects (mostly the strengthening of the US dollar against sterling). Meanwhile, APEO’s share price TR was -15.1% in FY22, affected by the broader sell-off in public markets. Its NAV TR between September and January 2023 (last reported data) was c -2.4%, mostly due to FX effects, as 98.8% of APEO’s private portfolio valuations at end-January 2023, excluding new investments, were still dated end-September. At the same time, its share price rebounded by c 6% between end-FY22 to date. APEO’s 10-year NAV and share price TR to end-January 2023 came in at c 14.9% and 13.4% pa, respectively, ahead of public markets (MSCI Europe Small Cap Index and UK All-Share Index at 10.0% and 6.3%, respectively), as well as the LPX Europe NAV Index at 11.5% pa.

LTM revenue and EBITDA across APEO’s top 50 underlying companies (making up 42.3% of APEO’s end-FY22 portfolio) grew by 22.7% and 23.8% in FY22, respectively (including both organic growth and M&A). This helped offset the impact of lower public peer multiples across the portfolio, though we note that APEO’s median EV/EBITDA across the top 50 holdings at end-September 2022 of 14.3x was slightly higher than the 14.1x at end-September 2021 (calculated based on different sets of companies). Private equity valuations are normally based on a blend of public peer multiples and recent private M&A deals, which smooths out the impact of public market sentiment. Nevertheless, we also note that public equity markets have recovered from end-September 2022 to date, suggesting some valuation tailwinds for APEO versus end-FY22 levels.

Exhibit 5: Investment trust performance to 31 January 2023 in sterling terms

Price, NAV and benchmark total return performance, one-year rebased

Price, NAV and benchmark total return performance (%)

Source: Refinitiv, Edison Investment Research. Note: Three-, five- and 10-year performance figures annualised.

Exhibit 6: APEO’s discrete performance versus selected indices in total return sterling terms (%)

12 months ending

APEO’s NAV

APEO’s share price

MSCI Europe Small Cap index

LPX Europe NAV Index

UK All-share Index

31/01/19

12.3

0.8

(10.0)

8.7

(3.8)

31/01/20

7.9

22.0

14.7

9.9

10.7

31/01/21

14.6

1.2

12.9

3.6

(7.5)

31/01/22

38.9

47.9

9.0

26.0

18.9

31/01/23

14.5

(11.2)

(5.2)

7.5

5.2

Source: Refinitiv, LPX Group, Edison Investment Research

APEO’s co-investment portfolio saw a considerable valuation uplift of 51.8% excluding FX in FY22. The company’s largest individual holding is its co-investment alongside 3i in the non-food discount retailer Action (5.1% of APEO’s NAV at end-FY22). 3i recently disclosed that Action achieved strong financial results, with headline LTM revenue to 1 January 2023 growing by 30% y-o-y on the back of an 18% like-for-like sales growth in 2022 and 280 new store openings (taking the total footprint to 2,263 stores across 10 countries). Action’s provisional EBITDA in 2022 reached €1.2bn, up 46% yo-y with margin expansion driven by sales leverage and good cost discipline, according to 3i. On the back of the solid financial performance, Action was revalued by 19% during the quarter to £10.3bn at end-2022. We understand that this has not been captured in APEO’s NAV yet (given it is largely dated end-September 2022, see above) and will add c 1pp to its NAV (before fees and carried interest), according to our calculations.

Overall, APEO’s performance was assisted by the solid exit activity (translating into £210.2m of distributions in FY22 vs £197.6m in FY21), which was executed at an average uplift to unrealised carrying values two quarters prior of around 20%. These exits represented a realised Multiple of Invested Capital (MOIC) of 2.2x in FY22 (close to the long-term global PE sector average) versus the 2.8x in FY21 (boosted by benign equity markets at that time). Notable exits include General Life (a European fertility clinic group), Benvic (a European developer and producer of thermoplastic solutions) and Sbanken (a Norwegian online bank). APEO also received £15.7m proceeds from secondary sales relating to two fund positions.

Some negative NAV impact came from APEO’s holdings floated recently, most notably the major initial public offerings in 2021 such as Moonpig (a UK-based online gifting business), Dr Martens (a leading consumer footwear brand) and Inpost (self-service lockers for e-commerce consumers). APEO’s listed holdings made up 12.4% its portfolio at the start of FY22, but their share declined to 5.4% at end-FY22 as a result of both share price declines and realisations.

Peer group comparison

The recent resilience of APEO’s portfolio valuations is a manifestation of a broader trend in the PE sector, with APEO’s one-year and three-year NAV TR to end-January 2023 of c 14.5% and 82.4%, respectively, being modestly below the peer average return of 17.9% and 84.1%, respectively. While its five- and 10-year returns are slightly lower than peer average, we note that this comes largely from the above-average performance of HarbourVest Global Private Equity, which has a significant weighting to venture capital and growth equity investments (c 37% at end-January 2023), which are characterized by a higher expected return.

APEO’s ongoing charges ratio of 1.06% in FY22 is somewhat lower than the 1.2–1.4% for peers (based on last available data) and unlike many of its peers, it does not charge a performance fee. However, we note that the ratios for APEO and its peers do not capture the second layer of fees charged at the level of underlying PE funds (in case of primary and secondary fund investments). APEO’s look-through ratio (excluding carried interest) stood at 2.73% in FY22, broadly in line with peer average of c 2.8% based on their last published Key Information Documents.

APEO’s discount to last reported NAV of 37.9% is moderately below peer average of 41.5%, though we still consider it wide compared to the historical average (see the Discount section for details).

Exhibit 7: Selected peer group at 17 February 2023*

% unless stated

Market cap £m

NAV TR
1 year

NAV TR
3 year

NAV TR
5 year

NAV TR
10 year

Ongoing charges ratio**

Perf
fee

Discount
(cum-fair)

Net
gearing

Dividend
yield

Standard Life Private Equity

698

14.5

82.4

121.0

302.6

1.1

No

(37.9)

103.1

3.2

CT Private Equity Trust

352

25.1

101.9

138.3

313.8

1.2

Yes

(32.1)

106.0

5.1

HarbourVest Global Private Equity

1,697

15.1

88.0

160.8

400.8

1.3

No***

(46.9)

100.0

0.0

ICG Enterprise Trust

765

19.2

76.6

124.3

288.8

1.4

Yes

(41.6)

107.2

1.4

Pantheon International

1,357

12.4

69.8

107.6

286.9

1.2

Yes

(45.3)

100.0

0.0

Simple average

1,043

17.9

84.1

132.7

322.6

1.3

-

(41.5)

103.3

1.6

SLPET rank in peer group

4

4

3

4

3

5

-

2

3

2

Source: Morningstar, Edison Investment Research. Note: Net gearing is total assets less cash and equivalents as a percentage of net assets. *NAV performance in sterling terms based on end-January 2023 NAV, or latest earlier available NAV (end-December 2022 for HarbourVest Global Private Equity and Pantheon International, end-October 2022 for ICG Enterprise Trust, and end-September 2022 for CT Private Equity Trust). **Excluding other expenses charged by the underlying investments held in the portfolio. ***No performance fee is charged at the HVPE level, but it is charged on the HarbourVest secondary and direct funds.

Asset allocation: High investment activity continued in FY22

APEO was quite active in terms of new investments in FY22 with total new commitments of £340.3m or 33% of opening NAV, compared to £307.1m and 40% in FY21, respectively (and FY17–21 average new commitments to opening NAV of c 26%). FY22 investments included 12 new primary commitments (£257.2m invested in total), two secondary transactions (£17.2m) and nine co-investments (£65.7m), as well as one follow-on in an existing co-investment. In line with APEO’s core strategy, its primary commitments were made mostly to mid-market funds, complemented by growth funds (Great Hill Equity Partners VIII, One Peak Growth III) – all run by PE managers with which APEO has established relationships dating back many years or decades.

Exhibit 8: APEO’s primary investments in FY22

Name

Investment size (£m)

Description

Hg Saturn 3

25.8

European buyout fund focused on software and B2B services.

Latour Capital IV

25.4

French mid-market buyout fund that focuses principally on companies in the business services and industrials sectors.

Advent Global Private Equity X

25.2

Global buyout fund that focuses on attractive niches within business and financial services, healthcare, industrial, retail and technology sectors.

Investindustrial Growth III

25.2

Southern European lower mid-market fund focused on niches within the industrials, business services and consumer & leisure sectors.

Nordic Capital XI

25.2

Northern European buyout fund, principally focused on the healthcare, technology & payments and financial services sectors.

ArchiMed MP 2

25.1

Healthcare specialist fund, focused on European and North American mid-market companies.

PAI VIII

25.1

Pan-European upper mid-market fund focused on food & consumer, business services, general industrials and healthcare.

IK Partnership II

20.8

Pan-European mid-market fund focused on co-control and minority opportunities in food & consumer, business services, healthcare and financial services.

Capiton VI

16.9

European lower mid-market fund with a focus on pharma, medtech, industrial automation and sustainable consumption.

Windrose Health Investors Fund VI

15.1

Mid-market buyout fund based in the United States that has a specialist focus on the healthcare sector.

Great Hill Equity Partners VIII

14.6

Growth-focused PE fund based in the United States.

One Peak Growth III

12.9

European growth fund that targets rapidly growing technology and tech-enabled companies.

TOTAL

257.2

-

Source: APEO

APEO’s secondary investments involved the acquisition of interests in a French e-commerce business (initially planned as part of a larger transaction, but the remaining assets were not acquired in the end), as well as interests in three mid-market buyout funds (providing exposure to c 30 underlying companies) managed by American Industrial Partners, Altor and Vitruvian (APEO is an existing investor with all three managers). In case of the latter secondary investment, APEO’s manager was able to carve out specific buyout fund interests from a wider portfolio offered for sale. APEO’s new co-investments in FY22 included Sport Pursuit, Suan Farma, CDL Nuclear Technologies, a portfolio of beverage brands (such as Tropicana and Naked), European Camping Group, NGE, ACT, Uvesco and CFC (see Exhibit 9 for details).

Portfolio positioning

APEO had a portfolio of 75 separate fund investments and 22 co-investments at end-September 2022, which in total provide exposure to 655 underlying private companies. We note that APEO’s 12 core European PE relationships represent 59% of its end-September 2022 NAV.

Exhibit 9: APEO’s top 10 private equity fund* holdings at 30 September 2022

Fund

Vintage

Number of holdings

Outstanding commitments £000s

Residual cost
£000s

Valuation £000s

% of NAV

Net multiple on cost

30 Sep 2022

30 Sep 2021**

Advent International GPE VIII

2016

29

-

31,652

52,171

4.5

5.4

2.0

CVC Capital Partners VII

2017

33

4,887

24,862

44,399

3.8

2.8

1.8

HgCapital 8

2017

11

4,504

12,668

42,144

3.6

3.0

2.5

IK Fund VIII

2016

12

2,150

22,947

38,225

3.3

3.4

1.8

Altor Fund IV

2014

16

12,930

27,886

37,158

3.2

4.9

1.9

Structured Solutions IV Primary Holdings

2021

50

20,780

27,594

36,504

3.2

2.7

1.4

Nordic Capital Fund IX

2018

14

2,905

22,355

35,841

3.1

4.2

1.6

Exponent Private Equity Partners III

2015

9

3,511

22,749

34,963

3.0

3.6

1.9

TowerBrook Investors IV

2013

10

12,497

16,056

34,936

2.8

3.5

2.4

CVC VI

2014

22

2,715

14,889

31,927

2.8

3

2.2

Top 10

-

206

66,879

223,658

388,268

33.3

36.5

1.9

Source: APEO, Edison Investment Research. Note: *Does not include co-investment in Action, made through 3i Venice SCSp fund. **Top 10 holdings at end-FY21 were different than at end-FY21. Commitments, cost and valuation figures relate to APEO's interest.

Control over capital deployment improved through co-investments and secondaries

At end-September 2022, APEO’s co-investment portfolio represented 19.1% of NAV versus 10.5% at end-September 2021 (see Exhibit 8) and is therefore approaching the 25% target. Meanwhile, the share of its primary fund investments was reduced to 70% of portfolio at end-September 2022 (vs 80% and 85% at end-FY21 and end-FY20, respectively), while secondary fund investments stood at 11% of portfolio.

Exhibit 10: APEO’s historical exposure by PE strategy

Source: APEO

Co-investments offer greater flexibility in terms of capital deployment (as they are done on a case-by-case basis and capital is deployed faster), leading to higher capital efficiency and easier balance sheet management. Moreover, unlike for LP positions, GPs normally do not charge fees on co-investments, translating into a one-layer fee structure (allowing APEO to blend down its look-through ongoing charges ratio).

A secondary strategy also provides greater control over capital allocation to private companies (even if still lower than direct investments and co-investments) and helps mitigate the J-curve effect (as it mostly involves buying LP positions in funds that have at least partially deployed their dry powder). In some periods, it also offers an opportunity to invest in PE portfolios sold by LPs looking to exit some of their positions (who sell either to rebalance their portfolios or to cover liquidity shortfalls), sometimes at a meaningful discount to last carrying value.

Exhibit 11: APEO’s co-investment portfolio at end-September 2022

Name

Description

Invested in

Valuation (£m)

% Investment portfolio

Action

European non-food discount retail

2020

58.7

4.9%

NAMSA

Healthcare business providing preclinical and clinical CRO specialised in providing services to medical device companies

2020

16.9

1.4%

ACT

Specialist intermediary in the global environmental certification market

2021

15.3

1.3%

Undisclosed company

Medical aesthetics company

2021

12.2

1.0%

Uvesco

Food retail operator in northern Spain

2022

10.4

0.9%

European Camping Group

Premium outdoor vacation accommodation

2021

10.4

0.9%

Insightsoftware

Financial reporting and enterprise performance management (EPM) software

2021

10.0

0.8%

Riskalyze

A risk-centric wealth management platform

2021

9.4

0.8%

Questel

Intellectual property solutions

2021

9.2

0.8%

NGE

Construction and public works services in France

2021

9.1

0.8%

Planet

Integrated digital payment services

2021

8.1

0.7%

Undisclosed

Portfolio of well-known beverage brands, including Tropicana and Naked

2021

8.0

0.7%

Visma

Provider of mission critical ERP software to SMEs

2020

7.9

0.7%

CDL Nuclear Technologies

Provider of turnkey cardiac PET/PET-CT imaging technology solutions and radioisotope delivery to independent cardiology practices and hospitals in the US

2021

6.3

0.5%

Funecap

French funeral services and crematoria business

2021

5.9

0.5%

Suan Farma

manufacturer, CDMO and distributor of active pharmaceutical and nutraceutical ingredients

2021

5.6

0.5%

Wundex

German home care provider for patients with chronic wounds

2021

5.1

0.4%

Sport Pursuit

Flash sale e-commerce business selling clearance stock from leading sports and outdoor brands

2021

5.3

0.4%

Mademoiselle Desserts

Pan-European manufacturer of premium frozen pastry

2019

4.8

0.4%

CFC

Tech-led insurance platform

2021

4.5

0.4%

Boost.ai

Conversational artificial intelligence

2021

3.1

0.3%

KD Pharma

Pharmaceutical grade omega 3 manufacturing

2021

1.8

0.1%

TOTAL

-

-

227.9

19.1%

Source: APEO, Edison Investment Research

Moreover, APEO has put much emphasis in recent years on expanding its exposure to tech (mostly profitable B2B IT businesses) and healthcare (with little exposure to higher-risk biotech), and each of these represented 20% of the company’s end-FY22 portfolio value (see Exhibit 10). Together with consumer staples (12%), the share of sectors deemed more defensive by APEO represented 52% of its portfolio at end-September 2022. Going forward, APEO’s manager expects a further shift towards sectors experiencing long-term growth (such as the above two) at the expense of more cyclical sectors, such as industrials (18% of portfolio at end-FY22) and consumer discretionary (14%).

In terms of regional breakdown, APEO remains focused in Europe on northern countries, including the UK (17%) and Nordics (14%), followed by France (13%), Germany (12%) and Benelux (9%). North America represented 23% of APEO’s end-FY22 portfolio.

Exhibit 12: APEO’s historical sector exposure

Source: APEO, Edison Investment Research

Balance sheet: A sizeable safety margin

Similar to other listed PE companies pursuing fund investments (ie LP positions in third-party PE funds), APEO follows an overcommitment strategy (see the Investment Process section below for details). This means that its outstanding investment commitments are normally in excess of available liquid resources (defined as cash and equivalents, as well as the undrawn part of its revolving credit facility) and that part of the capital calls on its commitments are normally funded through distributions. A fair share of APEO’s portfolio could be ripe for exits, with 47% of its end-September 2022 portfolio representing maturities of four years or more. However, as realisation volumes across the PE market started to decline recently amid the slowdown in global M&A activity (induced by macroeconomic uncertainties, lower debt availability and rising interest rates), it is instructive to examine the strength of APEO’s balance sheet in the event near-term distributions remain muted.

APEO’s overcommitment ratio (defined as the difference between outstanding commitments and liquid resources, divided by portfolio value) was c 39% based on last reported figures as at end-January 2023 (with 98.8% of portfolio valuations, excluding new investments, dated end-September 2022), which is closer to the lower end of its target range of 30–75%. This compares to 42.8% at end-September 2022, with the reduction assisted by the upsizing of APEO’s revolving credit facility from £200m to £300m completed after the FY22 reporting date (at the same time, the facility’s maturity was extended by a year to December 2025). Here, we note that out of the £710.6m of outstanding commitments at end-January 2023, £55.9m are considered by APEO’s manager as unlikely to be drawn (as they relate to funds that have completed their investment phase).

The end-January 2023 overcommitment level is well below the 63% at end-September 2007 (ie before the onset of the global financial crisis, see Exhibit 11). Furthermore, APEO’s commitment coverage ratio (ie percentage of outstanding commitments covered by liquid resources and the undrawn part of the facility) was 35%. While being somewhat below its FY17–21 average of c 45%, it is still broadly in line with the net cumulative capital calls as a percentage of FY07’s outstanding commitments in the extreme market conditions in the period FY08 to FY10 (40%). Moreover, APEO’s total cash and undrawn credit facility of £249.8m as at end-January 2023 was broadly at the level of its gross drawdowns in FY22 (£253.6m), with the latter including £74.7m of new co-investments and secondaries, so capital deployment directly under APEO’s control.

Exhibit 13: APEO’s historical overcommitment and coverage ratios

Source: APEO, Edison Investment Research. Note: The overcommitment ratio is calculated as outstanding commitments in excess of liquid resources as a percentage of NAV (until FY20) or as a percentage of portfolio value (since FY21); the coverage ratio is calculated as available resources as a percentage of outstanding commitments.

Consequently, we believe that the upsizing of the facility has provided the company with a sizable safety margin in the event distributions are muted in the coming months while capital calls continue. Although capital calls are also to some degree dependent on the activity across global M&A markets (and could therefore fall in the coming months as well), we note that APEO’s manager estimates that the underlying funds to which APEO has currently committed capital held credit facilities attributable to APEO’s commitments at c £113.3m at end-September 2022 (vs £47.3m at end-September 2021), which the manager expects to be drawn in full over the subsequent 12 months. So far, APEO has not experienced a spike in net capital calls, with similar drawdowns and distributions over the six months to end-January 2023 at c £98.0m and £102.9m, respectively (see Exhibit 12).

Exhibit 14: APEO’s drawdowns and distributions since January 2021

Source: APEO, Edison Investment Research

The median leverage multiple (ie net debt to EBITDA) across APEO’s top 50 holdings went up to 4.3x at end-September 2022 from 3.5x at end-September 2021, but remains below the average global entry buyout leverage in 9M22 across the market of c 5.9x.

Dividends: Delivering a growing payout per share

APEO has consistently delivered a regular dividend per share, with the annual payout increasing by 0.40p each year between FY17 and FY21, and by 0.80p (or c 5.9%) y-o-y in FY22. It pays dividends on a quarterly basis, in April, June, October and January of the year after the financial year end. Its latest annualised dividend payment implies a dividend yield of 3.2%.

Exhibit 15: Dividend history since FY14

Source: APEO

Discount: Visibly wider than historical average

Despite APEO’s solid NAV TR in FY22, its share price total return was -15.1% in FY22. While its c 11% share price appreciation from end-FY22 to date has reduced its discount to NAV from c 45% at end-September 2022 to 38% currently, the discount remains wide compared to APEO’s 10-year average of c 21%. We believe that this may reflect investor anxiety over a potential decline in portfolio valuations across the PE sector, as these have been marked down modestly so far despite the sharp sell-off in the broader public markets. Here, we note that this PE outperformance relative to listed equities may come from both PE valuation techniques (which make PE portfolio values less volatile) but also its sector composition (see the Market outlook section for details). The discount may also reflect investor cautiousness associated with APEO’s overcommitment strategy (which is a standard approach of listed PE with exposure to fund investments). However, as discussed above, we believe that APEO has good balance sheet headroom at present. APEO does not have a stated discount control policy but the board monitors the discount to ensure APEO is not an outlier compared to its peers and is seeking shareholder approval for share buybacks when appropriate.

Exhibit 16: Discount over 10 years

Exhibit 17: Buybacks and issuance

Source: Refinitiv, Edison Investment Research

Source: Morningstar, Edison Investment Research

Exhibit 16: Discount over 10 years

Source: Refinitiv, Edison Investment Research

Exhibit 17: Buybacks and issuance

Source: Morningstar, Edison Investment Research

Fund profile: Focus on ‘high-conviction’ PE GPs

APEO invests in a diversified portfolio of leading PE buyout funds (or alongside them through co-investments), focused mainly on the European mid-market, defined as funds with a size typically between €1.0bn and €5.0bn. It also invests in selective adjacent and complementary PE strategies in Europe and North America, most notably the lower mid-market (size between €150m and €1.0bn), large/mega funds (size over €5bn, focused primarily on mid-market core managers who ‘graduated’ to the large market, eg Advent International), as well as mid-sized growth equity. APEO has built a well-diversified portfolio of PE fund investments, acquired both through primary commitments and secondary fund investments. It targets around 50 ‘active’ PE fund investments, that in turn have exposure to over 650 underlying portfolio companies. In 2019, the company expanded its mandate to include direct co-investments alongside top-performing PE managers with which it has already established long and successful relationships.

Investment process: Relying on long-term partnerships

Although APEO’s main investment focus is the European market (76% of underlying private company exposure is in European-domiciled operating companies), it benefits from its management teams being located on both sides of the Atlantic (with abrdn Private Equity offices in London, Edinburgh and Boston), which enables broader monitoring of potential investments. The universe covered includes c 800 institutional-grade PE funds, with 100–150 funds screened for investment each year, of which typically c 25 are shortlisted and reviewed in detail. Consequently, APEO typically makes around four to eight primary fund commitments each year, coupled with secondary market transactions and direct co-investments.

To limit the amount of dry powder, the company follows an overcommitment strategy, which means it makes commitments that exceed its uninvested capital. The board has agreed that the overcommitment ratio should sit within a range of 30% to 75% over the long term. This strategy enables it to maximise the proportion of invested capital but requires careful monitoring of value and timing of both expected and projected cash flows within the portfolio. To fill in potential timing gaps between distributions and drawdowns as well as to seize attractive market opportunities, the company may use its revolving credit facility of £300m. Based on the company’s articles of association, borrowings should not normally exceed 30% of the NAV at the time of drawdown.

APEO’s approach to ESG

APEO is an indirect investor in private companies controlled by the PE managers that APEO partners with. However, APEO’s manager believes that, through direct engagement and legal negotiations, APEO can play an important role in ensuring that its GPs are focused and committed to implementing ESG improvements across their portfolios. It is noteworthy that the manager has been a signatory of the United Nations-supported Principles for Responsible Investment (PRI) since 2007 and received the highest PRI rating for Indirect Private Equity in 2021.

APEO’s ESG assessment depends on the type of investment:

Primary investments – The GP’s ESG cultural buy-in, its ESG process, procedures and reporting, its engagement with underlying portfolio companies, its score in APEO’s ESG survey and an operational due diligence review of the manager and the fund.

Co-investments – a detailed review of the underlying company’s ESG due diligence documents, sector and company analysis using RepRisk (a third-party ESG database) and leveraging the expertise on specific ESG issues via APEO’s manager’s central ESG & Stewardship team or a third-party expert.

Secondary investments – leveraging the process for primary investments and/or co-investments depending on the transaction profile. If a secondary represents a small number of underlying holdings, then it may follow the co-investment process. The primary ESG assessment of the PE manager will be taken into account where possible.

Capital structure

APEO’s share capital consists of 153.7m ordinary shares. The largest shareholder is Phoenix Group Holdings with a c 56.6% stake held through its 100% subsidiary Standard Life Assurance (SLAL). SLAL has irrevocably undertaken to APEO that, at any time when the SLAL group is entitled to exercise or control 30% or more of voting rights at APEO’s general meetings of shareholders, it will refrain from 1) nominating directors who are not independent of SLAL, 2) entering any transaction/arrangement with APEO that is not conducted at arm’s length and on normal commercial terms, 3) taking any action that would prevent APEO from carrying out an independent business or from complying with its listing rules, or 4) propose/procure any proposal of any shareholder resolution with the intent to circumvent the proper application of listing rules.

Exhibit 18: Major shareholders

Exhibit 19: Average daily volume

Source: Refinitiv, at 17 February 2023

Source: Refinitiv. Note: 12 months to 17 February 2023.

Exhibit 18: Major shareholders

Source: Refinitiv, at 17 February 2023

Exhibit 19: Average daily volume

Source: Refinitiv. Note: 12 months to 17 February 2023.

The board

APEO’s board consists of five independent non-executive directors:

Alan Devine joined the board in May 2014 and assumed the role of chairman in March 2022. Alan was formerly CEO of the Royal Bank of Scotland Shipping Group and has a wide background of knowledge and over 40 years' experience in both commercial and investment banking. He is a non-executive director of Capitalflow Holdings, where he is chairman of the remuneration, audit and risk committees. Alan is also chairman of the PE-owned cash logistics company GSLS. He holds an MBA and is a Fellow of the Institute of Bankers in Scotland.

Diane Seymour-Williams worked at Deutsche Asset Management Group (previously Morgan Grenfell) for 23 years where she held various senior positions, including CIO and CEO of Asia. More recently, she spent nine years at LGM Investments, a specialist global emerging and frontier markets equities manager, where she was the global head of relationship management. She is a non-executive director of Mercia Asset Management and PraxisIFM Group and a director of Acorn Capital Advisers. She is also a pro-bono member of the investment committees of Newnham College, Cambridge and the Canal & River Trust.

Calum Thomson assumed the role of a senior independent director (SID) in March 2022. Calum is a qualified chartered accountant and was an audit partner with Deloitte for over 21 years. He is a non-executive director and the audit committee chair of the Diverse Income Trust, the AVI Global Trust and Baring Emerging EMEA Opportunities, BLME Holdings, Bank of London and The Middle East.

Dugald Agble started his career in PE investments over 20 years ago at Nomura Principal Finance Group (now Terra Firma Capital Partners). In 2006, he moved on to investing in emerging and frontier markets at Helios Investment Partners and became a co-founding partner at 8 Miles in 2010. He is a supervisory board member at FMO, a Dutch entrepreneurial development bank.

Yvonne Stillhart has over 30 years’ senior executive experience in business building, transformational leadership, PE and infrastructure investment, finance, banking and risk and investment management across broad industries and geographical regions. This includes a co-founding senior partner position and member of the Investment Committee of Akina, a Swiss-based specialised PE manager that merged in 2017 with Unigestion. She is a non-executive director and member of the audit and risk committee at UBS Asset Management Switzerland and chairperson and member of the social and ethics committee of EPE Capital (an investment company listed on the Johannesburg stock exchange). She is also a non-executive director of Integrated Diagnostics Holdings.

Exhibit 20: APEO’s board of directors

Board member

Date of appointment

Remuneration in FY22 (£)

Shareholdings at end-FY22*

Alan Devine (chair)

28 May 2014

56,663

13,857

Diane Seymour-Williams

7 June 2017

44,000

31,500

Calum Thomson (SID)

30 November 2017

49,050

13,700

Yvonne Stillhart

1 September 2021

45,000

4,000

Dugald Agble

1 September 2021

44,000

1,400

Source: Company data. Note: *Ordinary shares held. Christina McComb, who retired from the board and as chair on 22 March 2022, received remuneration of £30,638.


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