HgT — Strong earnings growth and realisations in FY23

HgT posted an 11.1% NAV total return (TR) in FY23, which was mostly driven by sustained strong earnings growth across its portfolio (resulting in £496m of unrealised gains in FY23, or c 20% of opening portfolio value). Its top 20 holdings recorded last 12-month (LTM) revenue and EBITDA growth of 25% and 30% in 2023, respectively. Importantly, organic EBITDA growth across the portfolio was a high at 19% in 2023 (even above the c 10–15% pa historically on average according to Hg), assisted primarily by cross- and up-selling, and to a lesser extent new SME client wins (as CIOs of companies, including SMEs, have become more cautious in terms of new initiatives/technology partners lately, as noted by Gartner). Growth across HgT’s portfolio was ahead of the 12% organic EBITDA growth for listed US software and service businesses (according to Hg based on FactSet data). Hg believes that this is due to a higher emphasis on margin and a better quality of holdings on average versus the US software and service sector.

We note that this solid earnings growth was achieved at an average 31% EBITDA margin across HgT’s top 20 holdings (vs 29% in 2022, see Exhibit 1). This means that HgT’s portfolio continues to fulfil the ‘Rule of 40’ (ie displaying combined revenue growth and an EBITDA margin above 40%), which warrants a valuation premium versus the broader private IT sector (see our previous note for details). The average net debt to EBITDA across HgT’s top 20 holdings stood at 7.4x at end-2023 (down from 8.0x at end-2022), with an equity cushion of more than 70%. We also note that interest on 75% of the debt is hedged for an average duration of 1.7 years.

HgT’s top 20 holdings change over time, as it constantly refreshes its portfolio through realisations and new investments. That said, the recent superior earnings momentum across its portfolio also applies to companies that HgT has held for many years now (even beyond the usual private equity holding period of three to five years). One of the best examples here is Visma, which under Hg’s 17-year ownership (mostly as lead sponsor or co-lead investor) has achieved organic revenue growth of 15% pa at an EBITDA margin of 28%+ (see Visma’s five-year results in Exhibit 2). Despite being on a high-growth path for several years now, Visma posted increases in revenue and EBITDA of 17% and 24% y-o-y in Q423, respectively. Visma’s management considers the growth in earnings above top-line momentum as confirmation of its good business scalability. Its LTM cash conversion to end-2023 was 99.7%, and Hg noted that the share of recurring revenue is now 90% (which is common among HgT’s holdings), with 80% coming from software-as-a-service (SaaS) solutions. Visma will make up c 12.5% of HgT portfolio value after recent follow-on investment. HgT is well-positioned to run winners for longer thanks to the tiered suite of private funds managed by Hg (which HgT invests through), covering the small-cap Mercury funds, the mid-cap Genesis funds and the large-cap Saturn funds.

HgT’s portfolio companies continue to be supported by the secular corporate digitalisation trend and the associated adoption of SaaS solutions by SMEs. According to Gartner’s forecasts released in January 2024, global spending on software and IT services will grow by 12.7% and 8.7% in 2024, respectively (after increasing by 12.4% and 5.8% in 2023, respectively). Hg’s focus on strong players within selected clusters has likely contributed to the good earnings momentum, with the largest clusters in HgT’s portfolio currently being tax & accounting, ERP & payroll, as well as legal & regulatory compliance (see Exhibit 3).

We believe that HgT’s healthy long-term performance also comes from Hg’s value creation capabilities. Hg significantly expanded its specialist portfolio team to more than 85 in 2023 from 47 in 2022. It consists of, among others, board advisors, serial chairs and operating partners, as well as specialists across areas such as data and analytics, HR and talent, technology, growth, value creation projects, legal, ESG, finance and financial planning and analysis. Hg highlighted multiple tangible effects of the activities undertaken by its team (see Exhibit 5).

The above-mentioned EBITDA growth also comes from M&A activity (ie bolt-on acquisitions performed by HgT’s portfolio holdings, ie its ‘platform’ investments). Hg has a healthy pipeline of acquisition targets and its portfolio is running at over twice the usual rate of more than 100 bolt-on acquisitions per year. The manager indicated that there is less competition for these smaller businesses from some types of acquirers (eg venture capital firms).HgT’s portfolio companies have been recently executing bolt-on acquisitions at half the multiple at which the former are valued by Hg on average, providing significant benefits in terms of multiples arbitrage.

Despite the expanding multiples of listed peers last year (with median EV/sales and EV/EBITDA for US SaaS businesses up from c 5x to 6x and from c 25x to 26x, respectively), the contribution from multiples expansion to HgT’s FY23 returns was negligible (£9.3m of unrealised gains). This is partly because HgT values its portfolio holdings based on blended public and private M&A multiples, with the latter being less volatile that public multiples both to the upside and to the downside.

The positive contribution from earnings growth was partly offset by an increase in net debt (£103m unrealised valuation loss in FY23), mostly to fuel the ‘buy-and-build’ strategy. During the FY23 earnings call, Hg highlighted that most of its portfolio companies can maintain the strong bolt-on activity this year based on their balance sheet headroom and potential follow-on investments from Hg-managed funds (including HgT).

HgT’s solid FY23 results allowed the trust to maintain its strong mid- and long-term track record, with five- and 10-year NAV TRs of 20.4% and 18.4% pa, respectively (which was broadly matched by its share price total return of 21.7% and 18.8% pa, respectively). This is significantly ahead of the five-year and 10-year total returns posted by the MSCI World Small Cap Index of 10.2% and 10.1% pa, respectively, and represents an even greater outperformance of the UK All-Share Index, which posted returns of 6.6% and 5.3% pa, respectively (see Exhibit 6). Importantly, this was achieved at a loss ratio (ie percentage of invested capital realised below initial cost) of a mere c 1%, with 98% of HgT’s current portfolio being held above cost. Around 90% of investments realised by Hg over its more than 20-year track record to end-September 2023 (adjusted for events post period end) yielded a multiple on invested capital (MOIC) above 2x and an internal rate of return (IRR) above 20%. Overall, Hg achieved a historical MOIC and IRR on full and partial exits of more than 3x and 32%, respectively. HgT has also been the top performer across the listed private equity (PE) space over one and 10 years, and achieved the second-best result over five years (see Exhibit 8). We believe that this demonstrates the consistency of HgT’s returns over time.

In a difficult market environment, characterised by low PE exit activity, Hg put an emphasis on cash returns, generating strong total realisations of £345.9m in FY23 or c 17% of opening NAV (£323.8m net of carried interest) , despite the significant decline in global PE exit activity in 2023 (down 27% y-o-y and 66% from the 2021 peak, according to PitchBook data). Importantly, HgT continues to realise its investments at prices above previous portfolio valuations, which for full and partial exits in 2023 stood at a strong 25% on average (even if somewhat lower than the average 38% in 2017–22).

Realisations last year included £132.3m generated on the full exits of the cloud-based transportation management software platform Transporeon (at an uplift of 18% to carrying value, agreed in December 2022, sold to a trade buyer) and the business messaging solutions provider to local enterprises Commify (at a 32% uplift, sold to ECI Partners). Moreover, HgT completed the partial exits of P&I (with proceeds of £36.7m at a 25% uplift to end-2022 carrying value), Azets (£23.2m, at a 16% uplift to end-March 2023 carrying value) and Silverfin (£13.6m, sold to Visma). Finally, HgT completed a secondary sale of 25% of its limited partner position in Hg Genesis 8 (a 2017 vintage mid-market fund) for £91m at 100% end-December 2022 NAV (representing a healthy MOIC of 3.2x), with proceeds paid in two instalments on 31 March 2024 and 31 March 2025. It also agreed with Hg to reduce its commitment to Hg Saturn 3, which led to a £47.3m rebate of invested capital.

HgT reported further realisations post the reporting date, which Hg expects to generate £191m of proceeds. This includes £48m from the full exit from Argus Media (at uplifts of 7% and 15% to end-September 2023 and end-2022 carrying values, respectively), £82m from GGW Group (at a 40% uplift to end-September 2023 carrying value, though £44.2m will be reinvested in the same business), as well as £42.1m net proceeds from the partial realisation of IRIS (valued in line with end-September 2023 carrying value, but c 14% above the end-2022 value). Moreover, in January 2024, Hg completed the sale of the ‘MeinAuto’ and ‘Mobility Concept’ divisions of the MeinAuto Group to Mobilize Lease & Co, a subsidiary of Mobilize Financial Services, part of the Renault Group, for £11m. Following the transaction, Hg continues to hold an investment in Athletic Sport Sponsoring, a German flat-rate car subscription provider. Finally, HgT will receive £8m from the partial sale of TeamSystem (agreed in August 2023), with the transaction valuing the holding at £33.3m (a c 68% uplift to end-March 2023 carrying value). We believe that overall, the FY23 realisations and recently announced deals are a testament to the quality of the trust’s portfolio and its conservative valuation approach, particularly in light of the materially lower realisation activity reported across the private equity sector as a whole.

HgT was quite cautious in terms of new investments, with a modest £73.5m (3% of opening NAV) spent in FY23. This includes three new investments totalling £28.6m in GTreasury (a US-based treasury, payments and risk management software provider), JTL (a German ERP software provider specialising in e-commerce enablement solutions) and Nomadia (a SaaS provider of smart mobility solutions). HgT also made follow-on investments in its existing portfolio companies: Septeo, P&I, GGW Group, Howden, Citation and Waystone.

That said, Hg highlighted that an improving deal environment lately is supportive of increased investment activity in 2024. HgT announced several further transactions in late 2023 and 2024 to date, which Hg expects will represent over £200m investments in FY24. This includes a £13.6m new investment in CINC Systems (a cloud-based software business serving the community association management sector), as well as a £6.7m investment in Induver and Clover (two independent corporate insurance brokers in Belgium, which will be merged). Moreover, HgT announced in December 2023 a c £83.5m follow-on investment in Visma (which will bring the company’s share in HgT’s portfolio value to 12.5% vs 8.7% at end-2023), as well as the above-mentioned £44.2m reinvestment into GGW Group (a European insurance brokerage platform) to power its next phase of growth. We note that Hg normally targets eight to 16 new platform investments per year, with a similar number of liquidity events (ie full or partial exits, and refinancings).

HgT made new investment commitments of £183m to Hg funds in FY23. Its pro-forma commitments currently stand at £957m, which is 73% covered by cash and equivalents (£325m) and the undrawn credit facility (£375m, recently upsized from £350m), see Exhibit 10. We also note that the maturity of HgT’s credit facility was extended to three years (ie until March 2027). We consider this commitment coverage ratio a safe level given that these outstanding commitments should be drawn gradually over the next three to four years, and they will at least partly be financed by further realisations in the coming years.

We believe that this provides HgT with good headroom for further co-investments, as it aims to increase the share of co-investments in its portfolio from the current c 5% to 10–15% over the medium term. 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, Hg does not charge any fees on HgT’s co-investments alongside Hg’s funds, translating into a lower ongoing charges ratio.