Princess Private Equity Holding — Waiting for a rebound in global PE deal activity

PEY delivered a net asset value (NAV) total return (TR) of c 2% in Q223, bringing the H123 figure to 3.5%. Meanwhile, its share price TR was a strong 27.8% in H123, which represents a rebound after the de-rating in November 2022 in response to the suspension of the second interim dividend (see our previous note and podcast for details).

H123 revaluations stood at €55.4m (or c 5.4% of end-2022 portfolio value), of which we calculate roughly 65% (c €36m) was attributable to fair value changes in the top10 holdings (making up c 40.9% of portfolio at end-June 2023, see Exhibit 1). This excludes the negative FX impact, which amounted to €3.9m in H123.

Around 90% of PEY’s portfolio at end-June 2023 was valued based on EV/EBITDA peer multiples, with the average ratio broadly stable at 16.2x versus 15.9x at end-2022, which may suggest some minor positive contribution from peer multiples. For instance, PEY reported a multiple uplift in the case of KinderCare, a provider of early childhood education and care services.

Earnings momentum is also likely to have contributed positively, as PEY’s portfolio companies (based on a sample of 40 holdings making up 84% of NAV) retained robust revenue and EBITDA momentum, with LTM figures of 17% and 15%, respectively (although top-line growth decelerated slightly from 20%+ growth reported last year). This was the case, among others, for the top three individual contributors to revaluations in PEY’s top 10 holdings:

Importantly, the average EBITDA margin of 23% across PEY’s portfolio remained broadly stable versus 21.1% reported in Q222, indicating strong overall pricing power.

Given the normalisation of the interest rate environment, it is instructive to look at the interest coverage and debt maturity profile of PE portfolios like PEY’s. Average net debt to LTM EBITDA across the sample of 40 holdings, making up 84% of NAV, was c 5x at end-June 2023 (down from 6.1x at end-2022) and average net debt to enterprise value was 35% (vs 39% at end-2022). The average new issue loan spreads for a single B issuer in the US stood at SOFR +396bp in Q223 (according to Partners Group’s recent quarterly liquid loan market commentary). For illustrative purposes, if we apply this spread to the current SOFR (5.30%), a net debt to EBITDA of 5x translates into an EBITDA interest coverage ratio of 2.2x, which leaves some headroom in terms of interest cover (especially for less capital-intensive businesses). That said, we note that PEY highlighted during its Q223 investor call that, in anticipation of higher inflation, Partners Group decided in Q321 to increase the interest hedge rates across its portfolio, with c 80–90% of the debt now being hedged.

PEY has been proactively refinancing debt across its portfolio companies over the last 18 months (with most maturing in 2025 or later). Furthermore, many of these companies are highly cash generative, allowing for debt repayment during PEY’s holding period (often within approximately two to three years). Partners Group also noted a ‘flight to quality’ in the corporate debt markets and that it managed to complete two refinancings, each in excess of €1bn, in recent months. PEY therefore considers refinancing risk across its portfolio as low at present. Nevertheless, PEY underlined in its H123 report that Partners Group places greater emphasis on organic growth and real asset transformation, while inorganic platform expansion is appealing if it can be achieved through cash flow generation instead of expensive debt financing facilities.

Looking at PEY’s medium-term performance, its three-year NAV TR to end-June 2023 of 11.9% pa in euro terms is broadly in line with the MSCI World Small Cap Index return of 12.0% pa (we consider listed small caps as a better public comparator for private equity than broader all-cap indices), while it was slightly behind the MSCI World Index return of 13.8% pa. Over 10 years, PEY’s 11.3% pa NAV TR is broadly in line with both public indices at 10.3% and 12.0%, respectively (see Exhibit 3).

PEY’s 12-month NAV TR to end-June 2023 placed it among the top performers in the listed PE peer group (second to Deutsche Beteiligungs only) and compares to a peer average of 3.7%. That said, its long-term performance remains below peers, as illustrated in Exhibit 5, which may be due to several factors.

Firstly, PEY’s manager highlights that its portfolio was less exposed to sectors that saw a greater multiples expansion following the COVID-19 outbreak (eg IT) than some peers. This includes some listed PE peers with exposure to venture capital/growth investments (usually strongly skewed towards tech), which now face stronger market headwinds in terms of valuation compared to traditional PE investments. One of PEY’s distinct features compared to some peers (which some investors may find appealing) is its relatively high weighting to healthcare (21% exposure at end-June 2023), which includes, among others, several healthcare services providers which offer a combination of resilience/defensiveness, secular growth and ‘buy-and-build’ opportunities (see our July 2022 note for details). Together with its exposure to IT (13% of portfolio, predominantly enterprise software and services), education (8%) and consumer staples (5%), this suggests that at least half of PEY’s portfolio may be considered relatively defensive.

Secondly, PEY’s FY21 NAV TR of 19.4%, while solid in absolute terms, was below the peer average, partially due to a material cash drag stemming from record-high disposals (only partly mitigated by a temporary allocation to senior loans). Finally, PEY’s hedging policy also had a minor negative impact as positive portfolio revaluation coming from the stronger US dollar against the euro was offset by hedging losses. PEY discontinued its hedging policy with effect from 1 April 2023, as discussed in our last update note. PEY’s 10-year NAV TR is also below the peer average, but we note that it captures a period of portfolio transition away from the legacy fund investments to direct investments (the former represented only 2% of PEY’s portfolio at end-June 2023).

We note that a significant part of PEY’s direct investment portfolio at end-June 2023 is quite mature, with an average holding period of around four years (vs the target holding period of five to six years) and more than 30 investments (making up 47% of NAV) held for more than four years (see chart on the front page). This is also illustrated by the fact that eight of PEY’s top 10 holdings at end-June 2023 were acquired in 2018 or earlier, held at an average c 2.4x multiple of cost (on a weighted basis, see Exhibit 1 above), ie close to the 2.2x average historical multiple of invested capital for global buyouts fully realised in 2009–21, according to Bain & Company. Overall, the NAV-weighted investment total value to paid-in capital (TVPI) across PEY’s direct portfolio stood at c 2.0x at end-June 2023. However, realisation opportunities across the PE markets have been negatively affected by subdued global M&A markets, with global M&A deal volumes down c 34% year-on-year in Q223, according to PitchBook data as at end-June 2023. This has affected exit activity across PE markets, with PEY’s H123 realisations at a modest €14m, with €9m from direct investments and €5m from PEY’s mature legacy fund and debt investments.

Given that top PE companies tend to value their holdings conservatively, they often recognise sizeable uplifts to fair value in the run-up to and on exit (see our thematic report on listed private equity for details). Therefore, high realisation activity normally supports their NAV TR. In PEY’s case, the average uplift to fair value one year previously for fully realised direct lead investments with an initial cost of more than €5m held by PEY (either directly or through Partners Group fund commitments) stood at around 50% over the last five years to end-June 2023. This uplift represented a shift from 2.3x average unrealised gross TVPI to 3.5x average realised gross TVPI (see Exhibit 6). Direct lead investments currently represent c 70% of PEY’s NAV. That said, current muted exit activity may lead to extended holding periods, which (together with valuation headwinds from higher interest rates) could potentially limit the extent of uplifts on realised investments (as more of the value accretion may already be captured in PEY’s monthly portfolio revaluations). However, a pick-up in exit activity across the PE markets could still prove supportive to PEY’s NAV TR. In this context, it is worth noting that PEY’s shares still trade at a c 26% discount to NAV, which is materially wider than its 10-year average of c 17%.

Given limited realisation activity (see above) and a strong emphasis on balance sheet management, PEY remains cautious in its new investment activity, with investments of only €10m in H123 (vs €62.7m in H122), including drawdowns of commitments PEY had made to Partners Group Direct Equity V fund, as well as follow-on investments in portfolio companies. That said, PEY retains a solid balance sheet position at the holding level, with cash (€5.1m) and the undrawn part of its credit line (€127.5m out of €140m total facility) at end-June 2023 broadly equal to its unfunded commitments (€132.2m). PEY expects €60–70m of these commitments to be drawn over the next two to four years and for the balance to remain undrawn (€41.6m are commitments to third-party funds and Partners Group direct programmes that are past their investment period).

Importantly, after the brief pause last year, PEY reiterated its dividend policy of 5% of opening NAV, with the second interim dividend planned for December 2023 (the first interim dividend of €0.365 was paid on 2 June 2023). Based on end-2022 NAV per share of €14.62, this implies a second interim dividend payment that is at least equal to the first interim payment and in total implies a dividend yield of c 6.7% (based on the current share price), higher than any of its peers based on their respective LTM payments (see Exhibit 5 above).