For years, private equity investment group 3i (III) had looked burdened by excessive costs while presiding over a portfolio that comprised far too many low value investments. But in 2012 - with the appointment of chief executive Simon Borrows - all that began to change. Not only is the portfolio becoming significantly more focused, but costs have been slashed and - importantly for investors - the company's dividend policy holds the promise of chunky payouts ahead. That turnaround, however, doesn't yet look factored into the share price.
- Major restructuring
- Book value rising fast
- Streamlining the investment portfolio
- Strong income potential
- High asset prices make new investments expensive
- Facing currency headwinds
Mr Borrows' strategic shift - announced in detail in June 2012 - has been dramatic. By the time 3i revealed its 2013-14 full-year results in May, for example, the group's cost base had been slashed by a hefty £70m on a cumulative basis - well ahead of the £60m originally targeted. That was significantly helped by a much reduced headcount which, just in the past two years, has fallen to 266 from 435. Such heavy lifting allowed the group to cover its operating costs with cash income from management fees and portfolio income at the full-year stage. That may not sound like much of an achievement but, remarkably, the reverse situation had prevailed by some margin as recently as two years ago.
Just as important is 3i's strategy to focus its investment portfolio. At the end of March the private equity book comprised 81 different investments and management is aiming to roughly halve that figure over the next few years as lower value investments are realised. There has already been notable progress with this strategy: in 2008, for example, the book comprised 487 investments. Crucially, the move will allow 3i to free up resources to focus on its areas of expertise: largely mid-market investing in the group's core northern European markets (Benelux, France, Germany, UK and the Nordic countries). A good example of that strategy can be seen with its largest investment, Benelux discount retailer Action, which is growing fast on the back of a store roll-out programme.
3i (III) | ||||
|---|---|---|---|---|
| ORD PRICE: | 371p | MARKET VALUE: | £3.61bn | |
| TOUCH: | 370.9-371.4p | 12-MONTH HIGH: | 428p | LOW: 331p |
| FORWARD DIVIDEND YIELD: | 2.2% | FORWARD PE RATIO: | 6 | |
| DISCOUNT TO NAV: | 14% | NET DEBT: | 5% | |
| Year to 31 Mar | Net asset value (p) | Pre-tax profit (£m)* | Earnings per share (p)* | Dividend per share (p) |
|---|---|---|---|---|
| 2012 | 279 | -777 | -84.9 | 8.1 |
| 2013 | 311 | 189 | 20.0 | 8.1 |
| 2014 | 348 | 583 | 63.0 | 20 |
| 2015* | 390 | 546 | 58.7 | 8.1 |
| 2016* | 433 | 549 | 58.8 | 8.1 |
| % change | +11 | +1 | - | - |
*Societe Generale forecasts, adjusted PTP and EPS figures Normal market size: 5,000 Matched bargain trading Beta: 1.34 | ||||
Market conditions are providing a fillip, too. Specifically, buoyant investment markets are boosting asset prices and that's proving especially good news for 3i's realisations. In fact, in the year to the end of March, realisations jumped 12 per cent to £677m and a profit of £202m was booked on the disposals. Robust progress has continued since then, with management reporting that realisation proceeds reached £164m in the first quarter of the new financial year, with an additional £245m or so expected from exits that have yet to be completed. Such a trading backdrop is proving great news for 3i's book value, which is forecast by analysts at Societe Generale to grow by almost a quarter over the next two years.
Inevitably, high asset prices are something of a double-edged sword: it drives impressive levels of realisations but makes new investments pricey. Management says this "continues to result in a cautious approach" to new deals which, unfortunately, meant the group made no new investments in the first quarter. Moreover, the strong pound leaves 3i's exposure to European markets generating a currency drag, too. That reached a painful looking £68m in the first quarter alone.
But investors should take note of the group's dividend policy. Specifically, management is committed to paying a 'base' dividend of at least 8.1p a share each year, but will look to distribute more to reflect such factors as realisations. True, as realisations are hard to predict, analysts tend to merely forecast the base dividend (see table). But with high asset prices driving realisations up sharply shareholders can reasonably expect rather better, and last year the total payout reached 20p - leaving the shares yielding a tasty 5.4 per cent.
