A lesson in value creation

The fact that the holding has produced a total return of 93 per cent in the subsequent four years, but the shares are still trading on an identical 21 per cent discount to 2019 year-end NAV per share of 345p, up from 281p at the end of 2018, highlights the success of the company’s investment management team. The board has also rewarded shareholders by declaring cumulative dividends per share of 13.5p. It has been an education, quite literally, in creating shareholder value, and one that is still being significantly underrated by the market.

Indeed, Oakley’s peer group of direct private equity funds (excluding 3i) with ongoing mandates are only trading on a 7 per cent discount to their NAV. The valuation gap is anomalous, especially as Oakley will report a 2019 NAV return of 24.6 per cent (including dividends of 4.5p a share) when it releases its annual results on Thursday, 12 March 2019, and has more than doubled NAV per share since June 2015.

The private equity business

Founded in 2002, the company invests directly in investee companies and through a number of Oakley unlisted mid-market private equity funds with the aim of providing investors with significant long-term capital appreciation. The strategy is to focus on buyout opportunities in industries with potential for growth, consolidation and performance improvement.

Consumer (45 per cent of portfolio value), education (36 per cent) and TMT (19 per cent) are the three main areas targeted. Investee companies are typically mid-market western European businesses that have an enterprise value of between €100m and €400m (£85m and £340m). The majority of investments are primarily sourced from bilateral discussions with vendors and Oakley usually does not acquire secondary buyouts from other private equity houses.

Oakley primarily invests in businesses that are typically highly cash generative and can scale up quickly once they hit an inflexion point. Strong underlying structural market growth, asset-light business models that produce strong cash conversion, and the ability to accelerate performance through effective management, are key characteristics of the businesses Oakley is looking to invest in.

For example, in the digital consumer segment, Oakley holds investments worth £42m in European real estate websites Casa.it in Italy and atHome.lu in Luxembourg. They have been very successful, having increased in value by 60 per cent since Oakley first invested in December 2016. Other holdings in the digital consumer space include a £33m stake in Italy’s leading online comparison website, Facile.it, and a £71m equity stake in Time Out (TMO), the digital media and entertainment business that is pursuing an expansion of its Time Out Market concept in Lisbon by opening new markets in Miami, New York and Boston.

Specifically, Oakley invests in digital consumer businesses that have strong brand awareness, and attract lower-cost, direct traffic to their websites, thus helping to drive improved profitability. Disposals that have driven the sharp rise in NAV per share in recent years includes stakes in Germany-based online price comparison website Verivox, and internet dating site Parship Elite and Damovo, a leading European communications company.

Major TMT disposal boosts NAV per share

Oakley latest disposal was announced in mid-December 2019, so just before the financial year-end. The sale of its stake in WebPros Group, a leading provider of web hosting automation software that offers critical automation and security tools to hosting providers, web agencies and their customers, to a fund managed by private equity firm CVC Capital Partners, raises £110m for the company, or £53m more than the carry value of the stake in Oakley’s 2019 half-year accounts. It added 26p a share to Oakley’s NAV in the second half of 2019.

The bumper cash inflow equates to an eye-watering internal rate of return (IRR) of 140 per cent since Oakley first invested in WebPros in 2017, and reflects the operational progress WebPros has been making since then. Indeed, WebPros has completed six acquisitions to create a product portfolio that addresses the full end-to-end customer lifecycle for shared hosting providers. It now employs over 450 people across four continents to support customers across the globe, operating on more than 350,000 servers and supporting more than 10m websites and 18m e-mail boxes.

Oakley’s shareholders will still retain some upside to the future success of WebPros as the investment company will be investing £43m as a minority partner as part of a $200m (£153m) follow-on investment being made by one of Oakley’s funds alongside CVC. This enables it to continue its partnership with WebPros’ management team and co-investors, and to benefit from the long-term growth potential in WebPros, while crystallising some of the hefty gains made to date.

An education in creating shareholder value

Education has become a significant sector for Oakley in recent years and accounts for around 36 per cent of the company’s NAV. The focus has been on investments in premium private schools, higher education and after-school tutoring. Analysts at house broker Liberum Capital rightly point out that education assets have many attractive characteristics, making the sector an interesting area in which to invest.

For example, demand for education is growing strongly in both emerging and developed markets, and supply is limited by public spending constraints and high barriers to entry. Moreover, there is potential for value to be added through consolidation, technology and economies of scale. Also, education markets are typically non-cyclical, as parents place great importance on the investment they make in their children’s education. It’s proved an astute call.

In 2013, Oakley first invested in Inspired, a co-educational, non-denominational, independent school group that has grown rapidly by building new schools and acquiring existing successful ones around the world. In fact, it is now one of the leading global groups of premium schools, educating over 38,000 students in 51 schools across five continents. Its success has attracted investor interest, too. In May 2019, a strategic investment from Warburg Pincus, a global growth private equity firm, and TA Associates, an existing shareholder, enabled Oakley to realise £30m of its investment at an 80 per cent premium to book value, but still retain an investment in Inspired worth £91m. The gain on this part disposal added 21p a share to Oakley’s NAV last year.

Other investments Oakley has made in the education sector are Career Partner Group, the fast-growing private university in Germany; Schülerhilfe, Europe's largest after-school tutoring business; and AMOS, one of the leading international business schools in France. Oakley invested a total of £61.4m in the three companies in 2017 and 2018, and they now have a combined book value of £105m. Further valuation gains driven by improving profitability seem a realistic possibility for all the investments in this niche area.

Making waves

Oakley is making waves in marine education, too. Having successfully invested in Headland Media, a provider of media and entertainment services to the offshore and shipping sectors, the private equity group invested £20.2m last year, partnering with the management teams of marine e-learning technology groups Seagull and Videotel, to acquire majority stakes in the businesses.

Over the past four decades, Videotel and Seagull have established themselves as the best-in-class providers of e-learning to the maritime sector globally. In fact, every year they provide over 20,000 ships and installations with comprehensive and up-to-date compliance, risk and safety training that ensures adherence to International Maritime Organisation (IMO) requirements.

It’s easy to see investment upside here. That’s because the digital transformation taking place in the shipping industry, as well as the increasingly complex regulatory framework, offers a major opportunity for e-learning providers. The management teams of Seagull and Videotel believe that this can be most effectively exploited by working together as a combined entity by sharing knowledge and resources in order to provide their respective customers with a greater level of product and services.

Strong momentum

Oakley’s bumper investment returns in recent years have been driven by a combination of disposals pitched at hefty premiums to the carrying values of its holdings, and by ongoing strong operational performance of the investee companies themselves.

It’s worth noting that although the private equity sector is awash with capital ready for investment, industry estimates suggest there is a record $2.2bn (£1.7bn) of 'dry powder', and the segment continues to attract significant inflows from investors, Oakley continues to secure high-quality assets at attractive multiples. Indeed, the five deals the company sourced last year were priced on at enterprise value to cash profit multiple of 11.2 times, a deep discount to peer group multiples of 13.4 times.

Furthermore, after taking into account the proceeds from the WebPros disposal, I estimate Oakley has pro-forma net funds of £146m after accounting for two other new investments: Alessi, an Italian high-end design business focused on homeware products; and Seven Miles, a leading consumer technology company operating in the business-to-business gift card sector in Germany.

Potential for further realisations and investment gains

Around half of Oakley’s portfolio has a holding period of more than four years, thus offering scope for further positive newsflow on realisations at likely premiums to their conservative carrying values. Also, around a quarter of the investment portfolio has been acquired in the past couple of years, thus offering realistic prospects of valuation gains as these businesses mature in a benign investment climate where take-out multiples have been rising, too.

Importantly, net debt levels of the portfolio companies are relatively conservative at only four times cash profits. The portfolio is being valued on an average cash profit to enterprise value multiple of 12 times, a rating that offers further valuation upside as the underlying profitability of Oakley’s companies improves. In 2019, Oakley’s portfolio companies reported 30 per cent average cash profit growth, another key contributor to the NAV increase in the 12-month period. Also, the valuation multiple used by Oakley to value its portfolio still represents a discount to private equity industry peers, so there is scope for multiple expansion.

This is simply not being reflected in Oakley’s valuation, with the shares rated on an attractive 21 per cent discount to spot NAV. I also feel that Liberum’s predictions of portfolio returns for the private equity investments of 22 per cent in 2020 and 23.9 per cent in 2021 could yet prove too conservative. Clearly, the board sees significant share price upside as the directors sanctioned a 4m share buyback programme in late December. Managing partner Peter Deubens purchased 2.45m shares at 250p just before Christmas to take his holding to 17.6m shares, or 8.86 per cent of the issued share capital, and non-executive director Laurence Blackall purchased 100,000 shares at 270p last week to lift his stake to 400,000 shares, or 0.2 per cent of the share capital. Their lead is worth following. Buy.

Please note that my 2020 Bargain Shares Portfolio will be published on Friday, 7 February 2020 and I will also update the investment case of all 10 small-cap shares I included in my market-beating 2019 Bargain Shares Portfolio.

■ Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are priced at £16.95 each plus postage and packaging of £3.25 [UK]. Both books can be purchased for the special price of £25 plus discounted postage and packaging of only £3.95.

The books include case studies of Simon Thompson’s market beating Bargain Share Portfolio companies outlining the investment characteristics that made them successful investments. Simon also highlights many other investment approaches and stock screens he uses to identify small-cap companies with investment potential, too. Details of the content of both books can be viewed on www.ypdbooks.com.

Simon Thompson was named 2019 Small Cap Journalist of the year at the 2019 Small Cap Awards.