A PE trust built to perform in tough times

The trust, a listed vehicle that invests alongside larger funds managed by Oakley Capital, invests in a concentrated portfolio of 26 companies in the technology, education and consumer sectors, all with a focus on digitalisation. In 2022, it posted a per-share net asset value (NAV) total return of 24 per cent, around two-thirds of which was earnings growth and the rest via multiple expansion (chiefly from exits). Top contributors included IU Group, a digital university that with 100,000 students is now the biggest in Germany, and Contabo, a cloud hosting platform.

Contabo makes for a good example of Oakley’s ‘buy and build’ strategy. Oakley uses its network of entrepreneurs to source opportunities – meaning it is often the first institutional investor in a company – and then works to professionalise management before selling, sometimes to bigger private equity firms, and at times maintaining a minority stake. Oakley invested in Contabo in 2019 alongside three entrepreneurs and sold the group to KKR last year, at a 105 per cent premium to its carrying value. 

A resilient portfolio

Oakley’s companies have features that are well-suited to a downturn. Some provide services that are a ‘must have’ in their niche, such as TechInsights, which analyses electronics and semiconductor devices and sells intelligence on how they function, enabling tech companies to try to get an edge on their competitors. Others aim to disrupt sectors with low digital penetration, which helps them continue to grow even if the wider market they operate in does not, such as Italian car insurance price comparison website Facile. Three-quarters of the companies owned by Oakley Capital have shifted or are shifting towards a recurring subscription-based revenue model, notes partner Steven Tredget. 

On one hand, having a concentrated portfolio of niche companies improves the trust’s economic resilience compared with some more diversified peers. Some funds of funds groups such as HarbourVest Global Private Equity (HVPE), for example, own hundreds of company stakes, which expose them to bigger portions of the economy and make it harder to keep track of the underlying investments.

The flipside of this argument is that concentration is also a risk, as it magnifies the impact of one investment going wrong. This in turn places greater emphasis on how well the manager picks its businesses.

Fortunately, Oakley has an impressive track record when it comes to investments, making OCI a top performer in the listed UK private equity fund space. Despite this, the trust trades at a 30 per cent discount to NAV – implying carrying values are due a big markdown – amid broad investor pessimism towards listed private equity vehicles, as the discounts among OCI’s peers show.

A handful of Oakley’s holdings are still vulnerable to economic contractions. Consumer-facing businesses account for about 46 per cent of the trust's NAV and include a £61mn investment in Time Out (TMO). The company’s share price plummeted at the start of the Covid-19 pandemic, has not recovered since and is down by 76 per cent from its 2016 IPO level. 

Time Out and sailing wear company North Sails are partly owned by the investment trust directly, rather than via one of Oakley Capital’s funds, and the board plans to sell the holdings in the short to medium term. However, as Hardman & Co analyst Mark Thomas notes, Time Out is likely to need to approach a market price “that Oakley considers reflects the value it ascribes to the business”.

Conservative valuations

Oakley’s track record of lucrative exits should go some way towards reassuring investors of the relatively conservative nature of its valuations. As of June, the portfolio had a reasonable average enterprise value to Ebitda multiple of 13.7 times.

The trust has also sought to boost transparency by moving to quarterly rather than twice-yearly NAV updates. Tredget also argues that the manager has no incentive to inflate asset values, because its management fee and performance fee are not tied to current valuations. 

While the trust uses lower levels of gearing in its portfolio companies than some private equity houses, with portfolio net debt averaging 3.9 times Ebtida as of June 2022, higher interest rates cannot be overlooked. For one, higher returns from fixed income have clearly dented the attraction of riskier investments; second, the necessity of leverage to many private equity deals means buyout firms might struggle to transact or do business as easily as they did in the era of cheap capital.

For Oakley, this could mean a more difficult environment in which to make its pitches. However, Tredget argues that Oakley is not in a hurry to sell its companies, and that the impact of higher rates is ultimately not life-changing. “We can get a 70 per cent premium to our book value [when we sell],” he says. “If we got a 60 per cent premium to our book value, we'd still be generating.” The tech-backed credentials of its companies also mean profit growth should exceed the rising cost of servicing debt.

OCI also has a solid amount of liquidity at its disposal. A the end of 2022, it had £110mn in cash, equal to about 9.4 per cent of its assets, plus a £100mn credit facility available. Meanwhile, its outstanding commitments stood at £929mn, a sharp increase from £404mn a year earlier.

Because the trust invests almost exclusively in funds managed by Oakley Capital, its commitments are tied to the manager’s fundraising cycle. Oakley Capital launched its fifth fund in 2022, to which the investment trust committed €800mn (£705mn). As is commonplace in private equity, commitments are drawn over several years (although some never are), and investors have to balance having enough cash to meet them while avoiding so much that it creates a drag on performance. 

In this sense, investing in-house is an advantage, because OCI has the inside line on when capital calls are expected. Ultimately, “Oakley Capital controls the calls from the funds, and it would be improbable that it would do anything to stretch OCI’s financial position”, as Hardman’s Thomas puts it. Then again, while Oakley’s funds are growing with each vintage, the manager is still a relatively small player, which partly explains the trust’s above-average 2.22 per cent ongoing charge.

OCI pays a small dividend to its shareholders, but this is mostly a legacy from when the trust used to have some big income funds among its owners, Tredget explains. “Philosophically, this is all about capital growth,” he says. A few other private equity trusts do pay good dividends, but as private equity is not typically an income-generating asset class, the trust is better seen as a buy-and-hold play.

Such dynamics are reflected in the trust’s listing on the specialist fund segment of the London Stock Exchange, which is targeted at “institutional, professional, professionally advised and knowledgeable investors”. Some trading platforms don’t offer OCI, and others may carry out an appropriateness test.

The most critical thing for investors to know is that private equity is best held over the long term. At its chunky current discount, this trust looks well-positioned to keep doing its thing in 2023 and beyond.