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Chrysalis Investments managers: “sustained rates of growth drive outsized returns”

Richard Watts and Nick Williamson of Chrysalis Investments explain how crossover investing has huge growth potential
August 26, 2021
  • Chrysalis has seen huge growth from backing late-stage private companies
  • The investment managers explain what they look for and why they are optimistic about more growth to come

Richard Watts and Nick Williamson set up Chrysalis Investments (CHRY) in November 2018 to take advantage of the trend of companies listing later. While the launch was a little disappointing with the trust raising £100m, half what they had hoped for, it has gone on to be a resounding success. 

Making their names at Merian Global Investors (since acquired by Jupiter Asset Management) managing open-ended UK small and mid-cap funds, Watts and Williamson frequently participated in initial public offerings and saw rising numbers of companies exploring their IPO options before deciding to stay private for longer.  

Watts says the trigger point was when he met The Hut Group (THG) in 2017, which he viewed as a great investment but was clearly a number of years away from an IPO. They met Transferwise (now WISE) later that year and, realising they wanted to invest more in private companies, set up Chrysalis to provide an appropriate ownership vehicle for unquoted assets. 

Chrysalis is designed to provide permanent “crossover” capital. This means the managers buy late-stage private equity companies and own them through flotation. Watts believes there is a gap in the market for crossover investors because seed, angel and venture capital investors have finite investment periods and are often looking for liquidity before a company wants to list. 

Watts and Williamson look for companies that are growing quickly and have the capacity to keep doing so. This includes businesses that have a sustainable competitive advantage, whether it's the unit economics or the intellectual property around a product or service, that gives a sustainable competitive advantage that allows a business to carry on growing more quickly than people expect. “It is the sustained rate of growth that has really driven outsized investment returns,” Watts adds. 

Chrysalis now boasts a market capitalisation of £1.43bn and its share price rose by 93 per cent for the year to 24 August. Its latest funding round, in March this year, raised as much as £300m from investors keen to access its buoyant returns. The fact the trust has managed to reach such scale makes it appealing to companies looking for shareholders to help them come to market.

“I think we are seen to be very attractive to a number of entrepreneurs,” says Watts. “We’re definitely viewed as long-term investors. If you look at the [other] funds that we manage, many of the companies in our portfolios have been in from very early days at the point of IPO.” The reputation Williamson and Watts have built up is important because private companies can be picky about who they choose as investors.

Williamson adds that even in the past couple of years, “more and more companies are starting to understand the power of crossover investing, and more companies are looking for this type of money”.

 

 

The portfolio

Following the announcement of two new investments this month, the trust now has 17 positions in companies the managers believe are truly innovative with exciting growth prospects. This is at the higher end of the number of holdings the managers will ever look to have, as they believe the portfolio should be a concentrated mix of their best ideas. 

The trust’s largest holding is Swedish ‘buy now pay later’ payments company Klarna, which has seen phenomenal growth in recent months and is now Europe’s largest fintech company, valued at around $45bn in June. That’s up from just $10.6bn last September and means the firm now represents 25 per cent of the Chrysalis portfolio. While the ‘buy now pay later’ model has received some criticism for encouraging people to spend money they may not have, Watts and Williamson defend it by saying it provides a very cheap form of finance as users do not have to pay interest, enabling people to buy goods they might not be able to afford otherwise. 

Williamson says Klarna and other ‘buy now pay later’ apps are overhauling the traditional credit card system, which has historically been funded by people who can’t afford it and are paying off interest every month.  

“The credit card model is founded on the basis that the people less able to pay are the ones who are funding everybody else.” Williamson says. With Klarna, and other 'buy now pay later' providers, he says “the merchant is socialising the credit cost across all consumers”. He adds that credit card companies have been the most vocal against ‘buy now pay later’ because they view it as a threat to their business model.

Despite its significant valuation uplift, Watts says Klarna is still priced at a "big discount" to listed peers. "For most of the period we have owned Klarna it was valued at seven or eight times forward enterprise value (EV) to sales multiple where the listed peer group was on about 20 times," he says, adding that the recent funding round brought it to a 13 times forward EV-to-sales ratio. Defending the size of the trust's position in Klarna, Williamson says that most returns come from picking a few assets well and, had they sold Klarna earlier, that wouldn't have benefitted shareholders.  

Starling Bank is the trust’s second-largest holding, making up 10.8 per cent of the portfolio. Watts and Williamson favour Starling Bank over rivals Monzo and Revolut because the company has more of a banking angle and has achieved profitability at a much smaller size than Revolut did, with Monzo yet to turn a profit. 

Williamson says: “As we sit here today, you’ve got a company that is profitable with a loan-to-deposit ratio of only about 37 per cent, give or take. Most banks operate at 100 per cent.” As Starling Bank continues to grow its loan book, Williamson thinks it will become extremely profitable. Revolut, meanwhile, is still in the process of applying for a UK banking licence.   

Other financial institutions held in the trust include recently-listed Wise, Smart Pension and Embark Group, soon to be bought by Lloyds. Financials make up 38 per cent of the total portfolio. Williamson and Watts say: “We have invested extensively in financial stocks in the listed world throughout our career, so it’s a space we understand inside out. It’s also a sector we see the limitations of. We appreciate the business models of many of the fintechs are trying to disrupt existing markets and we see strong value in those who are able to do so successfully.”

They add that the background to the current fintech opportunity really lies in the UK’s stature as a global financial leader. This has meant there’s been an extensive talent pool from which fintechs can recruit with knowledge of the financial sector and expertise to grow strong businesses.

The trust’s latest additions – both added earlier this month – are Warrington-based developer of consumer technology products Tactus Group and the US parent company of Basingstoke-based software developer InfoSum. Tactus is aiming to become the go-to e-commerce group for gaming and computing globally, while InfoSum was founded in 2016 with a vision to connect the world's data without ever sharing it. The latter has multiple patents, protecting its invention of the 'non-movement' of data.

 

Chrysalis Investments holdings% of portfolio
Klarna25.3%
Starling Bank10.8%
Wefox7.8%
The Hut Group (THG)7.5%
Wise (Wise)5.7%
Smart Pension5.4%
You & Mr Jones5.0%
Graphcore4.9%
Embark4.7%
InfoSum3.4%
Deep Instinct3.4%
Revolution Beauty3.2%
Tactus2.9%
Featurespace2.7%
Secret Escapes2.3%
Sorted1.2%
Growth Street0.1%
Cash3.7% 

Source: Chrysalis Investments, 18 August 2021

 

Looking forward

Watts says the key difference between Chrysalis and funds that buy listed equities is the growth rate. He says that on a blended basis, revenue growth across the portfolio is just under 80 per cent, which is “much much faster than listed peers”. Williamson says that they frequently compare valuations to listed peers, and using their experience of investing in IPOs ask “if this was listed, what would it be valued at?” to make sure they are on the right side of market multiples.  

Currently the net asset value (NAV) of the trust is valued on a quarterly basis, which is why the share price and NAV can see large dislocations. Valuation uplifts in companies such as Klarna and Starling Bank, for example, took time to feed through into the NAV, which left the trust appearing to trade at a very large premium, 41.8 per cent at its highest according to Winterflood data. Watts says they are looking at ways to make NAV publication more timely but because it is carried out by an external valuer, IHS Market, it is not straightforward to speed up. 

Listen to the podcast version of the interview here.