Why UK investors should value privacy
Why UK investors should value privacy
Adding private equity to listed UK equity exposure can hugely expand the opportunities available for investors. That said, accessing the best deals depends on relationships, reputation, resource and reliability.
How the private equity landscape has changed
Since the global financial crisis the private equity market has been growing rapidly in size and sophistication. Over the past five years alone, global private equity investment has risen from $2.9 trillion to $4.6 trillion.
At the same time, the number of listed companies continues to trend downwards. Indeed, the number of public companies has roughly halved since the mid-1990s. Since 2000, the number of annual initial public offerings (IPO) – companies floating on exchanges - have been around two-thirds of the level of the previous 20 years. In the UK, the number of companies trading on the stock exchange has been steadily declining since 2015.
There are numerous reasons for this, some of which have strengthened over time. Some UK companies that have considered an IPO have simply floated elsewhere, where listing requirements, liquidity conditions and valuations have looked favourable. More generally though, the IPO process can be expensive, and there are significant and ongoing costs of being a public company. Listing comes with regulatory demands and potential concerns over short-termism in the investor base.
It’s important to note that we believe there are plenty of opportunities to generate value in listed UK equities, especially now. With the Brexit deal announced, a key impediment to UK growth has been removed, and the UK’s vaccine rollout is proceeding ahead of almost every developed economy. There is significant potential for expansion in the short to medium term, which will be good news for UK plc.
However, an investor limiting their exposure to only listed UK equity risks overlooking a huge part of the full opportunity set. Considering private equity – where appropriate – opens up tremendous potential.
The power of private
One of the key reasons companies are choosing to stay private for longer (or indefinitely) is simply because they can.
Private equity’s firepower has grown remarkably. It is now possible to raise sums of money privately that would have been unthinkable outside of public markets in the past. Google had only raised $25 million privately before it joined the stock market in 2004. Contrast this with ANT Financial, the Chinese online payments company, which raised $14 billion privately in 2018 alone.
With rising popularity comes increased amounts of capital in the private equity asset class seeking deals. This had led to concerns that private equity valuations are being bumped up. This is a risk that we are very alert to. The combination of uninvested “dry powder” and elevated public market valuations - a factor in private equity valuations - have indeed contributed to some deals looking expensive.
But there is a relatively large gap in valuation multiples between small and large buyouts. While large deals are susceptible to greater pressures of capital and demand, small and mid-size deals are often kept away from auction processes; these deals are our focus. Working closely and building long term relationships with high quality general partners (GPs) - the fund managers that initiate private equity funds - can grant direct access to such deals.
The benefits of specialist GPs
More specialisation by GPs means deeper and more thorough understanding of the operational risks of a company due to the focus on a given sector.
Operational risk is often lowered when dealing with specialist GPs. This is because they focus their resources on just one or two areas of expertise, compared to generalists who have exposure to a wider range of sectors.
A sector specialist is also likely to have better access to bolt-on acquisition targets that can drive further transformational growth in the underlying company. They also often have more in-depth relationships with key stakeholders in any sector. This can enable new commercial opportunities to be identified and pursued, again acting as a lever for further growth
Additionally, by dealing with specialist GPs we are better able to align our exposure with key megatrends. We anticipate that a large proportion of returns for the coming decade will be driven by a handful of key megatrends.
- Increasing globalisation
- An aging global population
- The rise of artificial intelligence and machine learning, and other technological advancements
- The energy transition and move towards cleaner technologies
The sector split of private equity in the UK is such that it is especially well exposed to these themes. British advances in fintech/payments, pharmaceuticals / biotech, “deep tech” and business services will drive them.
While the benefits of investing with quality, specialist GPs are in our view self-evident, gaining access to these partners in the first place is far from a given. Risk assessment in private equity is bi-lateral. That is to say, it is in the interests of a GP to ensure they are partnered with reliable investors (Schroder Adveq acts as a limited partner when investing in funds) who will execute their parts of a transaction efficiently and will become long-term partners over multiple vintages.
There is little that a listed company can do to prevent an investor taking an interest in their company. Not so with private firms.
To ensure the best deals are available for participation, a private equity partner needs to be of strong standing in the industry. Proving yourself a valued and reliable limited partner to GPs takes long-term presence, expertise and extensive resources in terms of capital and personnel.
Watching the exits
There are significant benefits to private equity exposure, but certain niches in the market carry specific risks.
It is important to diversify these risks by considering investments across all stages of private equity, from venture stage to growth, pre-IPO stage to buyout. Focusing on only one of these areas could give rise to specific risks that should be mitigated through diversification.
For example, focusing purely on pre-IPO as an investment stage could expose an investor to valuations that might be unsustainable if the IPO market weakens. It also significantly narrows the investment universe from which to select opportunities. We think there are some exciting prospects at the pre-IPO phase of their development and we are delighted to be invested into some of these names. Even so only a very small number of private equity owned businesses ever actually IPO..
We therefore prefer to have a broader universe of investment opportunities to select from. These may ultimately go on to be purchased by trade acquirers or larger private equity investors or - in less than 10% of cases we fee it must be noted - will go on to IPO. Keeping your options open and wide increases your investment selection universe, reduces risk and potentially increases exit valuations.
“Unheard of to many “ - getting at the best opportunities
We recently completed an investment in a classic “buyout” opportunity, in a company called The Learning Curve. This is a leading independent education and training provider in the UK, offering face-to-face and remote learning options to its customers. This opportunity was sourced via one of our longstanding relationships and as such put us in a unique position to be able to gain access, evaluate and ultimately invest into this opportunity.
Another recent investment was into one of the UK’s highest profile growth opportunities, Graphcore. This is a UK business with extraordinary technology that we believe has significant global potential in a rapidly growing market.
We have followed the business since we met the CEO over five years ago. It has achieved a tremendous amount already, but we expect to see even greater progress in the next few years. We join several other high calibre investors but we were able to access this opportunity at this time given our ability to invest into both private and public companies.
In our due diligence exercise we worked closely with our public markets analysts to develop an even deeper understanding of the technology and opportunity.
Rapyd is another example of what we believe is an exceptional business in a huge global market, demonstrating particularly strong growth. As with many of the best opportunities in private equity, this is a company which will be unheard of to many. We expect that to change. As it builds on its established technology, supporting smaller companies in developing their payment solutions efficiently around the world, we believe it will become a global name.
Exploring new hunting grounds
For “UK Plc” the coming five years looks especially exciting, but we feel many of the prospects with the greatest potential are privately held. The growth in sophistication in private equity markets means investors can accurately target key themes, via specialised GPs, at an early stage via nascent or rapidly growing companies.
Individual themes can be exploited through dedicated GPs with highly specialised skillsets. Perhaps most importantly, private equity is no longer the preserve of large institutions. There is a huge opportunity for retail investors to be able to access the superior returns that private equity has offered over the last 20 years. We strongly believe that this asset class should be accessible to all.
Any company references are for illustrative purposes only and are not a recommendation to buy and/or sell, or an opinion as to the value of that company’s shares. The article is not intended to provide, and should not be relied on, for investment advice or research.
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