28th January 2022
Last week we came out in support of the aims of AVI and their co-investors in their efforts to improve the governance standards at Third Point Investors Limited. I mentioned that we often find AVI as co-investors on the registers of investment trusts and companies we own. This is not surprising given our shared aims of improving corporate governance in recognition of the returns shareholders can earn when this happens. One such example is Oakley Capital Investments, a listed private equity investment company that we have mentioned a few times in this blog (see here for example).
This week Oakley announced a fantastic trading update, detailing how Net Asset Value (NAV) rose 21% in the second half of 2021, with over three quarters of this gain coming from fundamental performance (i.e. underlying investee company earnings growth), and the balance from multiple expansion, including the realisation of one of their investments at a 125% premium to carrying value. We first invested in Oakley in April 2018, and although we have added and trimmed many times since then the investment has compounded at 28% per annum since that first investment.
At the time of our investment, the Company was trading at a discount to its NAV of over 30%. The Company was beset with a terrible image problem: the Board had previously issued shares at a discount to NAV, the Board was accused of not being independent enough and information flow was not free-flowing. However, both the Board and the investment adviser were not deaf to these criticisms. While the Board still contains some non-independent directors, the independents are in the majority. Insider ownership both by the Board and the investment adviser (Oakley) is high, as outlined in our last blog on Oakley, these insiders now own c. 11% of the shares. The Company have bought back millions of shares – and even cancelled them. This latter point is significant in our eyes. Buying back shares is not done frequently enough by investment trusts and companies. Even when it is done, these shares are too often just placed in treasury. The cynic might worry that these shares could be sold back to the market at a discount to NAV again. By cancelling the shares, the Board of Oakley have signalled to the market their intent to act in the interests of shareholders by locking in the accretion to NAV that buying back shares at a discount creates. This also shrinks the trust, something that many Boards are loath to do in the name of liquidity reduction – even when doing so is clearly in the interests of shareholders.
As a brief aside, all too often share buy backs are characterised as tools to narrow discounts. They are not. Share buybacks are a means for a Board to act in shareholders’ interests and improve NAV/share. It is a capital allocation decision, and should a discount narrowing result, then that is up to the voting mechanism of the market. Our contention is that good governance and capital allocation will eventually be rewarded by a narrowing discount.
Finally, Investor communication has been excellent for many years under Oakley’s IR team and this year the Board will move to announcing NAV updates on a quarterly basis (as opposed to six-monthly currently).
All this has driven the discount in to a very narrow single-digit percentage prior to the latest NAV announcement. BUT: underlying all this excellent corporate governance improvement is the fact that Oakley are very good at what they do. The portfolio has grown NAV at a CAGR of 20% for 5 years now. This means the share price has to work hard to keep pace with the Net Asset Value. So, even after Wednesday’s 10% appreciation in share price, the discount to NAV remains 22% due to the performance of the portfolio over the prior 6 months!
With a Board committed to narrowing this discount, and an investment adviser having constructed a portfolio of underlying investments growing very quickly, this makes for powerful drivers of shareholder returns. Moreover, the portfolio still remains conservatively valued (we’ll learn more on 10th March when the company reports audited results) and of a vintage where we might expect more highly profitable realisations to further drive NAV growth beyond earnings growth.
We often hear that many investment managers around the country are put off private equity by high fees and the sins of bad actors 15 years ago. Madness. They are missing out on one of the best growth opportunities available to them.
Ben Conway – Head of Fund Management
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