Pantheon International has published results for the 12 months ended 31 May 2023 and in NAV terms it was good to see a positive return of 2.4% for the year, although this lagged the 4.3% return on the MSCI World Index. In share price terms, it is a different story as the discount widened further leaving shareholders with a return of -8.0%.
Highlights:
- Buyouts, which accounted for 71% of the portfolio at the financial year end, performed positively during the period.
- Weighted average uplift from fully realised exits was 27% and the average cost multiple on exit realisations was 3.0 times, demonstrating the embedded value in PIP’s portfolio. Since 2012, the weighted average uplift has been 31% and the average cost multiple on exit realisations has been 3.0 times.
- Slowdown in distributions in current macroeconomic environment with £223m received during the financial year, equivalent to a distribution rate of 10% of the opening attributable portfolio, resulting from realisations primarily to strategic buyers and to other private equity managers. After funding £155m of calls, this resulted in net cash inflow from the portfolio of £68m.
- The average age of the trust’s assets at the financial year end was 4.8 years (31 May 2022: 4.9 years).
- As Pantheon International increased its allocations to co-investments and single-asset secondaries, approximately 52% of its portfolio was invested directly in companies at the end of the period. [Ahead of these figures, we hadn’t appreciated the degree to which Pantheon International had transformed itself from a fund of funds to a mix of funds and direct investments in companies.]
- During the period, £441m was committed to 25 new investments, of which £180m was funded at the time of purchase. During the year, the company invested about £20m in buying back 7,600,183 shares.
- Net available cash was £63m as at 31 May 2023. This is in addition to its undrawn multi-currency revolving £500m credit facility that is due to expire in July 2027.
- Pantheon International’s undrawn commitments were £857m at the period end, of which £48m relates to funds that are more than 13 years old and therefore outside their investment periods.
- The trust’s undrawn coverage ratio, which is an indicator of the company’s ability to meet its outstanding commitments even in the event of a market downturn, was 98% as at 31 May 2023.
Extracts from the chair’s statement
The chair John Singer squarely addresses the trust’s discount problem in his statement:
Whilst [Pantheon International’s discount] is typical of the whole [listed private equity] sector, it presents a challenge, implying that the market does not believe the integrity of our NAVs, despite our long history of delivering significant uplifts to NAV when we realise our investments. The current discount, however, also represents an exciting opportunity that we intend to seize on behalf of shareholders.
Working with Pantheon, we are revising our capital allocation policy, which in the past has not taken sufficient account of the returns to be generated by reinvesting in PIP’s portfolio when the discount is high. By using buybacks, we are effectively committing capital to a portfolio that we know well and in whose asset value we have faith. At high discount levels, most obviously the current 40% for example, the resulting improvement to NAV per share is significant and immediate. In addition, in order to take advantage of the opportunities, especially those created by the current market dislocation, and for broader portfolio composition considerations, we will continue to make other investments alongside buybacks.
The Board has therefore decided upon three key initiatives:
Firstly, given the material discount at which the company’s shares are currently trading (42% at the time of writing), PIP intends to commit up to £200m during the current financial year to invest in its portfolio by acquiring its own shares in order to capture this value for shareholders.
Secondly, the board intends to implement an extension to its capital allocation policy with effect from the next financial year. This policy will dedicate a proportion of the company’s net portfolio cash flow to share buybacks. The exact proportion will be determined by reference to the prevailing discount to NAV at which the company’s shares trade and will be reviewed periodically.
In this way, the wider the discount at which the company’s shares trade at any time, the more attractive the reinvestment opportunity will be and thus the greater the proportion of net realised cash flow channelled to share buybacks whilst also reinvesting to participate in the best private equity opportunities. Further details of the policy will be announced in due course.
In determining the level of £200m to be committed to repurchasing PIP shares, which represents approximately 15% of PIP’s current market capitalisation, your board has been very mindful, as you would expect, of the impact on our balance sheet, and in particular the likely headroom on our credit facilities at a time when portfolio distributions are at relatively low levels. We believe this to be a significant but nevertheless prudent amount for two reasons.
Firstly, at the end of June, PIP had £60m of net available cash and £500m of unused credit facilities. Secondly, since a majority of PIP’s new investments are now made on a discretionary basis to individual co-investments and secondaries, it is possible to manage our cash position at relatively short notice by dialling those down if the outlook worsens, which would not be the case if the whole portfolio were committed to primary funds whose drawdowns are not within PIP’s control.
The third initiative is to redouble our marketing efforts to broaden the investor base for PIP in order to increase demand for PIP’s shares. In seeking to do so we are mindful of the fact that when investment trusts were created in the late 1880s, their objective was to democratise investing through allowing smaller investors to diminish risk by spreading their investment over a number of stocks. We view this as being an important part of PIP’s raison d’être today.
The best PE funds are “invitation-only”, and attractive co-investment and secondary opportunities are obtained through close relationships with top quality PE managers. Also, PE managers invariably require a high minimum level of investment in their funds. So it is not possible for many investors to access these types of investments directly, nor to build up an appropriate degree of diversification to spread the risk. PIP offers immediate access to a global, well diversified, high-quality portfolio of private companies for all types of investors, and is therefore an ideal vehicle through which both institutions and individual investors can achieve an appropriate allocation to private equity. Furthermore, since access is enabled through the purchase of shares traded on the stock market, liquidity is provided in an otherwise illiquid asset class.
[The £200m buyback commitment is very welcome and should hopefully stem the trend of discount widening. Adopting a more formal share buyback policy is also a good idea although we reserve judgement on that until more detail is announced. More emphasis on marketing is a ‘no-brainer’ in our eyes. In that vein, we are pleased that Helen Steers will be our guest on the weekly news show on 11 August.]
Extracts from a summary of Q&A with shareholders
Why do we have confidence in the value of PIP’s portfolio in today’s markets?
As I mentioned, the discounts indicate that the market does not believe in the stated net asset values of listed PE vehicles, particularly when market sentiment is generally unfavourable. Since PE valuations are based on the latest figures provided by our managers, which can be a month or two in arrears, one of the stated reasons is that, when markets decline, the valuations are overstated and will come down over time. Another reflects a concern that PE managers are too optimistic and do not bring their valuations down in line with the prevailing outlook. In a risk-off environment there is also a tendency for the higher perceived risk of PE, owing perhaps to leverage and the greater fragility of small companies, to lead to a greater sell-off than in other asset categories. In addition, PE vehicles recently have all been affected indiscriminately by the sharp decline in quoted technology valuations that took place during 2022.
We understand these concerns but believe that they are not justified in our case by the facts and past experience. Firstly, the evidence shows that when our PE managers sell an investment, the average uplift over their latest prior valuation is substantial. Last year, this uplift was 27%, indicating that our valuations relative to market are conservative rather than overstated. Since 2012 our average uplift has been 31%. Secondly, good managers have no incentive to overvalue their investments, partly since their remuneration is not linked to those valuations, but also because they would rather surprise their investors on the upside than the downside. Thirdly, we believe that the risk of PIP’s highly diversified portfolio, supported by highly experienced managers, is no greater than that of a diversified portfolio of public equities. Fourthly, through its close relationship with most of its managers built up over the years, supported by its presence on 585 advisory boards worldwide, Pantheon regularly probes the underlying valuation methodologies that they use. Finally, in the case of PIP, our exposure to venture capital investments of the kind that experienced a sharp pullback last year is only about 3% of the portfolio. Further details of the valuation methodologies used are set out below in this report.
Your Board therefore believes that now, as before, PIP’s net asset value tends to be conservative rather than the reverse, even when the prevailing outlook has turned negative.
[This is a key message that we keep repeating – even now, most private equity NAVs are more likely to be under- rather than overstated.]
Why does your Board feel that the risk of PIP’s diversified portfolio is no greater than that of an average portfolio of listed equities?
The PE model has a number of advantages over that of a publicly listed company. The PE fund managers with whom Pantheon works are led by experienced investment executives who are sector specialists and know the markets and the environment in which their companies operate extremely well. They are then complemented by a team of operating executives, all of whom have had proven experience of improving the performance of companies. Members of this operating team work with the management of their portfolio companies to improve operations in the areas where they are deemed to be weak. In the majority of their investments, particularly in buyouts which comprise over 70% of PIP’s portfolio, the PE fund as shareholder owns a majority share of its portfolio companies and is therefore able to exert a considerable degree of influence, including the ability to change the CEO or other senior managers. PE fund executives know their portfolio companies well and, through close collaboration with their management teams, decisions can be taken quickly and problems addressed at short notice. Portfolio companies also have immediate access to capital, should this be required to take advantage of acquisition opportunities or support the business through times of unexpected difficulty.
Compared to publicly listed companies therefore, these factors mean that PE-backed companies typically have quicker decision-making capabilities, more resources to make acquisitions or access other cash needs at short notice, shareholders who understand their businesses and markets in detail, immediate access to resources to effect operating improvements, managers who are highly incentivised to grow their businesses, and the ability to be much more nimble.
Another important factor is the composition of PIP’s portfolio and the likely resilience of its underlying companies in the face of a downturn. As mentioned, over 70% of PIP’s portfolio is in buyout investments of well-established companies, many of which are mid-market businesses with attractive growth and margin profiles. Of the remainder, the vast majority is in smaller growth companies, mostly with strong market positions and defensive characteristics in attractive industry sectors. Only a small proportion are in loss-making businesses or in early-stage tech businesses, which can be highly volatile in both performance and valuation. Furthermore, PIP’s portfolio businesses have been selected for investment by experienced sector-based investors in attractive market areas with long-term thematic growth drivers. The degree of leverage in most of PIP’s portfolio companies is relatively modest and lower than that typically prevalent at the top end of the market, which is the source of much of the negative market commentary about leverage.
….the average revenue and EBITDA growth of a large sample of PIP’s buyout portfolio companies is significantly higher than that of a portfolio of listed companies. Since growth over time is the principal driver of investment value and a source of value resilience in difficult times, this also suggests that PIP’s portfolio valuation is likely to be more resilient than a comparable public portfolio.
How is the rising interest rate environment affecting our portfolio companies and our management of PIP’s balance sheet?
Since interest rates have risen sharply over the last year, shareholders are naturally concerned about the impact that this is having on PIP’s portfolio companies as well as on the management of PIP’s balance sheet.
We consider the impact on portfolio companies to be at two levels: firstly, the impact of rising interest rates on the cost of their debt, and secondly the fact that as interest rates rise, earnings multiples and therefore the valuations of businesses tend to decline.
The managers that PIP backs and the single-asset secondaries and co-investments in which PIP invests directly are focused primarily on growing businesses that are cash-generative and where the value creation comes from growth, operating improvements and acquisitions rather than leverage. The average debt multiple for our small-to-mid buyout investments, which constitute almost half the portfolio, was 4.2x compared to the industry average of 5.9x, while the growth and venture investments have very little or no leverage.
Furthermore, where companies do have leverage, a significant proportion of their debt is either at fixed rates or protected by interest rate swaps. So far we have seen little stress from the rise in interest rates in either our direct holdings or our fund investments, based on feedback from our managers.
In terms of valuations, while the multiples used by our managers have contracted when appropriate in line with market comparables, the underlying growth in much of the portfolio has compensated for that, which is why PIP’s NAV has remained relatively static in spite of the decline in multiples since the beginning of 2022. This is why we are confident in the valuations provided to us by our managers and the NAV of PIP.
Turning to PIP’s balance sheet, we monitor the outlook carefully, run stress test sets of projections and take a prudent view at all times. This has become particularly important recently, as we have seen the distribution rates decline to levels similar to those experienced in 2008 and 2009.
Over the last financial year the annualised distribution rate from the portfolio declined to 10% of NAV, resulting in distributions of £222.5m, while calls, which were also below average at 21% of commitments, led to a cash outflow of £154.8m. In these less favourable conditions, the portfolio nevertheless generated a net cash inflow of £67.6m, leaving £63m of available cash on the balance sheet at the year end. The cash position and our £500m of unused credit facilities has led us to feel comfortable about our decision to commit up to £200m to invest in our own portfolio by buying back PIP shares (subject to discount levels), even if the environment worsens to that which combines continuing low distribution levels with a step-up in calls.
PIN : Pantheon International wades into discount battle