Scottish Mortgage (SMT) has announced that its board has taken the decision to make at least £1bn available for buybacks over the next two years. The trust says that its public and private portfolio is delivering strong operational results, with free cashflow from the portfolio companies having more than doubled over the past year, and that, collectively, portfolio companies have adapted to a higher cost of capital and are funding their future growth. In addition, over recent months, SMT’s balance sheet has been strengthened via debt reduction, leaving invested borrowings at 13% of net assets, at an average interest rate cost of 3.2%. These two improvements have given the SMT’s board the confidence to take more concerted action to address SMT’s discount to net asset value.
SMT says that, when allocating capital, a range of factors are considered including the level of gearing, exposure to private investments and general market conditions. Currently, private companies represent 26.2% of the portfolio, which would rise to 28.3%, assuming £1 billion of share repurchases at current market levels. Over the last two years, SMT has repurchased approximately £353m of its own shares. SMT comments that share buybacks are a key component of capital allocation decisions and that, during the last two years, the Board and managers have been actively considering increasing the level of buybacks. SMT comments that buybacks provide shareholders with significant benefits including improved liquidity in SMT’s shares, an immediate accretion to the net asset value per share for remaining shareholders and, in its view, a strong demonstration of confidence in the underlying valuation of the portfolio.
Comments from Justin Dowley, chair of SMT
“We remain committed to using share repurchases strategically to enhance liquidity in our shares and to seek to facilitate trading around net asset value. Our Company has a strong balance sheet, and its portfolio companies are delivering strong operational results. We are acting upon this investment opportunity by materially increasing the capital available to our liquidity policy over the next two years with the aim of maximising returns for our shareholders.”
Comments from Tom Slater, the manager of SMT
“In a volatile period for growth investment, we own a portfolio of established companies achieving rapid expansion, propelled by enduring structural trends. Advances in foundational technologies are unlocking exciting new products, services, and business models. These well-funded public and private companies are shaping the future of the economy. The stock market has yet to fully recognise their progress, which creates the opportunity for us to buy the portfolio for less than its market value. In doing so, we can provide liquidity and augment returns for our shareholders. We intend to pursue this opportunity with conviction.”
[QD comment: We are pleased to see the board of Scottish Mortgage stepping up its efforts to address the trust’s discount. It is no secret that, on the back of its very strong performance, SMT raised a lot of money from investors, when interest rates were low and its strategy was very much in favour. We have long believed that where funds have taken in a lot of capital in the good times, they should also be prepared to provide their shareholders with liquidity when times are tougher and the fact that SMT has some illiquid assets does not make it immune from this. Irrespective of the underlying asset class, buybacks should always be done in a measured way that also protects shareholders’ interests. It can be harmful to shrink a fund and make it subscale and, for funds with illiquid assets, value could be eroded should a trust aggressively fund buybacks to the extent that it does not have sufficient cash to fund follow on investments when needed. Size is not an issue for SMT and the board and manager have clearly been cognisant of the risk of not being able to provide liquidity where required. A bigger concern for us is the level of buybacks that SMT is committing too. £1bn sounds like a lot but is around 9% of the fund’s market cap today, or 4.5% per year once this is spread over two years. This is a decent start and should shift the discount but may not be enough to move it back to where it has traded historically. However, with inflation and interest rates past their peak, SMT’s style could come increasingly back into favour. If so, it may not need all of that firepower and it might not be so long before it is issuing stock and growing again.]