Private equity still showing value

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Shares in private equity funds have rebounded – but investors with a long-term view are still being urged to buy in.

Private equity funds are trading at a narrower discount than they were at the start of the year. The rise in the stock market means the average discount is now 40 per cent rather than 60 per cent in January. But analysts say that many private equity investment trusts still look cheap.

A number of the companies have announced they are raising capital to repair their balance sheets and put themselves in a better position to make acquisitions next year.

Electra Private Equity, JPMorgan Private Equity and JZ Capital Partners
all raised funds over the summer, while NB Private Equity Partners said it
was considering issuing
zero dividend preference shares.

While investors who choose to buy zeros in a private equity fund are not really gaining any exposure to private equity, as zeros simply repay a fixed amount of capital at a given date
in the future, the fund-
raising is viewed as a sign that the private equity funds are coming back to life.

Private equity investment trusts took a huge hit in 2008 as high levels of debt in their portfolio companies exacerbated falls in valuations, and many funds were forced to write down the value of the companies they had bought before the credit crunch.

Share prices took a tumble too, as investors sold
off any holdings that were not safe, leaving some
funds trading at 75 per
cent discounts to their net asset values. Candover and SVG Capital, two of the worst-hit funds, lost 90
per cent of their value in a year.

But now, analysts believe the worst is over.

“A lot of the strain is off the balance sheets,” says Simon Elliott at Wins Investment Trust.

“They’re all looking further down the track in hopes of great opportunities in 2010 and onwards.”

A number of private equity funds recently announced half-year results and all reported a drop in the value of their underlying assets,

However, analysts said currency differences exacerbated the falls, as many funds have holdings outside the UK and the pound has been strengthening.

Also, steps taken by funds to revalue their investments have improved investor sentiment.

SVG Capital said last month it had written down a number of investments in its portfolio, including the Valentino fashion group, which operates the Hugo Boss lines. This led analysts at Numis Securities to argue that the fund was “well-
positioned” to benefit from an upturn in the global economy.

“For long-term investors, it’s a good time to buy private equity funds,” says Charles Cade at Numis.

He recommends HgCapital, which has the strongest balance sheet of its peer group. He also recommends Electra Private Equity, which is trading on a wide discount but has a good balance sheet and fresh capital to invest after its fundraising in July.

Wins analysts recommend funds with high levels of cash such as HgCapital Trust, Electra Partners, Dunedin Enterprise and Graphite Enterprise. They think Standard Life European Private Equity and Henderson Private Equity also still offer value in
spite of a rebound in share prices.

Ian Barrass, manager of the new Henderson Private Equity fund, believes the recent fundraising marks a “turn in the tide” for private equity funds.

“I think the fact that JP-
Morgan and Electra were able to raise money could be the start of a series of fundraising,” he says.

He argues that while the discount on his fund is still one of the worst in the sector at more than 60 per cent, this was mostly due to uncertainty over the fate of New Star, which used to manage the fund until it was taken over by Henderson this year. He thinks private equity fund managers should be able to achieve an 8 per cent uplift per year in their funds from 2010 onwards.

Not all private equity funds have weathered the storm. F&C Private Equity, for example, is still in need of cash, according to a number of analysts.

The fortunes of these funds are also closely tied
to those of the stock market. The market’s rise has helped the funds so far
this year, but any correction could also mean a down-
turn for private equity shares.

In fact, some companies may now be overvalued after the sharp rise in their share prices over the past six months.

“The listed private equity sector has fully participated in the recovery in the
past six months but arguably the easy money has
now been made,” warns Alan Brierley at Collins Stewart.

Oriel analysts this week reduced their recommendation on 3i Group from “hold” to “reduce” after its share price nearly trebled since March, they argued: “We think there is a danger that the market may be getting too optimistic at the prospects of a sharp recovery in returns from the investment portfolio.

“Historically, private equity portfolios and investment valuations have tended to lag the recovery in quoted markets and we think this is likely to be the case for 3i in the reporting periods to September 2009 and March 2010.”

For now, private equity funds are not planning acquisitions as managers buckle down and focus on their existing portfolios, which could involve some cost-cutting as they try to manage the debt in the companies they own.

Investors looking to buy private equity funds are almost always urged to do so on a long-term view of at least five years.

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