The value creation that Private Equity can bring to businesses, by contributing expertise across strategy, M & A and process enhancement is well documented and particularly applicable to private family or founder owned companies. This value creation comes when growth is accelerated through customer expansion, operational efficiencies are improved,  cost are reduced,  IT systems are implemented and additional talent is employed.  In an analysis of the US Private Equity mid-market, Adams Street Partners found that over 70% of value creation either came from revenue growth or multiple expansion largely as a result of business process enhancement, as opposed to value growth through financial engineering or debt leverage, which is often the perception of how value is created.

What is possibly more important but less well-documented is the value that is created through the "art of the exit": being able to determine the right time to sell and identifying the best method of selling a company to maximise investor returns. 

There is a common misconception that the primary source of equity release or exit from a private equity fund's portfolio comes from an Initial Public Offerings (IPO) and listing on a public share market, which was predominately the case in the late 1990's and early to mid 2000's where there were a number of high profile Private Equity IPO exits that generated significant returns for private equity investors.

However, there are at least three main methods of equity release that Private Equity fund managers consider when planning to exit a business, often years in advance of the actual exit outcome:

1. IPO: by listing a company on a public exchange, a seller can often achieve an optimal pricing outcome by removing the discount that is typically applied to unlisted business valuations.  Further premiums can be achieved by listing when equity markets are more buoyant making timing an important decision.  As attractive as IPO's may seem, one drawback to an IPO as the primary source of an exit for Private Equity backed businesses is that IPO windows, that is those periods where public investor appetite exists to buy new listing opportunities, can rapidly close and we have seen this occur recently with a number of high profile IPO's being withdrawn due to a reduced level of support from brokers and their clients.  Another drawback can be that after listing, sellers need to retain equity in the listed company which introduces market risk that is not desirable for most private equity investors.
2. Trade sale: Selling to a larger or listed company often in the same industry sector who may be looking to expand their existing operations to other geographic regions or to add to their existing product or service offerings.  These exits can attract premiums in situations where the purchaser is listed and trading at a higher earnings multiple thus gets an automatic uplift through multiple arbitrage.  Alternatively, there are private buyers who may be prepared to pay a premium for a business that provides a strategic platform to launch a new growth initiatives.
3. Secondary Sale to a global private equity fund or institutional investor: These exits often occur where an acquirer is looking to either achieve a long term yield on the dividends from an acquired company or otherwise seek to expand the existing companies offerings to an expanded global market.

Private equity managers add significant value when it is time to sell / exit a portfolio company by allowing the company's executives to remain focussed on growing the business while the private equity managers utilise their expertise to pinpoint the right method and time to achieve the best price for the sale of the business.

In this article we will look at examples of some recent exits from the Vantage's Private Equity Growth Fund portfolios (VPEG2 & VPEG3) to illustrate how Vantage's private equity managers are able to generate significant returns for Vantage Fund investors:

1. IPO: Lynch Group

During April 2021, VPEG2 underlying fund Next Capital Fund III, completed the fully underwritten bookbuild for the IPO of portfolio company Lynch Group. Lynch Group successfully listed on the ASX on 6 April 2021, raising ~$206 million at $3.40 per share. The transaction followed a transformational investment period for the Company across the 5.4 years of ownership by Next Capital.

ynch Group has evolved from predominantly an Australian supermarket wholesale business with a fledgling growing asset in China, to the largest Asian vertically integrated grower and multi-channel wholesaler of cut flowers and potted plants across Australia and China. Next Capital sold ~50% of the fund's shareholding into the IPO. The remaining ~17.0% holding will be in escrow until release of Lynch's audited 1H FY22 financial results in March 2022. This IPO exit delivered Next Capital Fund III and its investors, including VPEG2's investors a strong multiple of invested capital.

2. Trade Sale: MessageMedia

During June 2021, Vantage's VPEG2 & VPEG3 underlying funds Mercury Capital Fund 2 (MCF2) and Fund 3 (MCF3) announced the sale of MessageMedia for USD$1.3 billion (AUD$1.7 billion) to Sinch, a leading global cloud communications business listed on the Nasdaq Sweden. This exit marks an excellent investment for Mercury Capital Fund 2 and Fund 3 and is representative of the strong partnership that Mercury formed with the founder Grant Rule and the management team.

Following MCF2's investment in MessageMedia in August 2018, the business transformed from a primarily Australia and NZ based SMS provider to the leading global Server Message Block (SMB) Customer Engagement platform. MCF3 subsequently made an additional investment in MessageMedia during November 2019, which further supported the business's transformation in rebuilding the management team, consolidating the platform and the successful add-on investment of US-based messaging platform SimpleTexting. Once completed, the sale will deliver MCF2 and 3 investors, including VPEG2 & VPEG3 investors with an exceptionally strong return on investment.

3. Secondary Sale to Institutional Investor: iseek

During June 2021, VPEG2 underlying fund Next Capital Fund III announced the sale of iseek, Australia's leading cloud, Data Centre and Connectivity provider to a UK based Information Technologies and Telecommunications Infrastructure Fund.

Following Next's acquisition of iseek in August 2018, management have heavily invested in the construction of two state of the art physical data centres in Brisbane and Townsville and captured material contract tenders from large state government agencies and tier one corporate clients. These initiatives, along with the industry tailwinds of organisations outsourcing data storage providers, positioned the business to have a strong long-term opportunity set, representing an attractive investment for the international acquirer. The sale of iseek will deliver another robust investment return to Next Capital Fund III investors, including VPEG2 investors.

All three of these transactions will result in excellent performance outcomes for our investors.  In fact, across the June 2021 quarter, five underlying company exits were either completed or announced from Vantage Fund portfolios. These exits will deliver Vantage's Funds an average gross 4.9 X return on invested capital, representing an average gross Internal Rate of Return of 73.9% per annum.

MORE EXITS PLANNED FOR THE SECOND HALF OF CY2021

The market environment and economy generally remains very supportive of exits at the moment and a number of other companies across Vantage's portfolios are also positioning for exit across the second half of 2021. As managers across each of Vantage's Funds position each underlying company for sale, the number of exits from each Vantage Private Equity Growth Fund portfolio is expected to increase. These exits will ultimately provide Vantage Fund investors with an increase in returns and further distributions, providing a robust platform for each Vantage Fund to deliver their targeted returns to investors over the term of each fund.

Vantage Private Equity Growth 4 (VPEG4) remains open for investment to new investor until 30 September 2021.

Please click below to access further information about VPEG4

A few weeks ago, I hosted some teenagers from an East London school on a (virtual) visit to learn about the investment business. In search of common ground, we focused on environmental, social and governance (ESG) questions and had an interesting exchange on climate change, sweat shops and overpaid bosses.

We also discussed the difficulty of deciding how a company stacks up on its ESG credentials. To help us along, I asked them to look through a sustainability lens at the websites of Tesla, Boohoo and BP and to review the recent news flow. Their conclusions were not what I predicted.

Needless to say, all three companies have had ESG challenges along the way so it seemed a fair question to ask the students which they would score most highly from a sustainability point of view on their day as a pretend investment analyst. To cut a long story short, they all singled out BP.

I had expected Tesla's electric vehicle story to put it on top, especially as the visit pre-dated the company's recent bitcoin embarrassment. But while they were all over Boohoo's employment record, what really caught their attention was the oil major's description of its clean energy ambitions. All credit to BP's comms, but it was not what I expected.

It's good to get out of the investment bubble where ESG is an article of faith and into the real world where these issues are just one among many. That's true whether you are still at school or the boss of a quoted company, as a recent sustainability-focused survey of our actual investment analysts confirmed.

What is abundantly clear from this global snapshot of 150 researchers, and the thousands of companies they follow, is that ESG as an investment approach is new, fragmented, complicated and inconsistent.

There are huge variations in how companies view sustainability and in how investors are attempting to measure it. The absence of common standards is glaring.

Focusing in on climate, some of the findings are unsurprising. Some sectors are well on the way to a new and cleaner world. Utilities represent an obvious green investment opportunity as the proportion of renewables rises. The energy sector, on the other hand, is more notable for its risks as fossil fuels are phased out and companies are left owning worthless stranded assets. Industrials sit in the middle, with clear opportunities to benefit from the climate transition but major risks too in the form of tighter regulation, disrupted supply chains and old-world legacy businesses.

What is also evident is a yawning gap between the parts of the world where the environmental challenge is well understood and factored into long-term business plans and the places where it is not. More than 70pc of analysts in Europe think companies have the right plans in place to decarbonise by 2050. In Latin America, Eastern Europe, the Middle East and Africa that proportion falls to a big round zero. American and Chinese companies are notable laggards on this front too, although the latter are starting to catch up fast since President Xi's adoption last year of a 2060 net zero target.

A couple of significant problems emerge from the survey. The first is that companies have been slow to link executive pay to real achievement on reducing emissions. Only a third of companies do this and only half expect their boards to demonstrate a focus on ESG more generally. Without financial incentives, sufficient progress is unlikely.

Secondly, while companies are increasingly keen to talk about ESG and sustainability, there remains a woeful lack of the internationally agreed standards that would enable investors and consumers alike to scrutinise their claims. Interestingly, in some countries like Japan, there are as many companies understating their progress in this area as over-inflating their achievements. The problem is bigger and more nuanced than greenwashing.

There's no shortage of regional standards being developed but none has yet gained any traction on a global scale. Until Europe, Asia and the US talk the same language about ESG, employ the same taxonomies and implement the same criteria to decide what is and what is not sustainable, we'll all be flailing around trying to make sense of different reporting frameworks, or worse, no reports at all.

One further problem is the clumping together of environmental, social and governance factors under one sustainability umbrella. It is too easy for companies to trumpet progress in one area while quietly glossing over their lack of interest in one or both of the others.

The solutions to the problems in each of these areas are different too. Driving change on the environmental front is most effective when governments are engaged via regulation and financial incentives. Consumers have more power when it comes to social issues. Investors have long recognised that they may be best placed to encourage progress on governance through engagement, votes or, more crudely, divestment.

Perhaps the real conclusion from all this is that, quite rapidly, ESG investing is becoming just plain investing. Companies that rate highly on the imperfect and inconsistent sustainability measures that we currently have perform well in stock market terms because they are, quite simply, better companies.

It makes sense to work towards common standards for fair comparison, but I suspect there will always be an extensive menu of these, not a single aggregate number for every company. Environmental, social and governance factors are just too varied to be corralled into one framework in the way that a company's income statement and balance sheet have been by the adoption of standardised accounting principles.

While we're working out how to measure sustainability ourselves, perhaps we could do worse than getting the kids from Tower Hamlets in to surprise us.

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