There is one aspect of PE style investing which still causes us some consternation – the subject of exits.
Many prospective LP’s we speak to seem to be almost as focused on the exit strategy as they are on the investment strategy and portfolio deployment. At first this puzzled us, because we feel very strongly that making the right investments, at the right price, executing well and stewarding them carefully under our ownership is far more important than the exit process. However, it is foolish to ignore your clients’ views for very long, so we looked more closely at what we were being told and realised that there was a basic disconnect between what we do and what PE firms do. More importantly, we were clearly failing to help our clients understand a fundamental difference between our investment strategy and a traditional PE style investment process.
However, before we delve into this in a bit more detail, it might be helpful for us to talk about our history & illustrate this with some publicly available data on some of our larger, earlier investments.
As a team, we have always worked in an environment where the businesses were being bought as permanent capital investments. From 2000 to 2010 we were buying as a strategic buyer, filling in capabilities which our organisation needed, but couldn’t build. From 2010 – 2020 we were running a fund with a long-term ‘buy and hold’ philosophy with no interest in short term investment.
Because of this, our track record selling businesses is mostly devoted to selling businesses which we didn’t buy. In the period 2000 – 2003 we inherited businesses in India, Chile, Brazil, France and Australia which we felt for various reasons weren’t worth keeping. In some cases, these businesses were perennial loss-makers, in others they were simply too small or were JVs with partners who just weren’t right for us. Despite an unpromising portfolio we exited all of these within, or above, expectations and with minimal fuss.
In a few cases we exited small businesses which came as a package with something which we did buy but again, these were very small deals. In fact, in our whole history, we can only find one business which was eventually sold in its entirety some time after we purchased it – and this was a deal which was not significant in terms of size.
So, why have none of our major acquisitions ever been sold by the firms we purchased them for? Simply put, they’ve been too successful to be sold.
In order to illustrate this point, we will focus for the purposes of this piece on the 2006 acquisition of Walter Scott & Partners – an Edinburgh based global equity manager, and our 2009 acquisition of Insight Investments; a London based Fixed Income and active LDI manager – two of our oldest and largest purchases.
In 2006, whilst at BNY Mellon the team led the acquisition of Walter Scott. Since its acquisition for a reported £313m ($440m at current exchange rates) it has been an entirely autonomous subsidiary of BNY Mellon. In the calendar years 2020 and 2019 alone the firm made cumulative post tax profits of over £364m, in other words, more than its original purchase price. These weren’t just accounting profits; the firm also paid £250m in dividends to its parent – our former employer – for that period.
These were not one-off results; in 2017 and 2018 combined, the firm made £245m post tax and paid £400m in dividends – again, an amount sufficient to pay back the firm’s entire original acquisition price. In fact, in the period from its acquisition in 2006 to 2020 the firm has earned over £1.2bn of pre-tax profit and paid out almost every penny as dividends. The firm remains successful, with the same distinctive investment process, strong management and deep collegiate, investment culture we fell in love with fifteen years ago.
Walter Scott is not an isolated case.
In 2009, we acquired Insight Investment Management, the world’s largest active LDI manager from Lloyds Bank for £235m. The business has remained an independent entity within BNY Mellon since then. Whilst it has bought and merged a couple of smaller businesses over that time it remains essentially the same business, under the same inspirational CEO as when we bought it. During that time the firm has earned roughly £0.75bn of post-tax profit and paid out almost every penny of that – £0.73bn – in dividends to the parent.
In short, these two firms have earned approximately 4x and 3x their original purchase price respectively in dividends alone and, as we write, each business remains robustly healthy and profitable with assets under management at record levels.
These businesses have produced healthy returns without needing to be sold to ‘unlock’ the value. If each were to be sold at a multiple of 8x EBITDA – hardly a stretch for two very successful businesses in highly sought-after asset classes, which have already demonstrated a capacity to survive an ownership change – then they would command valuations of approximately £1.57bn and £1.45bn respectively; or to put it another way, a combined total return of almost 10x MOIC for Walter Scott and 9.3x MOIC for Insight. Selling at the current market multiple would make these numbers even more impressive.
So, why is this relevant to exits?
Most PE firms seem to rely on a combination of leverage, synergy, cost cutting and multiple expansion to achieve their expected return at exit. Many PE firms “dress up” businesses for sale by underinvesting in the future of the business or increasing their exposure to risk in order to maximise the short-term growth in profits, believing this will justify a higher exit multiple. We don’t.
We don’t use leverage on any of our deals, we buy a business because we think that it will meet or beat our investors’ return expectations – with no heroic multiple expansion, no cheap leverage and no miraculous synergies.
Of course, there’s nothing wrong with using these traditional components of the standard PE playbook but they do not come without risk, and they often rely on some quite rosy assumptions to achieve the desired outcome. As such, under these assumptions, asset sales are very dependent on timing and market circumstances – which is why the exit becomes so important if maximising your exit price is an essential component of the return assumptions you told investors to expect. Put simply, achieving the target return for many PE firms relies on an exit price driven by the continued availability of cheap leverage and a favourable combination of market, performance and flows which is simply too ephemeral and too unpredictable for our taste.
In short, our investment process is geared towards buying great businesses, at reasonable prices, that our investors will want to own forever. Of course, they may want to sell at some point, and we believe we are well equipped to achieve this successfully for them, but if we buy on this basis the eventual exit is far less dependent on all the stars aligning or making use of an optimal window to exit the investment; the portfolio we assemble will always be attractive to buyers – individually or collectively.
Buying quality at a reasonable price never goes out of fashion.
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