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Cobas Commentary: Investing in Listed Companies With Private Equity Criteria

One of the most interesting asset types in recent years has been private equity, investment in unlisted companies. Historically, investment in this type of project has offered attractive returns, despite the fact that investment transactions have been carried out with quite high multiples.

According to the most recent study by Bain 1 on the sector, in the last five years private equity funds have obtained returns of around 12%, beating listed markets comfortably. In the same period, investors in the sector have paid between 10x and 11x the operating profit before depreciations of their acquisitions, a very high multiple that would hardly allow good returns to be reached if it were not for the combination of other variables that compensate for the high price paid.

These variables are, among others2, the improvement of companies' productive and commercial processes, the obtaining of efficiencies derived from the use of technology and digitisation, purchasing companies that complement the business and, of course, the use of financial leverage.

The challenge that we have set ourselves at Equam is to harness these same powerful forces of value creation, yet while investing in the listed market. Obviously, investors in listed companies do not have control over the management decisions of companies and until we decide to get involved in management by adopting an activist role, we will only be able to accompany management teams in the improvement process.

But in exchange for not having control of the big decisions, by investing in the listed market, we can take advantage of the irrationality of investors and buy those solid, well-managed companies at enormously attractive valuations. Usually at times of panic or when the market has forgotten about them. With these principles, we think that it is possible for an investment strategy, like venture capital, to comfortably beat the market.

In the almost 5 years that have passed since we started to invest the Equam fund, we have been able to verify that indeed, there is a great amount of companies that are implementing operational improvement programmes, that are gaining efficiency by digitising their systems, and that are benefiting from consolidation processes... but that are also listed at prices so low that they would make many venture capital investors pale in comparison. Analysing the market through the eyes of a venture capitalist, we find really attractive opportunities in the market.

A good example of what are looking for in the European market is our investment in Sesa Spa, the Italian company that markets the software of the world's leading developers (IBM, Microsoft, Oracle, Salesforce...) in Italy. Sesa is benefiting enormously from the investment in the digitisation of Italian companies. It also benefits from growing consolidation in its industry as it achieves a market share of more than 40%, and it is also developing its own buy to build strategy in the IT services sector, buying small companies that complement its business at very attractive multiples. The result of all this is that its profits are growing at a rate of 15%. If for some reason this company was involved in a sale process, because of the interest it would generate among financial investors, it could easily be sold for 10x or 12x EBITDA. However, its current price is around 5x EBITDA estimated for next year. And it has no debt.

This aspect, debt, is the only issue where we clearly distance ourselves from the unlisted approach: we do not use financial leverage. Nor do we burden our fund with debt and we do not want highly indebted companies. We have seen that in order to obtain good returns in the market it is not necessary to assume a high level of indebtedness, which, moreover, exponentially increases investment risks.

Lots of money and few ideas in venture capital

The good returns obtained by the private equity sector are attracting capital from all types of investors. Insurance companies, pension funds, funds of funds, family offices, governments and sovereign funds are all attracted by the sector's returns, so private equity funds are accumulating more and more resources that are available to invest. According to Bain & Co1 in addition to being concerned about high investment multiples, these funds are now seeing the lack of ideas as being the second biggest obstacle to maintaining their profitability (where to put all the capital they have raised?).

It is, therefore, not surprising that the sector is looking with increasing interest at the opportunities that exist in the listed market. In view of the lack of opportunities in its natural market, that of unlisted companies, the sector is beginning to be encouraged by public to private transactions, i.e. buying 100% of listed companies and taking them off the stock market. The overall volume of investment in transactions of this type has increased fivefold in the last four years, from 45 billion dollars in 2014 to 227 billion in 2018.

Josh Harris, one of the founders of Apollo Global Management, the private equity firm that listed LifePoint in 2018, summed up the industry's view of this type of transaction:

"If you have a troubled history, the listed market doesn't treat you well. This situation is creating fertile ground on which we can pursue private equity. More transactions like this will come".

We are also witnessing how this trend is beginning to be felt strongly in Europe. In recent months we have received five purchase offers involving venture capital funds, with an average premium of 31%. The Ares Life Sciences firm has bought us Stallergenes, EQT, with the support of GBL and Corporacion Alba have offered to buy Parques Reunidos and Spectrum has received a takeover bid in which the Norwegian firm Altor, which is already a shareholder, will continue to invest in the acquiring company after the transaction. Nice has also been bought by its main shareholder and the private equity firm Searchlight has launched a takeover bid for Latecoere. The combination of three variables, low valuation, stability in results and low indebtedness, make many of the companies in our portfolio the perfect target for private equity.

In conclusion, our approach and our method of selecting investments, which are very similar to those of private equity funds, have led us to build a portfolio of solid companies, that are well-financed, bought at attractive prices and therefore with upside potential, but that are also very interesting for the private equity sector, which has its pockets full and cannot find ideas.


1 Global Private Equity Report 2019, by Bain & Co.

2 Private Equity Trend Report, by PWC

This article first appeared on GuruFocus.