Investors seeking to mirror the superior returns generated by private equity can do so via a collective managed by GVO Investment Management. The London-based specialist fund manager believes the majority of the methods employed successfully by private equity players can be transferred, either directly or indirectly, to the quoted-company domain.

‘We apply private equity techniques to the public markets,’ says Jamie Seaton, manager of the GVO UK Focus Fund, a Dublin-listed open-ended investment company (Oeic) which is AAA rated and top decile on Citywire over one, three and five years. A multi-cap portfolio that invests ‘from the tiddlers up to the big ones’, the fund holds as many as 35 publicly-listed companies where GVO’s private equity based research indicates undervaluation as well as a catalyst for an increase in shareholder value.

Former Rothschild Asset Management man Seaton argues there are four key drivers of shareholder value creation, namely earnings growth, the rating applied to those earnings, the potential for corporate activity and de-gearing. Whereas traditional public equity fund managers focus mainly on the former two and private equity players more on the latter, the GVO UK Focus Fund has a balanced approach and aims to combine the best elements of public and private equity investing.

Proven process

In terms of growth, Seaton has a preference for growth in operating cashflow. He values prospective investments based on an in-house re-rating model which targets ‘GVO Cash Yield’, a calculation of enterprise value to operating cash less maintenance capital expenditure.

On the private equity side, investments are valued using an in-house, leveraged buy-out model with a focus on recent relevant merger and acquisition(M&A) transaction multiples. ‘Transaction multiples tend to be a much better guide to ultimate fair value than market multiples,’ says the manager. Also employed in valuing companies is GVO’s in-house de-gearing model, which Seaton describes as a focus on ‘the transfer of value from debt to equity holders through the underlying cash generation of the business’ over the investment period.

He insists these valuation techniques ‘are as relevant for a small cap company as they are for a mid or a large cap’, though this PE approach means ‘the subset of companies is considerably smaller than that which would be available to the institutional investor’.

‘This fund historically has been a major beneficiary of M&A,’ says Seaton, whose proven process targets high-quality, coveted assets with attractive cashflows. Such names retain value even in tough times and are more likely to be acquired. ‘Management is absolutely crucial,’ continues Seaton, whose process entails ‘extensive meetings with customers, suppliers and competitors’ as ‘an ongoing part of our due diligence’. Another competitive advantage is the fund’s use of an Industry Advisory Panel of seasoned industrialists able to ‘provide a real world perspective on our valuation analysis’.

Quality plays

Seaton highlights a focus on quality, with the portfolio invested in niche market leaders with intellectual property, pricing power, overseas or recurring earnings, outstanding management and typically trading at a significant discount to M&A multiples. ‘Typically, this leads us to businesses which are relatively capex light,’ such as media groups and asset managers ‘and away from sectors such as utilities and retailers. We don’t like low margin businesses,’ explains Seaton. He also says the fund has had no exposure to the banking sector for five years and has no exposure to resource companies.

Strong portfolio performers year-to-date include construction equipment hire provider Lavendon (LVD), as well as the fund’s biggest position, Dublin-based medicines developer, Shire (SHP). The latter is a beneficiary of a return to large scale M&A to the pharmaceutical sector, an area of significant exposure for the fund. Seaton argues Shire is ‘a better-quality company than AstraZeneca (AZN) with considerably better growth prospects. The implied multiple on the proposed Pfizer AstraZeneca deal was in excess of 14 times EBITDA. Shire trades on approximately 12 times’.

The manager believes luxury goods leader Burberry (BRBY) is undervalued given its very strong market positions, net cash balance sheet and double-digit earnings growth backed by cashflow. ‘Burberry is valued at just over 10 times EBITDA on 2015 forecasts and nearly 10% of its market value is in cash,’ says Seaton, arguing this suggests scope for a re-rating, given some recent M&A transactions in the global luxury goods space. In February this year Blackstone paid 14 times EBITDA for a fifth of Versace, the Qatari Royal Family paid 31 times 2011 EBITDA for Valentino, and LVMH (MC:PAR) over 28 times EBITDA for Bulgari in 2011.

‘We added significantly to our positions in Aberdeen Asset Management (ADN) and Rolls-Royce (RR.) following share price weakness in Q1,’ says Seaton, ‘and both have come back strongly in our favour’. The manager appears particularly upbeat about the fund management giant which recently completed (31 Mar) the acquisition of Scottish Widows Investment Partnership, flagging a net cash balance sheet with close to 10% of its market cap in cash and forecast to generate in excess of £200 million of free cashflow per year. Aberdeen has good organic growth prospects over the medium term and with its strong balance sheet ‘has the ability to add to that incrementally through acquisitions’.

The manager has taken a new position in health care IT firm EMIS (EMIS:AIM). ‘EMIS is generating 10% organic earnings growth with very high visibility due to its recurring revenues,’ the manager explains. ‘It also has a 24-year track record of unbroken organic growth which is pretty impressive and when purchased traded at a discount to the rating at the time of its 2010 IPO and precedent transaction multiples in the sector’. In addition, ‘EMIS generates 7% of its market cap per annum in cash after everything and it will be virtually un-geared by the end of the year.’

Jamie Seaton

GVO UK Focus Fund

ISIN: IE0033377494

Minimum investment: £10,000

Five-year annualised performance: 22.0%

Launch date: 05/08/2003

Fund type: Oeic

Fund size: £196.1 million (as at 1 May 2014)

Dividend yield:1.59%

Sector: IMA UK All Companies

TOP FIVE EQUITY HOLDINGS (AS AT 1 MAY 2014)

Company %

Shire (SHP) 9.8

Aberdeen Asset Management (ADN) 9.2

Rolls Royce (RR.) 8.1

WPP (WPP) 7.9

Jupiter Fund Management (JUP) 4.7