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Universal Partners performs, but for whom?

High management fees detract from the investment merits of a good idea.

It seemed like a good idea, and that has proven true. Towards the end of 2016, Universal Partners listed on the Stock Exchange of Mauritius, with a secondary listing on the AltX of the JSE, to offer investors access to European private equity investments. Investors could get exposure to fast-growing private companies, as well as strong currencies, by simply buying some shares.

The pre-listing document stated that the company’s primary objective was to achieve strong capital appreciation in pound sterling over the medium to long term by investing in high quality growth businesses across Europe, with a particular focus on the UK.

It touted several benefits to local investors looking at the prospectus. The directors said it presented “an attractive opportunity to SA investors who desire diversification against the risks arising from low growth on the domestic front”.

A basketful of benefits

The prospectus also stated that an investment in the company would provide currency diversification, as well as access to a class of investments not readily available to smaller investors. Individual investors could get exposure to the private equity deals usually dominated by big investor groups, which aim to take stakes in new companies in the hope of getting into the next big thing at the ground floor.

In addition, investors did not need to use their foreign investment allowance or go through the whole process involved in investing offshore.

And its investment strategy is solid. Universal aims to invest in companies with strong, sustainable profitability, high cash flow, a clear competitive advantage, and where a shareholding of at least 25% would be available. It also noted that potential investments should have a robust and easily understandable business model.

This week’s results for the nine months to March 2019 show that Universal did indeed follow through on its vision. It has invested in five private companies, a few of which are very interesting, and all offering the promise of good returns.

Yasa

Engineers, geeks and environmentalists will love Yasa Limited. The company has developed and patented electrical motors and other equipment for use in electric vehicles, seeking to stake a claim in this huge developing market.

An update on Yasa in Universal’s latest annual report reminds shareholders of the commitment by the UK to limit the sale of new diesel and petrol vehicles by 50% by 2030 and to ban them completely by 2040.

Yasa claims that its electrical motor is smaller, weighs less and delivers more power than similar motors. Its ‘topology’ was developed by Yasa chief technology office and founder, Dr Tim Woolmer, as part of his DPhil at the University of Oxford. The company recently also developed new controllers that are also lighter and more powerful than their conventional counterparts.

Universal reports in its latest quarterly update that sales of the motors are increasing, with management expecting that some clients will use Yasa technology in their automotive platforms.

The real pay-off for shareholders will come if this develops into production models.

Prospects look good. Rolls-Royce has chosen Yasa motors and related equipment for the ‘racing aircraft’ at the centre of its ‘Accelerating the electrification of flight’ project, which will chase the electric aircraft speed record next year.

Propelair

Environmentalists will also like Universal’s 14.4% investment in Propelair. While this might sound like another ‘racing aircraft’ type of investment, it isn’t. The company manufactures a modern toilet that uses only 1.5 litres of water per flush compared to nine litres for a traditional toilet. Management says sales are increasing in the UK and that several big companies in the UK are switching seats, including McDonald’s and a large service station chain.

Foreign banks

Two of Universal’s other investments seems mundane, but could deliver good returns. It invested ₤15 million for an effective interest of 5% in SC Lowy Partners, which owns a bank in Italy and one in South Korea.

The business is also a market maker in the volatile, high-risk market for distressed high yield debt instruments, and manages investments on behalf of clients. Universal joined a consortium with Investec as investment partner to get a slice of the action.

Boring, but good

An investment in JSA Services, rendering support services to self-employed and contract workers, seems quite boring, but Universal reports good growth in the business.

Private dental practice support

Its investment in Dentex Healthcare has already performed well. The group has grown to 56 dental practices and continues to expand. Dentex’s simple business model is to partner with dentists in the fast-growing private dental space in the UK, providing administration and business support.

The sector focuses on more lucrative procedures not covered by Britain’s NHS, and is growing fast. Universal estimates that the market will exceed ₤7.5 billion per annum very soon, and Dentex is positioning itself to be a big participant.

The quarterly results disclosed that Dentex raised more capital during the nine months under review, with the rights issue priced at ₤1.70 – giving Universal an opportunity to increase its shareholding and prompting it to revalue its stake by nearly ₤4 million (a nice gain of R73 million in rand terms).

The Dentex investment is now valued at more than ₤30 million (nearly R550 million).

The sting in the tail

And herein lies the sting in the tail. The agreement between Universal and its management company, Argo Investment Managers, provides for hefty management fees on growth in the value of underlying investments.

Argo, owned and run by basically the same directors as Universal, is entitled to a management fee of 2% on the value of the investment portfolio per annum, as well as 20% of any gain above a benchmark of 8% per annum. Certain other costs can also be recovered, such as the travel and subsistence cost associated with attending meetings or investigating potential transactions.

Thus, Argo has seen its management fee increase by 31% to around ₤888 000 in the nine months to March compared to ₤678 000 in the same period the previous year.

Administrative expenses paid by Universal increased by nearly 200% from ₤256 148 to ₤790 187.

CFO David Vinokur says these fees are in line with the market, and that the increase includes the potential performance fee of ₤543 358 that arose as a result of the revaluation of the investment in Dentex. He adds that it is simply an accounting entry at this stage; the actual fee will only be calculated once the investment is realised.

However, these fees will have to be paid eventually and accounting for them has a big impact on ordinary shareholders.

Universal shareholders saw the net asset value per share increase by just 3.7% to ₤1.07 over the same nine months – creating the impression that the bulk of the growth in the portfolio accrues to the directors through the management company.

The latest share price on the AltX of R15.98 represents a discount of nearly 20% to the net asset value (NAV) of R19.61 (at the current exchange rate), which can be seen as normal for such investment vehicles. The share does not trade often. This week the best bid was sitting at R13.60. This shows a big discount to NAV and would probably be a very good buy if a desperate seller comes along.

Universal mentions in its annual report that it might look to raise more capital to bulk up its portfolio. Hopefully it will choose a rights issue to enhance readability and get more small investors on board. Analysis of shareholders shows that most shares are held by big investors.

It might also be a good idea to reassure shareholders that they will enjoy the potential of huge returns too.

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Management companies that do still get 2/20 deals only get fees on realised gains, not journal entries put forward by the managers.

Nowadays the best deals are first taken by the likes of half trillion dollar technology companies. What they pass on gets to parade past the big boys (Blackstone, Carlyle, KKR, Sequoia, etc etc). Then it goes down the pecking order

No cash flow. Management compensation relies on valuation of unlisted entities.

What could go wrong?

“…creating the impression that the bulk of the growth in the portfolio accrues to the directors….”
If it looks like a duck and quacks like a duck….

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