In an efficient market for capital, incremental increases in risk would be matched by incremental increases in the investor’s expected return. The reality however is that the Australian market for capital is not efficient, particularly as regard shares not listed on the ASX.
It is generally much more difficult for unlisted companies to secure additional capital than it is for listed companies and those that are successful pay a handsome premium for it. For example, companies generating EBITs of AUD 2–10 million pa are generally valued on 4 to 5 times EBIT, which equates to 20% to 25% pa ROI (pre-tax and pre-gearing).
Rogers Morris (‘R&M’) intends to capitalize on this opportunity with a view to generating a much higher annual income and total return on investment than those one would ordinarily expect from medium to long term investments in the major asset classes.
R&M intends to achieve its objective by establishing a diversified portfolio of investments in over 20 well-established, profitable companies with sustainable businesses, where each investment has an expected ROI at the time of investment of at least 20-25% per annum (pre-tax and pre-gearing) and the maximum exposure is no more than 7.5% of FUM.
As R&M does not have the circa AUD 200 million it needs to achieve its objective, it is inviting others to co-invest with it in one or more of its investments.
Target market – Unlisted companies with annual EBITs of $2.0 million to about $10 million
Expected ROI – 20-25% per annum (including franking credits)
Investment period – Up to 5 years
Instrument – Ordinary shares with equal voting rights, provided R&M and the co-investors together hold more than 50% of the shares, or other instrument that gives them preferential rights. The latter includes convertible notes, preference shares and debt securities.
General investment criteria –
- Minimum of 5 years in business
- EBIT over past 3 consecutive years to exceed A$ 2.0 million per annum
- Expected maintainable EBIT of over A$ 2.0 million per annum
- Clear credit reports on the business and on material executive shareholders
- A reasonable exit strategy
- Excluded: R&D, biotechnology, mining exploration, property developers, ‘turnaround plays’ and other highly speculative or highly leveraged businesses.
R&M is in effect targeting ‘boring’ businesses. That is, well-established businesses that have proven their business models and are generating reasonably stable, but growing, profits. While R&M and the co-investors are unlikely to generate the spectacular returns investors in early stage businesses targeting global markets are hoping for, R&M and the co-investors are far more likely to earn a handsome (but not spectacular) return and are far less likely to suffer a loss of capital or below market investment returns.
Assessment process – An R&M business development person (‘R&M’s BDP’) will be the first gatekeeper. If willing to recommend the investment, R&M’s BDP will prepare an Investment Application (which will include summaries of both historical (the past 3 years) and forecast financials) and present it to the R&M Investment Committee. Investments will have been approved by R&M’s Investment Committee after operational and financial due diligence.
Management and reporting – Each investee company will be required to provide monthly management reports to R&M and present half- and full-year financial statements, with annual audited accounts for the larger investments and others as deemed appropriate.
Liquidity event – Investments will be held for up to 5 years. In the interim R&M will provide or list the instrument (ordinary shares or other) on a secondary sales platform. R&M currently intends to offer the investors the ability to exchange their instrument (investment) for units in the ‘R&M Private Equity Fund’ once it offers reasonable portfolio diversification. Nevertheless, prospective co-investors should regard the investments as illiquid, at least for the pre-agreed holding period.
Distributions – The dividend policy will be set out prior to the investment but may be revised by the investee company’s directors from time to time as circumstances change. R&M expects that in most cases dividends will generally be paid six-monthly following the half- and full financial years and be fully franked. R&M’s expectation is that in most cases the investee company will pay out (though dividends) a high proportion of its profits.
Governance – In the case of holdings of ordinary shares, one or more of R&M’s representatives will be appointed to the investee company’s board of directors and attend monthly board meetings. Any co-investors with substantial holdings will also be invited to the board.
The Investment Case
Provided the investor establishes a well-diversified portfolio of investments through R&M, there is a high prospect of the investor achieving the target 20% to 25% per annum pre-tax returns across the portfolio. This is due, amongst others, to:
- The target returns on each investment will be well above the medium to long term returns expected from a well-diversified portfolio of investments in the other major asset classes.
- The target returns are conservative as they reflect long standing value multiples, will exclude both ‘blue sky’ and material leverage and will not be dependent on material changes to management teams or business models.
- Across a diversified portfolio some investments would be expected to outperform, some to underperform and others to generally meet expectations, as a result the portfolio return is expected to be similar as the target return (of 20-25% pa) when investing in any company.
- The risk profile of each investment should be attractive relative to the risk generally applying to holding minority stakes in large listed companies – as R&M (acting for the co-investor group) will have more control over the decisions of the investee companies and the value multiples that apply to unlisted companies are generally far less volatile than those applying to top listed companies.
Fees and Costs
- Management fee – No management or similar fee will be payable to R&M. The company in which the syndicate has invested will however reimburse R&M for reasonable travel, accommodation and related costs for attending periodic board and other meetings.
- Entry expenses – It is expected that each investment will include an allocation for transaction costs, which may include R&M’s internal and other costs. In other words, if the co-investor is offered shares (or units) at a stated price per share, the co-investor will not also be liable for transaction costs. That is, unless otherwise advised prior to the investment.
- Exit expenses – All external costs and other disbursements relating to the disposal of the co-investor group’s investment will be for the account of the co-investors in proportion to their respective holdings. The costs related to the sale by any individual independently will be for the account of that investor.