3i buoyed by bargain retail

Dutch discount retailer Action – 3i’s largest investment – is now valued at 18 times earnings, up from 14 times at the end of 2015, but the outlook for European private equity returns is still uncertain.

Will Brexit put the brakes on European private equity?

That's the question preying on investors' minds since the UK voted “leave” on June 23, which is why LPs will be keeping a watchful eye on the performance of Europe-focused private equity firms like 3i.

And lo, resilience was the watchword when 3i reported its first-quarter results Wednesday. The UK-headquartered firm, which targets mid-market assets in northern Europe and North America, emphasised its investments in defensive sectors that will hold up in a downturn.

“While we cannot be immune to what we expect will be a volatile and challenging period, we expect the portfolio to be generally resilient as the wider implications of Brexit unfold,” the company said in a statement.

3i's net asset value per share in the first quarter surged to 538 pence from 400 pence a year earlier. That increase, however, was driven by the performance of one business: 3i's largest investment, Netherlands-based budget retailer Action, which made up some 20 percent of 3i's net assets at 31 March, according to an analyst note from Charles Cade at Numis Securities. 

Action sells household wares, from DIY to toys, and charges an average of about €1.40 per item; a glance at its website reveals bargains like a tea-light holder for €0.89, and a four-pack of Oreo cookies for €1.29. For shoppers, a key attraction is that the stores refresh their offerings several times a week, to encourage repeat customers on the hunt for bargains. 

3i bought Action in 2011, when its focus was on Benelux. The business has expanded since then, with even more new shops opened in France and Germany in 2015. At a time when shoppers are increasingly keen on deals, it's no wonder that Action posted an annual increase in earnings before interest, taxes, depreciation, and amortisation of 36 percent and like-for-like sales growth of 7.6 percent when 3i reported its full-year results in May.

And potential buyers have noticed. Action's valuation rose to £1.49 billion from £1.45 billion on June 30, when 3i broke with its usual reporting calendar to announce a 62 percent increase in the value of its investment, thanks to interest from unnamed buyers, as well as strong earnings growth.

The latest valuation suggests a run-rate EBITDA multiple of 18.2 times, based on earnings at 31 March 2016; that's up from 14 times at 31 December 2015. 

3i said that it has no intention to sell Action or float it in the “near future”, so for now, the discount retailer will continue to buoy the buyout firm's results.

Is there a takeaway for LPs hoping that 3i's results might offer some insights into the outlook for private equity in Europe? Post-Brexit, returns could well depend on portfolio companies operating in sectors that may not be glamorous, but where consumer demand is proving resilient.