Comment: Time to re–evaluate 3i

Mention investment group 3i and two polarised views predominate. One sees it as a relic of the 1950s, boring, bureaucratic and burdened with deadbeat investments. The other is that it is too volatile by half, a daredevil set of unquoted high-risk investments where you can lose your shirt.

Bill Jamieson. Picture: Ian Rutherford
Bill Jamieson. Picture: Ian Rutherford

There’s truth in both. The group was created in 1945 as the Industrial & Commercial Finance Corporation (ICFC), by the Bank of England and major banks to provide long-term investment funding for small and medium-sized enterprises. It had a whiff of earnest do-goodery about it. Its high purpose will be all too familiar in the modern era: filling the gap in available corporate finance for smaller companies due to banks being unwilling to provide long-term capital.

In 1983, it was renamed Investors In Industry, commonly known as 3i. In 1994 it was floated on the stock exchange as a collection of well-researched investments in both quoted and unquoted smaller companies, with a capitalisation of £1.5 billion. Performance since has been chequered. The shares hit a peak of more than £10 in late 1999, plunged to £2.50 in 2002, rallied to £7.34 in 2007 and fell to £1.63 in 2009 on its way out of the FTSE 100.

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Between the depths of 2009 and 2012 recovery was slow. The shares climbed briefly to 423p in May but have since fallen back to 388p. Indeed, between May and August they have retreated by 6.6 per cent while the Morningstar comparator index has gained 1.1 per cent. But the share weakness of this £3.6bn trust belies a notable transformation in 3i and its performance under new chief executive Simon Borrows. Results for the year to end March showed a strong total shareholder return of 30 per cent and realisation of private equity investments of £669 million, a £202m or 43 per cent uplift over book value. The group has achieved £70m of operating cost reductions, helped by a much reduced headcount, down from 435 to 266 in two years. Net debt has been cut from £335m to £160m and gearing from 11 per cent to 5 per cent. And the group’s total return hit £478m against £373m previously.

As important, Borrows is talking the scalpel to a long tail of 81 different private equity investments – easy to accumulate, much less so to prune. He is aiming to halve this total with the sale of lower value investments. Proceeds from sales have continued to be buoyant in the first three months of the current financial year, with proceeds of £164m and an additional £245m or so is expected from exits awaiting completion. This will free up capital to devote to its key areas of expertise, in particular investment in middle-sized companies in the UK, France, Germany and in Nordic and Benelux markets.

Two tangible benefits for shareholders are already in evidence. First, 3i is back in the FTSE 100. And second, the group’s dividend pay-out policy is undergoing a transformation. A final dividend of 13.3p per share brings the total pay-out for the year to 20p against 8.1p previously, with a commitment to improving the 8.1p per share “base” dividend level in the years ahead.

As for asset value, this has rallied from 279p per share in 2012 to 348p currently. The shares stand at a premium to net assets. But analysts at Societe Generale forecast that net asset value will climb to 390p in 2015 and to 433p in 2016 – well above the current share price.

A sustained upward progression by 3i can never be guaranteed: it is a venture capital trust which by its nature has to take higher risks than a conventional blue-chip investment trust. The prospect of big profits from young, innovative companies has forever lured investors. Realising such profits consistently has proved less easy. It requires analysis, knowledge, judgment, constant attention – and an astute sense of ever changing markets for products and services.

The group faces two challenges: high asset prices that make new investments expensive; and the strong pound, which resulted in a £68m knock in the first quarter. But many retail investors want to have a managed exposure to the unquoted sector to augment holdings in conventional trusts holding shares in large, long
established and well capitalised companies. It is not for a first time investor or for those reluctant to move out of the “cautious managed” sector.

But 3i is well worth considering for those who understand the risks. And the combination of investment portfolio re-structuring, cost reduction, debt slashing, a return to the FTSE 100 and the prospect of enhanced dividends suggests that a share re-rating here looks overdue.