Strategic Eqty Regulatory News (SEC)

Strategic Equity Capital Plc - Final Results

PR Newswire

London, September 28

To: PRNewswire

From: Strategic Equity Capital plc

Date: 1 October 2018

Results for the year ended 30 June 2018

The Directors of Strategic Equity Capital plc are pleased to announce the Company’s results for the year ended 30 June 2018.

Annual Financial Report for the year ended 30 June 2018

Key highlights:

Richard Hills, Chairman of Strategic Equity Capital plc, commented:

Holding a highly concentrated portfolio of investments, selected using a consistent methodology, can lead to returns that differ significantly from the market over shorter term periods. Following a near 30% increase in NAV in the previous year, last year proved more difficult for your Investment Manager to make strong returns.This is not unusual for your Company’s style of investing and we have seen similar periods before, when out-performance has given way to under-performance, and vice versa.

On a total return basis, the NAV per share increased by 1.8% during the year which was behind the FTSE Small Cap ex Investment Trusts Total Return Index (“FTSE Small Cap Index”) of 6.4%. The share price fell during the year by 1.6%.

The portfolio is significantly undervalued in the opinion of the Board and its Investment Manager. The portfolio currently trades at a discount to its net asset value of c.13.5% while the forecast earnings growth of the portfolio is significantly higher than that of the FTSE Small Cap ex Investment Trusts Index. In aggregate, over half of the companies in the portfolio by net asset value have net cash balances, illustrating their financial strength.

Since the year end the portfolio’s performance has been encouraging. Portfolio company updates have been good, leading to continued growth in the NAV set against a weaker market.

Chairman’s Statement

Introduction

Following a near 30% increase in net asset value (“NAV”) per Ordinary share in the previous year, the past 12 months have proved more difficult. It is not unusual for your Company to experience large swings from year-to-year in both performance and discount and this is to be expected when investing in a portfolio of fewer than 20 holdings.

At present we seem to be near one extreme, with moderately disappointing performance leading to a larger than normal discount. Our Investment Manager has kept true to its proven investment process of buying undervalued shares that are out of favour but which have good prospects, while avoiding chasing shares of companies that may be described as “flavour of the day”, where share price and value have become dislocated.

The Board, together with your Investment Manager, frequently re-assesses the investments held, looking not only at the potential for these companies to perform more strongly, but also considering their attractiveness to third parties. Over the years a significant degree of performance has been generated by the takeover of companies held in our portfolio, often added into the portfolio at a point where they are heavily out of favour, and by its nature this activity increases the volatility while reducing the predictability of returns.

In the opinion of your Investment Manager and Board, the portfolio is significantly under-valued. We anticipate that the public market will acknowledge this fact over time (or potential acquirers if the dislocation persists) and re-rate individual shares and, therefore, the portfolio in aggregate. As this transpires and performance improves, the discount should narrow.

Performance

As at 30 June 2018, the Company’s NAV was 260.16 pence per share (net assets of £174.3 million). This represented an increase of 1.6% over the period. On a total return basis, the NAV per share increased by 1.8%, which was behind the FTSE Small Cap ex Investment Trusts Total Return Index (“FTSE Small Cap Index”), which increased by 6.4%. The share price fell during the year by 1.6%.

The Company has delivered NAV total return per share of 20.4% over the past three years compared to a total return of 31.6% from the FTSE Small Cap Index. The five-year NAV total return per share of 112.1% has exceeded the return from the FTSE Small Cap Index by 33.3%. Importantly, this growth has been achieved without gearing.

The Board is also pleased to report that as a result of the management fee negotiations the ongoing charges figure has reduced from 1.25% to 1.14%.

Discount Management

The average discount to NAV of the Company’s shares over the past twelve months was 13.5%, which was wider than the equivalent 11.0% figure from the prior year. The discount range was 11.1% to 16.7%.

The Board monitors closely the discount to NAV at which the Company’s shares trade and has actively used the share buy-back powers granted to it by shareholders at last year’s AGM. During the year a total of 1,892,812 shares (2.8% of the shares in issue at the year end) were bought back at an average discount of 14.4% for an aggregate consideration of £4.3 million.

The Board accepts that using this facility may have a positive but limited effect on the level at which the Company’s shares trade. It is also aware that reducing the size of the Company through share buy-backs may reduce the long-term share liquidity of the Company. Nevertheless the Company will continue to buy back shares in normal market conditions while this represents an excellent opportunity to purchase shares in an undervalued portfolio at a wide discount.

In recent weeks I have met with a number of our major shareholders who are supportive of the Board on this approach.

Dividend

The Directors continue to expect that returns for shareholders will derive primarily from the capital appreciation of the Company’s shares rather than from their dividends. During the year more dividend income than expected was received from our underlying investments, reflecting their strongly growing profits. 

In order to continue qualifying as an investment trust, no more than 15% of the income which the Company derives from its investments can be retained in any financial year. Accordingly the Board is proposing a final dividend of 1.00p per Ordinary share for the year ending 30 June 2018 (0.78p in 2017), payable on 14 November 2018 to shareholders on the register as at 12 October 2018. This is an increase of 28.2% from the previous year.

Development of the Company

On 21 December 2017, RIT Capital plc (“RIT”) entered into a management buyout (“MBO”) agreement to sell its shares in the Company’s Investment Manager, GVQ Investment Management Ltd (“GVQ”), to GVQ’s management. RIT remains a supportive shareholder in the Company.

Following this transaction your Board has negotiated two significant and beneficial amendments to the terms of the Investment Management Agreement with GVQ: a new fee structure and a reduction in the notice period.

The terms of the new fee structure, which became effective from 1 January 2018, are detailed in the Strategic Report on pages 15 and 16. Under this new structure, management fees will potentially reduce significantly, particularly in years of strong out-performance, whilst leaving the Investment Manager well incentivised.

The reduction of the notice period is from 12 months to six months and will be effective from 1 October 2018.

The Board

Your Board has continued to operate effectively and at the corporate governance level it has succeeded in improving the terms and quality of services that the Company receives.

The composition of the Board has not changed during the year. However, as I noted in last year’s report, we will sadly lose Sir Clive Thompson at this year’s AGM. Sir Clive has been a Director of this Company for many years and has offered sound and helpful advice throughout; the Board will miss his input.

The Board is conscious that in replacing Sir Clive an ideal candidate should have experience of working in industry. We have engaged a firm of search consultants and are awaiting their initial review.

Gearing and Cash Management

The Company has maintained its policy of operating without a banking loan facility. This policy is periodically reviewed by the Board in conjunction with the Investment Manager.

The Board, together with the Investment Manager, has a conservative approach to gearing because of the concentrated nature of the portfolio. No gearing has been in place at any point during the period. Cash balances are generally maintained to take advantage of suitable investment opportunities as they arise.

Annual General Meeting

We hope that as many shareholders as possible will attend the Company’s Annual General Meeting, which will be held at the offices of Canaccord Genuity Limited, 88 Wood Street, London EC2V 7QR on 7 November 2018. This will be an opportunity to meet the Board and to receive a presentation from the Company’s Investment Manager.

Outlook

The Board remains committed to the Company’s investment objective of achieving absolute returns over a medium-term period and considers that the Company’s portfolio of shares remains undervalued. The Directors believe that the proven process, sound research and ability of the Investment Manager that underlies the purchase and retention of each holding will be reflected, in due course, in continuing positive returns to shareholders.

The Board, once again, thanks you for your continued support.

Richard Hills

Chairman

The Investment Manager’s Report:

“Investment Strategy

Our strategy is to invest in publicly quoted companies which we believe will increase in value through strategic, operational or management change. We follow a practice of constructive corporate engagement and aim to work with management to enhance shareholder value. We try to build a consensus with other stakeholders and prefer to work alongside like-minded co-investors as leaders, followers or supporters. Where possible we avoid confrontation with investee companies as we believe overtly hostile activism often does not produce the desired outcome.

We are long-term investors and typically hold investments over a rolling three-year investment plan. These plans can be shortened by transactional activity or lengthened by adverse economic conditions. Before investing we undertake extensive due diligence, assessing market conditions, management and stakeholders. We also refine our entry and exit strategy to generate a clearly identified route to value creation. Our investments are underpinned by valuations which we derive using private equity-based-techniques. These techniques focus on cash flow, the potential value of the company to trade or financial buyers and potentially beneficial changes in capital structure.

We believe that smaller companies provide the greatest opportunity for our investment style as they are relatively under-researched, often have more limited resources, and frequently are more attractively valued. The typical investee company, at the time of initial investment, is too small to be considered for inclusion in the FTSE 250 Index.

Market Background

The reporting period was ‘a year of two halves’. The second half of 2017 was fairly benign for UK equity markets with very low volatility and share prices rising gradually on the back of improving global economic growth and more positive investment sentiment.

In contrast the first half of 2018 saw greater market volatility and increasing concerns on many fronts including; the sustainability of growth, a tightening of interest rates and the resultant impact on asset prices, high debt levels, declining productivity trends, trade wars and geopolitical problems.

In our view, this volatility has been amplified at the smaller end of the market following the introduction of the MiFID II Directive at the start of 2018. This has perpetuated many historic trends, with reduced ‘sell-side’ resource and a decrease in the dissemination of research leading to heightened volatility on low volumes, often in response to limited news flow fuelling pricing anomalies, which can take a long time to correct. Whilst challenging, in our view, this will provide greater opportunities over the long-term, where securities are fundamentally mispriced. We discuss this further in the Outlook section.

The small cap market has demonstrated similar traits to that of recent years. Investors have sought shelter (often from the above) in dependable, highly rated growth stocks, which continue to perform well both operationally and from a share price perspective. Profit valuation multiples of 30-80x are not uncommon and, of slight concern, the definition of ‘peers’ becomes broader to justify high valuations and there is a growing incidence of public market valuations at premia to precedent transactions. As ever, owing to our defined process and focus on valuation, we do not participate in this part of the market. Although growth has continued to be impressive and even further re-ratings are possible, we would be reticent to chase these up.

As an asset class, UK equities remain out of favour with almost £10bn withdrawn from UK equity funds since the EU Referendum in June 2016. This downbeat view is not shared universally with a heightened degree of UK M&A activity over the past twelve months. Having raised record amounts in 2017, Private Equity is believed to have over $1 trillion in ‘dry powder’ according to Preqin and there have been notable take-outs in UK small cap including portfolio company, Servelec and others including Laird and approaches for BCA Marketplace and IWG. Furthermore, European target M&A is as high as it has been since 2007. Where markets don’t re-rate good companies, buyers often correct the valuation gap.

Performance Review

Whilst the first half of the period was strong, the second half was more challenging. In the main, performance across the portfolio was encouraging but weak share prices concentrated in a few names held overall performance back. Where 98% of professionally managed money involves portfolios of more than 30 stocks (according to General Atlantic), the Company is differentiated in running a much more concentrated portfolio. As such, single stock issues can have an amplified impact (in either direction) over discrete periods, with the fourth quarter providing evidence of this.

The primary positive and negative attributors to performance are detailed further on in this report. Those stocks that disappointed over the period have specific issues and continue to be an area of detailed focus and attention for us where we challenge both the veracity of our assumptions, and our portfolio companies on their delivery.

Top 5 Contributors to Performance

Valuation at

period end Period attribution

Company £’000 (basis points)

Alliance Pharma 6,616 300

Equiniti 14,327 150

Harworth 7,903 105

Clinigen 12,549 105

Numis 5,105 82

Alliance Pharma was a new investment made in May 2017. As detailed in the prior year Annual Report; we believed ‘the high free cash flow yield at investment is very attractive and, in our view, unreflective of the potential opportunities’. Our thesis at the time of investment was that there was an undue concern with gearing levels depressing the rating, which ignored the cash generation ability of the company. As it degeared, we believed the shares would re-rate. In addition, we believed improvements in the business model through European expansion and product diversification were underappreciated. Alongside solid growth and sensible product acquisitions, the rating improved significantly over the course of the last year. This was aided towards the end of the period with the approval of the anti-nausea treatment Diclectin. With the thesis playing out ahead of our expectations, with, in our view, limited scope for further re-rating, we have realised a significant proportion of the investment (substantially all of the initial cost), with the investment delivering an IRR of 87%.

The share price of Equiniti was very strong over the first half of the period and into the beginning of 2018. This followed the company announcing the acquisition of Wells Fargo’s Share Services business in July 2017. We view this as a long-term positive development for the company. Our belief is that the asset provides the company with the opportunity to replicate the success they have demonstrated in the UK market in the North American market which is seven times larger. Alongside the acquisition, underlying trading was strong with market share gains (in a traditionally stable market) and good revenue growth in the two core divisions. Computershare’s acquisition of Equatex in May 2018 for a reported 19x EV/EBITDA demonstrates the intrinsic value of these businesses.

Our investment in Harworth was significantly increased (c.1 million shares) in the prior year, first, in a placing in March 2017 and again in May 2017 with a block purchase. These were acquired at a significant discount to NNNAV. (NNNAV is the group’s measure of asset value, it includes the market value of development properties, less notional deferred tax). The share price increased by over a third over the period through a combination of continued growth in the net asset value and a closing of the discount of the shares to that value. Pleasingly, the company continues to generate NAV growth through internal actions such as successful planning permissions and uplifts on lettings, rather than the appreciation of land values. Furthermore, the company continues to realise sites at attractive premia to book value and recycle this into growing its strategic land bank and income generating portfolio. We took part in a visit to the company’s sites in Yorkshire which demonstrated the scale of Harworth’s development activities. 

The share price of Clinigen was volatile over the period. Results demonstrated strong growth in the Asia Pacific region and also in their portfolio of commercial medicines. The company acquired Quantum Pharma in September 2017 for £156m. This acquisition provides the company with in-house development capability and a pipeline of potentially new products.

Numis, the institutional stockbroking and corporate advisory firm, was a new investment made in October 2017, with the share price total return of 46% over the period. Underlying business performance has been very strong with Numis gaining market share from larger and smaller competitors and undertaking additional higher margin advisory work from its growing corporate client base. This has generated a substantial cash pile, which should provide the company with a strong market position through the cycle. 

Outside of the top five contributors, there was strong share price performance from Oxford Metrics which delivered a 32% total shareholder return. We took part in a site visit in January 2018 to evidence the progress being made in both the motion measurement division, Vicon and the infrastructure asset management business, Yotta. Recent results have been encouraging.

Bottom 5 Contributors to Performance

Valuation at

period end Period attribution

Company £’000 (basis points)

Medica 8,877 (280)

IFG Group 13,489 (171)

Dialight 4,328 (145)

Proactis 7,428 (109)

Brooks Macdonald 6,080 (26)

After a strong initial share performance following Medica’s IPO last year, the shares were weaker in the second half of the period. The main reason was the company’s full year organic growth rate of 18% was slower than the market expected based on guidance provided by the company. Whilst the poor guidance is disappointing and frustrating, the market appears to have taken umbrage whilst overlooking the continuing operational progress. The company is performing strongly, broadly in line with expectations at the time of investment and has made significant progress since listing. Underlying sales and profit growth are strong and radiologist recruitment is increasing at a supportive rate. The company is largely degeared and continues to generate strong cash flow. We do not feel that the current valuation reflects the company’s future prospects. We continue to engage closely with management on messaging in the public markets and the long-term business strategy. We bought shares in the company at what we believe were heavily depressed valuation levels through the first half of 2018. Following a strong interim results trading statement in July, with another period of 18% organic growth, the share price is back above its IPO price.

The share price of IFG Group weakened towards the end of the period. This largely resulted from the aborted sale of the Saunderson House division. In February 2018, the company announced that in response to incoming interest and with a view to maximising shareholder value, they would look to sell their independent wealth management business. Despite indicative offers in line with expectations, the company decided against a sale owing to transaction risks which could negatively impact value for shareholders. Whilst disappointed with how this was handled and that our thesis wasn’t realised through a transaction, the intrinsic value of the assets is unaffected. The company’s assets under management have grown over 15% per annum over the past three years to over £30bn and, in our view; both companies have enviable levels of client retention and have improved their business models over recent years. Our view remains that the two individual businesses (James Hay and Saunderson House) are independently more valuable than in the current group structure and than the prevailing share price suggests. Ongoing consolidation and an increasing incidence of listed peers in both the wealth management and platform industries demonstrate considerable valuation upside in our view.

Dialight was a disappointment over the period. The investment thesis is predicated on a leading business in a niche industrial electronics market undertaking conversion from conventional to LED lighting. The company has high market share and strong intellectual property. However, the long-term growth opportunity was only part of the thesis, with the company’s strategy to enhance its business model providing further potential margin and cash flow benefits. This included product modularisation and development, sales force improvements, increasing addressable markets and improving the manufacturing process. The last of these caused significant issues over the period with execution problems at Dialight’s outsourcing partner. This resulted in significant downgrades to profitability. Owing to the issues encountered, we expect the company to pursue a hybrid manufacturing strategy, outsourcing subassembly of certain elements, whilst retaining key techniques in-house. While disappointed to have incurred this disruption so early into our investment, we believe the expected scale and manufacturing benefits still pertain. Underpinning the investment is the long-term attractive characteristics of the market, the strong product position and intellectual property and a strong balance sheet. We continue to monitor the progress of the company against our investment thesis.

Proactis was a new investment made in the period as detailed in the following section. Following strong updates in October last year and February of this year, the company warned on profits in April. The primary reasons were the loss of two large customers, adverse foreign exchange movements and an incrementally slower pipeline of new business. The extent of the downgrade was magnified in the share price reaction. This was unexpected by us and the market given the market leading levels of customer retention (95%) and history of operational delivery. The company later disclosed that the two customers took a single product as opposed to a suite, were multinationals as opposed to their core base of SMEs and public sector bodies and had given notice to transition away over a number of years, but left sooner than this. Whilst this is very disappointing, the levels of retention remain very high, the ongoing customer concentration risk is low and the product quality is unaltered as evidenced by the continuing high win rate and a demonstration we attended at their Head Office. We believe the company is well positioned in the growing, but fragmented Procure-to-Pay (P2P) software market. We note a number of recent trade and private equity transactions in the space.

Brooks Macdonald’s share price suffered from additional costs relating to regulatory requirements and the addressing of legacy legal issues. Despite the company having one of the higher growth rates amongst its peer group, its valuation is at a significant discount. 

The average cash balance held by the Company was 8.42% over the period. The approach of the Board and Investment Manager is one of no gearing and to retain sufficient cash to enable the ability to participate in liquidity events without being a forced seller of existing holdings. The ending cash balance was 7.6%, the same level as at the beginning of the period.

Dealing activity

Disposals netted £51.0m (excluding distributions from unquoted listed investments) representing 28% of the weighted average NAV. In addition, £0.6m of net distributions were received from unquoted listed investments. Purchases of £48.1m were made, representing 27% of the weighted average NAV.

There were a number of full and partial realisations in the period. As detailed in the interim report, investments in Servelec and Goals Soccer Centres were fully realised. The takeover of Servelec by Montagu Private Equity concluded in January, realising £15.9m. The investment delivered an IRR of 15% over the four years of ownership. The position in legacy investment Goals Soccer Centres was realised for £6.7m in August 2017 at an average price of 100p. Owing to additional maintenance capex required to maintain the estate, our assessment of the return on capital the business makes has decreased. With a deterioration in cash flow, we believed there was also balance sheet risk.

In addition, the long standing investment in Gooch and Housego was fully realised. We view its business and management as very high quality: however, this is well reflected in a rating of greater than18x operating profit, with future returns increasingly dependent on growth.

Partial realisations were made in both Equiniti and Alliance Pharma. The share price of Equiniti was strong as detailed in the performance review owing to the continuing positive underlying business performance. As a result of the increasing portfolio weight and rating, £12.5m was realised at an average price of 296p over the period. Post period end, the share price weakened significantly owing to market concerns on the underlying business. We strongly believe that many of the concerns are based on a misunderstanding of the business and, in volatile markets, have led to a punitive derating and mis-valuation. As such, we bought back a large number of shares on weakness through the summer. Despite Alliance Pharma being a new investment made in May 2017, £6.7m of the investment was realised (substantially all of the initial purchase cost). One of our four drivers of returns; re-rating, materially played out, this prompted our sell discipline.

Investments were made both in new holdings and the existing portfolio. In terms of new holdings, Proactis was a new investment made towards the end of 2017 at a cost of £9.5m. The company is a global provider of e-procurement and spend control software as a service. Despite its small size, it has leading independent accreditation from Gartner and is ranked as a top global provider in a structurally growing market. The proposition delivers a tangible quick payback on the spending activity of over 1,000 enterprise customers and the company has strong financial characteristics in our view. This includes EBITDA margins of over 30%, high recurring revenues of over 85% and a strong cash profile. Given the attractiveness and growing nature of this niche market, peers are rated at significant premia and there has been consolidation at high valuations. Proactis has participated, acquiring to enhance its proposition and could itself, be a target over time if the valuation discount persists. 

We participated in a placing in Ergomed, a pharmaceutical services company, acquiring a £4.5m block. The company has two separate divisions, one providing clinical trial research services and the other pharmacovigilance services. We believe that pharmacovigilance (drug safety monitoring) is an attractive structural growth area with the increase in both pharmaceutical companies outsourcing this activity and the complexity of reporting requirements providing long-term drivers for Ergomed. This activity has high retention rates and repeatability of business with Ergomed holding a strong market position. As this division becomes a larger proportion of the whole of the business, we expect value to be realised through either a re-rating on the public market or a transaction.

A new investment was made in Numis at a cost of £3.7m. Numis is an institutional stockbroking and corporate advisory firm. The company has made very strong progress in recent years growing a leading position among both its institutional and corporate clients which provides a network effect. This has helped grow both the primary and secondary sides of the business. The business is highly cash generative which should help further improve the market position through the cycle. We believe Numis is a quality strategic asset.

Furthermore, we participated in the Equiniti rights issue (£2.7m) as part of the transaction to acquire Wells Fargo’s Shareholder Services business. Despite being investors in 4imprint for a number of years, we added to our holding (£2.3m) in the first quarter of 2018 following a temporary de-rating of the shares based on what we believe are unfounded concerns on its market.

Portfolio Review

The portfolio remained highly focused with a total of 18 holdings and the top 10 holdings accounting for 70% of the NAV at the end of the financial period. 99.5% was invested in quoted companies. The percentage of the portfolio invested in unquoted securities fell from 0.8% to 0.5%. 7.6% of the NAV was held in cash at the period end.

Changes in sector weightings have seen exposure to Technology (software and computer services) reducing from 27.1% to 22.1%. Financials has increased from 9.8% to 14.2% and Healthcare accounts for 18.5% compared to 17.6% in the prior year. The exposure to consumer services reduced from 4.1% to zero following the exit in Goals Soccer Centres.

Overseas sales have increased as a proportion of the portfolio. This is partially resulting from the realisation of investments in Servelec and Goals Soccer Centres and through the international nature of operations of underlying portfolio companies. For example, Tribal, Equiniti, Clinigen, 4imprint and Proactis have significant international earnings.

We screen for potential investments based on a long standing process focusing on ‘four drivers’ of equity returns; growth, value, corporate activity and de-gearing. We believe this combines the best aspects of public market and private equity investing and improves the chance of delivering shareholder value creation. Our focus is on specific companies as opposed to a ‘top-down’ overlay. Through the underlying holdings, we believe that the current portfolio is exposed to multi-year investment themes including the growth in regulation and compliance, digital health, non-R&D based pharmaceuticals, the growth in the pensions and savings market and infrastructure and building.

Portfolio as at 30 June 2018 – Top 10 Largest Investments

Portfolio as at 30 June 2018 – Sector split by industry

Portfolio as at 30 June 2018 – Size split by market capitalisation

Portfolio Characteristics as at 30 June 2018

Source: Factset Portfolio Analysis System, Bloomberg, FTSE Russell

*GVQIM cashflow yield: (12m forward Cash EBITDA minus maintenance capex)/(market capitalisation plus 12 month forward net debt).

Consistent with previous periods, the portfolio’s aggregate valuation (in terms of the P/E ratio) is higher than the constituents of the broader FTSE Small Cap Index. We have no exposure to traditionally lower rated sectors such as construction, retailers or resource companies. However, the portfolio companies enjoy less geared balance sheets and are forecast to grow earnings faster.

Unquoted Investments

Over the period, the Company received a capital distribution of £0.6m from Vintage I. The outstanding commitment relating to Vintage I is €1,560,000 and its adviser has communicated that it does not expect to make any further net draw downs.

Outlook

In the corresponding section of last year’s report, we emphasised the high conviction nature of Strategic Equity Capital’s portfolio. We have found it to be the case historically that maintaining this discipline in the face of uncertainty and potential misgivings is a suitable approach.

This is relevant today and we noted an insightful quote from a North American fund manager recently; ‘Stock prices fluctuate as underlying fundamentals change or are perceived to change. Since business operations don’t fluctuate nearly as much as shares or as perceptions, prices often change not because reality has changed, but because our perception of reality has changed’¹. With both reducing information and related fundamental analysis of smaller companies, actions can be driven more by perception or indeed the recent direction of the share price.

With all our investments, there is a well defined thesis of how we believe our target returns will be derived over a period of time and this forms the core of how we assess the performance of those companies. Looking out today, we believe that the valuation of the portfolio, at its lowest aggregate level in two years, is very appealing.

At a macro level, we are cautious. Despite an improving global growth picture, one could argue this has been largely reflected in asset prices. Alongside this, the confluence of monetary tightening and elevated debt levels is likely to present a challenge. Although now taken in their stride, it is hard to downplay geopolitical issues ranging from international trade wars, factional politics and potential global conflicts. All of these are set against a backdrop of long-term trends in globalisation, demographics and technology which are creating winners and losers and a sense of inequality and disenfranchisement.

Whilst acutely mindful, our focus continues to be on long-term secular growth areas and enduring business models. At a portfolio level, we feel well positioned. Portfolio company balance sheets are, in aggregate, as strong as they have been in a long time. Over half of the portfolio by NAV are forecast to be in net cash positions within the next twelve months. This provides both financial security in times of stress and optionality to enhance returns through accretive M&A (as has been the case with Equiniti, Alliance Pharma and Clinigen) or through supplementary shareholder returns (such as 4imprint’s special dividend). We expect this to be an ongoing feature and to attract recognition through improvement in the ratings ascribed to cash generative, financially sound companies.

Furthermore, given the ‘dual-track’ nature of the market where those that deliver become more expensive in the ‘fast-lane’ and those that have a wobble become quickly de-rated and unloved, a bifurcation of valuations is created. Clearly, there are situations where stocks are ‘cheap for good reason’, but often nervousness and worry trumps what can be transient issues, or information gaps which create opportunity.

As it stands, a high number of portfolio companies are trading at multi-year valuation lows. It is our view that for the long-term investor, this is a great opportunity. We will use capital provided through take-outs or where an investment re-rates ahead of our view on fair value to reinvest into situations where companies trade at a discount to intrinsic value. We believe this is a judicious strategy.

Ian Bowles

We were shocked and saddened by the very sudden passing of Ian Bowles, Chief Executive of Tribal Group on 29th August 2018.

Ian was very well known to us and played a key role in delivering value to our shareholders through both his time at Allocate Software and Tribal. Ian’s warm disposition meant he was admired and liked by all who knew him. He was a good man and fine professional who achieved a lot in his career and would no doubt have achieved a great deal more. 

The thoughts of current and former employees of GVQ are with Ian’s family and colleagues.

¹Broyhill Asset Management

Top 10 Investee Company Review (as at 30 June 2018)

4imprint Group is a leading direct marketer of promotional products in North America and the UK. It processes over one million customised orders. We have been involved with the company since a change of management in 2003. Following the disposal of Brand Addition, virtually all of the profits of the group are generated by the fast growing US business. The company has a significant net cash balance. Funds managed by the Investment Manager currently hold approximately 4% of the company’s equity.

Clinigen Group is a speciality pharmaceutical and services company. It has three business units –Clinical Trial Services, Unlicensed Medicines and Commercial Medicines. Activities undertaken by these businesses include: acquiring, licencing and revitalising hospital-only critical care medicines; and providing patient access to its own or other pharmaceutical companies’ products, whether to meet unmet medical needs or for use in clinical trials. The company has grown rapidly since its IPO in 2012, both organically and through targeted acquisitions. In April 2015 it acquired Idis, a peer, for £225m through a mixture of debt and equity and in September 2015, acquired Link Healthcare, a specialist pharmaceutical and medical business focused on the Asia, Africa and Australasia region. In September 2017, Clinigen acquired Quantum Pharma. We believe the cash flow characteristics are underappreciated which should see the company de-gear rapidly over the next two years. The company has a leading position in a multi-year growth market. Funds managed by the Investment Manager hold c. 3% of the company’s equity.

EMIS Group is a specialist healthcare software and services provider. It is the UK market leader in the provision of electronic patient records for GPs, with a 55% market share, and over 80% of total revenues are recurring. It also supplies electronic patient records to other healthcare organisations including community pharmacies, community and mental health trusts and accident & emergency departments. With solutions across every major healthcare setting, we believe EMIS is uniquely positioned to benefit from the NHS’s connected care strategy. The company is continuing to develop Patient, an online platform with 18 million unique monthly users to provide high quality healthcare information and solutions. EMIS is highly cash generative with a strong balance sheet providing future opportunity. Funds managed by the Investment Manager currently hold c.4% of the company’s equity.

Equiniti is a business services company providing administration, processing payments services and technology products typically to FTSE 350 companies. It is one of the three main share registrars for UK quoted companies. It administers company benefits schemes and share savings schemes. It also provides software and services to help manage the administration of company and public sector pension funds. We believe the business has a strong combination of stable, long-term repeatable non-discretionary corporate services alongside offering technology based solutions to growing regulatory requirements. The business was founded with the buyout of Lloyds TSB Share Registrars by private equity house Advent International in 2007. Following the buyout the company added to its product and service capability through a number of targeted acquisitions. The company IPO’d in October 2015. Whilst it was well invested under private equity ownership, there are significant medium to long-term opportunities through rationalising its UK office footprint as well as offshoring more activities to its base in India. Together with moderate organic growth we believe that the company has the potential to deliver high single digit/low double digit earnings growth, which should not be significantly impacted by the broad market cycle. Despite its quality, the company trades at a moderate rating. The acquisition of Wells Fargo’s Share Services business in North America is a positive development in our view and provides entry to the world’s largest capital market and significant long-term opportunities for the business. Funds managed by the Investment Manager currently hold c.5% of the company’s equity.

Harworth Group is a leading regenerator of land and property for development and investment which owns, develops and manages a portfolio of sites located across the Midlands and North of England. Spun out of UK Coal, the company specialises in the regeneration of former coalfield sites and other former industrial land into new residential developments and employment areas. The company is lowly geared, asset rich and a discount to a conservative view of NAV and has demonstrated the ability to grow this at a minimum of 10% per annum through the cycle largely through internal actions including successful planning applications, remediation of land and asset disposals. The company is scheduled to obtain a Premium Listing in the second half of 2018. Funds managed by the Investment Manager currently hold c.2% of the company’s equity.

IFG Group is a financial services holding company with two operating assets. London-based Saunderson House is a wealth manager with over £5bn of assets under advice. James Hay is an investment platform, originally a pioneer in the provision of Self-Invested Pension Plans (“SIPPs”) with over £25bn of assets on platform. We believe that both of these businesses offer long-term structural sales growth, as well as scope to make higher margins. The shares are dual-listed in Dublin and London, with the primary listing in Dublin. Comparative M&A multiples and listed peers in both the platform and wealth management sectors suggest that IFG shares trade at a considerable discount to its Sum-of-Parts valuation. Funds managed by the Investment Manager currently hold just below 10% of the company’s equity.

Medica Group is the leading provider of teleradiology services in the UK. The company provides outsourced interpretation and reporting of MRI, CT and plain film X-ray images. This is delivered through three primary services to UK hospital radiology departments: Nighthawk out-of-hours service; Routine cross-sectional reporting on MRI and CT scans; and Routine plain film reporting on x-ray images. Teleradiology as a service aims to improve patient care through faster response and overcoming the challenge hospitals face in the increasing volume in scanning activity. Medica was previously owned by Close Brothers Private Equity following a 2013 buyout. The company was IPO’d in March 2017 on the London Stock Exchange and admitted to the FTSE Small Cap Index in June 2017. Funds managed by the Investment Manager currently hold just below 10% of the company’s equity.

Tribal is a global provider of products and services to the international education, training and learning markets. Today, the company focuses its activities on student records and administration systems and quality review inspection services. It has a high market share in a number of product niches and geographies. We believe that the company has the potential to grow through increasing its international sales, as well as updating and upselling to its existing UK customer base. Since November 2015 the company’s board has been substantially refreshed, a non-core subsidiary sold and equity raised to strengthen the balance sheet. The company is executing well on a three year strategy to reduce its overhead and develop its next generation software platform. Funds managed by the Investment Manager currently hold just below 10% of the company’s equity.

Tyman is a leading international supplier of engineered components to the door and window industry in the new build and repair and maintenance (RMI) markets. We originally invested in the company following the fall in residential activity around the financial crisis in 2009. Under the current management team, the company has, through organic and inorganic investment, increased its market leadership, strengthened the product proposition and delivered significant cost and sales synergies. We believe future upside exists in the company’s ability to replicate its North American manufacturing template to its operations in Europe and the Rest of the World to achieve material efficiencies, and in the recovery of U.S. single family housing activity to long-term historical levels. Funds managed by the Investment Manager currently hold c.5% of the company’s equity.

Wilmington Group provides business information and training services to professional business customers in the financial services, medical and white-collar professional service sectors. More than 80% of revenues in the main publishing and information divisions are delivered digitally, typically on a subscription basis, and with high levels of client retention. The company is highly cash generative. Growth has been held back in recent years and we believe the presence of a new Chairman will improve the company’s execution and management of the portfolio to drive shareholder value. Funds managed by the Investment Manager currently hold 8% of the company’s equity.

GVQ Investment Management Limited 020 3907 4190Investment: Jeff HarrisInvestor relations: Theresa Russell

Canaccord Genuity Limited (Corporate broker) 020 7523 8000Andrew Zychowski / Robbie Robertson / Lucy Lewis

Lansons Communications on behalf of 020 7294 3687GVQ Investment Management LimitedDavid Masters

The Company’s Statement of Comprehensive Income, Statement of Changes in Equity, Balance Sheet, and Statement of Cash Flows follow.

Statement of Comprehensive Income

Statement of Comprehensive Income

Balance Sheet

Statement of Changes in Equity

Statement of Cash Flows

Principal Risks and Uncertainties

The Board believes that the overriding risks to shareholders are events and developments which can affect the general level of share prices, including, for instance, inflation or deflation, economic recessions and movements in interest rates and currencies which are outside of the control of the Board.

The principal risks and uncertainties are set out on pages 17 and 18 of the Annual Report for the year ended 30 June 2018, which is available at www.strategicequitycapital.com.

Responsibility statement of the Directors in respect of the Annual Financial Report

We confirm that to the best of our knowledge:

We consider the Annual Report and accounts, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s position and performance, business model and strategy.

Going Concern

The Company has adequate financial resources to meet its investment commitments and, as a consequence, the Directors believe that the Company is well placed to manage its business risks. After making appropriate enquiries and due consideration of the Company’s cash balances, the liquidity of the Company’s investment portfolio and the cost base of the Company, the Directors have a reasonable expectation that the Company has adequate available financial resources to continue in operational existence for the foreseeable future and accordingly have concluded that it is appropriate to continue to adopt the going concern basis in preparing the Annual Financial Report, consistent with previous periods.

Related Party Transactions

The Investment Manager may draw upon advice from the IAP of which Sir Clive Thompson, a Director of the Company, is a member. The IAP was established to provide advice to the Investment Manager in relation to the strategy, operations and management of potential investee companies.

The amounts payable to the Investment Manager are disclosed in Note 3 on page 46 of the Annual Financial Report. The amount due to the Investment Manager for management fees at 30 June 2018 was £329,000 (2017: £728,000). The amount due to the Investment Manager for performance fees at 30 June 2018 was £Nil (2017: £1,856,000).

Fees paid to Directors are disclosed in the Directors’ Remuneration Report on page 31 of the Annual Financial Report. Full details of Directors’ interests are set out on page 32 of the Annual Financial Report.

Notes

1.1 Corporate information

Strategic Equity Capital plc is a public limited company incorporated and domiciled in the United Kingdom and registered in England and Wales under the Companies Act 2006 whose shares are publicly traded. The Company is an investment company as defined by Section 833 of the Companies Act 2006.

The Company carries on business as an investment trust within the meaning of Sections 1158/1159 of the UK Corporation Tax Act 2010.

1.2 Basis of preparation and statement of compliance

The financial statements of the Company have been prepared in accordance with IFRS issued by the International Accounting Standards Board (as adopted by the EU), interpretations issued by the International Financial Reporting Interpretations Committee, and applicable requirements of United Kingdom company law, and reflect the following policies which have been adopted and applied consistently. Where presentational guidance set out in the Statement of Recommended Practice (“SORP”) for investment trusts issued by the AIC is applied to the extent it is consistent with the requirements of IFRS, the Directors have sought to prepare financial statements on a basis compliant with the recommendations of the SORP.

The financial statements of the Company have been prepared on a going concern basis, on the assumption the continuation vote is passed by Shareholders at the forthcoming Annual General Meeting.

Convention

The financial statements are presented in Sterling, being the currency of the Primary Economic Environment in which the Company operates, rounded to the nearest thousand, unless otherwise stated to the nearest one pound.

Segmental reporting

The Directors are of the opinion that the Company is engaged in a single segment of business, being investment business.

1.3 Accounting policies

The accounting policies used in the preparation of the Annual Financial Report can be found on pages 43 to 45 of the Report for the year ended 30 June 2018.

1.4 New standards and interpretations not applied

IASB and IFRIC have issued the following standards and interpretations which are not effective for the year ended 30 June 2018 and have not been applied in preparing these financial statements.

International Accounting Standards (IAS/IFRS) Effective date*

IFRS 9 Financial Instruments 1 January 2018†

IFRS 15 Revenue from Contracts with Customers 1 January 2018†

IFRS 16 Leasing 1 January 2019

* Years beginning on or after.

† Early adoption permitted.

2. Income

3. Investment Manager’s fee

A basic management fee is payable to the Investment Manager at the annual rate of 0.75% of the NAV of the Company. The basic management fee accrues daily and is payable quarterly in arrears.

The Investment Manager is also entitled to a performance fee, details of which are set out below.

The Company’s performance is measured over rolling three-year periods ending on 30 June each year, by comparing the NAV total return per share over a performance period against the total return performance of the FTSE Small Cap (ex Investment Companies) Index. A performance fee is payable if the NAV total return per share (calculated before any accrual for any performance fee to be paid in respect of the relevant performance period) at the end of the relevant performance period exceeds both: (i) the NAV per share at the beginning of the relevant performance period as adjusted by the aggregate amount of (a) the total return on the FTSE Small Cap (ex Investment Companies) Index (expressed as a percentage) and (b) 2.0% per annum over the relevant performance period

(“Benchmark NAV”); and (ii) the high watermark (which is the highest NAV per share by reference to which a performance fee was previously paid).

The Investment Manager is entitled to 10% of any excess of the NAV total return over the higher of the Benchmark NAV per share and the high watermark. The aggregate amount of the Management Fee and the Performance Fee in respect of each financial year of the Company shall not exceed an amount equal to 1.4% per annum of the NAV of the Company as at the end of the relevant financial period.

No performance fee has been accrued in respect of the year ended 30 June 2018 (30 June 2017: £1,856,000).

4. Other expenses

*No non-audit fees were incurred during the year

5. Taxation

The Company is subject to corporation tax at 19.00%. As at 30 June 2018 the total current taxation charge in the Company’s revenue account is lower than the standard rate of corporation tax in the UK.

* IFG Group withholding tax paid £29,642 (2017: £74,603).

6. Return per Ordinary share

Returns per Ordinary share are calculated based on 67,919,623 (30 June 2017: 69,731,772) being the weighted average number of Ordinary shares, excluding shares held in treasury, in issue throughout the year.

7. Investments

The Company is required to classify fair value measurements using a fair value hierarchy that reflects the subjectivity of the inputs used in measuring the fair value of each asset. The fair value hierarchy has the following levels:

Investments whose values are based on quoted market prices in active markets are classified within level 1 and include active listed equities. The Company does not adjust the quoted price for these instruments.

The definition of level 1 inputs refers to ‘active markets’, which is a market in which transactions take place with sufficient frequency and volume for pricing information to be provided on an ongoing basis. Due to the liquidity levels of the markets in which the Company trades, whether transactions take place with sufficient frequency and volume is a matter of judgement, and depends on the specific facts and circumstances. The Manager has analysed trading volumes and frequency of the Company’s portfolio and has determined these investments as level 1 of the hierarchy.

Financial instruments that trade in markets that are not considered to be active but are valued based on quoted market prices, dealer quotations or alternative pricing sources supported by observable inputs are classified within level 2. As level 2 investments include positions that are not traded in active markets and/or are subject to transfer restrictions, valuations may be adjusted to reflect illiquidity and/or non-transferability, which are generally based on available market information.

Level 3 instruments include private equity, as observable prices are not available for these securities the Company has used valuation techniques to derive the fair value. In respect of unquoted instruments, or where the market for a financial instrument is not active, fair value is established by using recognised valuation methodologies, in accordance with IPEV Valuation Guidelines.

Level 3 investments consist of an investment in a private equity fund of funds managed by 3i (‘the Fund’) and is valued at the Company’s attributable proportion of the reported Fund Net Asset Value in accordance with the IPEV Valuation Guidelines. The Net Asset Value of the Fund is derived from the Fair Value of the underlying funds based on the most recent financial statements of the underlying funds adjusted for any subsequent cash movements to and from the underlying funds.

The underlying funds primarily invest in private companies which are recorded at cost or Fair Value derived from private equity valuation models and techniques. The main inputs into the valuation models of the underlying funds include industry performance, company performance, quality of management, the price of the most recent financing round or prospects for the next financing round, exit opportunities which are available, liquidity preference and net present value analysis.

The level in the fair value hierarchy within which the fair value measurement is categorised is determined on the basis of the lowest level input that is significant to the fair value of the investment.

The following table analyses within the fair value hierarchy the Company’s financial assets and liabilities (by class) measured at fair value at 30 June 2018.

Financial instruments at fair value through profit or loss as at 30 June 2018

The below table presents the movement in level 3 instruments for the year ended 30 June 2018

by class of financial instrument.

8. Share capital

9. Capital commitments and contingent liabilities

The Company has a commitment to invest €1,560,000 in Vintage I (30 June 2017: €1,560,000).

These are not statutory accounts in terms of Section 434 of the Companies Act 2006. Full audited accounts for the year to 30 June 2018 will be sent to shareholders in October 2018 and will be available for inspection at 1 Finsbury Circus, London EC2M 7SH, the registered office of the Company. The full annual report and accounts will be available on the Company’s website www.strategicequitycapital.com

The audited accounts for the year ended 30 June 2018 will be lodged with the Registrar of Companies.