Tag Archives: Infrastructure Equity

DCC – Interesting “Special Situation” following KKR potential buyout offer at 58 GBP ?

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Disclaimer: This is not investment advice. PLEASE DO YOUR OWN RESEARCH !!!!!

DCC is an investment I made back in December 2022. The investment thesis back then was that it was a successful compounder/serial acquirer that had the opportunity to grow further through its 3 platforms (Energy, Healthcare, Technology).

In the meantime, a lot of unexpected things happened. After issues in the non-Energy segments, DCC is currently transforming itself back into the original Energy distributor and sold already a significant part of its non.Energy businesses. The transformation has progressed well including a share buy back tender but is not finished yet.

Looking at the share price, we can see that not much happened over the last 5 years but that the timing for buying into DCC in Dec 2022 retrospect was quite lucky:

After the recent jump to 58 GBP, I am up 42% in total (in EUR, including dividends) which is not spectacular and rather at the lower end of my expected outcome. However, given the “Pivot” it is still a decent result and mostly attributable to the low entry point and the relevant dividends.

Now fast forward to last week: 

Private Equity behemoth KKR and another energy focused PE called Energy Capital Partners approached DCC and seem to have informally offered to take over DCC at 58 GPB per share which only represents a 15% premium over the average share price for the last few months.

DCC immediately declined the offer as “too low”.

Energy Capital Partners is a pretty large Energy focused US PE/Infrastructure investor that owns a lot of “Energy Transition” businesses. AuM seems to be north of 40 bn USD.

Although KKR did not disclose which fund is bidding, it looks that both KKR and ECP see this as an infrastructure play which makes a lot of sense.

58 GBP per share is clearly a low ball offer and no formal offer has yet been made. Under the applicable Irish laws, KKR has time until June 10th to either submit a formal offer or walk away.

From a shareholder perspective, I assume that maybe a lot of investors have been frustrated that the stock only went sideways for the last 5 years or so and are maybe happy to exit at that level.

The “asset heavy” Infrastructure PE playbook

DCC so far has operated as a relatively capital light distributor, but I think it is relatively easy to pivot them into an Infrastructure like business that usually enjoys significantly lower cost of capital.

In contrast to “normal” Private Equity, Infrastructure Private Equity still enjoys a pretty good time. Many players have raised large funds and are eager to deploy money. Infrastructure is often considered “AI safe” these days.

So I guess there might be a chance that some other players might look very closely at this situation. DCC is a very obvious target and the timing is quite nice from a PE perspective. The refocusising on Energy at DCC is still underway and the results don’t look so “clean” at the moment,

DCCs business model, especially the LPG distribution business has a lot of potential to get easy access to many SME companies and sell them solutions.

Especially the current volatility in fossil energy prices opens up a unique selling opportunity for solutions that offer less exposure like rooftop solar etc. 

According to TIKR, DCC’s Net debt to EBITDA ratio is only around 1,2x. The company is valued at around 7xEV/EBITDA. The typical infrastructure playbook would be to make the company more “asset heavy”. Due to the low gearing, this could be financed by more leverage. A typical “asset owning” infrastructure company with longer term contracts can be easily levered 4-5x Net debt/EBITDA, 

In DCC’s case, with around 900 mn in EBITDA, increasing the leverage ratio to 4x would allow them to issue almost 3 bn in debt which could finance a lot of assets. Those assets then will automatically increase EBITDA,

A stabilized infrastructure like company can then be sold at much higher multiples, usually at 12-15x EV/EBITDA. So the value creation potential for a good Infrastructure PE shop is significant. 

Just for fun I did a high level calculation how that exercise would look from this perspective (I just took the current numbers from TIKR, before further disposals):

A potential IRR of above 20% p.a. is highly attractive for an Infrastructure fund and as I have written before, PE’s have some more levers to “juice up” the IRR and earn even higher performance fees.

Is DCC now an interesting special situation play ?

There is clearly the risk that DCC might reject even higher offers, but I do think the 58 GBP low ball offer provides a decent “floor” for the stock (“Anchoring effect”).

For one, DCC should expect some positive operational tailwinds. Volatile and high energy prices in the past have been good for DCC’s energy business. As we can see every day “at the pump”, distributors like normal Petrol stations immediately increase prices although they often have inventories for some weeks/months and often drop prices much slower.

Looking back to the last energy price shock in 2022, we can see that this was DCC’s best year, especially for the energy business:

Although there is no guarantee that the same will apply to 2026, there is a high likelihood that 2026 will look good for DCC from an operational perspective.

In addition, I do expect that the transformation will be more or less completed in the 2026 calendar year. 

So all in all, 2026 seems to look pretty good for DCC. I think this also explains the timing of KKR and ECP, as they don’t want to wait until this improvement shows in the results of DCC.

Even in case, DCC gets sold relatively quickly at 58 GBP per share, one would still get the Dividend that will be recorded end of may.

Quick handicapping exercise:

Overall, I would see the probabilities as follows until the end of the year::

25% probability of no deal with 55 GBP as the outcome (plus dividend, currently estimated at 2,10 GBP/share)

15% of a deal at 58 GBP (plus dividend)

60% probability of a better deal. My guess here would be 70 GBP plus Dividend

This is the quick and dirty calculation:

So based on my assumptions, my probability weighted expected return is around 16% until year end. This looks attractive to me, as in my opinion, the downside is very limited.

Of course, all the assumptions can be challenged and changed.

Summary:

So in total I see the following situation here:

  • The bid of 58 GBP is clearly too low
  • DCC’s short term operational results are supported by increasing energy prices
  • in addition, the full effect of the transformation “back to energy” will materialize in the following quarter
  • Other Infrastructure funds might also be interested in DCC

So even if the bid from KKR would not be successful, I do think that the share price has much more upside than downside potential at the moment.

From that perspective, I decided not to sell any DCC shares but rather increase my position by ~1,5 % of total portfolio value at around 57,50 GBP per share.

Private Equity Series (8): The “Stonepeak precedent”, a “Dirty PE Industry Secret” and what it could mean for the Industry 

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No one has asked for it, but here it is, the next episode of my Private Equity series. Previous episodes of the Private Equity series can be found here:

Private Equity Mini Series (1): My IRR is not your Performance
Private Equity Mini series (2) – What kind of “Alpha” can you expect from Private Equity as a Retail Investor compared to public stocks ?
Private Equity Mini Series (3): Listed Private Asset Managers (KKR, Apollo & Co)
Private Equity Mini series (4) : “Investing like a “billionaire” for retail investors in the UK stock market via PE Trusts
Private Equity Mini Series (5): Trade Republic offers Private Equity for the masses (ELTIFs) -“Nice try, but hell no”
Private Equity (Mini) Series 6: Private Equity for the masses – Y2K edition
Private Equity Series (7): Secondaries – The Magic Money Machine for the PE industry 

Background:

Everyone in the alternative (non-listed) investment space has been talking about the Blue Owl Private Debt “redemption gating” event lately, but in my personal opinion, another story which has not been so widely reported is much more interesting.

The case of the first Stonepeak Infrastructure Flagship fund is at least equally interesting for the whole Private Equity sector and I will try to explain why.

Traditionally, the Private Equity business model can be summarized from the the perspective of the Asset Manager or General Partner (“GP”) as follows:

GPs take a big junk out of any upside (usually 20% ,sometimes more) but themselves have very little downside risk as they charge a hefty 2% p.a. fee in any case and only, if at all, invest relatively little money themselves into the funds they manage.

So let’s look at Stonepeak. Stonepeak is one of the leading Alternative Infrastructure Equity Asset Managers in the world and has 89 bn USD Assets under Management. It is still privately owned.

Infrastructure was actually one of the few bright spots in the Private Equity space in the past few years, where fundraising still works, in contrast to the “normal” private Equity funds.

Although the dividing line between Infrastructure and Private Equity is a little bit blurry, Infrastructure investments are often “capital heavy” and considered more safe despite usually significant leverage. Typical assets are ports, Airports, railways, toll roads but also stuff like container leasing, warehouses etc. (among others Stonepeak bought the Canadian Port Operator Logistec which I owned)

Target returns for Infrastructure funds are usually a bit lower than for Private Equity (usually maybe 10-15% p.a. vs. 15-20%)  and fund duration is often a bit longer. But infrastructure should be also be more robust, i.e. have less downside than a PE fund.

Stonepeak was founded in 2011 and launched its inaugural “Flagship” fund in 2012. 

Now comes the interesting part: 

A few weeks ago, the founder of Stonepeak, Mr. Dorrell, pledged personal support for the rather badly performing initial flagship fund.

Although it is not unusual that Alternative Assetmanagers might maybe reduce fees going forward if a fund performs really badly, this is the first time that I have actually seen that an owner actually puts in personal money to make good on the not so great performance of the investors. Here is how it should work:

According to the article, the initial fund had “promised” 12% net IRR to investors at launch but currently, after 14 years it only shows an IRR of 7,4%. Not a catastrophy at first glance but also not great either for such a vintage that should have benefitted from a significant decline in interest rates which was especially beneficial for “long duration” infrastructure assets.

What is also really interesting is that graph that shows how calculated IRRs have developed in the last years from the perspective of investors in this fund:

Until 2020, i.e. for the first 7-8 years everything looked fine. But what happened then ? And why is this relevant ?

I guess it’s now time to tell you a little bit about a “dirty secret” of the Private Equity (and Private Infrastructure) world.

Whenever a new firm gets created and launches an initial fund, it takes a long time until investors can see actual results. On average, in the infrastructure space, investment are sold maybe 6-10 years after they have been bought.

However, Asset Managers don’t want to wait until then to raise a new fund. They want to raise funds more frequently in order to earn more fees. Normally the “fund raising” cycle is ~ 3-4 years. 

Even professional investors invest mostly based on past performance, often just simply extrapolating those past numbers in the future.

So what do you do when you have no exits to show ? Of course, you just mark up your portfolio yourself based on some loosely defined metrics which often is coincidently very close to the target return. So just to say this again: In the beginning, almost all PE/Infrastructure funds are marking up their investments “at will” to show a decent performance, of course with the hope that later on, they will actually realize those returns or even more.

You then can present this (unrealized) return to investors and they happily invest into the next fund and the next etc.

In Stone Peak’s case they were quite busy and raised another 3 funds during the time when performance was looking still OK for the initital fund in 2020 as we can see here:

The funds got bigger and bigger, Fund III was ~7 bn and Fund IV 14 bn. And they are currently raising fund V with a target size of 15 bn,

Most of that money got raised with investors looking at the track record and saying: Fund I looks good at 11% p.a. (or maybe even more in the beginning) and I guess Stonepeak was telling them that this was marked “conservatively” (GPs always say that about unrealized values).

But it turned out to be wrong and clearly overvalued. And this is clearly embarrassing for Stonepeak. 

If I were a potential Stonepeak investor doing Due Dilligence, I would ask: “How can I trust all the other performance numbers of your funds when the only one which is almost realised seems to have been significantly overvalued ?”

I guess that’s why Dorrell wants to make those investors “whole” with personal money:

As the first fund is significantly smaller than the follow up funds, this will not bankrupt him, but anyway, this is an industry first.

The industry relevance in my opinion is the following:

We can expect a lot more such cases where the initial, very positive performance will turn out not so positive at all or even funds may lose money (2019 to 2021 vintages for instance). 

So far, this has always been the sole problem of the investor, never for the GP.

Michael Dorrell now created a high profile precedent that will be taken up with gusto by many disappointed investors.

The smart LPs will use the Stonepeak precedent to ask their GPs for the same “Commitment” to make good on their initial promise. 

Otherwise they will not invest into a subsequent fund. Some GPs, especially the very big ones will resist, some will maybe just close up shop, but I guess a lot of GPs will get under a lot of pressure. 

Overall, this might be a first step to change the relationship between GPs and LPs going forward.  If you are an investor in any listed Alternative Asset manager, I think you should really pay attention to this. It could be that in the future, results might get even more volatile and in general lower if funds underperform.

Another relevant point is the following:

This case also puts a spotlight on how arbitrary especially early valuations are for these investments. Already last year, I heard rumors that auditors have begun to challenge valuations of PE funds as they see secondary transactions with large discounts.

I could also imagine that investors want better disclosure of unrealized return figures during Due Diligence and how those seemingly great early performance numbers got cooked up, or maybe not 😉

In any case, I am sure that there willl be a lot of interesting discussions already going on between disappointed investors and GPs, that’s for sure.

Timing wise, this comes at a pretty inconvenient time for most PE firms anyway. As this chart shows, the last year was not so good for the share price performance of the big shops:

Maybe we will see a turn-around at some point in the future, but for the moment I see more headwinds than tailwinds for the industry overall. If more GPs are forced to compensate investors, then valuations for those guys would need to come down significantly.