Oaktree Capital; market cap as of 04/03/2016: $7.33bn (£5.15bn)
Countryside Properties plc.; market cap as of 04/03/2016: £ 1.01bn

Introduction

On 14 January, 2016, Countryside Properties plc. (Countryside), UK-based real estate developer controlled by private equity firm Oaktree Capital Management, L.P. (Oaktree),announced its intention to proceed with an initial public offering. On 12 February, 2016 it has priced its IPO at £ 2.25 per share.Five days later the trading commenced on the LSE under the symbol “CSP”. Oaktree, the world’s largest distressed debt investor, purchased Countryside Properties Plc through debt provided by former owner Lloyds Banking Group in 2013, has now listed the company, valued at £ 1.01bn at IPO price. The IPO was the second biggest in London in 2016 so far, after the planned listing of Clydesdale Bank.

 Graph_1_Price_Chart

About Countryside Properties

The Group is a leading UK home builder and urban regeneration partner. Countrysidewas founded in 1958 and in its early years focused on small residential developments, primarily in Essex and East London. From 1972 Countryside was a listed company traded on the LSE, until it was acquired by Copthorn Holdings Limited, at that time a 50/50 joint venture between the Cherry family and Bank of Scotland (part of Lloyds Banking Group plc) in 2005. Countryside Properties underwent a restructuring of its balance sheet in 2010, and in 2013Oaktree acquired control of the Group from a consortium of banks. The Group’s strategy was refined to progressively exit from commercial and design, build projects and focus on the core areas of the Housebuilding and Partnerships divisions’ businesses, in which it operates now.

In February 2014, the Group acquired Millgate, which it subsequently integrated into the Housebuilding division. The move was seen as a milestone on the road towards a potential London listing.

In the year ended 30 September 2015, the Group generated revenue £547.5m and an underlying operating profit of £91m, and had a TNOAV of £388.5m.A significant share of company’s growth has been supported by The Help to Buyscheme, which provides government loans to supplement first-time buyers’ deposits on new-build homes and makes up 38% of Countryside’s sales. The company has also enjoyed house price inflation and a positive land market, which contributed to the financial strength of the company andbolstered its ambitions to expand.

Housebuilding

The Housebuilding division develops medium to larger-scale sites, providing private and affordable housing on land owned or controlled by the Group, primarily around London and in the South East of England. The Housebuilding division operates under both the Countryside and Millgate brands. Millgate was integrated into the Housebuilding division as its premium housebuilding brand in the Home Counties.

The division contributes 53.7% of the Group’s total revenue (including the proportional contribution of associate and joint ventures).

 

Partnerships

The Partnerships division specializes in medium to larger-scale urban regeneration of public sector land delivering private and affordable homes. It operates primarily in and around London and in the North West of England. Regeneration projects are developed in partnerships predominantly with public sector landowners, such as LAs and housing associations.

The division contributes 46.3%of the Group’s total revenue (including the proportional contribution of associate and joint ventures).

 

Key figures

As of year ended 30 September, 2015; £ ‘000 unless otherwise stated

Housebuilding y.o.y. % change Partnership y.o.y.% change Group y.o.y. % change
Revenue 278,743 10.2% 268,743 34.5% 547,486 20.9%
Underlying operating profit* 51,562 103.1% 39,604 82.2% 91,166 93.5%
Operating profit 37,997 79.2% 33,806 55.2% 67,926 60.8%
TNOAV** 334,321 15.6% 54,179 (9.7)% 388,501 11.5%
ROCE*** 16.6% 690bps 69.4% 1590bps 24.7% 910bps

* Group operating profit including the proportional contribution of associate and joint ventures’ operating profit and excluding the impact of non-underlying items

** Tangible Net Operating Asset Value, calculated as net assets excluding intangible assets, net bank debt and mandatory redeemable preference shares

*** Return on Capital Employed, calculated as underlying operating profit divided by the average TNOAV for the given year

About Oaktree Capital Management

Oaktree Capital Management is a global alternative investment management firm with headquarters in Los Angeles and offices (including affiliates) in other 17 cities worldwide. Oaktree currently has $97bn (£68.14) in assets under management and has a wide variety in its client mix, comprising for example prominent public funds, corporate pensions, insurance companies, other corporates and sovereign wealth funds. Its regional mix by AUM is 75% concentrated in the Americas, 15% in EMEA, 10% in Asia. Oaktree is the world’s largest distressed debt investor – more than 60% of its investment strategies focus on corporate and distressed debt, and in the asset class mix it also counts control investing, real estate, convertible securities, and listed equities.

Oaktree Asset Class Mix by AUM

Recently, Oaktree has been very active in the Media and Real Estate Development private equity and corporate debt landscape, in particular in the U.S., in Europe, and in New Zealand. It has also just announced it would set up a new shop in Australia, where it has been quite active in recent years, for example with the refinancing and IPO of Nine Entertainment, a television broadcaster.

Oaktree was also involved in the sale of London City Airport in February 2016. On 3 March, 2016, Oaktree and PatriziaImmobilienreported the preparation of the sale of a 90-acre business park near Reading for £375m. Moreover, Tribune Media, a U.S. company in which Oaktree still holds a 23% stake after its IPO, has just announced it is exploring financial alternatives, such as a sale.

Countryside is back on the London Stock Exchange

In February 2013, Oaktree bought U.K. homebuilder Countryside Properties using debt provided by seller Lloyds Banking Group, which had taken control of the company in 2009 as part of a refinancing deal.

After 3 years, Countryside has listed on the London Stock Exchange with a market cap of £1.01bn. It offered 135 million shares, representing around 30% of the company’s outstanding shares, since the company announced that after floating it would have 450m shares in issuance. Overall, the offering equated to an offer size of £304m, with a share-value of 225p, the bottom of the expected range of 225p to 275p a share. Existing shareholders sold 77 million shares, with £174 million in gross proceeds, while 58 million new shares in the global offer were issued, amounting to gross proceeds for the company of £130m (net £114m). The net proceeds received by Countryside will be used to reduce indebtedness (approximately £64m) as well as to accelerate the development of sites at Acton, Beaulieu, Hazel End and Rayleigh (about £50m).

Oaktree (including entities controlled by it), along with a part ofCountryside’s management and employees (mainly CEOs Graham and Richard Cherry, followed by Executive Chairman Ian Sutcliffe), sold shares in the offering. In case there is no exercise of an overallotment of shares, Oaktree would own 60.6% of the company’s outstanding shares (through its vehicle OCM Luxembourg), while Countryside’s management would own about 7.6%. When the IPO is complete in the next few months, Countryside Properties will have a free float of between 30% and 50% of its issued share capital.

The company’s underlying operating profits almost doubled to £91m in the year to September 2015. Moreover, the company plans to adopt a progressive dividend policy, aiming to pay out 30% of earnings. The EPS as of September 2015 was 4.36p, and accounts for an EPS growth (adjusted) of 93.51%.

A good time for an IPO? Rationale and Market Reaction

Market volatility has dampened activity in global IPOs so far in 2016. Investors have been pulling capital amid oil prices drop and global macro concerns. The decrease in growth rates in emerging markets (particularly China) and the economic and geopolitical risks in the U.S. (presidential elections) and in Europe (the potential Brexit and the migrants crisis) are all contributing factors to the dry IPO market we have been looking at more or less since the beginning of the year. Considering all the risks connected with a decision to IPO a company in this kind of environment, Countryside’s public offering can all- in- all be considered relatively successful. However, it is not just luck.

As noted above, Countryside is a British company operating in the housebuilding business, with activities in London, South East, East, and North West of England. Real estate prices in Great Britain have been increasing since the aftermath of the financial crisis, and, according to property agent Savills, houses in London are today over 50% higher than their pre-2008 financial crisis peak, after an incredible rise that began around March 2012 (see figure below). It is therefore no surprise to see Countryside benefiting from this trend, as demonstrated by its revenues and operating income rising at impressive double digits growth rates (see table above).

However, the earnings of the company, which are ultimately what make it attractive, have turned positive only in 2015. Given the growing trend of the operating indicators, the primary reason for these results is the amount of debt that Countryside is carrying (or more precisely was, before the IPO) on its shoulders, resulting from the buyouts operated first by Lloyds and then by Oaktree. Financial expenses amounted to about 170%, 123%, and 77% of the group operating profit respectively in 2013, 2014 and 2015.

 British House Prices Graph

Overall, despite the generally negative market trends, the good figures of the company and the positive trend in British house prices have contributed to generating a relatively good environment for Oaktree to begin exiting its investment and for Countryside to complete a decent IPO, with no stunning jump but also no drop below the offering price. The company was able to raise the funds it needed to finance its growth opportunities and repay the large amounts of debt on its balance sheet, while Oaktree managed to give a satisfactory value to its holdings. The private equity firm has, however, a 180-day lock-up period before it can begin to cash in its investment.

On the market, shares gained about 7% in the first three days of conditional trading, but suffered a slump when unrestricted trading began, closing at £2.2875 on Thursday, February 25, probably due to short-term oriented institutional investors unloading part of their holdings. Since then, shares have been re-gaining, and are now trading in the high £2.30s.

Insights on the Private Equity Market Going Forward

Both 2014 and 2015 were incredible years for the private equity business. Despite the backdrop of a slowing global economy and increasing volatility in public equity markets, exit activity, both via IPOs and sales to strategic acquirers, was strong and profitable (see figure below). Total distributions have in fact exceeded contributions each year since 2011, rising to a peak surplus in 2014 of $66.3bn (£46.58bn), $23.6bn (16.58bn) of which in the U.S. and Europe. PE firms took advantage of the favorable environment, this led to a strong reduction in the overall investment horizon, with a good percentage of 2014 and 2015 global sales coming from investments made between 2011 and 2015, as shown in the chart below (see figure below).

The negative market developments of the recent weeks and a potential further increase in interest rates by the Federal Reserve (for what concerns American companies) could be signs that the time to buy heavily has actually come again. In fact, as companies struggle to meet their growth/earnings targets or, worse, are unable to meet their current obligations or to refinance their debt as a result of a potential rate hike, they become appealing targets for private equity firms.

There are, however, a number of issues that need to be taken into account.

 Private Equity Deal Volume

PE Exit by Year of Investment

Primarily, while it is true that the Federal Reserve has begun a tightening policy, interest rates in the U.S. still remain very low, as well as in Europe, where the ECB has actually been strengthening its quantitative easing policy recently. This means that there are massive amounts of (unregulated) capital seeking satisfactory returns and flooding into the hands of private equity managers. Of course, abundance of capital is not something negative per se, but it becomes so when it starts to affect returns. This happens because easy availability of money stimulates competition among PE firms, which in turn considerably drives up target acquisition prices and often leads to assets being bought by one fund and then sold to another.

Moreover, unpleasant market conditions do generally offer good investment opportunities, but at the same time the uncertainty surrounding the evolution of the global economy brings about worries in terms of future exits from current investments and returns. A clear example of the materialization of these worries is Oaktree’s IPO of Countryside that we have just analyzed.

In conclusion, while the conditions seem favorable for a new wave of investments, overabundance of capital and economic as well as political concerns (including Brexit and the migrants crisis in Europe, presidential elections in the U.S., and uncertainties surrounding emerging markets) bring about the need for change in the PE industry to avoid unsatisfactory returns. This trend inversion could take the form of differentiation, with the most specialized companies leveraging on their expertise to guarantee investors value added and lock in high returns, or of longer horizon investments.

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