Review: Foresight 4 VCT

Foresight 4 VCT plc has a long history of takeovers, mergers and diverse investment mandates.  Look beyond this, however, and the underlying story is a good one, with potentially promising prospects.  The Foresight 4 VCT is merging with its smaller sibling, Foresight 3 VCT. Together they will raise £50 million, with an over-allotment facility of a further £50 million.  

Highlights

  • Well established, mature VCT portfolio
  • Experienced and well resourced team
  • Raising up to £100m: the managers are confident they have the deal flow to invest this
  • Merger with Foresight 3 VCT is expected to reduce costs and increase efficiencies
  • Wealth Club saving of 5% on initial charge
  • Minimum investment £3,000

The manager

Foresight Group was founded in 1984 as a specialist technology venture capital manager. In total, the group has £2.6 billion under management. £292 million is invested in its range of three VCTs (four prior to the merger of Foresight 3 and 4). David Hughes, Chief Investment Officer, is supported by 17 others in the private equity team. 

The merger of Foresight 4 VCT with Foresight 3 VCT is intended to save costs and improve administrative efficiency: the holdings of the two VCTs are similar. The managers estimate the cost savings to be positive within one year. David Hughes of Foresight believes the new VCT will also provide enhanced liquidity for investors: previously the two VCTs were constrained for cash. The new fund raise will allow the enlarged VCT to participate actively in new deals.

After the merger, the Foresight 4 VCT is expected to have assets around £70-80 million, with around 25 portfolio companies. 

As background, Foresight 4 started life as the Advent 2 VCT in 1998, and after becoming Foresight 4 merged with Foresight 5 VCT, Foresight Clearwater VCT and Acuity VCT. Foresight 3 was originally the Advent VCT, and in 2008 was merged with Noble VCT. 

Strategy

Foresight 4 will invest in UK unquoted companies with high growth potential. The broad aim is to deliver attractive returns to shareholders from a combination of dividends and interest payments from investments, as well as distributions from capital gains from trade sales or flotations. Foresight will focus on making investments in the following sectors: 

  • Business services
  • Industrials and manufacturing
  • Technology, media and telecommunications 
  • Consumer and leisure
  • Healthcare   

Foresight 4 was originally a technology-focused portfolio. In the late 1990s, Foresight changed the emphasis of the fund to a mix of environmental investments, MBOs (Management Buy outs), MBIs (Management Buy Ins) and replacement capital deals. The latter worked well whilst the environmental investments didn’t. 

This acted as a damper on the whole VCT: there was no dividend payable in 2010 from Foresight 4, for instance (see below for full dividend history and performance). As a result, the portfolio was refocused. Around 60% of the current portfolio is now is held in MBO, MBI and replacement capital investments and 40% in growth capital investments. 

Thanks to new rules, MBOs, MBIs and replacement capital deals are off the table for new VCT investment. However, in Foresight’s view, the distinction between MBO, MBI and replacement capital investments and growth capital investments is an artificial one. All are predicated on growing an investee company.  

Foresight has an interesting approach here which in our view sets the VCT apart from many of its peers. Foresight has set up offices in Manchester and Nottingham to access regional deal flow, with more locations planned. These offices raise institutional funds which are relatively unconstrained as to where and how they invest. So, if there is a deal Foresight likes, the regional funds take the replacement capital element whilst the VCT takes the growth capital. It’s a clever way to participate in deals the VCT rules otherwise restrict.     

The secondary role the regional offices play is to provide deal flow for the VCT. 

Foresight sources deals from a network of 1,300 intermediaries: legal firms, accountancy firms and insurance brokers are prime examples. It hosts events for entrepreneurs and small businesses across the country and sees deals from numerous non-executive directors in Foresight's extensive personal and professional network. 

Typically, Foresight sees 700 or so opportunities every year and will select 15 to 20. 

Before investing, Foresight must be satisfied a business meets the following: 

  • High-quality management team
  • Sustainable competitive advantage
  • Defensible margins
  • Well formulated strategy
  • Clear vision for growth 
  • Sector experience and track record 

Once it chooses to invest, Foresight adopts a hands-on approach. It takes board seats, works actively with each management team and commits resources. 

Example holdings in Foresight 4 VCT

Two successful investments and one that didn’t go as planned are shown below.  

Datapath is by far the largest holding and represents around a quarter of the VCT. It is a Derby-based manufacturer of PC-based multi-screen computer graphics cards and video capture hardware, specialising in video wall and data wall technology. 

Picture a traffic control room. Several people are sat behind desks in front of a large video wall. Datapath provides the hardware and control box which manages the whole video wall. 

A video wall can be anything from four TVs in a square to sixty-four. Video walls have multiple applications: they are used in advertising, universities, betting shops and retailers. Datapath has around half the total global market share of the controllers for video walls. The business has a turnover of £20 million per annum and profits of around £7 million. Two years ago, it paid £16 million in dividends. 

Foresight first invested in 2007 and now owns around 40 percent of the business across its VCTs. We asked David Hughes, Chief Investment Offer at Foresight, if he was worried about the size of the holding. He concedes it does represent a large portion of the portfolio and Foresight has held it for some time – ten years being at the far end of their investment timeframe – but it is a very cash-generative business and one he doesn’t want to let go prematurely.       

TFC Europe is a well established and, according to David Hughes, “very slightly boring” business, turning over £20 million per annum. It accounts for around 6% of the enlarged portfolio. Based in East Sussex, TFC is one of Europe’s leading suppliers of fixing and fastening products. From eight sites in the UK, Germany and the Czech Republic, it supplies injection-moulded technical fasteners and ring and spring products to customers across a wide range of industries, including aerospace, automotive, hydraulics and petrochemicals.

Take a Bosch lawnmower, which has around 171 parts. 11 are large, 160 are small. The smaller components – washers, springs and clips – are provided by TFC on a just-in-time basis to Bosch’s production line. 

TFC Europe has a UK and German licence to distribute Smalley springs. These are made of flat wire and take up about a third of the space of traditional springs but perform the same role. 

As is to be expected, not all of Foresight’s investments have worked out as intended. One such investment is Trilogy Communications Holdings.

Trilogy enables communication devices to speak with one another. The formal term is interoperability. Trilogy’s black box could connect a mobile phone to an ambulance communication system or a police radio. 

An example of its potential use was demonstrated during Hurricane Katrina. When the storm hit New Orleans the various rescue services realised they were unable to communicate with one another. Four Landrovers equipped with Trilogy’s device (and other hardware) were parachuted in, to allow the emergency services and authorities to communicate. 

The company turned over £10 million per annum and was making £1 million EBITDA. Then unforeseen events took hold. In 2012 President Obama introduced military cutbacks. This was hugely detrimental. Military sales fell off a cliff and remained low for four years. 

Foresight stepped in, cutting costs and pushing sales towards civilian institutions such as oil rigs and hospitals. It managed to recoup 40 percent of its investment when the business was sold for approximately £4 million. 

Although the investment did not go as intended, it shows Foresight can salvage an ailing business. 

Performance

The graph below shows the total return of the VCTs (dividends plus net asset value) compared to the FTSE AIM All Share index since 2004. Please also see the discrete performance below which gives a comparison over the past five years.

Foresight 4 VCT and Foresight 3 VCT past performance


Source: Foresight. Figures are rebased to 100p. Past performance is not a guide to the future.

Discrete 12-month performance to 31 December (%)

  2012 2013 2014 2015 2016
Foresight 3 VCT plc (Total Return) -6% -6% -4% -12% 5%
Foresight 4 VCT plc (Total Return) -8% -4% -9% -14% 1%
FTSE All-Share (Total Return) 12.3% 20.8% 1.2% 1.0% 16.8%
FTSE AIM All-Share (Total Return) 2.9% 21.3% -16.5% 6.6% 16.1%

Source: Foresight. VCT Total Return is the NAV plus any dividends in the year. Annual movement of the two combined makes up the TR per year. Past performance is not a guide to the future.

Dividend history

The chart below shows the dividends paid by Foresight 3 VCT and Foresight 4 VCT over the last ten years.

Source: Foresight. Past performance is not a guide to the future. Dividends are variable and not guaranteed.

Risks

This is a concentrated portfolio. Datapath represents a large chunk of the enlarged VCT and problems with that business will have a significant impact on performance. 

Foresight may raise up to £100 million in new money. A large portion of the portfolio will then be in cash awaiting investment, which could be a risk. However, the management is confident it will invest the cash in a relatively short period. Given the strength of Foresight’s deal flow, this is not unrealistic.   

As ever the usual risks are in play. Foresight is investing in smaller companies with little or no asset-backing. Investments of this nature are more prone to failure.   

Please remember capital is at risk. VCTs are high risk investments and are not suitable for everyone. Investors should not invest money they cannot afford to lose. Tax benefits depend on individual circumstances and tax rules can change.

Fees

The initial charge (normally 5.5%) is 0.5% through Wealth Club, including early bird saving to 31 July. Existing Foresight 3 and Foresight 4 investors benefit from a further loyalty saving of 0.5%, meaning their initial charge through Wealth Club is currently zero. 

The annual management charge is 2%. 

There is an administrative cost capped at £157,000 and dealing fees of typically 3% levied against the investee companies. The total expense ratio is capped at 2.9%. Foresight also level a performance fee of 15% of dividends paid to shareholders. For Foresight to take this fee, the NAV must exceed 108.5p. However, if a dividend is paid the hurdle increases by the amount of the dividend. For instance, if a 5p dividend is paid the new hurdle is 113.5p. Currently, the NAV is well short of the hurdle.

Early bird savings and deadlines

Unless the offer is fully subscribed before these dates, the following deadlines apply:

  • Deadline for early bird saving of 2.0%: 31 July 2017 (12 noon)
  • Deadline for early bird saving of 1.0%: 30 November 2017 (12 noon)
  • Deadline for shares allotted in the 2017/18 tax year: 5 April 2018 (12 noon)
  • Final closing date: 30 April 2018 (12 noon)

Summary

To judge this VCT on its past is perhaps unjust. The foray into environmental investments proved costly, but that should now be water under the bridge. Realising these poor investments and integrating other VCTs has dampened down the long-term performance of the VCT: note however past performance is not a guide to the future. 

Foresight benefits from excellent deal flow and the Foresight 4 VCT now has a settled mandate.  In addition to new growth capital investments, this offer and the enlarged VCT give investors the chance to access a mature VCT portfolio with an experienced and well regarded private equity manager. With some realisations imminent, investors could potentially benefit from a continued, if irregular, flow of dividends and some lumpy special pay-outs (not guaranteed of course). In recent years, Foresight 4 has been cash-constrained and this new fund raise will allow it to participate in the deals it wants to. The new deal flow looks promising: in our view this VCT is one to watch.   

This review is not intended to be advice or a personal recommendation to buy the investment mentioned, nor is it a research recommendation. Wealth Club aims to highlight investments we believe have merit, but investors should form their own view on any proposed investment and read the provider’s documents carefully.