Scottish Mortgage, one of the world’s largest investment companies announced last week it is to undertake a share buyback programme with at least £1bn made available over the next two years to bring down its discount.
The market reacted positively to the news and the discount narrowed from about 15% to just 8% in Friday trading alone.
At around 9% of the trust’s total market capitalisation ahead of Friday’s announcement, the buybacks amount to a significant sum, but with just 0.2% held in cash at the end of February, questions remain as to how the trust will afford to meet its goal.
Over the two-year span, it would equate to around £2m per day, experts calculated, with the trust off to a strong start, purchasing some £21m worth of shares on Friday alone.
Stewart Heggie, commercial director of the trust, said almost the entire amount will be funded from the sale of public companies.
“Realistically it will come from the sale of liquid assets. At the current time that would be public stocks,” he said.
Liquidity will come from a variety of factors. The first will be from transactions that take place all the time within the portfolio, such as trimming positions based on their size.
“When stock is sold, as opposed to reinvesting all of that, it might be 90% with the remainder used for buybacks,” said Heggie.
If there is a period where there are no natural portfolios changes, the second option will be to sell down some of the largest holdings slightly. However, he noted that the plan is not to “top slice everything” to pay for the buybacks.
The third option is dividends. Although the trust is known for its growth focus, a small number of stocks do pay an income, which can be used to fund some of the buybacks.
One option firmly off the table is debt. The trust is already 13% geared but has made a concerted effort to pay down its most expensive debt that was linked to interest rates.
“We took on about $450m of very long-dated debt at very cheap prices. The vast bulk of the debt we have is due between 12 and 40 years at an average 3.2% rate,” said Heggie.
“Gearing is 13% on the trust. If you were to take a long-term average, we tend to be in the 10% band and, given we think the portfolio is undervalued, then 13% is about where we want to be.”
What about the private companies?
There has been concern around the portfolio’s private company exposure, which stands at 26.2%, as Scottish Mortgage has a self-imposed limit of 30% in unquoted names.
After the £2bn programme, this would take the total in privates to 28.3%, but Heggie noted that there has been an “hiatus” in the initial public offering (IPO) market, suggesting some of the firm’s holdings could list in the coming years, easing that pressure further.
“We have been getting more phone calls than we were before about this and we expect the number of listed companies that we have will increase,” he said.
The trust, which has been discussing potential buybacks for the past two years, has spent this time making sure its private companies have had follow-on investments, meaning they require less cash from now on.
“We have gone through [the follow-on investment] process and many of the privates that we own have thousands of employees, billions in revenue, could list any time and are profitable – so they are not requiring us to provide capital,” he said.
Will the buybacks prevent the trust from making new investments? And when will it stop buying back its own shares?
Scottish Mortgage invests in high-growth companies that the managers believe can double in size over the next three years. Some investors may therefore question the rationale of putting money into a buyback scheme.
With the discount to net asset value (NAV) at 15% last week (and around 10% today), even if getting back to parity, there is a clear opportunity cost between investing in companies that have the potential to double (make a 100% return), versus the return from the discount narrowing.
Heggie said: “Part of this exercise is around managing sentiment around shareholders. We benefit from having a fixed pool of capital so we can make long-term decisions.
“One of the things that formed part of the decision is the trust’s shares and NAV have historically sat . We’ve always aspired to get back to around par. This is all about how we can maximise shareholder returns.”
For this reason, the trust will not buy back shares at a premium – as this is prohibitive to shareholders.
The wording, stating that £1bn has been made available, also means the trust does not have to spend the full amount if its goal of parity between the share price and net asset value is reached.