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Over the last decade, shares in private equity firm 3i Group (LSE:III) have left the rest of the FTSE 100 in the dust. The stock is up a huge 773%.
That kind of performance over an extended period of time is indicative of an unusually good business. And I think the company remains in a strong position going forward.
What is 3i Group?
The big difference between 3i and other private equity firms is that it doesn’t raise external funds from investors. Since 2015, the company has exclusively invested its own capital.
That might not seem like a big deal, but I think it’s hard to overstate how important it is. In my view, it’s the key reason the stock has performed so well over the last 10 years.
The challenge for private equity firms is that capital inevitably shows up when things look good. Investors want to get in on the action, but this is when bargains are hardest to find.
On the other hand, nobody wants to invest in businesses when things are difficult. But that’s exactly when firms with cash to deploy can find the best opportunities to generate returns.
By only managing its own money, 3i avoids this problem. Having no external investors to answer to means the company can wait for opportunities and be ready for when they appear.
It wasn’t always this way – before 2015, the firm operated with external funds. But a look at the company’s share price before and after this point tells investors everything they need to know.
Action (and inaction)
3i’s largest investment – and its biggest success story – has been in a company called Action. This is a discount retailer that operates in 12 different countries.
To cut a long story short, 3i invested around £106m in Action in 2011. And since then it has received back £2.9bn in dividends and it values its stake in the company at around £14bn.
There are a couple of things to note, though. One is that Action has been taking on debt while paying out dividends, so it hasn’t quite been the cash machine it might seem at first sight.
Another is that the company isn’t publicly traded, so its market value is a little less clear. And 3i has been accused of overestimating this on its balance sheet.
That’s an important point. Action is over half the FTSE 100 firm’s net asset value, so potential investors have to understand the reasoning behind that valuation and be comfortable with it.
These issues are important, but the bottom line is that 3i gets back more than its initial investment each year. That means the investment has been a success by any standard.
More of the same
Whatever Action’s growth prospects may be, 3i still has its key advantage. The ability to wait for the right opportunities sets it apart from other private equity firms.
This is why the stock has been the FTSE 100’s leading performer over the last 10 years. And I think it has every chance to keep doing well into the future.
I’d like to take a closer look at the details 3i’s valuation of Action. But subject to this, the stock is on my list of shares to consider buying.
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