Baillie Gifford private equity fund Schiehallion (MNTN ) is looking to snap up bargains from distressed investors pulling money out of unquoted technology businesses. 

Fund manager Peter Singlehurst said Schiehallion had so far only invested in late-stage fund raisings when the capital generated went straight to a private company’s balance sheet through the issue of new shares.

However, Singlehurst said he was increasingly ‘seeing some compelling secondary opportunities that are too good to ignore’ in buying shares from existing investors.  

He said early-stage investors, particularly venture capital funds with limited lives, were under pressure to return capital to clients and ‘this is giving rise to a spike in the supply of shares in private companies, with a corresponding decline in the price’, said Singlehurst.

‘Though we have not yet transacted in this manner, we see it as an extra string to our bow that, over time, has the potential to broaden the opportunity set for the fund,’ said Singlehurst in comments in Schiehallion’s annual report.

The results for the 12 months to 31 January confirmed a pummelling for the US-focused and dollar-denominated Schiehallion, just like its tech-heavy big sister Scottish Mortgage (SMT). Named after a Scottish mountain, Schiehallion was the UK’s best-performing investment company in 2021, with the shares doubling in the aftermath of the pandemic. 

Its top five holdings, representing over 23% of net assets, are Elon Musk’s SpaceX, online gaming provider Scopely, video sharing platform Bytedance, new wave chemicals manufacturer Solugen and online money transfer specialist Wise.

Savage deratings

As inflation surged and interest rates hiked, performance careered down hill with the net asset value of its two share classes tumbling. The NAV of the ordinary shares, which Schiehallion launched at its £364m flotation four years ago, slumped 24.5% in the year to January. The ‘C’-shares, which raised a record £500m ($700m) two years ago, fell 18.4%.

Both share prices more than halved, however, as investors dumped the red-hot stocks, fearing their asset values did not reflect the true bear market conditions for tech companies, despite Baillie Gifford’s regular efforts to keep the valuations up to date.

The derating from big premiums to NAV saw the ordinaries slide nearly 57% in the 12-month period. At 65 cents today they have fallen more than a third since launch and trail at 42% discount to NAV. 

The C-shares, which will convert to ordinaries when most of their money is invested, fell 58% and at 39 cents have crashed 71% since the top-of-the market share issue and languish on a 48% discount.

Liberum analyst Shonil Chande said investors clearly doubted the ‘real world’ value of the investments but said like Scottish Mortgage, Schiehallion benefited from preference share holdings which accounted for 83% of the portfolio and ensured there was some downside protection when markets fell. 

‘In the year to January 2023, the average movement at the private company level (-28.5%) was 12.1 percentage points ahead of the average markdown,’ of companies in the portfolio, he said.

Singlehurst admitted the steep sell-off in growth stocks made 2022 ‘a year in which we stepped backwards rather than forwards’. He said there had been ‘significant declines in the value of our holdings that had entered the public markets, markdowns in the carrying values of our private company investments due to reductions in the valuations of comparable public companies and indices, and poor operation performance for some portfolio companies.’

Consumer-facing companies caused the most problems, as the leaps they saw during the pandemic faltered as ‘consumer spending retrenched’. This included buy-now-pay-later credit provider Affirm, which went from being the portfolio’s third largest holding in September last year at 4.2% of the fund, to 17th, at just 2% of assets.

Online prescription glasses group Warby Parker, online education group Masterclass, and online pet retailer Pet Circle, all suffered.

‘Epic Games faced another kind of challenge in a large fine by the Federal Trade Commission for historical issues around online child protection and payment practises,’ said Singlehurst.

‘These issues have long since been rectified, but it was nevertheless short of the standards we expect of our companies.’

‘Price realism’

Last year was not only frustrating for Singlehurst in terms of returns, but also for deploying cash. He said ‘we made fewer investments in the last 12 months than in any year since inception’. The two exceptions were semiconductor group Kepler Computing and autonomous flight technology company Merlin Labs.

He said the factors behind this were an unwillingness of companies to raise money in light of the tough economic conditions, but also the ‘mismatch between companies’ valuation expectations and what we believed reflected market conditions’.

‘This led us to walking away from opportunities after deep diligence based on price,’ said Singlehurst.

There was also one opportunity that appeared to be a ‘good company at a compelling price’ but ‘misalignments uncovered in our legal due diligence process caused us to walk away from the investment’.

There has been a turnaround in opportunities this year, with Singlehurst stating ‘2023 has got off to a good start’. A more realistic attitude among companies meant his eight-strong private companies team at Baillie Gifford was engaged in due diligence for potential investments in the US, China, Italy, and Israel.

‘In all these instances, price realism exists, sometimes at valuation below previous rounds,’ he said.

‘We believe normalising down rounds is essential for high-growth private markets. Far from viewing it as a marker of failure, we applaud those founders and boards willing to adjust their expectations to market norms. We have more respect for those companies that raise rounds at lower valuations than those that use artificial means to maintain valuations set in an environment that no longer exists,’ Singlehurst said.