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The following segment was excerpted from this fund letter.
Our investment in Countryside Partnerships, a UK homebuilder with an asset light division, has evolved into Vistry following the November acquisition of Countryside by Vistry. I detailed the mistakes I made with Countryside at LWC’s 2022 Investor Day, as well as why I think the opportunity going forward is more attractive than ever. I would note that my current intermediate term optimism is at odds with UK housing market headlines, all of which are dire. However, if you read past the headlines, you will see that current weakness will likely lead to the strong getting stronger. Vistry is arguably the strongest.
Vistry is our UK homebuilder that recently acquired our previous investment in Countryside Partnerships, to become the largest player in affordable housing in the UK. While at present there are concerns around housing affordability, the UK faces a chronic shortage of housing, and we have already seen actions from both the government and lenders to keep people on the property ladder. Vistry has a clear plan to increase the amount of houses it can deliver while improving margins and earnings power. The real gem however is the Company’s asset light, recession resilient Partnerships business, which focuses on affordable housing. This business should be able to grow double digits and gush free cash flow.
Perception will change – and already is changing – as concerns around affordability fade, and as the market comes to appreciate the resilience of the Partnerships business, which should shortly comprise more than 50% of revenue. Additionally, management has already stated that if the market does not reward them for the Partnerships business, they will take steps to spin it off in a few years.
If I am correct on how I think earnings power and perception will change in the years to come, Vistry can generate GBP 450M in normalized after tax profits from just the Partnerships business looking out 3-4 years. This suggests a multiple of 5x after tax earnings, giving no value to the traditional homebuilding business. 10-14x would be more appropriate for a traditional homebuilder, but would likely be conservative for Vistry given the defensive nature of the Partnerships business. At 18x, the Partnerships business alone would be worth ~250% more than current share prices. Surely the traditional business is worth something as well. Additional upside is probable as the Company will likely soon become an aggressive buyer of its own shares.
The key to this investment is the Partnerships business, which is growing at double digits (completions up 17.6% in 2022) and more economically resilient than traditional housing. The Partnerships business sees Vistry partner with local housing authorities in arrangements that typically see the housing authorities contribute land, while Vistry contributes their homebuilding expertise. More than half of planned homes are typically pre-sold as affordable housing or as private rental for sale. This capital light arrangement allows Vistry to earn 40+% ROCEs, while pre-selling homes eliminates sales risk. Importantly, housing associations typically work with Homes England – a quasi-government agency tasked with funding affordable housing – to pre-fund their housing development in conjunction with 5 year plans. This reduces the impact of macro conditions on Partnership completions. As CEO Greg Fitzgerald recently commented, “Our partnerships business is extremely well placed to meet the high level [of demand] that is there. And of course, that’s countercyclical. If the market comes off, partnerships will do better than they’re currently forecasting.”
At present, Vistry is valued as a traditional homebuilder, with management even commenting that they believe they get no credit for the value of the Partnerships business. Over time, and through a cycle, perception will likely change as the resilience of the Partnerships business is demonstrated.
In my view, the Partnerships business alone should be able to generate GBP 600M of EBIT looking out a few years. The Company is in a net cash position, so we can theoretically ignore the interest payments, and then deduct taxes and reach normalized after tax earnings of GBP 450M for just the Partnerships business. At present, this suggests a multiple of ~5x earnings looking out a few years. A low double-digit multiple does not strike me as inappropriate for a traditional homebuilder, and given the superior model of the Partnerships business, a high teen or even 20x multiple may ultimately be appropriate, suggesting that ~400% upside is possible for the combined business. Additional upside is likely in the form of aggressive buybacks.
Again, I realize the potential returns that I have outlined above may seem too good to be true. Rather than focusing on the potential returns, I suggest focusing on the margin of safety. In the event that my view of the unknown future is wrong, I think the valuations are such that we will still generate acceptable returns. The key takeaways should be that our businesses are operating in cockroach type niches with secular tailwinds. Looking out a few years from now people will still need fire safety, the world will still be increasingly relying on biologic drugs, people will still go on vacation, small businesses will still be transitioning their operations to the cloud, and the UK will still be severely under-housed. I believe our businesses are well positioned to benefit from each of these unstoppable trends, and each of our businesses will be significantly stronger a few years from now. Importantly, I believe we are paying low prices too.
Also, Vistry was a buyer of its own shares prior to the Countryside merger, and CEO Greg Fitzgerald recently bought GBP 5M worth of stock through an entity he controls, which suggests he believes the future is bright.
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Disclaimer: This document, which is being provided on a confidential basis, shall not constitute an offer to sell or the solicitation of any offer to buy which may only be made at the time a qualified offeree receives a confidential private offering memorandum (“CPOM”) / confidential explanatory memorandum (“CEM”), which contains important information (including investment objective, policies, risk factors, fees, tax implications and relevant qualifications), and only in those jurisdictions where permitted by law. In the case of any inconsistency between the descriptions or terms in this document and the CPOM/CEM, the CPOM/CEM shall control. These securities shall not be offered or sold in any jurisdiction in which such offer, solicitation or sale would be unlawful until the requirements of the laws of such jurisdiction have been satisfied. This document is not intended for public use or distribution. While all the information prepared in this document is believed to be accurate, Laughing Water Capital, LP and LW Capital Management, LLC make no express warranty as to the completeness or accuracy, nor can they accept responsibility for errors appearing in the document. An investment in the fund/partnership is speculative and involves a high degree of risk. Opportunities for withdrawal/redemption and transferability of interests are restricted, so investors may not have access to capital when it is needed. There is no secondary market for the interests and none is expected to develop. The portfolio is under the sole trading authority of the general partner/investment manager. A portion of the trades executed may take place on non-U.S. exchanges. Leverage may be employed in the portfolio, which can make investment performance volatile. The portfolio is concentrated, which leads to increased volatility. An investor should not make an investment, unless it is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits. There is no guarantee that the investment objective will be achieved. Moreover, the past performance of the investment team should not be construed as an indicator of future performance. Any projections, market outlooks or estimates in this document are forward-looking statements and are based upon certain assumptions. Other events which were not taken into account may occur and may significantly affect the returns or performance of the fund/partnership. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. The enclosed material is confidential and not to be reproduced or redistributed in whole or in part without the prior written consent of LW Capital Management, LLC. The information in this material is only current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Laughing Water Capital LP, which are subject to change and which Laughing Water Capital LP does not undertake to update. Due to, among other things, the volatile nature of the markets, an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment. The fund/partnership is not registered under the investment company act of 1940, as amended, in reliance on an exemption there under. Interests in the fund/partnership have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws. The S&P 500 and Russell 2000 are indices of US equities. They are included for informational purposes only and may not be representative of the type of investments made by the fund. |
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