IS THERE AN M&A BUBBLE?

Analysing the deals of the State’s Isif fund,

WHAT’S it like to have €8bn to spend? Eugene O’Callaghan is one man who knows. He’s the director of the Ireland Strategic Investment Fund (Isif ), the successor to the National Pensions Reserve Fund (NPRF), which has €8bn of taxpayer’s money to deploy.

The fund’s mandate is to “invest on a commercial basis in a manner designed to support economic activity and employment in Ireland.”

Projects it has backed already include venture capitalist Draper Esprit plc, and life sciences investor Malin plc.

An arm of the National Treasury Management Agency, Isif has been prominent in backing housing projects including Activate Capital, as well as non-bank lenders such as Billy Kane’s Finance Ireland, and equity investors such as Carlyle Cardinal Ireland and Business Growth Fund.

After opening for business in late 2014, the fund has thus far committed about €2.8bn. The plan is to spend the rest in the period up to 2020 or 2021. What makes Isif different to your standard private equity fund is its so-called “double bottom line” requirement — as well as the fact that management’s remuneration is not tied to the performance of the fund.

As well as a financial return, its investments are supposed to generate a positive economic impact in Ireland.

Part of that strategy is that it is not supposed to act as a so-called “deadweight”. In other words, it should only make an investment in areas where the money wouldn’t otherwise be forthcoming. The idea is that this money would better be used elsewhere, and that there’s little point in getting involved when there is a “considerable private sector presence”.

But O’Callaghan admits this is not so simple as it sounds. How can you ever be sure investment wouldn’t materialise from another source?

“There’s never a black and white in all of this but there’s a high level of confidence,” he told reporters in Dublin on the margins of Isif ’s annual market engagement event, which sees its bosses mingle with entrepreneurs, investors and corporate finance advisers.

“This is something that we look at on every transaction. We would speak to people that we are potentially investing in and say: ‘Well, who else have you spoken to looking for the finance?’ And they will tell us and we will essentially analyse and understand the reasons why finance is not necessarily available,” O’Callaghan said.

“We will do our own research on the market separately in relation to some sectors around where finance is coming from. We talk to market participants all the time as well so we understand generally speaking where the participants in the market are coming from.

“And ultimately if we were on a significant scale just doing stuff that market participants were willing to be doing, we would be hearing from those market participants because they know that it’s not in our mandate to displace willing and active finance.

“We’re very confident that we’re adding incremental finance that would not be available but it is assessed on a case-by-case basis.” In many Isif deals the funds invests alongside private sector investors — it sees this as bringing more bang for its buck.

Isif didn’t answer specifically when asked whether there had been underbidders on any of its equity investments, saying: “underbidders are generally not a feature of equity investments — the fund’s role is to invest alongside private sector investors on the same commercial terms as these investors.”

The Sunday Independent asked Isif to outline the basis on which it was satisfied that its investments in the Draper Esprit and Malin IPOs would not have been sourced from elsewhere. For one, Malin said in its 2015 annual report that its IPO was oversubscribed and recently raised €30m from the market in what it claimed was a response to market demand. Isif argues that there are other measures to consider.

“Both investments achieved significant commitments from each company to invest in Ireland. These commitments would not have been achieved by private sector investors and are an example of Isif’s ability to act as a catalyst for attracting investment into Ireland that would not otherwise have taken place,” Isif said.

“In Malin’s case, the company undertook to invest €150m in Irish life sciences companies, or firms with significant operations in Ireland and pledged that ten of the companies in which it invests will employ at least 200 people in Ireland on a full-time basis over the following five years. Isif ’s role as a cornerstone investor was critical in boosting support for the IPO from private sector investors outside Ireland and introducing new international capital into Ireland through this investment.

“In Draper Esprit’s case, the company has undertaken to invest €50m in Irish investments. Isif ’s role as a cornerstone investor arose as it had already been a venture capital investor in the company for a number of years and the Fund saw significant opportunity in following its money.”

With European Central Bank president Mario Draghi ensuring there is plenty of money available via quantitative easing, there’s a general acceptance in the Irish market that equity valuations in the SME sector have become high. Add Isif ’s money on top of that in the Irish context and it’s not unreasonable to raise the prospect of some sort of bubble being formed, particularly when it’s not black and white as to whether the investment Isif provides can be sourced from elsewhere. That being the case, isn’t its activity in the market bound to put upward pressure on prices?

O’Callaghan said valuations are currently above the norm but that he believes this is a “global phenomenon”.

“The impact of quantitative easing by the Fed and the ECB and the Bank of England and so has been to flood the world with money essentially and that then drives up prices.

“So I don’t think the Irish economy is any different than anywhere else. And then we will look at every transaction that we enter into and we’re acutely conscious of valuation. But ultimately we look at the cash flows of the business, the cash flows of the project.”

Headed by O’Callaghan, who previously worked for the NTMA and Irish Life Investment Managers, Isif has been provided with 41 people from the NTMA, most of whom work on finding and executing deals.

It also draws on support from the NTMA’s wider functions, including its compliance, risk, legal and finance teams. The Fund reports to the NTMA’s Investment Committee, which includes independent non-executive members including Enterprise Ireland chief executive Julie Sinnamon and former Accenture Ireland managing director Mark Ryan.

Currently Isif is working on a pipeline of 100 investments — 60 that Isif is actively working on and 40 at an initial stage. The pipeline is worth about €3bn but clearly not all of those potential investments will materialise. The fund but isn’t bound by any particular timeline and doesn’t have to spend if it doesn’t want to.

“That’s really important from our mandate point of view that we’re not seen as someone who has to deploy... because particularly as a state entity that would be a very foolish place to be. Because then that’s when you would be in the risk of bubble territory and overcrowding the market,” said Donal Murphy, Isif ’s head of infrastructure and credit investments.

Whether it’s driving up prices or not, there’s no doubt that Isif has helped fuel a resurgence in corporate activity over the last few years. O’Callaghan’s view is that even if Isif pays a frothy amount on its way into an investment, the mathematical difference in its return over the long term will not be that significant. It’s too early to say when Isif will begin to start looking for exits, O’Callaghan said. “We adopt a sort of patient capital philosophy. We have no need to exit, we’re a long-term fund.

“We’re not in any hurry.”