Souter Investments – a lesson in direct private equity investing

It’s not unusual for a family office to stay close to the business that generated its wealth, while putting spare capital to work in real estate, quoted shares and private equity funds. It may also dabble in a few ventures of its own.

But there is no such thing as a typical family office.

Sir Brian Souter’s family investment office, Souter Investments, owns his 14% stake in Stagecoach, the transport group he co-founded in 1980 and chairs. In fact, he has never sold a single share in the business.

Sir Brian seems quite happy, and that’s the main thing. Andy Macfie recalls Sir Brian was considerably less happy when he investing in funds sponsored by major investment banks

Souter Investments retains real estate in regions like Lothian in southern Scotland, where it understands the market. It has a small quoted equity portfolio. But it generally avoids private equity funds and hedge funds after bad experiences and invests directly in unquoted companies instead.

Far from a dabble, this amounts to a serious business in its own right, staffed by six investment professionals and six support staff. Thanks to this expertise, plus the involvement of Sir Brian in key decisions, Souter is rated among the top 700 family investment groups in the world by Family Capital.

Since inception in 2006, Souter’s overall returns from unquoted investments have annualised at 18%. A spate of recent disposals has left Souter with 25 unquoted investments, with a cost in excess of £200 million, employing more than 15,000, plus £100 million in cash to reinvest.

Souter has beaten the UK stock market by 55% over twelve years, and its unquoted returns compared to an annualised 13.4% return for UK smaller-cap private equity funds over the ten years to December 2016, according to the BVCA.

Sir Brian, a committed Christian, recently gifted 28% of Souter Investments, valued at £109 million, to his charitable trust, in potentially the largest single charitable donation by a Scot since donations by Andrew Carnegie in the 19th Century.

“Sir Brian seems quite happy, and that’s the main thing,” says Souter Investments managing director Andy Macfie, not without affection. He recalls Sir Brian was considerably less happy when he investing in funds sponsored by major investment banks.  “He became tired of their fees, their net performance and a lack of transparency.” Angel investing also proved a disappointment.

In late 2007, Souter Investments invested in a portfolio of diversified hedge funds. It asked an adviser to vet the funds to ensure they adhered to their stated investment criteria and, in particular, weren’t invested in private equity deals, then much in vogue. But the hedge funds tanked in 2008, falling in value by 18%: “They did have private equity investments held in what they called their ‘side pockets’. We only got our money back from one fund, last year.”

These days, Souter only backs one hedge fund – Toscafund – run by Martin Hughes, a co-investor and specialist in financial stocks.  

Souter has invested a little of its spare cash in quoted equities.  Macfie says: “Sir Brian might say, sometimes, that we should invest in countries like Hong Kong, Argentina or Chile, when their markets and currencies are down. He keeps an eye on such things.”

Sir Brian created Souter Investments to bring professional focus to his family investment office and got to hear of Andy Macfie’s skills in the area.  Macfie used to work for private equity firms, Morgan Grenfell and Charterhouse. He went on to develop a family office for Sir Fraser Morrison, Teasses Capital, who sold a family construction business to Anglian Water in 2000. 

Initially cautious, Macfie became intrigued by the approach from Sir Brian and agreed to start work at Souter Investments the next Monday. 

Macfie is pleased at the way Souter has developed its reputation as a player: “The last thing people want is someone who says they are doing a deal, and then they don’t. We have a reputation for doing deals. And we can do them quickly.”

Investment banks are not a frequent source of deals. More often, Souter Investments sources them from friends, boutique advisers, accountants, commercial lawyers and co-investors. It typically looks at 500 deals a year. It backs just over 1% of them.

Sometimes Souter leads a deal, sometimes it joins a syndicate. It has worked with UK investment groups Tosca and Penta Capital on a number of financial deals.  Its other co-investors include Scottish corporate adviser Sir Angus Grossart; private equity specialist Jon Moulton; Magenta, which acts for the Singh family, founders of retailer New Look; Duke Street; JZ International, an investment company owned by David Zalaznick and Jay Jordan; and Sir David Murray and his Edinburgh investment group, Murray Capital. 

Sir Brian likes knowing exactly how his money is being put to work at Souter Investments. “He prefers to talk to managers about their businesses, rather than Goldman Sachs about its structured products,” says Macfie.  

But Macfie makes sure Souter Investments’ portfolio does not become too concentrated. It generally commits no more than £30 million to a deal, although it can lift its investment if the business develops nicely.

Now Souter has plenty of cash to invest, it may stretch to £40 million. But such larger deals will need to be special, given the current investment climate. Souter Investments has a record of successfully investing through the economic cycles and Macfie notes it will continue to do so. 

Souter Investments does not generally back start-ups although it is happy with early-stage growth funding where businesses have a proven commercial model. It also likes to get involved in management buy-outs which, on average, have provided better returns.

Over the years, Souter Investments has put its transport experience to use by investing in the bus and ferry sectors. One of Souter’s largest deals, and one of its earliest, was its purchase of Scottish bus manufacturer Alexander Dennis (see separate profile).

It has gone on to back, and sell other transport businesses, including some in  New Zealand once owned by Stagecoach. It has even backed disruptive bus start-ups in Poland and Finland, introducing much-needed customer focussed, reliable, and internet-based yield managed pricing to inter-city transport in Central Europe.

Macfie says: “It helped to know people in New Zealand because oversight of a business from a distance can be really hard. In Poland and Finland they recruited excellent local teams and advisers who were supported by key managers well known to Sir Brian.” 

He says the level of Souter Investments’ involvement in individual businesses depends on how the company is progressing and how management develop and rise to the challenges. Cash flow problems require Souter’s immediate, and direct, involvement.

Souter’s transport deals have generally been successful, although Macfie confesses to disappointment with IDO, the Turkish ferry business.  He is happy with the local team, but less happy with business conditions in Turkey. 

Souter is prepared to invest in the financial sector, where he believes there are plenty of exciting opportunities. Esure, an insurance buyout from Lloyds/HBOS, led by Peter Wood formerly of Direct Line, ranks among Souter’s most successful investments. Its Mobius Life buyout, which offers an investment administration platform to pension schemes and institutions, was sold this year after posting a 500% increase in assets administered.

Elsewhere in financials, Souter has backed Global Risk Partners, an insurance business led by Peter Cullum, who is renowned for developing Towergate the insurance broker. It has also invested in Eaton Gate which takes an entrepreneurial attitude to insurance underwriting in sectors like fine art, and in Fin Tech business DivideBuy, which offers retailers a cost-efficient way to provide customers with e-commerce point of sale interest-free credit.

Souter has backed businesses in a range of other sectors, such as health care, mobile phones, broadband, industrial products, funeral plans, oil and gas services and property.

Macfie avoids high technology and biotechnology businesses, saying he and the team don’t have the necessary skills to evaluate them. Sir Brian will not invest in businesses he considers unethical, such as armaments or payday loans. 

Macfie readily concedes technology applications have helped Souter’s companies to develop their own businesses. Disruption looks set to remain in force, leading to new unquoted opportunities for Souter, plus interest from larger corporate buyers keen to buy growth.

 Macfie adds that the development of expertise in a chosen niche makes it all the easier for Souter to evaluate other opportunities.