Evaluating 3i Group’s Relationship with Action Retailer

3i Group stands out as a top performer in the FTSE 100, boasting a remarkable return of over 250 percent in just five years. This impressive growth is largely attributed to one standout asset: the Dutch discount retailer, Action.

In 2011, 3i made a significant investment, putting €279 million (£233 million) into Action. Fast forward a decade, and 3i now values its 57.6 percent stake in the retailer at a staggering £14.8 billion, suggesting a market valuation that surpasses major competitors like Tesco, which is the largest retailer listed on the London Stock Exchange.

However, 3i’s heavy reliance on Action has caught the attention of short-seller ShadowFall Capital & Research, which has reportedly placed a multimillion-pound bet against 3i’s stock, as reported by The Sunday Times.

ShadowFall is known for its critical stance against firms, previously exposing issues within the German payment processor Wirecard. The firm posits that investors in 3i may be overlooking how inflation has artificially bolstered Action’s profit margins, which are now returning to more standard levels. ShadowFall has also raised concerns regarding 3i’s valuation of Action, currently set at 18.5 times its underlying profits, which contrasts sharply with the average valuation of competitors at 14.4 times.

Scrutinizing Action’s Valuation

Founded in 1993 and headquartered in the Netherlands, Action has expanded significantly since 3i’s acquisition in 2011, establishing stores in Belgium, Luxembourg, Germany, France, Austria, Poland, Italy, the Czech Republic, and Slovakia. The retailer serves millions of customers weekly.

Part of Action’s valuation premium arises from its scale; its market capitalization exceeds that of Tesco and is more than five times that of its closest FTSE 100 peer, B&M European Value Retail.

Action employs a strategic discounter model, offering a carefully curated assortment of small homeware items, durable groceries, and seasonally rotating products. Its stores maintain a uniform format, and the company leverages its expansive international presence to negotiate bulk purchasing.

Although Action’s business approach is not entirely unique, its vast scale distinguishes it from competitors. As of March, Action operated 2,608 stores across 12 eurozone countries and asserted that its ability to source locally while selling internationally allows it to offer prices that are typically 40 percent lower than local rivals.

3i holds Action at a valuation of 18.5 times its adjusted cash profits, yet this is considerably higher than B&M and Pepco, the Polish owner of Poundland, which are valued at around seven and six times, respectively. For context, American discounter Dollar General is trading at a multiple of 12.

Given Action’s robust growth rate, its valuation appears more defensible. For the quarter ending in June, Action reported a year-on-year growth rate of 24 percent in adjusted cash profits. Like-for-like sales jumped by 9 percent in the first half of the year, and the company is on pace with its expansion plans, opening 119 new stores and aiming for 330 by year’s end.

About 3i Group

3i Group was established in 1945 by the Bank of England and several high street banks to supply equity capital to small businesses in Britain. It has since transitioned into a specialist in private equity and infrastructure, primarily investing in enterprises outside the UK, focusing on Europe and North America.

A typical private equity model involves acquiring assets, enhancing their value over a span of five to seven years, and then returning the profits to investors. However, 3i has maintained a prolonged investment in Action, which now constitutes over 60 percent of its portfolio, up from less than 10 percent in 2013. CEO Simon Borrows has previously expressed confidence that shareholders accept this high concentration, though analysts from RBC Capital Markets project that Action could make up 70 percent of 3i’s investment portfolio by 2026.

Since Action is a private entity, 3i is the primary avenue for ordinary investors seeking exposure to it. Currently, shares of 3i are trading at a substantial premium—55 percent above the net asset value of its portfolio, while most other London investment firms have an average discount of 14 percent.

Although 3i’s price per share is significant, the remainder of its portfolio appears less exciting. Its second-largest investment is a 30 percent stake in the listed 3i Infrastructure fund valued at £879 million, followed by a £586 million investment in Cirtec Medical, a manufacturer of medical devices.

Considerations for Investors

The current short interest for 3i remains minimal, below 1 percent. The stock did experience a 3 percent drop recently, but further details regarding the rationale behind ShadowFall’s position may emerge.

This situation highlights that 3i’s significant exposure to Action effectively makes its shares a proxy for the retailer. The investment has become somewhat skewed, diverging from traditional investment trusts found on London’s market.

While Action represents a strong asset, 3i is additionally bolstered by approximately £1 billion in liquidity and low gearing. However, such a concentrated investment carries risks: any adverse developments at Action could adversely affect 3i’s performance. Investors should remain aware that, despite Action’s strong growth and market size, it does not possess a distinctly durable competitive advantage to ensure its expansion in new markets. Since this analysis classified the stock as a buy in May of the previous year, it has provided a return of 88 percent. With the absence of a clear exit strategy from Action and its continued concentration, some investors might consider taking profits.

Advice: Hold. Why: Concentration risk is becoming increasingly significant.