Unquoted companies can be a nightmare for investors. But in the hands of a cautious Scot, one trust is doing nicely

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The Independent Online
Dunedin Enterprise, a pounds 5lm venture and development capital investment trust, has had a good run in the past 18 months. Its shares and net asset value have grown strongly, winning it awards this year from Micropal and What Investment?

It was not always so. Brian Finlayson, who manages the trust, says its performance after coming to the stock market in 1987 was poor. Investing in start-up and high-technology businesses had not worked.

In the early 1990s the focus of investment was switched to later-stage financing of management buyouts, buy-ins and development capital for growing private companies. That switch is now paying off.

Investments made two and three years ago are taking advantage of a buoyant stock market and a renewed corporate appetite for acquisitions, and are floating or being sold to bigger companies. The trust has benefited through rising asset values and a growing cash pile to put into new investments.

Buying and selling unquoted companies is a very different game to stock- picking in the quoted market. Information about companies and access to their shares is restricted. Accountants are often in the driving seat and invite venture capital fund managers to make competitive tenders, often on the basis of just one meeting, Mr Finlayson says.

Despite the somewhat haphazard system compared with the efficiencies of the quoted market - Mr Finlayson admits he never knows where the next deal will come from - deals do arrive and some prove to be out-and-out winners.

Dunedin Enterprise's largest holding is LDV, formerly Leyland DAF Vans, which was bought out from the receiver in February 1993. It made pre- tax profits of pounds 19.4m last year and paid the trust a net dividend of pounds 295,000.

Although income is welcome, capital growth is the objective. That will come in full when LDV floats on the stock market, possibly next year. The impact on asset values could be considerable. At present the trust values its 6.5 per cent holding in a much more conservative fashion than 3i, another big investor in LDV.

The concentrated nature of the trust's portfolio - the top 10 holdings accounted for 74 per cent of total value at the end of April - underlines the need for care when making investments. Mr Finlayson is a cautious Scot. "I have a philosophy that says we don't lose money."

Given that investing in small, private companies is much higher-risk than buying big company shares, such an aim is not necessarily easy to achieve. Mr Finlayson, who likes to see every company the trust backs, is quick to remind his team that they are investing his money.

He has pounds 100,000 in Dunedin Enterprise, his second-largest investment after his house. He also monitors investments closely and sits on the boards of three of the trust's biggest holdings.

Most investments perform satisfactorily and a few perform spectacularly, he says. A few take a long time to come right. Of the 43 holdings, 10 are "still alive" but have no value attributed to them. They are just ticking over or making some money, but have no realisation prospects in sight. "Patience can be rewarded," Mr Finlayson says, but adds that it is more important to concentrate on the fast-growing companies of value.

"We invest in management and make money out of basic businesses," he says. The trust has a bias towards manufacturing and towards Scotland. Its bigger holdings include Motherwell Bridge, the Scottish engineering company, Coal Products, a smokeless fuel buy-out from British Coal, Macdonald Hotels, Scottish Highland Hotels, and Travel & General Holdings, which underwrites bonds for the travel industry.

Its method is to buy on a low price-earnings ratio and sell some three to five years later on a high price-earnings ratio, explains Mr Finlayson. In the past four years the trust has not paid more than 10 times the previous year's earnings for a company.

It values its bigger holdings at around 10 times historic profits and its smaller holdings at four to nine times historic profits. The FT All- share index is presently on a historic p/e of 16, giving plenty of scope for a huge uplift in value when investments come to market.

The trust then sells out, although not always immediately. When Domnick Hunter, the filter manufacturer, floated in March last year, Dunedin Enterprise topped up its holding as another investor wanted to unload. It is gradually selling into strength, having seen Hunter's shares rise from 200p on listing to 325p this week.

A spate of realisations means the trust is sitting on pounds 13m cash, the most it has ever had. Mr Finlayson is unperturbed. "There is no point in rushing into deals and no point in going into quoted stocks. We'll stick to our knitting," he insists.

The "knitting" means only investing in businesses Mr Finlayson can understand. In the main these are cash-flow, high-margin businesses. There have been no high-tech investments for the past five years and start-ups are only countenanced if the management is well proven.

The average size of each investment is between pounds 750,000 and pounds 2.5m and the trust aims for an annualised return of 25 per cent to 35 per cent. Although this sounds desperately ambitious, with inflation running at 3.2 per cent, Mr Finlayson says the trust has been hitting its target in the last two to three years.

In the long run unquoted equity should outperform quoted to justify the extra risk. Dunedin Enterprise has comfortably outperformed the FT-SE A investment trust index over five years, yet as Mr Finlayson points out the shares of many venture capital investment trusts including Dunedin Enterprise languish well below their net asset values.

The lagged effect of asset values, which are updated twice a year and based on historic profits of investee companies, means there should be more good news to come even if the pace of asset growth is slowing.

Mr Finlayson certainly believes there is plenty of value in unquoted equity still to be unlocked.

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