ANNUAL FINANCIAL REPORT for the year ended
31 December 2022 (audited)
This is the Annual Financial Report of Herald Investment Trust plc as required to be published under DTR 4 of the UKLA Listing Rules.
Results and dividend
The net asset value (NAV) of the Company as at 31 December 2022 was 2,099.1p per ordinary share (2021 – 2,719.3p). This represented a decrease of 22.8% during the year, compared to a decrease in the comparative total return indices of 21.9% (Numis Smaller Companies plus AIM (ex. investment companies) Index) and a decrease of 28.4% (Russell 2000® Technology Index (small cap) (in sterling terms)). The discount at year end was 15.1% (2021 – 7.9%).
The directors do not recommend a dividend for the year ended 31 December 2022 (2021 – nil).
The financial information set out in this Annual Financial Report does not constitute the Company’s statutory accounts for 2021 or 2022. Statutory accounts for the years ended 31 December 2021 and 31 December 2022 have been reported on by the Independent Auditor. The Independent Auditors’ Reports on the annual report and financial statements for 2021 and 2022 were unqualified, did not draw attention to any matters by way of emphasis, and did not contain a statement under 498(2) or 498(3) of the Companies Act 2006. The Company’s statutory accounts for the year ended 31 December 2021 have been filed with the Registrar of Companies. The Company’s statutory accounts for the year ended 31 December 2022 will be delivered to the Registrar in due course.
The financial information in this Annual Financial Report has been prepared using ‘FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland’ (FRS102), which forms part of Generally Accepted Accounting Practice (‘UK GAAP’) issued by the Financial Reporting Council. The financial statements have also been prepared in accordance with The Companies Act 2006 and with the Statement of Recommended Practice ‘Financial Statements of Investment Trust Companies and Venture Capital Trusts’ issued by the Association of Investment Companies (‘AIC’) in July 2022.
STATISTICS AND PERFORMANCE – YEAR’S SUMMARY
| 31 December 2022 | 31 December 2021 | % change | |
| Total net assets | £1,305.0m | £1,760.9m | |
| Shareholders’ funds | £1,305.0m | £1,760.9m | |
| Net asset value per ordinary shareA | 2,099.1p | 2,719.3p | -22.8 |
| Share priceA | 1,782.0p | 2,505.0p | -28.9 |
| Numis Smaller Companies plus AIM (ex. investment companies) Index (capital only) | 5,406.8 | 7,116.5 | -24.0 |
| Russell 2000® Technology Index (small cap) (in sterling terms) (capital only)B | 3,814.1 | 5,340.9 | -28.6 |
| Dividend per ordinary share | – | – | |
| Profit/(loss) per ordinary share (revenue) | 0.21p | (8.33p) | |
| Ongoing chargesA | 1.05% | 1.02% | |
| Discount to NAVA | 15.1% | 7.9% |
| Year to 31 December | 2022 | 2022 | 2021 | 2021 |
| Year’s high and low | High | Low | High | Low |
| Share price | 2,570.0p | 1,560.0p | 2,630.0p | 2,045.0p |
| Net asset valueA per ordinary share | 2,719.0p | 1,978.7p | 2,849.1p | 2,285.0p |
| DiscountA | 25.2% | 4.1% | 16.8% | 1.8% |
| At 31 December | 2022 | 2021 | |
| (Loss)/profit per ordinary share | |||
| Revenue | 0.21p | (8.33p) | |
| Capital | (641.23p) | 439.51p | |
| Total | (641.02p) | 431.18p |
A Alternative Performance Measure – see page 82.
B Investments and indices valued at USD/GBP exchange rate of 1.209 at 31 December 2022 (1.354 31 December 2021).
® Russell Investment Group.
CAPITAL RETURN SINCE INCEPTION
| Inception | |||
| 31 December | 16 February | ||
| 2022 | 1994 | % change | |
| Net asset value per ordinary share (including | |||
| current year revenue)A | 2,099.05p | 98.70p | 2,026.70 |
| Net asset value per ordinary share (excluding | |||
| current year revenue)A | 2,098.83p | 98.70p | 2,026.47 |
| Share price | 1,782.00p | 90.90p | 1,860.40 |
| Numis Smaller Companies plus AIM (ex. investment | |||
| companies) Index | 5,406.82 | 1,750.00 | 208.96 |
| 2000® Technology Index (small cap) | |||
| (in sterling terms)†| 3,814.11 | 688.70* | 453.81 |
A Alternative Performance Measure – see page l.
* At 9 April 1996 being the date funds were first available for international investment.
†The Russell 2000® Technology Index (small cap) was rebased during 2009 following some minor adjustments to its constituents. The rebased index is used from 31 December 2008 onwards.
CHAIRMAN’S STATEMENT AND REVIEW OF 2022
Recent stock market declines have inevitably affected the Company and it is disappointing to report a decline in net asset value (‘NAV’) per share of 22.8% in 2022. The decline was surprisingly uniform across all four of our regions (UK, North America, Continental Europe and Asia). More positively, we have seen profits growth in aggregate within the portfolio and generally resilient trading in investee companies. As clearly set out in the Manager’s report, price to earnings (‘p/e’) valuations have been reverting to more normal levels (17.8x) having been elevated in recent years as we highlighted at the time. However, it should be noted that share price declines often precede forecast downgrades.
Market-= induced valuation volatility is one dimension to performance. The more important one for the long term is investing in successful growth companies. The aims of this Company and its Manager are to achieve capital appreciation by providing primary capital and being active in the secondary market in smaller quoted companies in the telecommunications, multimedia and technology sectors. In 2022, a further £21.4m was invested in primary capital (both new issues and follow-on fundraisings by companies), which takes the cumulative total to £645m since inception in 1994. That compares with just £95m of capital that the Company itself has raised in total (1994: £65m and 1996: £30m). Our belief is that good companies will grow whatever the economic backdrop, and that technology will continue to open up new markets. Early-stage capital is always scarce and by ensuring that we identify and research good companies ahead of others we can benefit from this.
Technology spend used to be mainly a capital expenditure decision, and demand was vulnerable to economic cycles. However, today businesses cannot run without information systems which are increasingly provided as a service on a rental basis, in effect outsourcing capital expenditure. This also means that more technology spend, across datacentres and communications infrastructure as well as software, has become non-discretionary. Importantly it means many technology companies are less exposed to cyclical demand and have defensive characteristics like utilities. Furthermore, businesses and governments alike are faced with other inflating costs, and the UK and North America in particular have very tight labour markets, so there is greater pressure than ever to find efficiencies, driving further demand for technology investment. The consumer, although wedded to the internet, is perhaps more fickle and may reduce expenditure on content and consumer electronics in uncertain times. Equally, inflationary pressures may squeeze advertising demand which is showing signs of weakness, but digital media continues to gain share. Business-facing subscription content should be more resilient.
Companies manufacturing technology products such as semiconductors are more exposed to softening demand than software companies. They have suffered from supply chain issues associated with Covid and capacity constraints, particularly in the semiconductor industry. This has left many companies with record order backlogs so short-term demand is assured, but for those higher up the supply chain the inventory cycle could produce adverse impacts.
Takeovers have continued to be a strong feature this year. There were thirty one takeovers of portfolio companies completed or yet to be completed, with an aggregate value of £161m. Of these, thirteen were in the United States (£73m) and nine in the UK (£57m). In contrast, IPOs were few and far between, with stock markets virtually closed to new entrants. These takeovers, together with the Manager’s purposeful rotation into lower-rated stocks over the last couple of years, have helped offset the losses in the portfolio. In addition, the Manager has adopted a defensive stance by holding a lower proportion of early-stage loss-making stocks (12.0%) than in the past, and by retaining high cash balances. At the end of the year, cash and short-dated government bonds were 12.1% of net assets (£158.1m). This is a near record level and provides plenty of ammunition to invest at lower valuations in the coming year.
Current year losses in the portfolio have been mitigated by the weakening of sterling, relative to the dollar in particular, which has reduced the losses on overseas holdings, and (albeit on a delayed basis) will improve revenues and profits for UK companies with exports and overseas subsidiaries. In addition, the Company bought back more of its stock in 2022: some 2.6m shares, or 4.0% of the outstanding capital at the start of the year, with an aggregate cost of £50m. During the year, the discount widened from 7.9% on 31 December 2021 to 15.1% at year end, but with such dramatic market movements during the year, this is not altogether surprising.
The income statement is showing a marginal profit after several years of losses. This reflects a growth in dividends received of 16%, increased interest income on cash and government bonds, and reduced costs reflecting the lower asset value.
Whilst we remain confident about the longer-term prospects for the majority of the investee companies, we have concerns about the state of financial markets particularly for smaller companies. The UK smaller quoted companies market is the most challenged with particularly poor liquidity. This is an existential threat. It is very sad when over the life of the Company the UK listed investments have delivered a return in excess of £1bn including nearly £400m of profits on AIM holdings. The returns from investing in smaller UK technology companies have been first class over the longer term, bettering those of the index of US smaller technology companies (Russell 2000® Technology Index) by over 1,000% since 1 July 1996. The Company’s capital is much needed in the UK. The entrepreneurial early-stage part of the market, which the Company addresses, is on the frontline in the conflict between regulation and economic growth. Whilst we respect the need for regulation, it appears to us that the process of reducing risk from the markets seems also to be reducing the available risk capital. This is surely an unintended and undesirable outcome and a major factor in our gradually decreasing exposure to the UK market.
As previously announced, after ten years I shall retire from the board at the forthcoming AGM. It has been a great honour to serve as Chairman of a company which has served its shareholders so well and, at the same time, has made such a significant contribution to the UK technology sector. I would like to thank our excellent manager, Katie Potts, and the entire team at HIML for their unstinting efforts on your behalf. Equally, my fellow board members have made my time at Herald very straightforward with their ever-ready support and constructive contributions. Andrew Joy joined the Board last October and will replace me as Chairman in April. Andrew has already demonstrated that he will add a great deal and I am sure I am leaving you in good hands.
Whilst the current economic and geopolitical challenges seem likely to continue for some time, I am very confident that the Company is well-placed to benefit and even thrive in such uncertain times. Your Board remains excited by the investment opportunities in the sector and looks forward with confidence.
TOM BLACK
Chairman
15 February 2023