Lowell and JPM's report this week
All,
JPM this week published a long report on Lowell with all kinds of detail. The report is negative, although it does not contain any new findings. However, the team at JPM don’t seem to quite see the wood from the trees. Most points the bank makes are at their core entirely valid, but together they do not amount to any more than we already know for a long time now: Current performance won’t be sufficient to refinance the bonds and all major debt collectors have to find efficiencies to refinance.
So nothing in the report has changed our understanding or view. We are tracking the name with an integrated model and understand the company’s cashflows.
But with Ardonagh in limbo, the market is nervous and the opacity of debt collectors is not helping.
Our bet has been and remains that the company has the wherewithal to change that. We’d prefer to see it via tangible cost cuts, but management seem confident that from H2 this year they can present improved profitability through revenue synergies. Now we don’t agree with the way management are presenting a lot of things, but the promise of reducing %age Cost To Collect should (in theory) be unequivocal. Also, the company is slow moving enough for management to know how this is going to happen some 6 months before we see it in the numbers.
The Debt Collectors case comes down to this:
- All major debt collectors are running CF deficits. Some are even FCF negative. Lowell at least cover half their interest bill. None of it is pretty.
- All major debt collectors are also locked in pretty direct competition while the entire European sector is going through a land-grab period. Hence the low profitability.
- As we have been learning from a number of debt collectors recently, the industry is feeling the pinch from financing and competition has been easing somewhat - resulting in higher IRRs than before. Note that IRRs are a bit of a soft concept, as JPM have correctly pointed out again. We still go by Gross Money Multiples (GMMs).
- As all debt collectors are facing the same financing challenges, they all have to take the foot off the pedal now, so that sufficient profitable portfolios roll through their books by the time they need to demonstrate refinance ability. If this does not happen over 2019, and we can’t observe a rise in IRRs (whatever the measurement as long as within the debt collector it is consistent over time) then this would be a reason to sell (Note to self in 9 months time), as it would suggest that competition is too stiff to make money. Those with the longest maturities would then likely become the last men standing.
As regards Lowell specifically:
- Its leverage far exceeds the book value of its portfolio. In par that is because Lowell carry a significant off-BS asset in that their collections curves are significantly longer than the 10 years recognised on balance sheet. But that only amounts to a few hundred million. The remainder will have to be covered with the EV of the business - currently (theoretically) zero for all debt collectors, given none is making money.
- We think a good cost cutting round at Lowell should do the job. E45m (steady state NCF shortfall) are less than 10% of Opex. But management are not minded this way.
- Management are guiding to significant “relative” cost improvements visible from H219 due to revenue synergies as well as renewed volumes to cover the recent cost overruns in their 3PC business.
- Given the multitude and life time of portfolios, these companies are slow moving behemoths. H219 is practically tomorrow for management. And to profess these synergies with such confidence, we are inclined to believe that management already know exactly where they are coming from and how much. Clearly, if that does not happen or is vaguely postponed, that would be a reason to sell Lowell specifically as our confidence in management would be eroded by then.
Until such time, our “bet" is that in general: debt collectors will become less aggressive and more inward looking and for Lowell specifically: that management can quantify synergies 6 months in advance.
Wolfgang