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Edited Transcript of ARW.L earnings conference call or presentation 12-Nov-19 8:30am GMT

Q3 2019 Arrow Global Group PLC Earnings Call

Manchester Dec 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Arrow Global Group PLC earnings conference call or presentation Tuesday, November 12, 2019 at 8:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Lee Rochford

Arrow Global Group PLC - Group CEO & Executive Director

* Matthew James Hotson

Arrow Global Group PLC - Group CFO

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Conference Call Participants

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* Gary Greenwood

Shore Capital Group Ltd., Research Division - Research Analyst

* Gurjit Singh Kambo

JP Morgan Chase & Co, Research Division - Head of Diversified Financials Research

* Hugo Moniz Marques Da Cruz

Keefe, Bruyette & Woods Limited, Research Division - Analyst

* James William Lawrence Hamilton

Numis Securities Limited, Research Division - Analyst

* Manu Nair;NatWest Markets;Vice-President

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Presentation

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Operator [1]

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Good day, and welcome to the Arrow Global Q3 results call. Today's conference is being recorded. At this time, I would like to turn the conference over to Lee Rochford, Chief Executive Officer; and Matt Hotson, Chief Financial Officer. Please go ahead.

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [2]

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Thank you, operator, and good morning, everyone. As usual, we're going to keep this quarterly update brief and give you a quick overview of the numbers before we move on to Q&A.

As we've said before, we believe the best way to look at this business is on a cash basis, and I'm pleased to say the group has delivered another strong cash performance this quarter. We've also been clear that our primary strategic focus is to develop our fund management business, and the continued build-out of AGG Capital Management is progressing very well. In fact, I couldn't be more pleased with where we're at, but there still remains a lot to do.

While capitalized third-party AMS income increased by over 8.5%, we continue to view the development of our fund management business as a catalyst that will help to achieve our ambitious 5-year target to double gross AMS revenues. Growing the fund management business will allow us to ramp up the volume of assets we push through our servicing platforms, growing our servicing revenues faster than current organic growth would imply, whilst also enabling us to charge management fees as an incremental source of capital-light income.

Arrow's been investing now in the nonperforming loan market for over 15 years, and during that time, we've consistently generated high returns. And with this exceptionally strong track record, we believe we're uniquely positioned in this sector to build a scalable fund management business by offering a compelling proposition to gain exposure to an attractive high-yield asset class in an environment where yield is increasingly difficult to find.

Growing this business line will further drive the cash performance of our business, providing us with even more optionality when assessing our capital allocation option of investing for growth, rewarding shareholders and deleveraging. The implications for our future funding model are also compelling. We remain extremely excited by the prospects of developing the fund management business and the positive implications it has for the group's cash generation and funding optionality.

While earnings growth won't be as pronounced as in the past, those earnings will be higher quality and derived from recurring revenues. This pivot in our strategy is supported by the growing strength of our client franchise. I'm particularly pleased in the first 9 months investment volumes, and these are indicative of the quality of opportunities that we're now seeing through our expanded platform. We're running into the year-end and beyond with the biggest forward pipeline I've seen in my 3 years at Arrow.

Whilst we're managing our own capital commitments carefully in order to manage our leverage, this is supportive of our ambition to operate a fund management business at significantly greater scale in the years to come. Our focus on building our fund management business is absorbing a considerable amount of the time and resource of management and certain of our colleagues around the group. However, we're happy that we're continuing to trade in line with current market consensus for the full year.

So at that point, I'm going to hand over to Matt, and he'll take you through the numbers.

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Matthew James Hotson, Arrow Global Group PLC - Group CFO [3]

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Thanks, Lee. Good morning, everybody. Before I get on to the numbers, I thought it might be useful to just give some initial views of Arrow from my perspective. I've been in the business now for a few months, joining just after the interims. It's been great to spend time on the road with -- meeting all of our top investors with Lee and Duncan, and what is very clear from those meetings is the overwhelming shareholder support for our strategy to grow the fund management business, reduce costs and move to the capital-light business model that Lee has described.

Arrow operates in a market which has hugely attractive characteristics, growing demand, attractive returns and significant barriers to entry. As Lee said, we've got a clear and compelling strategy, which has the potential to deliver attractive cash returns to our shareholders.

Inside the business, I've been really impressed by the quality of our people. And whilst, as Lee said, there is a huge amount for us to do, we generally execute well. As well as getting to grips with the business, I've spent time confirming my view from the outside that the balance sheet is robust and the control environment is working.

So turning to this morning's numbers. As Lee noted, the business has continued to produce strong cash flow with free cash flow increasing by over 14% to GBP 174 million. And as you can see from the cash graph that we published in the presentation this morning, both collections and AMS growth meant that total cash income increased by over 8% to GBP 381 million.

As Lee said, we believe cash is the best way to look at our business, and so these are the important numbers from this morning's announcement. Developing the fund management business will allow us to push more volume through the servicing platforms, further driving our capital-light AMS revenues and accelerating us towards being self-funding and covering the dividend with capital-light recurring cash flows.

The strong cash performance has also fed into continued IFRS revenue growth. Income from balance sheet assets was down 2%, and that's comprised of a 6% increase in income from collections activity more than offset by a GBP 30 million fall in impairment gains as the gains in half 1 2018, were not repeated. Total balance sheet portfolio investments have grown by 13% in the last 12 months and 7% during 2019, to GBP 1.16 billion at the end of September.

Third-party Asset Management and Servicing revenue was up 8% to GBP 69 million, making total income broadly flat at GBP 257 million. Collection activity costs continued to reduce as we realize efficiencies, down GBP 7 million from 56% to 49% of collection income. Other operating expenses, however, increased primarily due to the M&A that we undertook earlier in the year.

Whilst I'm on costs, the GBP 20 million cost efficiency program announced at the half year is progressing very well. And we've delivered actions -- or we've taken actions, sorry, which will deliver GBP 8 million of the annualized savings that we talked about in August.

Both statutory and underlying profit increased in line with the positive revenue and cost dynamics, with statutory operating profit up 4%. And while that statutory profit was -- sorry, so again, while statutory profit after tax increased strongly, underlying profit after tax reduced, driven by the same nonoperating items highlighted at the interims: higher finance costs from operating lease charges and deferred consideration amortization, higher tax rates as we move towards higher tax countries and one-off noncontrolling interests.

Looking ahead, finance costs will continue at this elevated rate into 2020. The tax rate may increase a little bit further as we continue the shift of the business away from the U.K. and towards Italy. And NCIs are harder to predict. They are an occupational hazard of what we do, but they should be relatively low, and any guidance we give will be net of the impact of any NCIs.

As we've said in the release, we're comfortable with market expectations for the full year on both an underlying and reported basis. And as we move into 2020, I expect both the underlying and reported numbers to converge. And I've made it very clear to the organization that the market is intolerant of further exceptional charges, and we don't expect them to be a feature in the future.

Turning to the balance sheet. The balance sheet is strong. We have a long financial runway in terms of our debt refinancing. Cash generation is strong, and we are creating alternative capital sources through the fund management project. I'm very happy with the balance sheet and very optimistic for its future prospects.

Leverage was 3.7x at the end of Q3 and is on track to fall to the upper end of our 3 to 3.5x target range by the end of the year. On a cash basis, interest costs are covered over 7x. And as we increase the capital-light earnings, I'd expect the leverage number to continue to fall towards the bottom end of the range over the next couple of years.

So in summary, we feel comfortable where we are and with where people expect us to get to. A huge amount of energy is going into the development of the fund management business, which if successful, will transform the business. We have a great deal to do, but before we get back to running the business, we'd be delighted to take any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will now take our first question from Gary Greenwood from Shore Capital.

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Gary Greenwood, Shore Capital Group Ltd., Research Division - Research Analyst [2]

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Just one question for me. Obviously, you've done well in terms of the portfolio purchases year-to-date, and I know you referenced the strength of the pipeline. I think you've previously guided to somewhere around GBP 265 million of purchases for the full year. Obviously, you're looking to be well on track to deliver that.

So just wondering if you're still comfortable with that guidance. And in terms of sort of allocating that pipeline going forward, sort of how we should think about that in terms of split between owned book and third party?

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [3]

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Yes. I mean, you're right. We are very happy with the quality of transactions that we're seeing. Clearly, 70% -- 78% of everything we do is off-market, and therefore, we have good visibility about forward flow. They're coming right across the platform. And as I sort of said in my comments, that, I think, is to do with as much the expansion of the Arrow platform in the last 2 years into the new niche asset classes and geographies that we're targeting.

That forward pipeline does look very strong. And we are balancing carefully, I would say, the quality of opportunity we're seeing to manage the returns and to manage our capital commitments so that we meet the commitments we've made to the market on leverage.

So it's a little early to say exactly where we'll end up for the year. But as you rightly point out, we do have significant options with our business model to toggle, if you like, between the amount we invest and the amount our current investors invest.

So I would expect to be slightly more than we've said in our guidance for the year, which I think our guidance was around GBP 250 million for the year. Given where we're at right now, that would be reasonable. Exactly where we'll end up remains to be seen, but I'm confident that we'll meet the commitments we've made to the market.

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Operator [4]

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We will now take our next question from James Hamilton from Numis.

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James William Lawrence Hamilton, Numis Securities Limited, Research Division - Analyst [5]

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I was wondering if you could pass some comments on the progress and outlook for asset management, which you've spent some time on in the past as opposed to the AMS business.

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [6]

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Yes. Sure. Thank you, James. I mean, you're right. When you look at our business going forward, there are different components to the asset management business. There is the servicing businesses we have, both for third parties and our financial institution clients. And then there's a component of that within that, which is the fund management business.

Looking at the servicing business -- and we've had some great wins over the third quarter. Particularly, I'd call out our Portuguese business that I think won for co-investors 4 auctions on the bounce. So very happy with some of the quality of the third-party contracts that are now being put in place that we'll see through next year. Some important wins as well in the U.K., which is a more nascent part of our servicing business, and a good balance across the rest of the geographies.

So we continue to make good organic progress. I would say we have pointed out, particularly with some of the new acquisitions, that there is a process we go through early doors in terms of weeding through some of the more marginal profitable contracts. And so there's a bit of that effect going through.

But also, I think it's probably pretty clear to you our really significant focus right now is getting that fund management business built out. And that is an enormous effort, putting the plumbing and the wiring in place for that to support the growth in AUM we expect in future years. And so we're not highly focused on the short-term organic growth of AMS because we know the major catalyst for the amount of volume that will go through the business will come from the increased AUM delivered by the fund management business in future years. And that's what underpins our confidence that we've doubled those AMS revenues over the period we set out at the Capital Markets Day.

So not unhappy with how AMS organic origination is going, but it's not the big driver that the fund management business will be when we get that up and running. I don't know if there's anything...

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Matthew James Hotson, Arrow Global Group PLC - Group CFO [7]

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So just to kind of reiterate the points on the fund management business, and I think as Lee said at the half year, there's a -- we're quite limited in what we can say in terms of any detail. But I think we feel the market is starting to get an appreciation of the potential of our business. And hopefully, people can see why we're expending so much energy on it.

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Operator [8]

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We will now take our next question from Gurjit Kambo from JPMorgan.

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Gurjit Singh Kambo, JP Morgan Chase & Co, Research Division - Head of Diversified Financials Research [9]

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Just a couple of questions. Firstly, what is the market environment like in terms of pricing for -- I guess you've got a big pipeline there. What's the sort of pricing outlook within that? And just sort of linked to that also, I think you indicated that you've been making investments in assets with slightly slower initial cash returns. So can you just perhaps sort of elaborate what sort of investments they are versus perhaps what you've been making in the past? That's sort of the first question.

And the second one was really around cost. It feels like you've taken the actions to be able to deliver the cost savings, and I know we've seen some coming through in Q3. But -- and sort of how much more should we expect in Q4 and into 2020?

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [10]

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Okay. Thanks, Gurjit. Maybe I'll take the first one and then Matt will take costs. I mean on market pricing, I think it's hard to generalize, but what I would say is that it's pretty much the same as we set out the interims, which is our belief right now is the significant amount of increase in IRRs that you've seen over the last 12 to 18 months is really as a consequence of the improvement of the Arrow platform, growth of that business into the target niches that we've identified that we want to be in. And that is growing the volume, if you like, at the top of the funnel and allowing us to filter to the high end of our target returns. It will be target mid-teens. We hit 18% at the half year.

And I would say the pricing environment since then, given that the platform is now stable, is broadly stable. So I don't think you've now seen, if you like, a market dynamic-driven pricing shift. If that were to happen for whatever reason, supply and demand, economy, whatever it might be, I think returns could go another leg higher. We haven't seen that yet. I think with extended QE and the chase for yield, it's reasonable to expect a more stable environment. For us, that means you should expect us to be within our mid-teens target and hopefully towards the higher end certainly for this year.

In terms of the return profile of the assets, I mean, that again comes really with the expansion of the platform into some of those target niches where both the cash flow profile, and therefore, the earnings profile could be a little different from some of the assets that we've booked in the past, so more sort of consumer-based assets, which are generating cash and revenue from day 1. Some of the more real estate-based assets have a slightly extended profile but still very attractive IRRs, which is the basis on which we look at it. And you see that balance sheet shift coming through when you look at our balance sheet metrics.

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Matthew James Hotson, Arrow Global Group PLC - Group CFO [11]

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And then on cost. So just to kind of be crystal clear, so obviously, cost savings, there's work to do and then you kind of earn the cost savings over time. The announcement we said this morning is we have taken the actions which will deliver around 40%, GBP 8 million, of the GBP 20 million savings we announced at the half year. So that GBP 8 million, we'll earn through 2020. We'll get a little bit of earnings of that through Q4 as well.

Of course, we've not stopped, and there's still further actions going on, which need to ultimately get to the point where we get to a GBP 20 million annual run rate. I suspect that, that -- those actions will take through to the half year next year, maybe a little bit beyond that before we get to the run rate. But we'll make sure we kind of update you as we go, and we'll give a quarterly kind of running total as it were -- as how the cost savings have gone.

The other thing I would say is we -- for obvious reasons, we've done the easy things first. And when I say easy, that really is a statement about how quickly we can get on with stuff but also how -- the good payback things. So if you look into the P&L, you'll see that the charge -- we said we'd spend GBP 20 million. Within that GBP 20 million, we've delivered -- we've spent about GBP 4 million or GBP 5 million of that so far. So we've kind of spent GBP 4 million or GBP 5 million to get GBP 8 million. That's a good payback. But as I said, we've done some of the easy stuff first.

So we expect that we'll still get through the GBP 20 million of investment required to deliver the GBP 20 million. My hope is that we would spend the majority, the vast majority of that GBP 20 million. Either we'll spend it or we'll accrue it in 2019, as I said, so we kind of move into 2020 where exceptionals are not a feature of the P&L.

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Operator [12]

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We will now take our next question from Manu Nair from NatWest Markets.

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Manu Nair;NatWest Markets;Vice-President, [13]

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Just really a clarification on the calculation of adjusted EBITDA, which you disclosed in the release. I see there's a negative provision release of GBP 8.9 million and adjusting items, which I assume has to do with [expenses] you just discussed, where you add back around GBP 8 million versus GBP 9 million last year. Could you just clarify what these items are, especially the negative provision release, which I'm quite surprised by?

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Matthew James Hotson, Arrow Global Group PLC - Group CFO [14]

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So the -- you're right. The -- we obviously adjust for the one-off items that [cut back] the adjusted EBITDA because of the -- because we want to do that on an underlying basis. The negative provisions are just releases, some provisions relating to some of the deferred considerations that we've kind of -- we assess on a periodic basis to say whether they're still required. We've tended to, if you will, provide conservatively for those things, and we took a view that some of them were -- we were over-provided for. So we released some of them.

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Manu Nair;NatWest Markets;Vice-President, [15]

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So just to confirm that, I mean you don't have to pay -- in your view, you don't have to pay the GBP 8.9 million, but it's a noncash adjustment?

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Matthew James Hotson, Arrow Global Group PLC - Group CFO [16]

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It's just a noncash adjustment, exactly, right. Yes.

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Manu Nair;NatWest Markets;Vice-President, [17]

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It's just a noncash adjustment. And GBP 8 million, could you just explain exactly what it was kind of spent on? And any -- I think you mentioned the figure...

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Matthew James Hotson, Arrow Global Group PLC - Group CFO [18]

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It's related to provisions that were put aside for previous acquisitions but we now realize that we don't need to spend.

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Operator [19]

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And the final question in the queue comes from Hugo Cruz from KBW.

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Hugo Moniz Marques Da Cruz, Keefe, Bruyette & Woods Limited, Research Division - Analyst [20]

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I was just wondering, can you say anything in terms of any deadline for the announcement of the fund management business? I think that would be very helpful for the market.

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [21]

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Well, thank you, Hugo. Two things I would say on that. We are building a business line here. It's not a transaction. And so you should expect, over time, clearly a growth in AUM, which I think will be considerable over time so that we end up managing on a discretionary basis a significant amount more than we currently invest with our own capital.

So that would be the first thing I would focus on. This is a business buildout, which have a significant shift in the nature of our business, which is why we've talked about this being a pivot year. I think the business will look very different going forward.

I think I did explain at the interims that in the short term, we are under some regulatory restrictions from the SEC and other regulators in terms of how much color we can give on the specifics. And I'm afraid I'm going to stand behind that for now as well. As soon as we have some news beyond that, obviously, we'll talk to the market about it. But we're really not in a position to say anything more specific than that at this stage.

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Operator [22]

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As there are currently no more questions, I'd like to hand the call back to our host for any additional or closing remarks.

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [23]

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No, I think that's all from us, operator. We look forward to updating people after the full year results, early March. Thank you for your questions. Thank you for your interest, and we look forward to talking to you at a later date.

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Operator [24]

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Ladies and gentlemen, this concludes today's call. Thank you for your participation. You may now disconnect.