Description

1PM PLC

Thesis: long 1PM PLC

1PM PLC trades at a 15.8% cash earnings yield, pre-reinvestments. Since the GFC, it has developed a more diversified and higher quality portfolio, providing a large margin of safety against the inevitable turn of the credit cycle. We believe that the PLC wrapped around the underlying assets adds value to shareholders and it is our view that no further growth, synergies or cross-selling are required for this investment to pay out in the near term.

Introduction

1PM PLC is a non-bank finance provider to UK SMEs ("1PM" stands for "1 Payment Monthly"). The company started out on the AIM as a subprime SME lender in 2006. Today it has grown through multiple acquisitions to become a multi-channel/product offering to SMEs in the UK. A lot of SMEs are underserved by the traditional banks, which is where 1PM steps in. US investors can view 1PM as something akin to a Business Development Company however subject to UK corporation tax.

Business and Segmental Overview

After a spurt of acquisitions since 2015 it’s somewhat burdensome to understand where the revenue comes from. 1PM has 3 main product lines: leases, loans and invoice financing with several subtypes that are scattered across trading names.

Within leases there is a separation between hard and soft asset lending. There is also a car financing business within this segment. Within loans we have unsecured loans to SMEs and a secured consumer finance business called Intelligent Loans. Recently, 1PM acquired two invoice financing businesses which form part of the Invoice Finance segment. 1PM has flexible funding and broking capabilities across all segments which enables it to manage growth and risk throughout the credit cycle. All consumer, car and property business is brokered onwards. Off all H1 2018 origination volume, 55% (£61.9m out of £112.6m) was brokered onwards for a fee of 7.8%.

Management stresses that underwriting is not robotised and that it will not be fully automated going forward, despite the secular fintech move. There is always a pair of eyes on a deal. We see this as a positive as we don’t believe in computerised underwriting in the short to medium term, especially as it comes to SMEs. One key feature that has kept historical losses low has been a focus on owner operators who can personally guarantee a loan, lowering probability of default and raising potential recovery.

The loan size varies across segments but is between £1k and £500k. Currently, 1PM has 16k+ SMEs that it has lent to. In terms of concentration no lease or loan is over 0.5% of the total book. 1PM currently receives a coupon on the leases and loans around 17.5% for an average duration of 3 years, whilst the short term invoice financing business generates an IRR of 20.5% on a rolling basis.

Pro-Forma 15.8% Cash Earnings Yield, Impact of Dilution

In order to calculate the pro-forma cash earnings yield (pre-reinvestments) we model the business from the bottom up. For simplicity we split the business into only 2 segments: invoice financing (“IF”) and non-IF for a total principal of £116.1m. We have inferred most of the input parameters assuming H1 2018 (ending on November 2017) will be reflective of the business going forward while the revenue and cost numbers are multiplied by 2x to arrive at  FY 2018.

Impact of dilution

• Contingent considerations: there are several earnouts outstanding in respect of past acquisitions, however these are all  contingent on 1-3 year growth targets. The total amount of contingent shares that can be issued is 5.6m and are struck between 60p and 66.7p.
• Long Term Incentive Plan: management has put in an incentive plan that grants them 8.0m contingent shares vesting linearly upon the share price hitting 60p to 110p, granted for zero consideration.

If we dilute fully for the two elements above our cash earnings metric drops to 14.6%, which we still think is cheap on an absolute basis. However we think this evaluation of profitability is conservative: given that some of  the dilution can only happen after growth, which have assumed at zero for our thesis. Also, for the LTIP to kick the share price has to go up first, creating a profit for investors going long at the current price.

Does the PLC add value?

An interesting question to ask with holdcos, BDCs and closed end funds is whether the corporate structure “wrapped around” the underlying assets objectively adds return on shareholder capital. This is especially relevant in the case of 1PM where several smaller outfits have been acquired over time. In this case we see it as a trade off between a) a higher return on shareholder capital on the back of better funding terms for a larger, diversified business and b) the costs of running the PLC.

Based on the calculation below we can see that the PLC adds 6.2% of return on an Cash Earnings basis. One can observe that due to their growing book and track record 1PM has been able to achieve lower funding rates over time which clearly creates shareholder value.

Management

We have spoken to management to better understand the businesses and we deem them competent. We were concerned about their strategic goal to achieve a £100m market cap company, especially in light of historical equity funded acquisitions. That said, the acquisitions have all been done on low multiples (weighted average of 8.9x P/E, source), with performance based earnouts and deferrals and the shares from the incentive program vest on a per share metric. They have also recently publicly stated a focus on organic growth going forward.

Discussion of Main Risks and Mitigants

• Credit losses: the main risk we see are losses due to defaults on loans and leases. The current annual run-rate of losses on loans and leases is between 1-2% of principal. As the credit cycle turns we can expect this rate to go up. A big mitigating factor is the invoice factoring business that has a structural default rate close to zero. Management estimates a total peak loss of ca. 3% based on conversations with similar companies that went through the crisis. We think 6% is more appropriate. As per the table below the margin of safety is quite high as even at a 10% loss rate the cash earnings yield will be still positive.

• Funding and interest rates sensitivity: funding of loans and leases is almost fully matched and the invoice business is funded back to back. Whilst liquidity is well managed, 1PM has no long term committed lines yet. So if the cycle turns the origination might have to decline if funding dries up. However, as mentioned earlier, 1PM has an extensive broking capability that enhances credit and liquidity management. Historically, interest rate increases have been passed on to the end-borrowers without slowing down origination.

Catalyst

1 or 2 more trading statements underpinning current earnings power