Description

Thesis

We think Urban Exposure PLC (“UEX”) is cheap @ 35p with a 58% discount to intrinsic value and the ability to withstand an extreme drop in property prices.

UEX operates as a specialist finance company for UK residential developers. UEX IPO’ed in 2018 at 105p and has traded down to 29p in the last week. UEX consists of cash, loans to residential developers and income from asset management agreements - most notably with KKR. 

Net Cash: +10.4p Per Share

This can be inferred from the circular published on the 10th of March 2020 and the latest tangible NAV announcement on the 17th April 2020:  83.9p tangible NAV - 73.5p of loans at par.

Loans @ Par:  +73.5p Per Share

Based on the latest pre-COVID numbers the weighted average loan to gross development value (WALTGDV) stood at 66%. UEX typically lends to projects that have already pre-sold some units via receipt of irrevocable deposits. On the basis that deposits will lead to actual purchases in most circumstances the WALTGDV would be 45%. The WA IRR is ~10% and the WA term of the loans is 36 months.

Holdco Costs: -18.9p Per Share

In their most recent announcement the running costs have been £8.8m. We assume 3 years of costs @ £10m will be enough to rundown the current portfolio for a run-off inspired SOTP.

Projected Aggregate Income: +17.5p Per Share

The future revenue derived from the assets management agreements - which UEX calls “Projected Aggregate Income” (“PAI”) is an important driver of intrinsic value. The total interest UEX receives from a development loan over the term is fixed but the timing is uncertain. UEX said that the 2018 vintage of originated loans would provide £26.9m of revenue over the period to end 2022. Whilst the total PAI of the 2019 vintage loans has not been guided (but the expected timing of recognition has been) we can make an assumption based on the disclosure of £498m of loans having closed by a simple proration to 2018 figures versus loan notional amounting to £25.6m. The PAI does not appear on the balance sheet and is excluded from “tangible NAV” calculations (presumably) due to the timing uncertainty. For SOTP calculation purposes we assume the disclosed expected recognition schedules but defer these by 2 years. To get a PV we discount by 10%.

Sum of the Parts

The Apparent Discount

• Holdco costs are relatively high in a run-off scenario where no new business is written post 2019. But it’s offset mostly by the PAI. 

• The upside comes from a look through discount we are getting on the loan par notional amount which is 67%.

• The look-through WALTGDV amounts to 22%. As noted earlier, a significant amount of GDV has already been pre-sold. On a look through basis at the current share price, 95% of the EV is currently covered by only the GDV that has been pre-sold. 

• This also means that GDVs would have to drop 78% for an impairment to occur on the investment. For context in 2008 the largest fall on record has been 22% with a recovery within 22 months.

Activism / Acquisition

UEX is an asset manager and a loan balance sheet in one. Because the business did not scale fast enough investors got disappointed with the lack of profits due to high running costs - expecting a dividend cash cow in the near term which was promised at IPO. In late 2019 activists got involved (most notably Robert Tchenguiz) and the company decided to evaluate several proposals which culminated in an SPA being signed on the 10th of March 2020. However, the chosen buyer Pollen Street Capital has pulled out since and the stock price has drifted lower again. UEX has stated on the 17th of April 2020 that “it intends to consider all credible proposals which may be forthcoming”. Of other notable interest is the 13.2% shareholder Cloverleaf 374 LTD - which is Wellesley Finance PLC. They voted against the Pollen Street Capital transaction and had a 25% effective blocking stake at the EGM. Maybe they thought they were being short changed at a take out price of 73p, or had potential other plans in mind. Given that management only holds 10% it looks like activism in general has a good chance to mitigate value dilution by management.

Litigation v Pollen Street Capital

It seems very likely that Pollen Street Capital walked away from a definitive contract without being able to call upon any MAC based on what has been disclosed publicly. The MAC language disclosed refers to a loss due to a developer defaulting / breaching contract. UEX is suing Pollen Street Capital and if there is recourse for damages beyond the bidco that entered the SPA, then that would be free upside beyond the SOTP stated above.

Risks and mitigating factors

• Funding mismatch: UEX has funding lines committed from at least UBS and Aviva PLC through which they fund their loan commitments to developers. On 17 April 2020 they said: “our funding facilities and joint ventures remain in place”. Also, we have understood from management that draws under the current COVID-19 lockdown are severely limited and can be mitigated by numerous “outs” on the side of UEX (we understood that a typical loan doc spans ~ 1000 pages). However, we have learned from experience that until we have read the documents ourselves we can’t be certain of anything. So we see the most material risk to the investment thesis that some funding mismatch would occur requiring some form of capital raise.

• Holdco cash drag: we have to assume that management has the incentive to pay themselves handsomely even in a rundown scenario and this might go beyond the £10m we have assumed in our SOTP. Although as noted above enough activist interest in the company and smart investors are on the register to be able to prevent this to a some extent. We also assume UEX has enough cash on hand and in the near term to fund the holdco costs in the near term and if not would defer payment of those costs until the realisation of PAI, especially if those were management fees. If not, UEX could raise dilutive capital if not funded by debt.

• Delinquency management: whilst being remote as shown above, if it would come to an actual delinquency and foreclosure where step-in is required then we think UEX might be in need of capital in a scenario where such capital might be quite expensive. Although UEX’s zero default track record goes back to 2002, we still see this as a potential source of value erosion.

Catalyst

• Restart of construction across the UK
• Publication of FY 2019 results
• Acquisiton of the company