(Debtwire) Lowell targets margin expansion and future NPL opportunities following balance sheet boost – CFO

26 November 2020 | 18:52 GMT

Lowell’s 4Q20 EBITDA will be down YoY and leverage could creep up given guidance for a full-year earnings decrease. But the UK-headquartered debt purchaser still expects EBITDA margins to be at 57% by FY21 while metrics will remain in the 3.5x-4.0x range before NPL opportunities are seized in 2022 and 2023, CFO Jamie Wilson told Debtwire in an interview.

The company this morning (26 November) reported 3Q20 results and held an earnings call. This followed the preliminary trading statement released on 15 October. Lowell's 3Q20 cash EBITDA rose 5.9% YoY to GBP 138.9m with quarterly EBITDA margins up at 57%, or 55% excluding a 200bps boost from a slowdown in litigation expenses due to the pandemic. FY19 EBITDA margins were 52.2% and 3Q19 margins 50.9%.

While some 200bps of margin improvement was due to not spending on litigation, there has still been 400bps margin accretion [versus 3Q19], the CFO noted. “We intend to improve margins by 300bps versus 2Q20 to 57% by FY21 throughout 2Q22,” he said. “The refinancing of the capital structure and equity injection with sponsor support and RCF roll-out means the balance sheet is in a great position.”

The company faced a question on the earnings call over the likelihood of weak 4Q results given previous roadshow guidance of FY20 EBITDA being down YoY and LTM 3Q20 cash EBITDA up 9% YoY to GBP 521m.

“At the refinancing we said the strong performance in 3Q20 continued into 4Q20 and we are targeting a 19% IRR and GBP 300m of purchases for FY20,” the CFO said. “Results for 3Q20 continue to demonstrate the resilience of the business. There was a strong performance in collections with the DACH and Nordics outperforming static curves and the UK continuing its recovery and above reforecasts.”

Lowell capitalized

Despite the expected 4Q20 earnings drop, Lowell had a healthy 3Q20 liquidity position of around GBP 405m pro forma its GBP 1.6bn refinancing. It had GBP 99m 3Q20 pro forma cash and extra liquidity sources given it had drawn GBP 159m of its EUR 455m (cGBP 405m) 2025 RCF. It had also drawn GBP 203m of its GBP 255m ABL facility maturing in 2024 as well as GBP 12m of its DACH securitization facility.

Lowell is now just 3.6x net levered at 3Q20 pro forma its recent refinancing under which the company received a GBP 600m sponsor equity injection to help get the deal over the line. The equity injection was provided by the Permira V Fund, which closed in June 2014. Permira holds a 63.9% interest in Lowell, with Ontario Teachers’ Pension Plan owning a 27.7% interest and management members holding 8.2%, according to the bond prospectus.

Management noted on the earnings call that the equity has come in and is not expected to go out again. They added the sponsor view Lowell as having a buoyant market for defaults during COVID and being well set up to achieve these opportunities. The recent refinancing included a General Restricted Payments basket while there was no prohibition on the new GBP 600m equity contribution being designated as an “excluded contribution”. There could also be leakage during a default, as reported.

One buysider noted that although Permira can re-extract the equity they are reliant on the bond market for the business, so they’d only take if Lowell delevers in the long-term. “Lowell needs a few more quarters of free cashflow and then people will be comfortable and Permira can retake the cash,” he said. “But they put it in so recently, so it doesn’t make sense to take out soon.”

They can benefit from the capital structure and the end game for Permira is to IPO the business so cash will be used to grow the balance sheet, a second buysider countered. “If Permira take money out then they cannot IPO the business, so the cash needs to be there.”

Lowell has improved cash generation in recent years. With a GBP 527m 3Q20 LTM pro forma cash EBITDA, it could face GBP 149m interest, GBP 6m maintenance capex and GBP 260m replacement rate expenditure, which would leave GBP 113m of annual excess cash, or 0.2x deleveraging per year.

The group remains committed to its 3.5x-4.0x deleveraging target and should be able to keep net leverage within that range given it does not expect to take advantage of NPL opportunities till 2022 and 2023, according to the CFO.

“We believe more supply is coming into the market. Many commentators and agencies have suggested growth by 2.5x–4.0x in NPLs and it is clear there will be a substantial increase,” the CFO said. “There are still forbearance initiatives from originators, but we expect the NPL wave to hit the market in FY21 to 2Q22 and we will take the opportunity in 2022 and 2023 with the refi putting us in a position to access it with the balance sheet extension and good liquidity.”

Lowell delivered

Lowell is still deploying capital for growth even if amounts have reduced in the past year. The company made GBP 302m of portfolio acquisitions in LTM 3Q20, which was GBP 42m above the GBP 260m replacement rate compared to a GBP 92m difference in LTM 3Q19 based on GBP 366m portfolio acquisitions and GBP 274m replacement rate.

Management noted on the earnings call that they expect no material impact on the business from risks from upcoming German regulatory caps on debt collection fees. They also added that asset sales are not a material part of the business when asked to explain differences in analyst cash income estimates versus reported figures.

Lowell’s GBP 400m 7.75% senior secured 2025s are indicated over a point higher at 103-mid yielding 6.5% while the EUR 740m 6.75% senior secured 2025s are indicated over a point higher at 103.25-mid yielding 5.5%, according to Markit. The EUR 600m Euribor+ 625bps senior secured 2026s are indicated a point higher at 100-mid with an 630bps discount margin.

“It looks pretty good. The UK collection performance has been a drag, but it is coming back to 86%. It is still a drag and depends on lockdowns but the backdrop with the equity injection and net leverage being low now means this story looks better,” the first buysider said. “In the short-term the bonds can gain and there is a good spread, but they need to prove the numbers for much longer.”

UK static pool collections versus the December 2019 static pool increased to 86% in September versus 79% in April. Around 91% of plans are set up on direct debit with a 5.7% LTM default rate.

“The concerns on 4Q20 are a little overdone as the business litigation slowdown was a major benefit and while it will restart in 4Q with an upfront cost and no initial revenues, the revenues will soon flow through, and against the December 2019 static pool UK collections will increase,” the second buysider said. “The costs will eventually bring revenues with 4Q20 not down due to exogenous effects.”

Special opportunities firm Sarria had three of its theses confirmed from today’s call. Firstly, that other debt collectors have written down portfolios and Lowell could next quarter. Secondly, that management seem confident the equity injection will stay, and they want the business to grow. Thirdly, that the company may have accelerated collections, either through selling NPLs or offering deals to delinquents for one-off payments.

Sarria had been looking to bring a group of bondholders together to structure a refinancing plan, as reported. It also previously held a conference call for noteholders, as reported.

by Adam Samoon