Lowell - One Year
All,
Please find our updated analysis of Lowell here.
Elephants don't fly. Unless GMMs expand vastly (to 3x) and presto, the company won’t be able to fund its interest payments without selling further assets, eroding bondholder ERC collateral. Unless a buyer is found soon, we see stakeholders back at the negotiation table within a year from closing this deal. Perhaps that will be a better time to think about entering the New OpCo SSNs.
Investment Considerations:
- We are not taking a position in Lowell and are unlikely to do so for the foreseeable future. As such, we may not be updating this name every quarter, but only when asked, or we see a change.
- Not enough debt reduction: On the basis of £1,7bn residual book value of ERC and a 3PC business generating £160m in fees, the remaining business is too small to sustain the £180m of annual cash interest that will be payable after the recapitalisation. We project with high confidence that the business will lose £80m p.a. in NCF and we are concerned that Lowell are having to conserve cash in H125 to pay for the cash portion of the transaction.
- Without further asset sales (BS Velocity), the business should run out of money or fail to replenish its ERC within a year. But with further asset sales, the bonds will see their collateral eroded as 2/3 of proceeds so far have been used to fund losses. In that context it is also worth noting that the bonds have £0.9bn of debt in front of them, i.e. are only 40% ERC collateralised in the first place.
- The great hope of cheaper portfolio purchases has yet to materialise. While we are told of 23% IRRs at purchase, the uptick in bought GMMs so far has been consumed by a static collection engine that has become disproportionately large relative to the shrinking book it is feeding off, which requires relatively higher (static) expenses to extract the same performance as before.
- Even if we ignore the still significant execution risks in the not-yet-finalised agreement with the RCF, the notes are trading too tight as our valuation is based on book value and ignores the insufficient cash flow the company is producing to pay interest / maintain asset coverage going forward.
- To become interested in the bonds, we would have to be able to buy them at a discount to our theoretical value that reflects the cashflow pressure to sell the company quickly. Given the narrow buyer base and execution risk / cost, a price of 45p/£ springs to mind. That sounds far off, but if we are right and bondholders are looking for the fire exit before the year is over, we could be tempted then.
Key Insights:
- Were we invested, we would choose Option 1. We struggle to assign more than 55p/£ of value (in old money terms) to the New OpCo Notes. The cash element provides another 10p on average between the options, resulting in a valuation of only 65c/€ for the current Notes. (See section on Sum of the Parts.)
- Deeply negative cash flow of £-80m p.a.: Whichever way we twist the model, we cannot make this company pay for its interest burden under the new capital structure. We'd have to flex the GMM to 3x to allow Lowell to service its new cash interest burden. (See Model section.)
- The higher GMMs at which the company is buying new portfolios are consumed by the proportionally higher churn of its book, which requires higher ERC purchases for net/net the same cash Lowell needed to spend before. (See Model section.)
- The balance sheet velocity program is only a thinly veiled attempt to increase Cash EBITDA, but it churns the book faster. Without the balance sheet velocity transactions that have distorted the financials in recent years, Cash EBITDA leverage would now stand at 5.6x. (See section on BS Velocity.)
- Since 2021, UK rates have widened by over 4%. If portfolios were not undervalued at that time (not to our knowledge - only recognised purchase prices and constant value write-ups), then their value should arithmetically be 7% lower today, or £1.6bn. In the absence of a sale of the business or sufficient operating cash flow, creditors' only money-making opportunity is a steep drop in interest rates that would not immediately be accompanied by portfolio price rises (a drop in GMM). (See section on ERC.)
Summary:
- The debt collector is going through a recapitalisation in early 2025, which should, however, drop its leverage only slightly and maintain the high interest burden on the business, even though its ERC portfolio has shrunk by £750m following a series of Balance Sheet Velocity transactions that upheld its Cash EBITDA figure, but failed to reduce debt by more than £200m (a ratio of just 30%).
- Same engine, smaller tank: If Lowell investors drove cars, they'd know the new setup won't get them as far. Lowell's collection team is undiminished, yet in the last two years, the ERC book it is working out has shrunk by nearly 20% with only minor gains in servicing fees. The company's organic collections have remained remarkably stable over the last years and we have no reason to assume any change now. That also mostly removes any organic upside. For now, the higher GMMs at which the company is buying new portfolios are consumed by the proportionally higher churn of its book. The company would have to be sold or immediately solvently liquidated to preserve any value for Permira or even the PIK notes, but we don't know who would buy the business at a high enough value. There have been press reports of Lowell hiring Barclays to sell its Nordic business, but that would have to happen soon. See Background section.
Upside to our sombre outlook:
- A near-term deal on the Nordic business. The bond documentation is now tighter on using proceeds to pay down debt. But some cash will have to be held back to fund ongoing negative cash flow.
- A steep fall in inflation or UK interest rates in particular could drive the ERC collateral up 3p for every 1% rate drop. A 2% drop would return the book to near its balance sheet book value.
Here to discuss with you,
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk