Lowell: "Tactical" Retreat - Positioning
All,
Please find our unchanged analysis of Lowell here.
As is easily the case in a trade that isn’t based on solid fundamentals, but rather on the market itself, the fundamentals play out, but by that time the market changes. So it was with Lowell. In September we forecasted that Cash EBITDA Leverage would slip below 3x and consequently bet that sufficient - mostly continental - demand would stand ready to refinance the name - against all reason.
Investment Rationale:
- We are selling our 2% position in the 25s at 70.5c/€, down from the 78c/€ where we bought it. The name briefly traded up into the 80s, but even though the company’s favourite leverage stat fell below target, it was all over when Intrum disclosed the terms of its deal with Cerberus.
- Ahead of Lowell’s own maturities, the company looks in broadly the same predicament as in 2020. Permira offered €400m in fresh cash to hold on to the company, the deal was rejected, but then Goldman Sachs seem to have found some extra €200m to leverage Permira’s equity in the name and on €600m of fresh cash the deal was agreed.
- The fresh cash was primarily to pay for the next five years of interest and we are coming to an end of that period.
- We think that neither Permira, nor Goldman Sachs can repeat their performances and therefore struggle to imagine that the next catalysts for Lowell should be positive. If anything the noise at intrum over the coming months should add further pressure.
- In the low 70s a short is becoming expensive. The bonds are better collateralised than Intrum’s.
3x Cash EBITDA:
- We’ve been complaining about Cash EBITDA for a long time. It’s a useful figure for certain management tasks and to run the company, but it doesn’t serve to calculate leverage or profitability.
- That Lowell are now beneath their 3x target is a function of the Balance Sheet Velocity program, which aims at merely “eating the cake faster” rather than baking more cake.
- We were betting that a large contingent of the market still believes in this figure, but we are now too far off par for there to be that final pull that we had been betting on.
Cash Flow and leverage:
- As you know our cash flow model is very light this time. After rolling the vintages and building the world’s most complicated model in 2020 we did not feel the need to repeat that effort. A look across the last years reveals zero cash generation - despite what should have been management’s best efforts.
- A look forward across the next few years suggests none of that is going to change until 2027 at the earliest and only when assuming that competition will ease. The trouble with that assumption of course is that it will only ease if the space is unattractive and even then (now) margins remain tight.
- The idea of 100% leverage portfolio purchases has simply not worked. The returns are eaten up by too much competition on a plain playing field.
- The service business too has this problem. In some way, the purchasing businesses were only invented to protect these platforms from this direct competition in the first place. So a return to this model will not be helping - at least for some time. Now that we have some very large players in the market (Intrum) perhaps those large players can leverage some competitive advantage. Smaller players like GFKL seem to have nowhere to hide.
Permira:
- We doubt the next step in this saga will be Permira emerging from the basement with a big coffer of another €600m. But failing that, we struggle to see what other positive catalysts could drive value for the bonds except perhaps a frivolous equity investor who is new to the business. Do Onepoint also invest in the UK?
Here to discuss with you,
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk