Earnings Call: H1 2021

Feb 28, 2021

Good day, and welcome to the Pacific Current twenty twenty one Half Year Results Conference Call. Today's conference is being recorded. At this time, I would now like to turn the conference over to Mr. Paul Greenwood, CEO and CIO of Pacific Current. Please go ahead. Thanks, Belinda. I would like to thank all of you for joining us on the half year earnings update for Pacific Current Group. We appreciate your time and interest and look forward to taking you through the results presentation. I will start with some high level thoughts and then get more granular, probably more granular than I typically do. 2020 was obviously a year dominated by the impact of the COVID pandemic on the entire world. The disruptive nature of the pandemic has had some short term impact on PAC, but I believe our portfolio companies have navigated the year quite well. And as a result, I believe the majority of them are actually in a much better place competitively than they were a year ago. As noted at our AGM, the biggest specific challenge brought on by the pandemic has been related to capital raising. The inability to go out and meet prospects has slowed the capital raising efforts of numerous portfolio companies as well as PAC's efforts on their behalf. This challenge is heightened by the large number of boutiques that offer private capital strategies. This relates to the fact that when private capital strategies go to market to raise a new fund, the fund documents that govern the terms of the funds set out a finite period over which the fund is to be raised. This time period is typically 18 months. For obvious reasons, COVID delayed the beginning of fundraising for the next round of funds for multiple boutiques. This combined with travel restrictions meant that some of our portfolio companies were not in a position to grow as fast as they had planned. That said, as we begin to emerge from the restrictions of the pandemic and as capital allocators have increased their level of activity, we expect essentially all our portfolio companies to be in full fundraising mode in the first half of fiscal twenty twenty two. This combined with some of the early data points that we have visibility into give us confidence that we will see the next 12 to 18 months be one of building fundraising momentum across the portfolio. With that, I'm going to jump into the presentation. So starting on Page 3 of the presentation, we highlight some key metrics. You will note that substantial thumb growth of 24% over the last 6 months. In local currency, this number is actually 40%, so it's enormous growth. While G2G represents the biggest thumb growth, as you will see later in the presentation, the growth was actually widespread across the portfolio. Underlying earnings per share fell from $0.28 a share to $0.23 a share. I'll dig into the reasons for that in a minute. And then the interim dividend tax declared was $0.10 a share, which was the same as last year. We have reiterated that we expect the full year payout ratio to be in the 60% to 80% range and we expect with the final dividend payment, the full year payout ratio will equal or exceed last year's payout ratio, which was about 69%. Moving on to Page 4. The reason for the decline in revenues is primarily related to performance fees in the period, in this period, versus the first half of FY twenty twenty. A year ago, performance fees were more than $7,000,000 In this period, they were $5,000,000 lower. The reduction is primarily attributable to 2 managers, Carlisle and Victory Park. This period, Carlisle didn't recognize any performance fees. And I'll elaborate more on this later. Victory Parks were down, but not due to performance, but rather the episodic nature of when they're received. Indeed, we expect more performance fees in the second half of the year from Victory Park than we did in the second half last year from then. Commission revenues declined by about $1,000,000 reflecting the runoff of GQG commissions, though there were some nice new commissions posted this period from sales related to Victory Park. The revenue highlight for the period was the strong growth in underlying management fee revenues, which make up the largest portion of our revenues. They increased by 10%, but actually 16% in local currency. The increase was primarily driven by increased contributions from GTG and the annualization of results from Pennybacker and Proterra. Operating expenses continued to decline reaching $6,900,000 for the period, down 24% for this from the same period a year ago. Reduced travel costs and commission expenses were the main contributors. In terms of profitability, the net profit before tax fell 14% or 9% in local currency. The appreciation of the U. S. Or I'm sorry, the Australian dollar cost us about $1,000,000 in reported profits. Going to Page 5, I think Page 5 is actually the most important slide in this presentation, though I apologize that there's a bit going on, so it may seem a little confusing to some. This slide shows how profitable PAC is based on management fee revenues alone. Obviously, management fee revenues tend to be more predictable than performance fees or commission revenues, which are episodic by nature. The stacked bars on the left side represent the management fee revenues less PAC's total underlying expenses. The bar on the bottom is the first half of the fiscal year and the bar on the top is the second half. The bar on the right side is the total net profit before tax for the year or the period. There are several observations I want to make about this page. The first is that our profits from management fees tend to have a seasonal bias to them, whereby they are generally higher in the second half of the fiscal year as compared to the first half. This attribute is primarily a function of the structure of our investment in GQG, which pays us the most during the Q1 of each calendar year. The second observation I would make is that growth in manage is actually the growth in the management fee profitability. In this period, our pre tax profits from management fees were $9,700,000 which is a 62% increase from the same period a year ago. This increase in profitability from management fees is being driven by lower costs of the business and higher management fee levels. Putting currency aside, it is our expectation that management fee profitability will continue to grow in the second half of the year. Moving on to Page 7, you will note some of the portfolio highlights during the period. Before touching on some specific developments, I should note how well our investment managers performed from an investment performance perspective during the year. This was particularly true of our active equity managers that on average exceeded their benchmarks by more than 1,000 basis points per year. That's sort of an average across all the products they manage. However, the strong performance was actually generally true across the portfolio, which in light of the market environment was something that we found quite encouraging. In terms of important developments at the portfolio company level, there are a few I'd like to highlight. First off, Carlyle experienced an increase in redemptions in its open end fund as the pandemic progressed and investors saw liquidity at the same time where liquidity in the life settlement market was drying up. This occurred despite decent performance from Carlyle. The magnitude of the redemption request was such that Carlyle needed to halt the redemptions in order to protect investors in the fund. This gave Carlyle the opportunity to restructure its open end fund. This work is largely but not entirely complete. Once completed, the restructure will have the effect of converting some of the open end fund assets into closed end assets. The net result is that at December 31, Carlyle managed about $2,400,000,000 with about 85% of that in its open end fund. After the completion of the restructure, we expect approximately the same firm wide funds under management with about 40% in these contractual long term revenues. In other words, those are revenues that are locked up 7 to 10 years. And the rest of the FUM will be committed for at least 2 years. So, we're going to actually have very strong visibility into Carlyle's contributions here, going forward. The reason that the FUM balance should stay relatively flat even while restructuring the open end fund is because of the progress Carlyle has made raising its closed end fund vehicles. In January, they closed their 2nd absolute return fund with a new $150,000,000 allocation, which brought the fund's total assets to $290,000,000 which was $40,000,000 above its target size. We expect post restructure of the open end fund, Carlyle will quickly deploy its most recent absolute return fund and then be back in market to raise its next fund by year end. Moving on to GQG, they continue to experience enormous growth during the 6 month period, actually adding more than US20 $1,000,000,000 to their funds under management, and finishing the year at US67 $1,000,000,000 I think at last count that number is certainly over US70 dollars sizer, as previously noted, we sold our interest in Sizer back to management for US5 $1,000,000 Given the challenging landscape in the U. S. Active management industry, we thought that made the most sense for our shareholders. By doing so, we will be eligible for a $5,100,000 tax rebate actually after filing our next tax return. And then Victory Park, I received numerous questions about Victory Park and SPACs. For those not familiar with SPACs, they are special purpose acquisition companies. I think in Australia, they might be called cash boxes. But in the U. S, they're often called blank check companies. Once IPO ed, these funds or these not funds, these companies have 2 years to find an acquisition target, which if successful, is sort of a different approach to taking companies public. This area is very it's a very hot area in the U. S. Right now. There have been more than 160 SPACs launched this calendar year to date, so roughly 4 per day. So far, Victory Park has launched 2 SPACs and has 2 more about to go public over in the next few days. The first SPAC has already announced business combination, but has not yet reached the point of shareholder approval of that combination. I received a lot of questions about how, Victory Park SPACs impact PAC's financials. SPACs can be a little complicated, but I'll try to hit the highlights. To begin with, Victory Park sponsors these SPACs primarily from its investment vehicles and not the management company. This means that a successful SPAC will provide considerable value to Victory Park's clients by increasing the value of their accounts. Victory Park receives performance fees for all of its accounts and thus if its SPACs are successful, their performance fees will be enhanced, which benefits us given our participation in their performance fees. Some of these performance fees could be crystallized at calendar year end, while other performance fees will be crystallized episodically depending on where the sponsoring fund may be in a slide cycle. Even one successful SPAC will be economically noteworthy for Victor Park and us. If they have success with multiple SPACs, so much the better. Moving on to Page 8, we did announce one new investment in the period in Startate Capital Partners, a London based real asset private equity firm. We're very excited about this for several reasons. First is that the firm has a distinctive business model, very unique actually that offers enormous amount of upside optionality for us. The second is it seems to be gaining business momentum quite rapidly. I'll be very excited to update shareholders on the progress of this business probably at the full year results. I expect it to be maybe a small drag on results in this period, but if it executes well, this could easily be one of our largest contributors in 3 or 4 years. Page 9 shows the growth of portfolio companies with funds under management. Only 2 of the businesses lost FUM during the last 6 month period. Those 2 were Black Crane and Carlyle, while the others were stable or grew Post 30 1 December actually both Black Crane and Carlyle have received net inflows. Page 10 provides an update on the investment pipeline. We have seen the level of opportunities accelerate fairly dramatically and we are we expect at the current rate that we'll probably see more than 200 new investment opportunities this calendar year. Lastly, on Page 12, we provide some forward looking thoughts. To begin with, I'm feeling really good about the growth prospects of our portfolio companies. Most of them have strong investment performance, which is, as everyone is aware, is generally a prerequisite for future growth. And they have new business pipelines that are growing, not shrinking. Some of our early stage investments that have been trying to reach escape velocity seem to be trending in the right direction, which is encouraging. And lastly, we expect to make at least one more investment in this period. In terms of the financial outlook, there's a few things I'd like to say. First is we expect management fees and management fee profitability continue to grow, at least in local dollars. Commission revenues are lumpy and difficult to forecast, but as growth picks up within the portfolio, which we think is likely, that should translate into commission revenues trending upward, albeit not in a straight line. We expect stable expenses during the second half of the fiscal year. And as I noted earlier, we expect a full year dividend in that 60% to 80% range. Lastly, obviously, the appreciation in the Australian dollar impacted results and it's no secret to anyone that most of our revenues and expense are not in Australian dollars. And so appreciation of the Australian dollar works against us. Depreciation helps our reported results. That's all I have to say about the presentation, but I'd also received a couple questions that I thought I'd sort of preemptively address since I suspect I'll be asked them anyways. And the first is, what is the status of raising outside investment capital? And what I'd say is that we continue to explore ways to access additional investment capital since our capacity to deploy that capital vastly exceeds our ability to fund investments organically. If we did obtain capital, then PAC would presumably benefit from the management fee revenues and the ability to invest alongside that pool of capital. Figuring this out is a high priority in a very near term initiative that we will be spending a lot of time on in the near term. Another question I frequently get is why don't we buy back PAC stock given where our stock price is? And what we'd say about that is every time we deploy capital, we compare the expected return to alternative uses of capital. And that includes considering repurchasing PAC shares. So we are certainly amenable to buying our stock back when that's the highest expected return for our capital. That said, our business is transactional by nature and as opposed to a lot of businesses. And so in reality, more often than not, we are engaged in sufficiently advanced discussions to buy or sell assets that would be viewed as material. And thus, we're actually prohibited from buying PACS stock back because of when we're in possession of that sort of information. So this is something that's just sort of endemic to our particular situation. So with that, I will stop. And Melinda, I'm happy to take any questions at this point We'll take our first question from Nick Virges, Ordinance. Us. Yes, good morning, Paul. Just one quick question for me actually. Just commission revenue, can you just give us a bit more detail around what the commissions are earned on and how that behaves over time, what the mechanism is there? Sure. Thanks for the question. So for the managers where we are engaged in sales activity, so our sales team is trying to raise capital on their behalf, That is an economic relationship that is independent of our equity investment in those businesses. And it is primarily sort of success based revenues. And the way it typically works is if it is a long only manager, we are generally paid over actually, we're generally paid over 3 years, typically in a decremental way where we get more upfront and then each year sort of drops by half. And from a financial perspective, we recognize in that situation, we recognize those commission revenues as received, because the so and that's somewhat different when we raise private capital strategies. We get we will recognize because it's sort of contractual, we recognize the commission amount the full commission amount upfront even though it comes in typically over 3 or 4 years. The actual commission schedules, I'd say, are typical sort of placement type fees. As a rule of thumb, you could imagine that private capital strategies we receive about whatever the management fee is, is sort of the if it's a, we'll call it a 1% management fee and we raise $100,000,000 it might that commission might average to $1,000,000 that would be then received over a multiyear period. And then with long only managers, it varies, but it might be 20% of 1st year revenues, 15% of 2nd and 10% of 3rd or it varies because it's always negotiated. That's a long winded answer to your question. Yes. Okay. That helps out. Thanks very much. Yes. We'll next go to Stuart Dodd, Renaissance Asset Management. Hi, Paul. Thanks for the call. You bet. Question just on Slide 5. Pronounced seasonality. Certainly in the last 2 years, not in fiscal 'eighteen. So first question, why wasn't that seasonality there in fiscal 'eighteen? But then the real question is twothree of your annual revenues to the management fees have come in the second half of the last 2 years. Is that the sort of SKU we should be expecting? Let's yes. So, I'm sorry, Stuart. First question is, actually, I don't think I think I was distracted because the I don't think the second statement is was accurate about the skewing of the revenues. I think the revenues aren't nearly Profitability, sorry, profitability. Yes. And so one of the things that's this about Page 5 is, it's a little and this is where I had the caveat that I said, it's a little confusing because the bars in this period, I think our management fee revenues were about 80% of our total revenues. And so in a sense, in these graphs, it's not the right side and the left side aren't exactly comparable. So these on the left side of these bars, we're subtracting all of the underlying operating expenses, but that does not imply so the revenues as it that's the profit contribution, but that means everything else would be just pure profit above it. So it's not you need to not misinterpret that as sort of contribution of revenues as much as it is contribution to profit. So it didn't really answer that well. I'm sorry, Stuart, what else did you ask? The skewing? Yes, the skewing, yes, so why wasn't yes, in FY 2018, one of the reasons why that skewing gets more pronounced over time relates to the structure of GQG, because I think we've described that structure before, but it's every calendar year, we sort of start the clock anew with GQG. And we get that more generous participation in their revenue in the early part of the year. And so given their growth that has that impact has become larger and larger across time. Okay. That clears up the fiscal 'eighteen one. But just back to that second part of the question, which you answered first. I was only looking at the left hand bars. So I understand what you're saying. I should say profitability. But if we just boil it down, the light green bar on the left as a proportion of the 2 added together is twothree in each of the last 2 years. So the question still stands, is that the sort of skew we should be thinking? I don't think that I wouldn't expect it to be that much because more and more of it more and more of this should be driven by management fees. And so but I expect you would you see you've seen growth in both if you look at the management fee profitability in the first half and the second half over the last few years, we would expect based on everything we know that the management fee profitability for the second half would continue to grow vis a vis second half profitability last year. But I would I think that 2 third, 1 third skewing is probably not accurate. One of the things that is introduces some uncertainty into the second half of the fiscal year is we have our investment in SCI has been a successful investment. It was a small investment that's been successful. But last year in the second half, for example, it produced a $1,400,000 performance fee. It will crystallize performance fees on March 31, and those performance fees could be 0. They could be or above what they did last year. We just it's very difficult to predict in this particular situation. So if they had a gangbuster on performance fee, that could impact things. But I would not I would certainly not think of it as 2 thirds, 1 third. And part of that is just because of how rapidly the management fee profitability is going. Okay. Maybe we take that offline because I'm reading that performance fees aren't included in the left hand bars. You're right. I mean, I'm talking about, yes, but I don't think they are not, but I don't think we're going to have a 2:one ratio on I expect management fee profitability to be bigger than the first half, but not a 2 third, 1 third ratio. Yes. And it doesn't detract from the underlying message, which is the recurring nature or the lower volatility earnings stream is increasing as a proportion, which is important. And Mr. Greenwood, there appears to be no additional questions at this time. I'll turn things back over to you for any additional or closing remarks. Thank you, Belinda. Well, thank you for your time today. I think over the next week or 2, we have some roadshow discussion set up. We look forward to those. And if you're not on that and would like to be, please let us know. We'd love to sit down, albeit virtually and chat with anyone who's interested. Thank you for your time. And that does conclude today's conference call. We thank you all for joining