Computershare Limited (CPU) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Computershare Sale of US Mortgage Services Business and Investor Conference call. [Operator Instructions] I would now like to hand the conference over to Mr. Stuart Irving, Chief Executive Officer. Please go ahead.

Good morning, everyone, and welcome to today's investor conference call. I've got Nick Oldfield, our CFO; and Michael Brown from our IR team on the call. And today, we're going to take you through announcement we've made to divest 100% of our US Mortgage Services business to Rithm Capital Corp. or Rithm. And I'll also touch on our recent acquisition of Morgan Stanley's U.K. and European share plans business, Solium UK. Now both are important strategic developments for Computershare. The transactions are firmly in line with our strategy to simplify Computershare, strengthen our core businesses and also improve the quality and consistency of our earnings and are good steps forward in executing the plan. And following the presentation, we will open the line for Q&A. And finally, just to remind you, we will be talking in constant currency and in U.S. dollars unless we state otherwise. Okay. Now let me start with the sale of US Mortgage Services, and I'll take you through the transaction details and then comment on the significance for Computershare. Back in August, we stated that we're undertaking a strategic review of this business. And we completed the review, and we determined that a full divestment of the business via a competitive process would be in the best interest of all our shareholders. And we are pleased to announce today that we've entered into a definitive agreement to divest 100% of the business to Rithm for an estimated consideration of $720 million. The final sum will be adjusted for movements in the MSR portfolio up to closing. And we will also continue to acquire MSRs between now and close, but we do expect to sell the majority of the new MSR acquisitions on a forward-flow basis to Rithm as we go. Now the sale price values the U.S. mortgage businesses at roughly 1x tangible net asset value as at 30th of June 2023 under U.S. GAAP accounting. Now many of you will remember us saying that these businesses generally trade at around about 1x tangible book value rather than an earnings multiple, so we do consider this to be a fair price. The transaction is expected to result in a one-off statutory loss on sale of roughly USD 150 million to USD 180 million under IFRS accounting. Now this noncash loss reflects the variances between IFRS and GAAP accounting, goodwill allocations, and also estimated transaction costs. Now this noncash impairment does not impact the underlying performance or cash flow of Computershare. And to be clear, this is an accounting-driven loss only. If I step back and look at all the actual cash deployed into this business since we first entered into U.S. mortgage servicing back in 2011, including all our MSR purchases, and we can see that we're marginally ahead from a cash perspective on our investment overall. And Computershare will also continue to provide some technology and operational support for the business for up to 12 months under a limited transition services agreement to allow a smooth transition for our clients and our employees into Rithm's environment. So who is Rithm and why is the business a good fit for them? Well, Rithm is a New York-based asset manager focused on real estate and financial services. It's listed on the NYSE with a market cap of around $5 billion. Unlike Computershare, it runs a vertically integrated model in mortgages. It's a top 5 nonbank mortgage originator, owns roughly $600 billion of MSR portfolio, and services the majority of its loans in-house. Importantly, it has strong mortgage industry credentials and ability to bring capital to scale the business further. And with its track record of successful M&A execution and integration, we do expect a smooth transition for the business and, of course, our customers. So what are the financial implications for Computershare? Well, first, we're affirming FY '24 earnings guidance. Now depending on the timing of closing, the transaction is not expected to have a material impact on our FY '24 EPS guidance. We continue to expect management EPS to be around $1.16 per share this year. The transaction is expected to be EPS accretive in the first full year following divestment. Now we have simply compared FY '24 guidance of around $1.16 per share as we gave in August to what that guidance would have been if we had not owned Mortgage Services in FY '24 and instead used the cash proceeds to retire debt. This also includes the impact in the change in balances. Now US Mortgage Services has average cash balances of around about $2 billion, and we'll obviously lose these as part of the transaction. So assuming a March 31 completion, average balance sheet for '24 will be lower roughly by about $500 million. Now we have included a pro forma table and announcement to show what our FY '23 group results would have looked like if we had not owned US Mortgage Services for the whole of last year. In summary, management EPS would have been $0.05 higher and reported against $1.13 that we reported at. And unsurprisingly, given the capital intensity of the business, without it, ROIC would have been at around about 29.8% compared to the 22.7%, and free cash flow would have been $544.6 million, which is quite a different set of financials. So why is today's sale strategically significant for Computershare? I'm sure many of you will have a clear view on this. First, it represents an important milestone in executing our simplification strategy and drive to increase the quality and consistency of earnings. Over the past 3 years or so, the U.S. mortgage business has underperformed against group margin and ROIC targets. We know it's more capital intensive compared to our core businesses, and it also has high levels of regulatory risk. It also has had periods where it's been impacted by a number of things outside of our control, a bit too macro, as I've often said. Now if we recap our history, you'll see what I mean. Now we entered the business in the U.S. in late 2011 through the acquisition of Specialized Loan Servicing. Over the following years, we executed our strategy to build scale and servicing, maintaining a mix of owned MSRs and capital-light subservicing both performing and nonperforming, all whilst building up our higher-margin ancillary revenues to enhance returns. Now we're always pretty clear and disciplined that we did not want to be a loan originator or take credit risk. But it is a large market with plenty of scope for growth, and we're actually making good progress. We saw the business as capable of generating around about 12% to 14% post-tax-free cash flow return on capital and around about 20% PBT margins, and just prior to COVID and the lockdowns, we're pretty much there at these numbers. However, as we know, the substantial reductions in global interest rates through 2020 drove record levels of runoff. And as U.S. mortgage rates plummeted, we saw the collapse in margin income in the business as well. And at the same time, the U.S. government put in place and then extended the moratorium on foreclosure, which impacted our ability to generate revenues from nonperforming loans. And with lower servicing revenues and an accelerated amort profile, the business went into loss. Of course, as we all know, post the COVID period, rates rose rapidly but originations slowed, and refinancing activity dropped. MSRs became scarce and therefore, increased in value and price, and our book value rose as we took out costs and returned the business to profitability. So in short, lots of moving parts. But we determined that 2023 was probably a good timing window to sell the business to an operator with an appetite to deploy more capital, allowing it to continue to grow. And we're delighted to sell to Rithm who will provide that capital, grow the book, and enjoy the synergies of being vertically integrated with a large origination engine. So as a result of the sale, the next question is what are our priorities for capital deployment? Well, number one, we've consistently said that complementary M&A on good financial terms is our top priority in our 3 core growth businesses of Issuer Services, Corporate Trust, and Employee Share Plans. And we expect to have around about $2.5 billion of M&A firepower even post our buyback. And there are plenty of growth opportunities across these business lines. We will also prioritize organic growth investment. And whilst these are not expensive overall, we will continue to focus on ways to improve our services and capability and invest in technology to keep us at the forefront of our chosen markets. Our third priority is ensuring we reward our loyal shareholders. Now given our franking position, we will prioritize buybacks. Now this transaction caused us to defer the AUD 750 million buyback for compliance reasons. So it will be good that we can get a start on that next week. And finally, we'll always look to balance buybacks and dividends when it comes to capital deployment for shareholders. So overall, with this transaction, we can redeploy the capital to strengthen and enhance the core business and also reward shareholders. And it also upgrades our return on capital, EBIT margins, and free cash flow, and of course, it improves the quality and consistency of our earnings, which are all good things. And finally, on a personal note, I am looking forward to focusing on our core business lines and not waiting for all the stars to align to get the returns that we seek in US Mortgage Services. Now let me quickly move on to another transaction that we put out a notice on the other week there, which was the purchase of Morgan Stanley's U.K. and European Employee Share Plans business; it's called the Solium UK. We do expect that deal to complete in Q4 this calendar year subject to regulatory modifications and other customer closing conditions. The earnings contribution is not material to the Computershare Group, and we're not changing guidance as a result. And it's a small but important bolt-on for us. It has an impressive list of 124 public market clients with over 300,000 participants and around about $20 billion of assets under administration. Revenues are approximately $28 million per annum, and we bought the business on less than 1.5x revenue. And it's a great fit with our strategy to really enhance our core businesses. The business increases our exposure to that underlying growth in equity-based remuneration. Now we've talked about the structural growth trend before. More companies are issuing equity to attract the team and incentivize employees, and they're issuing equity deeper into their organizations. Equity is not just a C-suite benefit anymore. And Solium UK adds to our scale in the U.K. and European markets. And post the transition period, the intent is to move the client to EquatePlus, our market-leading platform. So I'll close by saying that we are pleased to be able to talk about these 2 transactions today. They do mark a good step forward in our plans to simplify the group, improve the quality and consistency of earnings, and position us for further growth in our core. Now let's move on to some Q&A.

[Operator Instructions] Your first question comes from Kieren Chidgey with Jarden.

Maybe just starting on the earnings contribution from US Mortgage Services. So we're clear, you've disclosed last half down to about $17 million of EBIT. Can you just talk about the line items below that, specifically the advanced facility interest expense, how big that is? Just keen to get into what the PBT contribution in second half '23 was.

Yes, it's about $20 million, Kieren.

Sorry, what is that?

$20 million.

For the advanced facility?

Yes, the CLS or the interest expense specific to this business line was about $20 million.

Per annum?

Yes.

Okay. All right. Okay. And just on the margin income balances at $1.8 billion or $2 billion that disappears. So I presume sort of there's no impact on hedging as a result of that. The hedges stay with you. So just the hedge ratio goes up. That all comes out of exposed balances, doesn't it?

Yes, that's right. There's a lot of hedging using these balances because they're very, very sort of short-dated yet, so it shouldn't alter it that much. And of course, we also have these instruments and hedging rolling off all the time. So if we want to take the percentage back down closer to the sort of 50% number, we can do that fairly well.

Okay. And stranded costs, just keen to understand if there's any sort of group allocation or other stranded costs we need to be aware of?

Look, there are stranded costs in this business. There's around about 250-or-so staff that are not sort of on the SLS of entity. They're shared service staff. They will also be transferring across at close, and that's a lot of -- everything from internal audit, compliance, et cetera, et cetera, and technology staff. We do have a TSA, which will cover some of that stranded cost for a period of time. But we do have plans to look at the stranded costs, not just in isolation of this business, but of course, across the entire group, so we can remove as much of that cost as possible.

Okay. And any indication on quantum of those costs? And sort of when you make the comment that the transaction is EPS accretive first full year, what are you assuming around those stranded costs?

Well, you've got a TSA agreement that covers all of them, covers stranded costs in the first year. So we probably have 6 to 12 months to work hard to try and get as much of the -- what will remain behind as all staff from data centers and other bits and pieces and [ staff ]. We've got sort of partial rules that are within the CLS business and also with the other businesses. We've got a fair reasonable sort of line of sight of that, not any significant impact on stranded costs in the first 12 months, but -- and by that time, some of our news of cost-out initiatives will kick in. So we're hoping to neutralize as much as possible of that going forward.

Your next question comes from Siddharth Parameswaran with JPMorgan.

Just a couple of questions, if I can. Can I just clarify what exactly was your EBIT and EBITDA expectations on mortgage servicing -- on U.S. mortgage servicing for FY '24 within your comments as being EPS accretive in the first full year?

Well, in the EPS accretion, Siddharth, what we're saying is that the saving on interest expense basically -- the saving on the interest expense, having applied all of the proceeds against reducing debt, would have offset the earnings contribution from the business by a couple of cents per share. So we will have about a net cash reduction of about $600 million in -- this should be the sale proceeds less $100 million or so of cash that was in the business already. And we'll save our interest expense on that. And just the net cost of interest in the second half in FY '23 was 6.34%. So that's really what's driving the accretion calculation.

And so you say a couple of cents? Sorry, I just wanted to be clear exactly what the figures were. So I mean, those numbers are helpful, but just to understand exactly how much accretion you're saying there is.

Well, we're saying we guided to -- so for FY '24, we guided to $1.16 per share of earnings. And had we -- for the full year of FY '24, had we do not owned this business and had we instead apply the proceeds, net proceeds from selling this business against our corporate debt, the combination of those would give us an extra $0.02 per share.

Very helpful. Okay, great. Can I just ask a question just on U.K. mortgage servicing? Does that remain? Are we any closer to any resolution around what your plans are for that division?

We're still investigating possibilities through this process, which was quite a wide and varied process and looking at US Mortgage Services as a whole, looking at the MSR asset, looking at the platform asset. There was a number of bidders that did express an interest in our U.K. division, but we have been prioritizing the U.S., which is obviously far larger. So at the moment, we're still working through potential options for that business.

Great. And just a final question, just on maintaining guidance of $1.16 per share, I just wanted to be clear what's happening with balances and also interest rates? I mean, I would have thought interest rates to be slightly higher. I think about 10 to 20 basis points from what I can see from -- for FY '24 versus what the point at which you gave us guidance a couple of months ago. I just keen to get your thoughts on what's included in maintaining guidance just on interest rates and also balances.