MUFG Pension & Market Services Holdings Pty Limited (PPM) Earnings Call Transcript & Summary

Thank you very much, and good morning to all those investors and interested parties that are dialed in this morning. John McMurtrie here. I am in London. I am physically in the same location and room as Robbie Hughes, the CEO of our Banking & Credit Management business; Andrew MacLachlan, our CFO; and Craig Curry, Head of IR, are together in Sydney. I'll just say, though, at the outset and some of you on the line here would have come to our Investor Day in London on the 18th of June 2019. And at that session, Robbie Hughes gave a very detailed rundown of the activities we conduct in Banking & Credit Management. So for those, and there may be some new investors on the line, so perhaps you should read the releases we've made today and go back to June 18, 2019, to get a more comprehensive, perhaps, description of what we do. But as we've announced this morning, we're very excited by this acquisition. What it does, it almost doubles the revenues in Banking & Credit Management area. It's very complementary in terms of geography. It exposes us to some new prospective territories. We've taken Banking & Credit Management into Netherlands and into Italy since we acquired the business just over 2 years ago. We're now pushing into some quite prospective territories such as Spain, Greece and Cyprus. This acquisition also increases the share of annuity revenue. Be fair to say that our book has had a bias towards nonperforming loan portfolios, which still, of course, required some regular refreshing. The revenue impact of this acquisition will add over 10% to the group revenues at Link. We've identified, through our due diligence, synergies in the order of EUR 10 million. And this is earnings per share accretive at above 10% with an additional 5% to 6% coming from the full exploitation of the synergies. We do have, together with the -- with Pepper, large operations in the U.K. and also in Ireland. So I think there are some opportunities for some rationalization. Our premises and central functions, which will feed into the $10 million identified. I would also add that one of the factors was that the team at Pepper are all very well regarded in the industry. And from discussions with them as recently as yesterday, there is a high degree of enthusiasm from them to come aboard, and they are all of very high quality. I'd also say that in briefings that Robbie has made today with his team, a very high degree of enthusiasm for this transaction. This will put Link, together with Pepper, right at the forefront of pan-European asset servicing. What I'll now do is introduce you to Robbie Hughes to talk about Pepper, then Andrew will talk about some of the transaction dynamics. I'll come back to conclude. And then we'll have, hopefully, at least 20 minutes on Q&A. So, Robbie, over to you.

Thank you, John, and good morning, everybody. In this next segment, there's quite a lot of detail in the slides. I don't intend going through all of that detail, but I think it is some good background context for everyone who's on the call. And -- but I thought I would start with just reminding you about the -- some of the activity that exists within BCM and some of the dynamics of our business because then it's a good context setting for explaining the past business, that's Pepper European Servicing that I refer to, and why it's complementary and why we're so excited about the transaction. So turning to Slide 9 in the slide deck. Really, the key theme that I want to draw from this is, look, this is an industry and a business that's been going for more than 20 years with over EUR 90 billion of assets under management. And we, like the potential acquisition here, have 3 core service lines that underpin the business. It's really important to understand each of those service lines because what it does for our business is it's a natural hedge to the economic cycle that we may encounter in any jurisdiction. And I think that's really important as we move forward in this presentation to understand that context. And just to refresh everyone's memory on this, post-GFC, there was obviously a major issue in the banking industry, which led to these sales of nonperforming loan books. So that's a major part of what we're doing in helping banks to clean up their balance sheets post that default. I think that type of transaction activity is typically closed book. Typical average life depending on jurisdiction is anywhere around 3.5 to 4 years. And as John said, it's something that needs to be replenished on an ongoing basis. I think as banks move through the NPL cycle and clean up their balance sheets, they are then left with legacy noncore activities. And that's where we see a lot of activity now, particularly in jurisdictions that are moving towards the end-stage of the NPL cycle like the Irish market. So lots of activity in banks trying to reshape their cost base and deal with legacy and noncore activities. And then the final piece, which is equally as important, is when banks retrench from lending in certain segments. Those segments were filled by a number of institutions, what we call nonbank lenders. And they were a combination of private equity firms looking to disperse and deploy capital into lending businesses, pension funds and life insurance companies, and indeed, investment banks looking to deploy capital through new origination platforms as well. The reason why that's important, and we've talked about the importance throughout this presentation of building each constituent aspect, is because that cycle will continue over the coming years. And as we build new originations of performing loans, at some point in the future, there will be another economic crisis or shock in the jurisdiction. And that then becomes our first portfolio that we begin to work out, and then we're back to the start again of NPL cycles. So you can see that it is a natural hedge depending upon where jurisdictions are within the economic cycle. So on the left-hand side, I won't go through in detail, but we're a business that is predominantly generating revenue from our core markets of Ireland and the U.K., but a lot of potential growth in the Netherlands and Italy, which we've entered into in the last 2 years. Moving on, next slide. Again, I don't intend talking too much detail on this other than to say each of these component boxes play a part within the jurisdictions in which we operate. And it really needs some or all of these dynamics at play in order for us to believe that there is a sustainable market for us to -- in which to enter. I think the top left-hand corner is one that is really important to us, which, again, gives us that natural hedge of activity and global economic cycles. So as we come to the end, particularly in -- of the NPL cycle in Ireland, at the other extreme, there are markets like Greece that haven't really begun to deal with that. So again, I think it gives us opportunities to prioritize the markets in which we want to enter. Moving on then. Again, the opportunities we've seen, and we talked last year about setting a strategic vision out to 2023 of what we were trying to achieve, and we used the statement of following the NPL curve around the globe. I would like just to clarify what we actually mean by that. Those markets, just because they have NPL activity, doesn't mean they're attractive to us. It is about the scale in those markets. And it is about the opportunity beyond NPL activity into those other 2 core services that I mentioned a little bit earlier. So that's really important. In the last 12 months, we have declined to enter certain markets just because we didn't see sustainable growth in those markets beyond the short-term NPL curve. I think last year in our strategic road map, we mentioned a number of potential new markets to you. They're still on the strategic road map, and indeed, the acquisition of PES accelerate some of that. So certainly, in a European context, the Greek market, given its size and scale, and they're at the early stage of that cycle, is particularly attractive to us. And then as we move outside of Europe, we also mentioned a market assessment that we're conducting on India and China. And certainly, there's no change in our strategic view as to the opportunities that exist there. I think we've touched on the bank outsourcing and what's going to drive that over the coming years in terms of bank deleveraging and noncore activities. But the new lending services, we're seeing particularly strong early growth in the Dutch market, which is the third largest mortgage market, a very evolved outsourcing market and one that is -- the growth is being driven by nonbank lenders who typically don't have the operational infrastructure that we have, so we see significant growth in there. And then it's about taking that disruptor technology that we've developed in that market and moving into other markets that show similar characteristics. So look, that's a quick summary of BCM. And I think it should be consistent with those of you that watched or attended the presentation last year. So I'd like to take you through a quick overview then of PES, or Pepper European Servicing. And then we'll begin to talk about what combined operations might look like and why we're so excited about this transaction. So again, I think when we look at this, it's commonality and diversity is the attraction here. So very similar in terms of the services that they provide, but some nuances in terms of how they approach the market and some of the capability that they have along the value curve, particularly in real estate and real estate advisory services. Scale in existing markets is obviously an attraction in this acquisition. And as John alluded to, the U.K. and Ireland, that combined, provide us with significant scale and opportunities. Complementary to that is obviously the European strategy that they have followed, which is quite different to ours. So we chose the Netherlands and Italy. They've chosen, Spain, Greece and Cyprus. And we'll talk a little bit later on about the characteristics of those markets and how we see growth moving forward. And in terms of client base, there's very little overlap of the clients between BCM and the PES business. So I think that's really positive from our perspective. It also means that we're operating in markets where PES clients are, but they've been forced to choose an alternative service provider because PES aren't operating in those jurisdictions. So I think there's a great cross-selling opportunity for us in our core and existing markets. Some details there in terms of their scale, just under EUR 40 billion of assets under management, EUR 93 million of revenue and EBITDA of EUR 20 million. They have had some good growth over the last 18 months in particular. That growth has been driven predominantly in 2 areas. Very successful in capturing new mortgage origination clients in the U.K. market, and those clients have got the distribution and pricing strategy right and have grown AUM quite substantially. So I think that's really positive in the market in the context of Brexit and what we've seen. The other area that I think they've carved out a niche, which has been very clever, is as we move towards the end-stage of the Irish NPL markets, you're seeing secondary trades, which are also seeing loans being restructured and becoming what we're calling reperforming loans. And there's huge appetite for RMBS paper from the Irish market, and we're seeing those portfolios being securitized, and the PES management team have carved out a strong niche in that area, and they've shown substantial growth over the last 18 months to 2 years. So really positive in that sense because it adds a different profile of income and capability to us. Similar to the BCM business, predominantly U.K. and Ireland-based in terms of its core revenue. And the assets under management only beginning to grow then in the 3 continental European jurisdictions. If we move on then to talk about the strategic rationale of why this business was so attractive to us. I think we talked and we said that last year in our strategy that what we look for typically in an acquisition is something that would give us scale in existing markets, would add capability to our portfolio. We will also accelerate our entry point into new strategic markets, and I think this acquisition covers and ticks a lot of those boxes. I think combined, the operations create a leading pan-European servicer. And I think the key to this is the insertion of the word independent. I think if you were to look at some of the periods across Continental Europe, there are certainly some who have larger assets under management but they're typically owned by private equity. And typically, they're also debt buyers. I think the acquisition also helps us in terms of diversification, both location strategy but also client base as well. And it also, coincidentally, the PES platform runs on similar technology in our core markets, but also brings new technology to us from a continental European perspective. So I think combined, the 2 businesses are positioned really well strategically for growth, particularly given the complementary growth jurisdictions that we've identified in Continental Europe. So really looking at, not just how we combine capability, but how we can accelerate the organic growth off the back of that. I think in any acquisition that we look to do, it always has to be a strong brand, good reputation in the market and a strong management team. I think as John has alluded to earlier, and we'll talk a little bit later in the presentation about this, we're very pleased with the depth of talent that we're taking on board as part of this acquisition and really pleased to be able to integrate them into our business. And finally, the deal is highly accretive in terms of the transaction. The scale certainly gives us opportunity to drive operational efficiency, which will provide greater upside to the deal. So to Slide 16, I'm not going to go through this. It's really to try and give you some context as to how separately as 2 businesses, there's a lot of strategic alignment in terms of how we approach our business, our markets, our clients and also our capabilities. So it's really about kind of incrementally enhancing what we're doing but also transforming what we're doing in terms of services and moving along the value chain. And I think the PES management team have done that quite a bit. They certainly do a lot more one-off transactional type activities, whether it's due diligence services or in the real estate space. I think that's a welcome addition in terms of capability enhancements to our business. They clearly also had a marketed services expansion strategy. And I think that's very complementary to what we're doing. And then finally, from the technology perspective, I think it is really about rightsizing the technology estate and taking the best-in-class from both organizations to try and drive and support our strategic imperatives going forward. The following 2 slides, I think, just geographically tried to give you visually a view as to why and where they're complementary. I think the recurring theme that you'll see from these 2 slides is really about the difference between what we deem to be origination markets and what we deem to be nonperforming loan markets as well. I think it is complementary in the U.K. in terms of the PES business being a lot larger than ours. And the type of origination clients they've managed to attract, I think, gives us real scale and gives us, more importantly, as John alluded to, a different income profile. Remember, these are performing mortgages that are typically 20 years in term. So it gives you that long-term stable annuity stream of income, which I think is really important to counterbalance NPL income. In Ireland, I think it's where we have the greatest scale. And I think the challenge there is really around the integration and how we bring the businesses together. And then what propositions we can bring to the banks that operate in the Irish market. The Netherlands, I think, we're really bullish on over the next 3 to 5 years in terms of mortgage origination growth, and that's something that I think we can also learn from the U.K., the PES U.K. team, in terms of how they manage and distribute mortgages through their network. The second slide is, really, we've coupled together the Continental European businesses or jurisdictions where the NPL curve is still in full flow. So Italy is still a strong growth market for us, and that's where we have devoted a lot of our time and energy. And on the right-hand side, you'll see Greece and Cyprus in particular, who are at a very early stage, but you can see the scale of the combined markets in NPLs makes it quite attractive for us. So it's really about how we can help PES accelerate the growth in those jurisdictions. Spain is a slightly different but interesting play, given that it is much further down the NPL cycle. And they, too, are seeing the emergence of what I alluded to earlier, which is reperforming loans and restructured loans. So again, I think it's quite clever on how PES have taken that capability in an Irish context and taken it to a different European market. And while at the very early stages, I think the early signs are quite positive about similar growth trajectory in that market. In terms of just turning to Slide 19 and how we bring the businesses together, just to give you an idea of some numbers, John has alluded to them a little bit earlier. But combined, just under $320 million of revenue and about $54 million of EBITDA, which initially will place us at about 18% of the Link Group revenue and 15% of total EBITDA across the group. I think there's one thing that I would draw your attention to, which may look obvious on this slide. And it's the operating EBITDA margin of the 2 businesses. I think that's driven for 2 reasons, I think, from a PES perspective. One, I think it's the fact that they've been hugely successful in new origination growth, and underpinning that is some very good software technology that has helped them drive a huge degree of operational efficiency and therefore, margin enhancements. In an Irish context, I think, historically, they've been very much aligned with our clients in terms of aligning interest, where they put some of their servicing revenue at risk in order to get a much more enhanced exit fee if they hit certain hurdles based on recovery targets with our clients. And obviously, if you're hitting those hurdles, those exit fees and performance fees are hugely accretive to margin. So again, I think that's kind of flowing through in terms of the enhanced EBITDA margin that we're seeing there. Just moving to the bottom of that slide, I think, again, diversification is hugely important as a result of this acquisition. I think both businesses have been hugely successful because, combined, we have 4 out of the 5 global NPL buyers. So with that, I think, comes great growth and success. But I think the downside of it is some concentration risk. So I think the combination of these 2 businesses then begins to derisk that from that perspective. I talked a little bit about the kind of movement then in income profile away from NPL and more into new origination, which I think, again, is important in terms of rebalancing the portfolio. But I also think the geographic diversification is huge for us. Each market being at a different stage of development, each market requiring slightly different approaches in terms of the services we provide, and I think having those 5 European growth markets within the portfolio are going to show significant growth over the next 3 to 5 years. So really excited about what that slide brings together, not only for Link Group, but for now the new combined BCM and PES businesses. I think it will be unique in the European context in terms of its end-to-end capability, but the breadth of coverage that we can give to clients across those jurisdictions, which should never be underestimated. Slide 20 is really just greater detail on the comments that I just made on the previous slide, so I don't intend to speak to that much. Moving on then to Slide 21. We've touched on this a little bit earlier. I won't go through the detail but other than to say, if you look at the group of individuals at the executive level in PES, I think firstly, very highly experienced, very well regarded in the industry in which they currently operate, but also a very eclectic background. So from real estate, from restructuring, from capital markets, and indeed, from the banking world. So I think the combination of those capabilities and experiences, we're quite excited about being able to take that talent onboard and look to drive the business going forward. So to conclude then, I just want to touch briefly on integration and what our plan is around integration. So clearly, the PES business will sit within the Banking & Credit Management world. I will create a joint executive team to begin to drive and reshape the combined strategy going forward. Both myself and Paul Gardiner will be executive sponsors on the integration and transformation. I think one difference around this is given our global operating model, each of the global ELT members will take responsibility for their global-enabling function in terms of how to reshape that, how it supports the strategy of the business, but also how we drive synergies out as well. So I think that's really important that it's a shared responsibility right across the ELT members. In terms of sequencing, integration is obviously the first and most critical piece to us, which is really getting the PES business plugged into Link Group. So focusing on HR, finance integration and then, obviously, embedding our legal and risk frameworks quite quickly into the business and then rebranding and relaunching the business in our core markets. I think then we move to, in the medium term, what I call the transformation piece, which is where I think we can drive EUR 10 million of estimated annual efficiency benefits. I think that comes from really taking the best from both organizations. And if we have a simple mantra of what activities should be done in what locations and, of course, software, that begins to help shape our location strategy. It begins to help drive the target operating model and ultimately, the organizational design. So I think this deal for me, while the integration and transformation and the benefits, particularly the synergy benefits that we derive are quite important, for me, it's about the accelerated organic growth over the next 3 to 5 years that makes this a really exciting transaction for us. So I'd now like to hand you over to Andrew MacLachlan, who will talk you through the acquisition structure and some of the key terms.

Thanks very much, Robbie, and good morning, everyone. As Robbie said, I'm just going to run through the acquisition structure and some of the key terms before I hand back to John for a brief summary and then Q&A. So turning to Slide 25. As John highlighted earlier, this is a very attractive acquisition for Link Group and is consistent with the shareholder value initiatives we outlined in our August '19 results presentation. We've structured the acquisition to provide some protection in respect of the existing earnings base whilst also providing some additional consideration payable on the achievement of some significant growth hurdles in Spain, Greece and Cyprus. Whilst the PES acquisition is being done at an attractive multiple in its own right, once we factor in the achievement of synergy benefits of EUR 10 million, the acquisition multiple of 6x normalized EBITDA is very appealing. We strongly believe that synergy benefits can be achieved over the medium term, whilst at the same time, as Robbie mentioned, we're also very excited about the growth opportunities for the combined BCM-PES business in both its existing mature markets of the U.K. and Ireland and the new growth markets in Europe. The acquisition is highly EPS accretive prior to the inclusion of synergy benefits, which provide further upside, as John highlighted. We also consider it compares very favorably against the buyback and will result in significant shareholder value enhancement. Turning now to the pro forma leverage, Slide 26. Prior to the inclusion of efficiency benefits, but including the impact of the EUR 15 million contingent consideration payable on AUM protection, which happens in December '22 and '23, and the transaction costs of around EUR 6 million, our pro forma leverage will be about 2.58x, which is slightly above our guidance of 1.5 to 2.5x. Our pro forma leverage on the upfront consideration of EUR 165 million will be about 2.51x. We'll be funding the acquisition using available facilities, and our interest cover ratio remains above 10x. We expect the earnings contribution from the PES acquisition as well as their existing businesses will see our leverage ratio come back to our guidance range in the future. Our balance sheet remains strong, and future buyback activity will take into account this pro forma leverage and will retain a prudent approach to capital management. Turning now to the acquisition structure on Slide 27. As mentioned earlier, we structured the acquisition to provide both risk mitigation in terms of the existing AUM across key existing contracts and an upside opportunity if significant growth hurdles in those new Mediterranean jurisdictions are achieved. We believe the structure strikes the right balance and provides the appropriate incentives for the vendor. As Robbie highlighted, we see an attractive pipeline of opportunities in Spain, Greece and Cyprus with PES positioned well to grow in these markets. As a result, we believe it's more likely than not the maximum consideration of EUR 200 million will be payable. And in this event, the earnings of the PES business will be materially higher than they are today with significant scale, having been built outside the U.K. and Ireland. Turning now to key transaction terms and timing on Slide 28. We set out on this page the summary of both key terms and the expected timing, which is dependent on regulatory and competition approvals being obtained. There is some restructuring to be done by Pepper between now and completion to extract its lending business from PES, primarily in Spain, but we don't expect material stand-alone costs to result from this separation activity. As you would expect, we have done extensive due diligence and have built an appropriate level of warranties and indemnities in the transaction documents as well as obtaining warranty and indemnity insurance. In terms of timing, at this point, we would expect the approval process to take up to 6 months, but there is a chance these approvals could take longer than this. I'll now hand back to John before we take Q&A.

Thanks, Andrew. And so Andrew has just been through the transaction structure, and as Andrew said, we think that provides an adequate upside. And we just -- frankly, we've been looking at this, call it, now for almost 9 months. And as we've gone on, we felt more comfortable about the -- all of the benefits of combining both businesses.