Pacific Current Group Limited (PAC) Earnings Call Transcript & Summary

Good day, and welcome to the investment in Banner Oak Capital conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Paul Greenwood. Please go ahead, sir.

Thank you very much, and thank you all for joining us on the call today sort of on short notice. I trust everyone had a great New Year's, and I appreciate the discussion of our new investment today is interrupting vacation time for many, so I apologize for that. But given our announcement this morning, we want to promptly answer any questions that people may have. Earlier today, PAC announced that it's making a USD 35 million investment in Banner Oak Capital, a private real estate firm based in Dallas, Texas. In exchange for our investment, we will receive a 35% equity stake in the firm. And before I elaborate more on the specifics of the investment, I'll provide a little bit of an overview of Banner Oak as they have a somewhat unique business model. I'd also encourage you to review the presentation we lodged with the ASX for more background information. Banner Oak Capital was founded in 2016 when the real estate team from Hunt Realty Investments spun out to start their own business. The firm forged a deep strategic relationship with a prominent U.S. pension fund that has provided the capital for all of the firm's investments. The firm has grown rapidly and now manages $5.7 billion. This number is a little confusing because it represents something called regulatory assets under management, which is different from fee-paying assets under management, which are notably lower. Banner Oak's business model is a little different in that it doesn't find a specific real estate investments per se, but rather it identifies talented real estate operators and developers and buys a stake in their business and acquires the proprietary access to fund their investments. The firm has created so far since -- in its lifetime, it's created 12 different investment vehicles, performance has been exceptional generally across the board. Over the last decade, the Banner Oak team has made more than 200 investments and realized more than 130 of those. Most investments have been in the U.S... The primary market segments they have invested in are industrial, followed by multifamily and senior housing, although they've also invested in retail, office and some other segments. Most of what they do is development or predevelopment. And -- so that sort of covers sort of briefly who they are. And then I'll elaborate a little bit more about our investment. So in addition to the $35 million that we -- PAC is investing upfront, we are going -- we are offering an additional $5 million of additional consideration if the firm hits certain growth targets by the end of 2025. PAC is also receiving a distribution preference, which means that it will receive meaningfully more than its pro rata share of earnings until certain return thresholds are met. We believe that's likely to occur sometime in year 4 -- or around year 4, I should say, after which time our earnings will go to our pro rata 35% stake. PAC will not be receiving performance fees that Banner Oak generates. We will not be participating in those. In terms of valuations, since I know someone will ask, we have noted that our expectations are that over the next 12 months, we expect Banner Oak to contribute a figure that is around 25% of PAC's underlying FY '21 net profit before tax. These forecasted contributions include the distribution preference I noted earlier. And lastly, I'd note that the majority of Banner Oak's management fees are paid on the net asset value of invested capital, which means they can fluctuate as real estate prices fluctuate. In terms of the rationale for this investment, I would note the following: PAC made this investment, first and foremost, because of Banner Oak's great management team, led by Patricia Gibson. This is evidenced in the wonderful firm culture that the firm possesses, which aligns very well with ours. We believe Banner Oak's growth prospects remain quite strong. And lastly, its business model is distinctive and offers a more attractive return proposition than traditional private real estate managers because of the lower all-in fees and the ability to participate in the success of the real estate operators. We think this model positions them well given the way traditional asset management models are evolving. In terms of risk of this investment, the primary risk here is an obvious one, client concentration, given that Banner Oak has 1 large strategic client. We were able to get comfortable with this risk because of, one, the long-term nature of their revenues. Most of these fund vehicles they invest and have -- are at least 8 years in duration, some longer. We've not only talked with management, but we have met with their existing clients. Banner Oak offers a compelling value proposition, as I mentioned, sort of with the lower fees and higher returns, which positions them very well. They've produced compelling investment performance. And the structure of our -- we've structured this investment and this distribution preference I mentioned is a way that we can expedite returns to PAC, which helps mitigate the client concentration risk. And lastly, while its priority is deploying capital on behalf of its existing client under the right circumstances, it could engage with another strategic client or 2 and attempt to replicate its existing relationship. So in summary, with this investment, we have deployed most of the after-tax proceeds from selling our 20% stake in GQG. And as I have noted earlier in our last call, based on GQG's forecast, it's not clear we will receive any less money from GQG or, call it, something approximately the same. So we haven't -- we don't expect to lose a lot of earnings in our GQG position, lose it a lot, if any. And yet we've taken those proceeds and redeployed it in Banner Oak, which should be a nice enhancement to our revenues and profits going forward. So with that, operator, I'll ask if there are any questions and happy to answer whatever I can.

[Operator Instructions] We will take our first question from [ Mark Fobian ], private investor.

I just had a couple of quick questions. Firstly, I was just after the thinking behind the exclusion of the performance fees from the share that PAC Group takes? And then secondly, just roughly what sort of quantum is the base fee on the thumb? Is it 40, 50 basis points more than that? Just a rough ballpark figure to try to understand the metrics of this deal.

Yes, sure. I'll see what I can give you there on those. So answer to the first part was the performance fees, yes. So on performance fees as we're fond of saying, we don't mind receiving performance fees. We don't like to pay for them. And the reason I mentioned that is because in an organization like this or investing in a -- let's say, it's I think of -- let's say, we're investing in a private equity manager, you have the same sort of issue, which is your -- the performance fees, you have to agree on the price of the future performance fees yet the certainty of those fees -- and they're highly uncertain. What that means practically is that we have to discount those performance fees at a pretty significant rate. And our general belief is that if we're discounting those fees at, let's say, 25% and management agrees to sell us those performance fees given the sort of information asymmetry around that, we think that's not a great trade. And so we would rather -- and plus, over the long term, we don't think our stock will perform as well if we get a big episodic carried interest payments versus more steady, reliable growth. So anyway, that's the rationale. At the right price, we'd certainly pay -- we'd certainly buy some. But our experience has been that our capital is -- sort of a better use of our capital to focus on earnings that are more certain and where there's less information asymmetry. And then -- I'm sorry, then you asked a question about the fees. I'd say think of this as a 50 to 80 bp business in there, depends on the situation. And as I mentioned that -- yes, so I'll stop there.

We'll take our next question from Jim Craig, Bellwether Investment.

First of all, Paul, let me congratulate you on the GQG deal. I don't think we've spoken since then. But from a shareholder perspective, it's created a lot of value. Following on [ Mark's ] question about performance fees and base fees, do you have any protections in the deal so that the team can't skew things towards performance fees? Or is that -- or are you just relying on the fact that you're on the Board, et cetera?

We -- the best protections we have on those sort of things is alignment of interest and the fact that they still own a majority of the business is a powerful incentive to -- they want to get paid like we want to get paid. I'd say -- and obviously, base fees are predictable and certain versus that unpredictable performance fees. I think practically speaking, the capital source to the pension fund that's been providing the capital is probably going to be highly sensitive to any attempt to move performance fees beyond market rates. And we do have a variety of other protections.

Sure. So what part of your strategy be about using your team to get other capital involved in this business?

That's a good question. So the answer is they don't -- this -- that could happen, and it's certainly not a part of our thesis, per se. I think it's something that we're open to if they want to explore that with us. Their current relationship is a great relationship that continues to grow. So I think our perception or our belief is that will likely continue to be the case. But should they want to pursue adding, let's say, another selective relationship with, let's say, a big Aussie super fund, we would be happy to work to facilitate something like that.

Okay. Turning away a little bit from this deal back to PAC strategy. From my calculations, I think this uses most of your cash. What does that say about your thinking around potentially bringing in third-party capital and a fund? And how are you thinking about the strategy going forward from that perspective?

Yes, great questions. So I'd say there's sort of 2 things we're thinking about on that front. The first is, as I've noted previously, we are working on securing some debt for the organization that would provide us with additional dry powder. And obviously, we're -- I'm pretty conservative on the debt front. So we're not going to leverage up the company to imprudent degree, but we can certainly take -- we certainly think we can add some incremental earnings through financing some investments via debt. As for taking on outside capital, that is also something that we have considered and is something that initiative, I think, will be something that we'll look really hard at in this year. Theoretically, the benefits of that would be sort of the obvious ones where PAC could be a recipient of management fees and that sort of thing. So one way or the other, we think between debt and between some external capital, I think we're going into and then reinvesting some incremental earnings, I think we'll have -- that should keep us pretty busy in 2022.

We'll take our next question from Nick McGarrigle from Barrenjoey.

Just a quick one. I'm working it out correctly that you paid around 6x PBT multiple for the stake, is that right?

Well, I'm not going to argue with that math. But as I noted, that includes that preference, yes.

That includes the -- so the initial over...

So in terms of -- Yes. So let me say that based on what -- based on the fact that we are receiving this distribution preference for a while. So based on the earnings we expect over the next 12 months and based on the price we're paying, yes, you're correct, it's actually a little less than that.

Right. And then just maybe a question for Ashley or yourself, but the tax consequences of the investment -- the effective tax rate across the broader group is relatively low, but does an incremental investment come with a more full tax rate?

We assume that it will be consistent -- given U.S., it will be consistent with that as always tax rate.

The sort of low 20s?

Yes.

Fortunately, it's in Texas, but not in California.

Yes. Maybe just to take a step back, can you talk through how you came to the deal? Obviously, it was helpful having the cash received from the GQG sell down. I mean is this -- can you just talk through how the deal was originated? And sort of whether there before this -- before the GQG money came in and you were just keeping it warm? Or how -- just talk through that pipeline.

Yes. So we were working on executing this while we -- while the GQG IPO was underway. The deal originally came to us from an investment banker we know who was running, I would say, selectively discussing this opportunity with a small number of potential investors. And came to us and said, are you interested? The one thing you need to know is there's a lot of client concentration risk. And that actually intrigued us because we felt that most firms would just bow out at that point in time, and we felt that why don't we learn some more information before we make that decision. Because there are ways both like, for example, it would be great to talk to that client, which we have. Also this ways structurally, we can mitigate risk. And so we figured that this would -- there would not -- wouldn't be a super crowded field that would entertain this. And yet it's a wonderfully high-quality firm with exceptional performance and a great growth trajectory, both historically and prospectively. So that's sort of the background story.

And just in terms of the way that the money is invested, is it Banner Oak finds other real estate companies to invest in and draws down on capital from the pension fund, Texas [ teachers ], as they find opportunities? Or do they have an own amount of committed capital that restricts the amount that they can invest in any given year? How does the sort of drawdown work?

It's sort of a combination of those that I think every year, there's a commitment made at the pension level as to how much they're going to fund over the next 12 months and provided that Banner Oak brings that quantum of opportunities to them. And thus far, there's no issues in terms of -- their platform is wonderfully scalable. So it's no problem in providing ample deal flows to their client.

[Operator Instructions] We have Nick, again.

Just to give everyone a sense of the public pension fund that you -- that was obviously partnered up with Banner Oak runs close to $200 billion in assets. Do you have a view on the runway that they would look to invest through this partnership? And do you feel like the $5.7 billion is a mature number? Or do you feel like there's still capacity to take on more? I know you mentioned opportunities don't -- are abundant, but is there still an ongoing desire to sort of invest in the partnership from that pension fund?

Yes. I think it's a very healthy relationship with their client. We expect it to grow. I think all the parties do. I can't obviously speak for the other ones, but we've chatted with all of them, and I think it's a wonderfully healthy partnership. And there's a whole bunch of things that I probably won't get into now that I think create -- that will really result in Banner Oak providing a great service and solution to their client. So we don't -- we expect continued growth for -- as far as I can see. I can't see forever, but it's a healthy relationship. And obviously, their client is incredibly sophisticated. So it's genuinely a partnership and a very collaborative partnership.

And I think someone might have asked the question a bit earlier, but you'd expect that the management fee margins that come with those incremental assets, even though they are from 1 client, to be sustainable at the current rate cut?

On average, yes. Yes, I mean, I think everything is -- they have lots of different vehicles. So each one, I think, has its own fees and things like that. But yes, I -- we don't -- we're not assuming a lot of compression there aside from anything we -- unless there was something we already knew about.

We'll take our next question from Jim Craig from Bellwether Investments.

Paul, just in the annual report, you talked a little bit about a number of approaches that had been received on other assets that PAC owns. Is there any update that you can give us about that? Or is the market similar to how it was when you put out the annual report?

Yes. Look, the markets, I'd say -- in the world, we play in the -- call it, the larger end of what we look at. So think of investments, USD 40 million and above, it's a pretty frothy market. And so I don't -- so to answer your question directly, we have no updates to report on any potential sale. And if I did, I probably couldn't tell you anyways, but we don't. But it is the time in the market where all of these firms where -- that are big enough are getting approached or sort of getting inundated. So -- and we're seeing -- we're bowing that -- regularly bowing out of opportunities where someone says, "Hey, this deal is going to go at 20x EBITDA." And we're not going to pay 20x EBITDA for something growing at 5% a year. We're just not going to do it. So we're focusing on trying to find some marketing efficiencies where we can find deals that are not as -- that are just -- where there's something unique or distinctive about the opportunity, but where you still have super high-quality investment firms. So that's the update. There's nothing eminent there. But something could happen, and I'm not being cryptic. It's just -- given the market, something could happen.

We'll take our next question from [ Mark Fobian ], private investor.

I really appreciate the openness that you displayed. Quick one. It mentions the current sum as being USD 5.7 billion, but then it sort of says the actual fee earning base is materially lower than that. Is there -- are you able to disclose what that fee earning base would be currently?

Yes, I'll give you -- it's sort of, call it, in the neighborhood of a couple of billion.

Okay. Okay. Fair enough. Couple of billion currently...

Yes, in that -- because the definition of regulatory capital is -- I think it's the -- it's like the gross -- it says that actually on the -- one of the slides in the presentation. But you get debt that's factored into it and you get undrawn commitment that's factored into it. And so if you're getting paid on committed capital and you have a whole bunch of money that's been committed but not deployed, you're not getting paid on that. So anyways, that's sort of the short answer to your -- I should say, a cumbersome answer to your question. Any other questions, operator?

No further questions at this time.

Okay. Great. Well, I think, obviously, if you have any other questions, feel free to give us a call at our e-mail, and we're happy to respond. Thank you for your time today. Sorry for the interruptions on your -- of your vacations. And with a little luck, we will look forward to seeing you sometime in March if we can -- if the -- we're allowed to come down and do the roadshow in the flesh. So thanks a lot. Have a great day.

This concludes today's call. Thank you for your participation. You may now disconnect.