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

Good day, and thank you for standing by. Welcome to the Pacific Current Group 2022 Half Year Results. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Mr. Paul Greenwood, MD, CEO and CIO. Thank you. Please go ahead.

Thank you very much, and thank you all for joining us today for the Pacific Current Group First Half 2022 Update Conference Call. We're excited to walk you through the first half and, more importantly, provide our outlook on the future. Before we get into the details, I want to thank the PAC team for its exceptional performance in the first half and the PAC forward for its leadership and support. There's a bit to wade through here, and we will be having a more granular discussion than is typical. But I think as we do, you'll get a sense for the growing momentum in PAC's business. So jumping right to Page 3 of the presentation. Page 3 provides a reminder of our business strategy and some highlights for the first half of '22. For those not familiar with PAC, I would note that our business strategy is to make investments in a broad array of investment management firms who work with those firms to help them grow their businesses. By using bespoke economic agreements and diversifying across different business models and asset classes, we believe we can build an earnings stream that is not highly sensitive to equity markets and demonstrates strong organic growth. We explicitly are trying to avoid creating a company whose financials are excessively linked to the stock market. So the first half was an exciting and strong half for us. Funds under management grew 16% for the half, 11% growth if we strip out the new investment in Banner Oak, which happened on the last day of the period. It should be noted that Victory Park Capital had the highest growth rate in the first half of the year at 25%. Investment performance was strong among private capital strategies. Our active managers had a decent, though not spectacular, year of performance with the exception of Blackcrane, which lagged significantly. I should note that GQG has had a great start to 2022 in terms of performance due to some timely modifications in their portfolios. This has resulted in the firm largely avoiding the large declines in growth stocks that many managers have experienced. In fact, as of Friday, they were larger than they were at December 31 despite market corrections globally. Obviously, their strong performance helps their revenues because their assets under management don't decline as much, but it also helps future growth prospects because of the strong relative performance. So the major highlights for the half year are really, first, 21% growth in underlying revenues and 26% growth in underlying NPAT. We note that this was achieved despite only recognizing 4 months of GQG earnings in the period, and I will elaborate on the reason for that later. PAC declared a $0.15 a share dividend, up 50% from last year. We note that this increase is consistent with our prior statements about reducing the SKU in PAC's dividend toward the second half of the fiscal year. Obviously, the biggest portfolio development was the IPO of GQG on the ASX in one of the largest IPOs of the year. Once again, we'll elaborate a little bit more on that later. And then lastly, we made a large investment in Banner Oak Capital on the last day of the period. We're very excited about that. So while I'll elaborate on our outlook later, I would note that while we expect FY '22 to be a really solid year, things are really shaping up for FY '23 to be particularly strong with projected revenue growth in double digits. Going to Page 4 of the presentation, you'll see a sort of the -- it shows the PAC's income statement in both Aussie dollars and U.S. dollars. Those management fee revenues would have been perhaps 20% higher if we could have recognized all of GQG earnings. And I believe net profit before tax would have been close to 50% year-over-year increase had we been able to do that. On Page 5, we are showing what we call management fee profitability. And as a reminder, management fee profitability is defined as management fee revenues less all costs. This didn't work -- this did not grow on a year-over-year basis, but would have grown more than 25% were not for the GQG earnings recognition issue. Going forward, we expect this number to grow meaningfully as management revenues accelerate across the portfolio and new investments like Banner Oak come online. Page 6 covers GQG. Well, obviously, a big success. The listing of GQG has some accounting implications for us that investors should understand. Specifically, it changes to -- it changes how we recognize earnings and we also -- it changes how we reflect changes in its value. So first, with regard to earnings recognition, we are moving from an accrual basis to a cash basis. Now that we own common stock and not a preferred security. This means that the dividend GQG declared today for the 2 months ended 31 December is not something we can recognize in the first half, but rather it must be recognized in the period it's received. GQG has stated that we'll be declaring dividends quarterly. So for the first half of FY '22, we are only recognizing the 4 months of earnings through the date of the IPO, which I believe was October 28. And in the second half of the fiscal year, we will recognize 5 months of GQG dividends, 2 months from the interim dividend that declared today and then the dividend declared for the quarter ended 31 March. After the 30th of June, every half year, we will receive 6 months of earnings. So to be clear, none of this has anything to do with cash. We actually expect that we will receive cash faster now than we did beforehand, but it does mean we will miss out on recognizing 3 months of earnings in this fiscal year from GQG. With regard to marking the investment to market. Once again, the accounting standards are not our friend. You can see from the graph here that at the time of the IPO, our stake in GQG was marked up in value by $185 million. We then received $59 million of proceeds at the IPO. The stock then declined, but the write-up of GQG went through equity reserves and not the income statement. But now because of the different accounting treatment, changes in the value of GQG go through the income statement. And this is the reason for our statutory loss in the first half of the year. Moving on to Page 7. We provide net asset value per share and share price and compares these. So I think the important takeaways here are really, one, PAC continues to trade well below NAV; and two, our NAV does not necessarily reflect the full value of our assets because some portfolio companies cannot be written up. So for the first time here today, we are actually noting what our internal -- that are -- we're sharing some of our internal fair value estimates. And in aggregate, they exceed the values at which we carry these assets by an aggregate of $40 million, which is about $0.78 a share. These fair values are not audited, but are calculated identically to our other valuations and using the same methodology. And I would note, in cases like Aperio, IML, RARE or GQG, we've noted that when there's actually transactions, prices tend to go -- get done at significantly -- at values significantly greater than what we -- than even our fair value estimate. Moving to Page 9. Page 9 just touches on some of the portfolio highlights for the period. I won't go through all of them, happy to answer questions about them. But I would highlight really the last one here is Victory Park had a great period, largely due to enhanced incentive fees in part due to the SPACs that they sponsored during the year. While we don't expect the same level of incentive fees next year from them, the Victory Park's business is now growing quite rapidly. So management fee revenues should grow very nicely. And one thing I want to note about private credit managers in general is that private credit managers typically get paid as they invest capital, while private equity managers generally get paid on committed capital. So in other words, private equity managers start to get paid immediately after securing those allocations and private credit managers start to get paid once they deploy capital. This means that for our private credit managers, there's a lag between when FUM growth occurs and the resulting revenue occurs. In fact, I would refer you to the very last page of the appendix under Key Concepts, something called key concepts where we -- where certain revenue and expense recognition concepts are discussed in a little more detail. On Page 10, it highlights performance, as I mentioned. In general, it was a good year. I would note that the real interesting performance that's occurred has actually been what GQG has done post December 31. Because of how they position their portfolio, they've produced very noteworthy outperformance in sort of generally across the board. In the emerging markets, product is the only one that's still above average, but not the other ones are literally first percentile year-to-date. And then Page 11 is just -- shows the growth of our boutiques. And it's worth reminding people that private capital strategies or firms sort of by nature can't grow as fast as long only boutiques can, but they do have more resilient business and assets under management. But you can see across the portfolio that all of -- almost all of these companies have strong records of growth in over the last 3 years. Page 14 is just an update on deal flow, and I'm glancing over just the list of our companies. But on Page 14, the deal flow has really accelerated in recent months. And so we are finding no shortage of attractive opportunities. We expect 2022 to be a record year in terms of the number of investments we reviewed, and we're starting out way ahead of sort of pace already. So moving on to Page 15. We feel quite good about the future, particularly as we get into FY '23. We have intentionally been building our business differently than others. We don't want our company to be a leveraged beta play. All you have to do is look at the experience of the last 4, 5 weeks and market declines to appreciate why -- how that can be problematic. We want to build a business that's as resilient as possible so that our earnings are not wiped out in times such as these. And now I'll walk through some of the specifics of why we are particularly bullish on FY '23. First off, we believe we will experience growth across -- broad growth across the portfolio. Even in the last 2 days with conversations with portfolio companies, I have received confirmation of recent milestone victories that are consistent with what we expect, but very good news. So while today's headlines underscore that the world is uncertain place, the combination of these recent achievements and additional fundraising milestones we expect to achieve in this fiscal half year should result in pronounced acceleration of revenue and profit growth. So I'll get into the specifics of why that is. First off, next year, we will recognize 12 months of GQG earnings. In FY '22, we have so far received USD 2.9 million from GQG. And if we add to that, 5 months of dividends at the rate they just announced today, we get projected earnings from GQG for fiscal '22 of USD 7.5 million, which is a little over AUD 10 million. If we take 12 months of dividends at that rate, so not even assuming growth rates but just assuming GQG produces the same level of dividends that it declared today, we get an estimate of USD 11 million. So it's an increase of USD 3.5 million, which is about AUD 5 million just from GQG assuming no growth. And on top of -- this last half, we did about $25 million of revenue. If you think of the second half of our fiscal year was similar and we had $50 million for the year, that suggests GQG alone could be about 10% revenue growth. Second, we'll receive 12 months of earnings from Banner Oak this year versus 6 months in fiscal '22. As a reminder, we did that deal the last day of the year. So we'll only get 6 months of earnings in that -- in fiscal '22. If Banner Oak delivers consistent with our expectations and the expectations we shared at the time we invested, the -- their additional contribution sort of in FY '23 versus FY '22 should be similar to GQG's. So then third, we expect some new FUM commitments in this half for specific companies to have a big impact on FY '23, but they may arrive too late in this have to have much impact during this half. And lastly, we expect some of the early-stage investments like IFP and Seizert to move toward and hopefully become profitable in FY '23 versus losses in FY '22. Both of those firms seem to be tracking very well. Obviously, there's caveats around any of these sort of forward-looking suggestions. And I would note that the macroeconomic concerns, I think at the current rate or level, I think those don't represent an issue. But obviously if something happened so that people would really change their fundraising -- or help their fundraising or new allocations and fundraising or their capital allocation, if that gets impacted by events, then obviously, that could hurt us. Equity market declines certainly don't help us. And some of our clients or some of our managers, I should say, have some marketable securities on their balance sheets, and we could -- we're always subject to reflecting our pro rata share of the gyrations in those assets as well. But absent sort of extraordinary items, I think that explains why FY '23 is looking quite promising. So those are all the prepared remarks we have. So operator, we're happy to entertain questions now.

[Operator Instructions] And our first question comes from the line of Jim Craig from River Capital.

First of all, congratulations, Paul and Ashley. I think you've done a great job explaining clearly how GQG's accounts flow through. Not an easy task that, but it's been done well. I also think the presentation just gets better and better in terms of understanding the value of what you're doing. Two, one comment and one question. The first is it would be very useful to have a table showing the values on an asset-by-asset basis. I know I can chase through the actual accounts to find them, so you do publish them, but it would be very helpful if we could see that so that we could just understand relative values. The second one is Victory Park. Victory Park's performance fees were obviously significant to this half's result. And I know you push us towards thinking about management fees and not so much performance fees. But how do we get any insight into what performance fees could be going forward or any real analysis of how that major assets going other than funds under management?

Great questions, Jim. So on your first observation, I would say that when I mentioned that there's roughly $40 million in aggregate value not reflected on our balance sheet, that is largely limited and, Ashley, correct me if I'm wrong, but that's largely limited to Victory Park and ROC. Secondly, with regard to performance fees, so -- well, Victory Park is by far and away the most complicated manager to get one's arms around from a financial perspective. So think of them as really having -- they have their management fees. They have something they call incentive fees, which are essentially performance fees that get crystallized annually based on -- largely based on a London-listed vehicle that they manage. Then the third component is what they would call performance fees. So once again, there were sort of splitting hairs here or carried interest, and that would be sort of traditional performance fees based that their set accounts and commingled funds that would apply to them. So what would be noteworthy in this fiscal year was the high incentive fees driven from those listed vehicles. We expect to receive performance fees or carried interest from them. We will receive a little in this next half. But what I would note is we do have a multiyear projection there. And we will see that -- I would say, we're going to see that accelerate fairly dramatically over the next 3 or 4 years. And to give some approximate quantum is that it's not inconceivable 3 or 4 years down the road, we received USD 10 million in performance fees from Victory Park alone. Yes. So -- and obviously, that's -- yes.

What I'm hearing is I decided to read across from incentive fees, which are effectively disclosed through the London Stock Exchange to carried interest. The carried interest comes through later and is a different calculation.

That's right.

Okay. That's very helpful.

Yes. And the other thing is I would note -- one other thing, when we include some of these things, we like key concepts. We do it for a reason because one of the things that -- to help people appreciate when a firm is -- a private capital firm is growing rapidly, let's say I grew -- I had an external placement agent, so some firm helping me grow my assets, raise capital for me. And they raised $1 billion, and let's say, we get paid that manager charges 1% on that. That's not uncommon for that fee, the placement fee to be $10 million, so 1%. So in other words -- and the challenge -- that fee gets recognized all at once by the manager, although paid over multiple years. So one of the things that does is it tends to -- in periods of very rapid growth, it can obscure some of the economics because of some of the additional expenses going through. Layer and then add on top of that, the manager may not get paid until that capital is deployed. So you can see that there's this little -- this lag effect that exists in some sort of private capital situations where they're using outside placement agents.

That's very helpful. What I'm hearing is that you guys are very excited about the outlook for Victory Park. And as an investment, it looks like it's going very well. So thank you.

Yes. Well, look, it clearly started slow and now the momentum appears to be building fairly dramatically.

And your next question comes from the line of Nic Burgess from Ord Minnett.

A few questions. Just on your outlook statement of double-digit growth. Can you just confirm you're talking about revenue or underlying profit there?

Yes. Well, I mean, certainly talking about revenue. So I would hope the underlying profit grows faster than the revenue. So -- but yes, I'm talking top line.

Yes. Okay. And then just some color...

And our costs won't. Our costs won't. The only cost that would go up in any notable way, frankly, would be commission expenses from raising more money.

Yes. Okay. That was my next question. And just part of that, if you could just restate -- apologies I just missed your point on all of the numbers when you're talking GQG as a key contributor to that outlook. Can you just run through those numbers again?

Sure. So far, in fiscal '22, in the first -- the half that just ended, we recognized USD 2.9 million of earnings from GQG. That represented the earnings we were entitled to under the old preferred security we held from July 1 through the time of the IPO. If you now take -- because we can't -- we have to now recognize dividends when they're received, if you then estimate what we should receive from GQG, they declared their dividend today, I think it was $0.154 a share. If you look at that, what that means -- and you add -- and you give us 5 months of that for this fiscal year, which would be representing the 2 months for the interim dividend and the 3 months for the March 31 dividend, not assuming any growth, I come up with an estimate of about USD 7.5 million we would recognize in FY '22 from GQG. If you just take then on FY '23, if you just take that monthly, your dividend rate or that quarterly dividend rate, assuming no growth, you actually get -- everyone can do their own math, but I get USD 11 million for next year, like I said, assuming no growth and assuming the same rate. So you pick up USD 3.5 million incrementally just because, frankly, we weren't able to report. So we missed out on these 3 months of reporting. Does that make sense?

Yes. And that's where the $5 million...

Yes, that's correct.

Yes. Okay. That makes sense. Just moving on to the potential deal outlook. You mentioned that the deal flow had accelerated. Just wondering on any comments around quality and whether that's deteriorated with an increase in volume. Or any comments around quality of deals that you're seeing at the moment?

I would say it's actually an interesting question. We've never looked at as many high-quality deals as we have now, and we've never seen as many low-quality deals either. And by that, I mean you're starting to see investment bankers taking deals, working on deals that, frankly, are not bankable and shouldn't be in market. But we're also seeing -- we also are seeing some really interesting unique deals. I'd say the common thread among what's interesting is we're for us, are some -- we like -- we always like things a little off the beaten path. And so they're looking at some deals across Europe, even South America. And so we're trying to find deals that are less traffic. So we're thrilled with the quality, but absolutely, we're seeing some lesser quality deals brought to market.

Okay. And still on the subject of deals, what do you regard your funding capacity at the moment?

Yes. Right now, I think we have -- we certainly have the capacity to do some small deal or two, but we will need additional capital to do something on the order of the next Banner Oak. And so -- we are -- we -- as I've mentioned before, we are pursuing borrowing. We've -- we fully expect to secure debt financing this year. The slowness in this process is sort of on us, but it really relates to us trying to make sure we do this right and don't incur large interest costs ahead -- too far ahead of any investment. So we're still -- there's nothing that -- we don't have any impediments there. We're just trying to finesse that. But we're -- any larger deals, we would need to access external capital like that.

And broadly, the size of round numbers, the size of the facility that you're targeting.

I think we'd be -- sort of our comfort range, we're not going to -- there's firms in the U.S. that will lever even investment firms that will put 6 turns of debt on a business like ours. I would never do that. So I think we're probably comfortable in like 2x EBITDA range, that sort of ballpark.

Yes. Okay. And last question just on -- again, on the outlook for FY '23. Just you mentioned Victory Park with the fundraising pipeline, just the couple of boutiques there that you're seeing the most interest in at this point.

Sure. Well, I think we're going to see, I think, some great strides at Pennybacker capital this year. We'll see progress at ROC. There'll be some progress at Proterra. I'd expect progress at Carlisle. And I always hate doing this off the top of my head because I can always forget someone, but those are ones that sort of leap to mind.

[Operator Instructions] And our next question -- a follow-up question from Jim Craig -- or a question from Jim Craig of River Capital.

So Paul, just following up on Nic's questions. In the last presentation or actually I think it was in the annual report, there was a discussion about a number of boutiques being approached, and I wouldn't surprise you if the founders of some of them decided to divest. I don't see any mention of that here. Has that sort of phase moved on? How should I think about that?

I would say, no, that phase has not moved on. I have not learned of one of our boutiques being approached by an external party in the last 45 minutes. So there's a high level of activity. Whether they're interested or not, that is a whole other matter. But the high level of activity -- but frankly, one of the challenges if you're growing your funds for -- we have a whole bunch of these firms that are growing their funds under management very rapidly right now and will be, and so I think that makes it difficult to want to sell. So none of our managers are engaged in any process, but they -- many of them are being approached frequently. Yes. And by the way, I should add, like I don't expect any -- I don't have any reason to expect any transactions. If any transactions get done, the type of multiples people are paying these days are well beyond what we would. And so I don't -- I think if we had to lose a great portfolio company, we'd at least do it at a really attractive valuation.

[Operator Instructions] There are no further questions at this time. Speakers, you may continue.

Great. Well, I'd like to thank you all for joining us today. And I know we are happy to -- if we haven't already, if people want to chat more with us, happy to set up a set of meetings and answer any questions that you may have. So thanks for your time and attention, and have a great day.

Thank you. And that does conclude the conference for today. Thank you for participating. You may all now disconnect.