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

Thank you for standing by, and welcome to the Pacific Current Group 2022 Full Year Results. [Operator Instructions] I would now like to hand the conference over to Mr. Paul Greenwood, MD, CEO and CIO. Please go ahead.

Thank you. And thank you all for joining us for the Pacific Current Group FY '22 results presentation. We appreciate your interest in our company. And today, we'll go through the highlights of FY '22 and share some thoughts on what we believe the future holds for PAC. I would like to thank the entire PAC team for their work this year. It has been a year of significant progress that we plan to build upon in FY '23. Our model of creating a broadly diversified portfolio, primarily of alternative asset managers has exhibited the resilience we expect when capital markets are challenging. As I go through my remarks, I'll be sharing some forward-looking thoughts about what we expect in FY '23 and beyond. When doing this, we typically assume flat equity markets and stable currencies and to state the obvious, we can't know with certainty how much FUM a boutique will gain or lose, how it will perform and how stable this business will be in the future. So on Page 3, we cover some of the highlights for the year. Clearly, the biggest development was the IPO of GQG Partners in what was the largest IPO on the ASX last year. As a reminder, our initial investment in 2016 was $3.6 million, and we sold 20% of our stake in GQG on the offering. This netted us $59 million in pretax proceeds. In the interim, we have received about more than $40 million in distribution since our initial investment. And today, our price -- today's price, our remaining stake is worth around $200 million. That means the combination of what we've already received and our ongoing position is worth somewhere between 80x to 90x our initial investment. We reinvested the proceeds of our GQG sale into Banner Oak Capital, a private equity real estate manager, which has been in the portfolio for 6 months. Fund growth was quite strong during the year, growing 19%. When we strip out GQG because it's so large and adjust for the purchase of Banner Oak, our boutiques FUM grew 18% year-over-year, which we are thrilled about. A year ago, we had estimated our boutiques ex-GQG would receive $3 billion to $8 billion of gross new commitments over the 24 months ending June '23. We are pleased to say that the tally reached $6.2 billion in just the first 12 months and are poised to exceed the upper end of this range by the end of this fiscal year. Investment performance was generally good across the portfolio. Among our traditional active equity managers, GQG had spectacular results. However, our higher growth-oriented managers, EAM and Blackcrane lagged benchmarks as we would expect. In terms of financial performance, underlying revenue increased 7% to $49.8 million and underlying NPAT grew 3% to $27.1 million. PAC also declared a final dividend of $0.23 bringing the full year dividend to $0.38, a 6% increase year-over-year, and that dividend will be fully franked. Underlying revenue growth would have exceeded 14%, and underlying NPAT growth would have exceeded 13% were not for the fact that we could only recognize 9 months of earnings for GQG during FY '22. This foregone revenue totaled approximately $3.3 million. As a reminder, this loss of revenue recognition came about because upon listing on the ASX, PAC preferred interest in GQG converted into common stock, and now we must recognize earnings in the period when we receive the dividend as opposed to the previous situation when we could accrue GQG's obligation to us. This really has no bearing on when we actually receive cash, however. On Page 4, summarizes the financial results both in $and U.S. dollars. And you can see that management fee revenues declined slightly due to the GQG earnings recognition issue that I just touched on. I would also note that Banner Oak was a great contributor as a new investment that was only in the portfolio for 6 months. Had Banner Oak been in all year, and we had recognized 12 months of GQG earnings, management fees would have grown more than 20% year-over-year. Specific current commission revenues increased significantly due to the success we had in raising capital for Victory Park last year. And performance fees grew substantially 113% primarily to Victory Park, though SCI and Roc also made very nice contributions. We had some mark-to-market losses of about $1.2 million, which reflects our share of the unrealized losses on marketable securities held on certain PAC portfolio company balance sheets. We are breaking this out because as the value of our boutiques balance sheet continues to grow, we think we'll be seeing more of these. It's important to note though that these are noncash items. From a statutory results perspective, we recorded a $35 million loss. This has to do with the decline in GQG stock after it went public. Admittedly, it's a bit confusing as we had to change the method of accounting. So we recognize the post-IPO losses through our earnings, though the gain at the time of listing was recorded through OCI. In the end, we believe it is important to note that our stake in GQG is worth more than it was a year ago, and it's nice to see that their stock has actually risen since June 30. On Page 5, we cover is an important overview of the composition of PAC's revenues. As noted earlier, PAC's corporate expenses were basically flat. So the story of FY '22 is about revenue. Page 5 breaks it into the component pieces, boutique management fees, boutique performance fees, unrealized mark-to-market gains and losses and our corporate revenues. The numbers on this page are in U.S. dollars to minimize any currency-related distortions. The way we think about our business is that corporate revenue, which is primarily commissions related, will be volatile. This is readily apparent as commission revenues increased 72% last year after falling 49% the prior year. We will also have some mark-to-market gains and losses, which will be volatile but don't involve any cash and should be modest in the context of our overall revenues. At the end of the day, what drives our results are the returns we received in exchange for allocating capital. For a specific amount invested, we receive our share of management fees and performance fees. We expect the management fees and performance fees will typically comprise more than 90% of our total revenues. What this chart show is that FY '20 and '21 were very stable, something we attribute to the limited ability of our private capital boutiques to raise capital during the pandemic. FY '22 saw the combination of management fees and performance fee revenues grew more than 14%, due to the growth in performance fees. If we layered on the missing GQG piece, these core components of revenue would have grown more than 22%. If Banner Oak had been in the portfolio all year, then we'd be looking at something in the neighborhood of 30% year-over-year growth in these core components of revenues. Page 6 touches on management fee profitability, which represents the profits we earn just for management fees and netted where we met corporate costs against them. This management fee profitability declined during the year, primarily because of that missing GQG revenue and because of some mark-to-market impacts. We expect to see significant improvements in this metric in FY '23 for a variety of reasons that I will touch on towards the end of my comments. Page 7 is an important slide because it details how our net asset value is growing, and it speaks to our effectiveness at allocating capital. When we look at net asset value per share, we have seen that it's grown 19% a year for the last 5 years. We think this is great, but we also don't think it tells the entire story. NAV presented here ties directly to PAC's balance sheet. As such, you will only see increases as a result of fair value assets being written up and more notably, when we sell assets and realized proceeds in excess of book value, much like the FY '18 sale of IML, the FY '19 sale of Aperio and most recently, the IPO at GQG. What this chart does not capture is the increase in the value of our equity accounted boutiques like Victory Park, Pennybacker, Roc and others, which are required under the accounting rules to be held at cost or lower if they have been written down. And so it is our opinion, which we cannot prove absent liquidity events is that the true NAV has grown notably faster than this chart suggests. Page 8 speaks to what we're really trying to accomplish with our investment strategy. As we have said on numerous occasions, we don't want to be a leveraged beta play, where our revenues and fortunes primarily reflect those of the stock market, but with just higher volatility. With public equity managers, downward movements in equity markets have meaningful impact on managing these revenues, which disproportionately impacts the returns to the owners of those businesses because of the essentially fixed operating expenses that they have. So instead of that, we endeavor to produce double-digit organic growth. That's our objective, but to do so, largely independent of equity markets. Our view is that if we do a good job of allocating capital, we will ultimately hit those return targets. And I think the prior slide on NAV speaks to our ability to do this. The way we avoid being a leveraged beta play is to diversify into private capital strategies, limit exposure to liquid markets and use a breadth of financial structuring tools. We believe the benefit of this approach is apparent on this page. We have the lowest beta among our ASX peers over the last 5 years. Our stock price performance is notably different as well, particularly in periods where equity markets are declining such as the first half of this calendar year. On Page 10 of the presentation, we show the cumulative gain in FUM for our manager in the last several years. We note that with the exception of Blackcrane, our boutiques have shown impressive growth in recent years. In Pages 11 to 15, we are now deciding to provide updates on all portfolio companies instead of doing it selectively as we've done in the past. And then Page 17 speaks to our opportunities we see in the -- in our pipeline and we continue to see a large amount of deals. We are seeing as many high-quality deals as ever, but we're also seeing more marginal deals come to market. I think I may have mentioned that in the last call. The most important point to make here is that we are confident that we can still find attractively priced, high-quality investment opportunities. At this point, we are expecting to fund them with a new line of credit we hope to finalize in the immediate term. Page 18 provides some thoughts on our operational outlook for this year. We expect modest increases in expenses, primarily due to some inflation and increased commission expenses and a pickup in corporate travel. We expect at least $3 billion to $5 billion of gross new commitments ex-GQG during the year. And we anticipate finalizing the credit facility of up to USD 50 million to provide the dry powder for new investments. I also note that we would not be surprised if there are some liquidity in our portfolio. Nothing to certain, but there are large number of portfolio companies have had inquiries and so that suggests there's a heightened possibility. And the one thing we are confident in is that if any of those events occur, it will come at valuations that we would believe are highly attractive, such that the after-tax proceeds could be reinvested and our earnings would increase. And then last, on Page 19. Given the financial outlook, we are confident of seeing meaningful growth in management fees next year. And really, this is due to several things. One, receiving a full 12 months of earnings from GQG, receiving full 12-month contribution from Banner Oak instead of 6 months. Companies that were loss-making, breaking into profitability. Organic growth at VPC and Pennybacker in particular, but other boutiques as well and then the new investments that we expect to make during the year. We note the results, we think, will be biased toward the second half of the year. And I'd say that there are very specific reasons for this, so I'll touch on those. First is we expect less incentive fees from Victory Park's listed vehicle in FY '23. These are fees crystallized in the first half of the year. We expect more carried interest and performance fees from Victory Park's commingled funds and separate accounts. These tend to be biased towards the second half of the year. VPC's management fees will be growing throughout the year as it deploys the newly raised capital. Thus, second half management fee revenue should be bigger than its first half. Pennybacker is in fundraising mode. We expect its fund rates to be quite successful. If they secure commitments in the second half of this fiscal year, those investors will have to pay what are known as catch-up fees, which is basically the fees that they would have paid had they been in the fund since May of 2022. And then we think new investments made this -- or obviously, the new investments made this half won't have a full 12 months of impact. This year, we do expect somewhat lower commission revenues, although they're very hard to predict, just because we won't be as active with Victory Park given that they just raised a fund. In terms of performance fees, this can be difficult to predict. Last year, they were $14 million. It could exceed this level this year, but that is not our expectation. I would expect perhaps slightly less, but they are difficult to predict. That said, beyond FY '23, it is our expectation that performance fees will rise to what we're just trying to characterize as a sustainably higher level. The reason for this is primarily related to Victory Park and where it stands in terms of some of the funds it manages. Basically, the performance fees are largely paid at the end of fund lives. So it's possible to make reasonable estimates about performance fees because the products are private credit strategies that have fairly even returns and fairly predictable. So as long as performance is expected, then what we expect, we should get those sort of consistent higher performance fees. The combination of growth in management fees and expected performance fees at VPC lead us to project that from FY '24 onwards, VPC will be our largest economic contributor. So those are my prepared remarks, but we received a variety of questions that I thought I would sort of preemptively address and then after that, we can -- and they're nice, detailed questions. And so after that, we'll take any other questions, but I think some of these will be shared by other people. So in no particular order, I'm going to sort of jump into these.

Question number one was in the helpful tips for analyzing PAC slide, you only highlight private credit as taking time to earn fees from deployment, not raising of fund, which managers get paid on what? And so I'll try to provide some clarity on this to the extent possible, though this can get a little complicated. The private credit managers generally get paid once capital is deployed. So once it's invested, not once it's been committed. That is one of the reasons we know that your approximate fees will grow over time. Private equity strategies such as Pennybacker and Carlisle get paid from the point of commitment, not investment. Proterra is generally paid on committed capital, though there is a minority of what they do that is paid on invested capital. Banner Oak is an exception for private real estate firms and gets paid once it invests capital. Aether just paid on committed capital. And I believe Roc is generally paid on committed both as a private credit strategy that is more likely paid on invested capital. So you can see how this gives a total noise. Question number two. Roc's earnings appear to have fallen over the year despite outstanding growth in FUM. Is it reasonable to assume that was because 2021 included performance fees that fell into 2022, and the FUM still includes low fee FUM that is being replaced with high fee FUM? I have modeled Roc getting towards Tier 1 in a few years, is that reasonable? My thoughts on that are Roc's new business continues to come in at fees that exceed its legacy business. Their earnings contribution declined in FY '22 due to the fact that FY '21 had a small accounting true-up payment. And 2, we recognize less performance fees in FY '22. That said, the firm's revenues grew double digits, and we are confident that they will do the same this year. Because they are primarily a private equity manager, performance fees will be highly variable and will likely comprise the majority of their earnings and thus our earnings that we received from them. We expect performance fees to be higher in FY '23 than they were in FY '22, and we expect they will continue to trend higher over time. I think if you gross up Roc's contributions for the taxes paid because Australian firms, they pay taxes before the money gets to us and that's different than U.S. firms. If you gross that up for the taxes paid, then we expect them to be right around that Tier 1 threshold on a go-forward basis, though subject to a high level of variability based on when performance fees are realized. Question three, Banner Oak's earnings look less than I expected for the half. I get $3.5 million compared to my expectation of $4 million. This is a timing issue or is Banner Oak disappointing you? Let's see, you call out that it will -- that Banner Oak will increase this diversification of clients that imply it is already diversified away from the original one client. Banner Oak came in slightly lower than expected, but still sort of provided a very nice contribution. The investment is tracking to roughly at 15% pretax yield, which we think is great. Banner Oak continues to deploy significant capital from their clients on an annual basis over the next several years. It's deployed USD 428 million through June of this year, and it estimates that will deploy another USD 380 million for the remainder of the calendar year. Most of this deployment is related to previously approved commitments -- previously approved investments. The relationship with the client is not likely to grow beyond these commitments given their overall exposure. Diversifying this business has always been an objective of the firm. And as we move forward toward calendar year '23, those efforts will ramp up. My expectations for this year and next year in terms of contributions from Banner Oak are roughly in the ballpark of what the annualization of what we've seen so far. Question number four, Aether appears to be doing well with the new fund heading towards a good closing. Has the firm been reenergized do you expect future funds? And the seed fund Aether is working on is very important to the business because it represents a departure from their old flagship style funds, and it offers the firm a higher capacity strategy. Having a first close of USD 70 million was a major milestone for the firm. At this point, it all comes down to how much success they can have raising additional capital for the fund. As you might expect, this is the primary focus of the firm at this time. Question number five had to do with Carlisle. Carlisle's value has increased substantially yet its fund has not moved materially and its discount rate appear to have increased. This suggests that you expect their fundraises to be quite successful. Is that an unreasonable interpretation? Our forecast for Carlisle did not change significantly. About 1/3 of the 27% increase in valuation is just currency related and unrelated to business performance. In U.S. dollars, the value went from USD 44.1 million to USD 51.9 million, so not that dramatic. The discount rate actually that we used for Carlisle, actually dropped about 70 to 80 basis points due to the greater portion of their asset base that is now in longer locked-up vehicles. Most of the increase in the value stems from an increase in forecasted carried interest in the out years of the financial model. Question number six, I'm struggling with the potential significance of distribution from Northern Lights IFP and the start date. Would it be reasonable to assume that in aggregate, they approach Tier 1 status? Last year, the collection of these were probably slightly negative. And NLAA was a positive contributor and IFP were -- start date were loss making. This year, we expect all 3 to be profitable as they are all moving in the right direction. I don't think they will collectively contribute what a Tier 1 manager will this year. But in the best-case scenario, they could reach that on a run rate basis by year-end. It is worth noting that with the start date, there is a lot of operating leverage. So once that flywheel starts to spin, their contributions will grow quite rapidly and they could easily become a Tier 1 contributor on their own. Question seven, the statement that additional value could be recognized through an FY '23 sale of one of the assets is consistent with last year's comments in relation to liquidity. However, at the half year, you said that there is nothing active at the moment but that was a general comment on the market. Am I to interpret this as a general comment? Or do you intend to imply something specific could be contemplated by this comment? And you're right that my comment last year was more general observation. While no liquidity in any investment is certain at this point. my comment is not a general comment either. In other words, I think there is an elevated probability of some liquidity based on various ongoing discussions. As noted in the presentation, while we're not certain of any of this liquidity at this point, if it is achieved, we are highly confident that the valuations would allow us to pay tax on the proceeds and improve earnings through reinvest. I also think that it will validate our contention that the true fair market value for some of our assets can be notably above the book value. Question number eight, the strategy of investing funds using debt to increase earnings is clearly spelt out due -- compare that strategy to increasing earnings per share by buying back shares. When I look at the increased FUM forecast of more FUM raising and hence earnings growth potential, I can't help think EPS could be increased by buying back shares. How do you think about that comparison? That's a good question we often receive. And when it comes to capital management, we certainly look at buying our own stock back, and we do that math exercise and compare it to alternative uses of cash. That said, there are a couple of reasons that reduce the likelihood of this occurring. The first is that everything else equal, we want more shares outstanding since having more liquidity should expand the universe of potential buyers of the stock. The other reason relates to how seldom we are in a position where we don't have material nonpublic information, and thus would feel free to buy back stock. Examples of this would be potential and significant investments that are well advanced that we're looking at. And also, if there -- any of our portfolio companies have advanced discussions about selling all or parts of their firms. And such events are underway, they often go on for many months, which basically means we seldom are in a position to engage in a buyback. We go through that exercise of talking with our General Counsel every reporting period to figure out if we can even open the window for employee trading. And the reality is we've very seldom been able to open that window for employees and Board members to buy stuff. And then the last question, and then we'll get to your questions, is your sentiments around Victory Park are quite positive. Having written down the investment earlier, why are you so bullish now? And if you expect them to contribute more than GQG in FY '24, does that mean they are worth more than GQG? And as we've noted previously, our investment in VPC did not get off to a great start and the business contributed less than we expected. However, one of our strongly held views is that if you get the quality of the asset right, there's a good chance you're going to arrive at a positive outcome. And that appears to be what is playing out in Victory Park. Over the last couple of years, VPC has really hit its stride. There is increasing demand for the type of strategy it offers. Their investment performance continues to be excellent. Their distribution strategy has been refined. The most recent fundraise for their ABOC, which is the asset-backed opportunistic credit fund was USD 2.4 billion. We expect that this fund will be fully deployed this fiscal year, and they will be back in market in the second half of this fiscal year, raising another ABOC fund. The firm's growth prospects combined with the visibility we have on performance fees over the next 4 years, make us confident in the likelihood they will become the biggest economic contributor to PAC beginning in FY '24. While value is in the eye of the beholder, I think if they become the largest economic contributor, it would be hard to argue that they are the most valuable asset. So with that, apologize for the length of all that, but hopefully, I answered some people's questions. With that, happy to address any questions people have.

[Operator Instructions] Your first question comes from Nic Burgess from Ord Minnett.

Paul, thanks for that additional detail over the last few minutes. That's been helpful. A few questions. Firstly, just on the flow guidance, so $3 billion to $5 billion over the next 12 months or in FY '23. So in the fourth quarter of '22, you mentioned $1.3 billion of flows that weren't recognized in that fourth quarter and would roll over into the first quarter of '23. So does that 3% to 5% include or exclude that $1.3 billion that you called out previously?

Yes, that's a great question. I guess that would be kind of cheating a bit. But no, that excludes that.

Right. Okay, excludes the $1.3 billion. Okay. Secondly, just the line of credit, can you give us a sense of the potential quantum of the line of credit that you're after?

Yes. We're looking for a credit facility of up to USD 50 million.

Okay. And lastly, just the boutique in the underlying P&L, the boutique unrealized mark-to-market, can you just explain again in a bit more detail what that is and which boutiques that comes from?

Yes. In the past -- yes, happy to do that. Basically, some of our boutiques and -- is primarily frankly, Victory Park, their balance sheet has been growing, their corporate balance sheet, which is actually sort of in one sense, an undisclosed asset that we have is our pro rata share of that balance sheet. But that is -- there's a couple of other, I think, companies where we have some exposure to balance sheet, but that primarily sits at Victory Park. And a lot of that was PAC-related that decline. And now -- and a lot of the strong performance fees they achieved in the first half of the year were crystallized in their listed vehicle, and that's where they actually benefited as a result of those facts.

Okay. So I guess my question is, if we think about 12 months ago, why was the benefit in that year described as a management fee? And I guess the second question is, how are you going to disclose them moving forward?

Yes. Well, it's a good question. I mean I think we've always defined management fees if you look in, I think, in our dictionary, a little glossary there is sort of everything nonperformance fees. But we realize that going forward, we'll just break them out like we did this time, and so you'll have very explicit detail around that.

Your next question comes from Gabe Neri from River Capital.

Congrats on the result. Just a few from me. Firstly, on some of your assets, Blackcrane looks to have had a pretty bad year and written down to 0. It just seems surprising that's happened just quickly. And last year, you guys were positive on it. Talk to what went wrong [Technical Difficulty] if there are any other [Technical Difficulty] and risk.

Yes. Their performance last year was exceptionally difficult. And they had -- their client base was large -- a small concentrated institutional client base. And so the loss of 2 or 3 big account sort of is what you're seeing impact there. And the prior year had the -- the performance has been very good. So it was but it was -- last year it was sufficiently rough, but it sort of precipitated that.

And on CAMG, still failed to raise any FUM despite a big boom in infrastructure globally. Can you talk to that?

Yes. Sure. So that is CAMG as you know a start-up private infrastructure manager than trying to get lift off here for several years. What I'd say is that they obviously haven't achieved that yet. They still have a decent chance of pulling it off. And I think we'll know in this half, if they are able to do that. And we should -- I should say, we -- I don't think we have any additional capital commitments to them. So I don't think -- I'm pretty sure I'm right on that.

Great. And then on Nereus, do you have a sense of how much this will actually cost us? Seems every year, there's another provision, and I'm hoping we must be near the end?

Yes, I think we are near the end. We think that what we have provisioned for -- we think there'll be -- will ultimately be about the right number. I think the -- how the timing of the cash flows there will be a little complexity to it, but we think at the end of the day, what we've provisioned will be about what it will cost us in cash.

Okay. And then just on your asset valuations. Can we get some color around the movement in discount rates?

Yes. I mean in what sense?

Just trying to unpack the changes in valuations and if you've seen on discount rates increase across a couple of them or what's…

Yes, that's a great question. I think I'm going to call on Ashley, who's on the phone. I think in general, we have seen them tick up a little bit, although in some cases, like I mentioned with Carlisle, the specific component was actually declining. Ashley, is that…

Yes. Rather than getting into a 20-minute conversation about how we see our cost of capital, I think you hit the nail on the head. Generally speaking, the cost of capital have risen over the period across the board, but specific boutiques had some -- sorry?

Apart from Carlisle, there's nothing particular to call out that you've seen a significant increase in discount rate?

Yes. Basically, Carlisle is a great example and that there's been a transition away from the open-end fund to the closed-end funds, but would be underlying changes in operational that have seen a changing discount rate more than risk as such.

Perfect. And then just on FX, you guys are enjoying a nice tailwind there. Do you have a sense of what EPS would have looked like on a constant currency basis?

I think -- I mean, I think it's probably the best and I actually might have some thoughts on that, but I think the best way to look at that is on the -- it's not entirely perfect, but on the -- I think it's Page 4, the -- where we break things out in U.S. dollars because most of our revenues and costs are U.S. dollars.

Down in the appendix 24, Page 24, which is an USD 8 in U.S. dollar profit losses. So from the impact, the bottom line, you can see, it was reasonably flat, a little you've got.

Okay. I'll have to look at that. And then last one for me on corporate costs in FY '23. How much of the [Technical Difficulty] will flow through the P&L in '23? And can you just give us an expectation of how we should be thinking about corporate costs this year?