1pm: Bad or late lunch?

2nd Mar '19 by mojomogoz

16 comments 2432 reads

I would really like to hear what's wrong with this stock. Why does it deserve to be in the doghouse? If you're bearish on it share your view with me as I'd like to understand what I'm missing and perhaps save myself from hubris.

This is not the most exciting company in the world but at this price I think it is really stand out in terms of valuation given decent organic growth, high margins and good record with bolt on of acquisitions making them perform well synergistically.

What follows is not an analysis of the company but my view on why there is a severe misperception. I've skipped the analysis from a valuation perspective as at 5.5x historic earnings, 26% operating margin and looking like at least 10% earnings growth trajectory (that is probably far too conservative over a few year horizon) there's got to be something very wrong or limiting about the company and/or environment to justify price.

I bought a position in specialist lender 1pm (LON:OPM) in late 2018 when the share price headed to 40p....and I went back and filled my boots to near brimming today at 41-42p as it swooned down after touching 50p ish in last few months. Bid-offer can be wide as only £40m market cap and not loved. At today's closing bid of 42p I'm 5% underwater all in.

Despite this being quite illiquid trade by appointment sort of stock I am willing to fill my boots to brim over if the share price carries on down from here. Severely negative and imminent news is needed to justify the current price....that doesn't mean that it won't stay or go below this price and of course I do not know what future news may emerge.

IMO there's a confluence of factors pushing down the price despite the evidence of good performance. A summary of headwinds and my reasoning on why they are not worries:

Bad debt cycle or Brexit 1: There's a concern of increase in non payment and bad debts. Concern that Brexit could blow up things is something to price into investments. However, at this valuation (approx 6x historic) and with double than normal bad debt reserving ( £2.4 bad loan reserve representing 38% of 2018's £6.4m net profit) investors would be better to weight their concerns somewhere else such as in…

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Mojomogoz

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16 comments

AnonymousUser605348

2nd Mar '19

Price to free cash flow is absolutely dreadful... And given the risk of default of micro cap financials, you're not exactly getting paid huge sums to assume the risk. 2.4% dividend? Price-to-TangibleBook not great either, again given it's in financials. Where's the "backstop" if speculators have a pop at this stock? There isn't one really...

mojomogoz

2nd Mar '19

Cash flow lags business growth due to way accounted for / generated. There is a degree of natural break on too high growth for that reason (ie the 30%+ territory). They broke on the riskiest loans rather than take them on book...I suspect this is also a way of letting high growth happen where they get to book some profit (less from broking but its immediate cash flow so can recycle back into growth). So, at the moment, they've got a large amount of future booked (I think something like half market cap or more but need to look back into accounts for figure and will do later) waiting to be turned into cash in future which occurs unless they have high rates of default.

Why is there a generalised chance of default? What's the mechanism in this case? Of course it can happen but what's a high chance?

Board has promised a 30%pa dividend growth for next 3 years. I don't think the big shareholders were so keen on this but mgt keen as they want to hit remuneration targets based on getting the share price up to high double and triple digits. So they want to play to the investor crowd.

What relevance speculators having a pop? The ability to short sell this share is super low. Who shorts a stock just based on it being a micro cap financial? Particularly if its cheap, has earnings growth and very high margins? So your last comment only has some reality to it if you can see a fundamental business model problem and/or a hole in the balance sheet.

Overall, you've made my case quite beautifully...if there's enough like you then I probably will get indigestion ;)

AnonymousUser605348

2nd Mar '19

The question you asked was "Views?".

It's my view that small financials that have poor cash flow are at higher risk of default than say large non financials with great cash flow.

I hope it ends up being a winner for you.

Thanks.

mojomogoz

2nd Mar '19

Errr, exactly....thanks for the view and the best wishes...

What you state that small cap with poor cash flow (financial or not) have a higher risk of default than large caps with great cash flow isn't news though. Right?

1pm (LON:OPM) is of course a financial but there are many types of small financials, some of them become bigger. Perhaps your rule applies better to tech, biotech, small retailers, etc. 1pm's business is rather dull and simple and driven by network. A lot of lending is also asset backed with providers of funds given direct security over assets and so 1pm effectlvely not taking balance sheet risk but getting a high broking commission in the middle. Its really quite dull...but nice high margin with visible cash flows in the pipe.

I have given you some factual and informed responses as is the point of discussion.

Next time I'll ask your permission before I respond. Okay? ;)

gus 1065

2nd Mar '19

Hi mojomogoz.

If you’re interested, here’s a link to an old thread on 1pm (LON:OPM) from May 2017 when the bull and bear case for the stock was discussed.

https://www.stockopedia.com/content/opm-fundraising-for-acquisitions-the-cycle-repeats-at-lower-levels-189359/?comment=1#1

Gus.

AnonymousUser605348

2nd Mar '19

There's no need for that man. Sorry if I stepped on your toes okay?

I didn't say you weren't being factual. I didn't argue with you at all! I imagine you do know more than me... I was just giving my opinion. Wish I hadn't.

All the best.

Richard Goodwin

3rd Mar '19

The consumer side attracts criticism for charging 50% interest on friends and family guaranteed loans. Even on R4 Moneybox this morning https://www.bbc.co.uk/programmes/m0002ycr
In 2015 there was management upheaval with the CEO and perhaps CFO replaced and the NEC taking the CEO role. I didn't study it closely but I got the impression there was a lot of politics around it.
Other than that you are probably right, someone is selling into a thin market.

mojomogoz

3rd Mar '19

My apologies if seeming snarky. I know something about 1pm...I may know it badly and have misinterpreted. I am well aware that by implication the market and other investors think I am wrong and acutely aware that taking a position may just be hubristic of me.

I responded to you without a thank you as you gave me generalised comment against my more specific and implied that I didn't know it was risky and might lose money (I have scars). I often invest a bit contrarily looking for situation where I think there is a big misperception. This goes badly wrong at times. My return profile is not smooth and with the market or crowd. I always worry I am being stupid.

Whilst you weren't seeking to patronise you implicitly did. I wasn't really worried about that and just saw it as part of the "bants" of the site....however, given I'd taken the time to write a semi-informed (perhaps wholly misinterpreted) piece I felt I should rebut yours generalised bants with some specifics. That seems to be the point of a discussion page.

Please feel free to comment on anything I post in future. You're comment will be welcome.

Best wishes

mojo

mojomogoz

3rd Mar '19

Thanks Gus

I did read the Dearg Doom pieces. They are good. The last one you gave a link to is spot on in that the mgt have been empire building and using equity issuance to do it. Despite the fact that the financials seem to show they have acquired and integrated well creating additional eps the stock fell into a value trap vibe. This is understandable.

What's changed? In link to interview in my piece the CEO says they want to grow their lending book to £350m over the next few years through organic and inorganic growth. Given this is c.£200m increase they will definitely need inorganic/acquisitions to do it. So that's a signal that there will be more dilution to come. However....

CEO does state that the share price/valuation needs to be higher before doing that. If he is true to his word that means no equity issuance for a few points of valuation upside.

Obviously, taking a CEO at his word about his empire is a risky game. Something more profound changed around the last full year results. On 5 June LTIP incentive plan linked wholly to share price performance was introduced. 7,900,000 shares awarded between 60 and 110p proportionately.

This LTIP happened before I bought shares late 2018. My initial thought when I read it researching the company was "you cheeky bar stewards" as its a fairly hefty reward and they had sat on investors to build their empire and now they have they are looking to take a hefty chunk out of them too. Then, on reflection, I felt it was a very strong signal about change of focus and a catalyst to put the value trap days behind them. From 40p, 60p is 50% and really they want to aim as high as they can. This is a very meaningful incentive not to dilute.

CEO is paid £200k, CFO £140k and COO £160k. In the scheme of things not egregious. Its probable that they are not very wealthy fat cats. The LTIP has the potential to deliver a life changing amount.

Imagine with some growth they get their p/e to 9 times (more typical of broad sector). That's probably roughly a double in current share price to c.85p. They are half in the money with the LTIP but the other half to play for. The judgement around making an acquisition will be acute and a real balance between long term value creation and short term share performance will be in their minds.

The above is probably the key fact that triggered me to buy. I felt it was clear signal that priorities had changed.

Best wishes
mojo

mojomogoz

3rd Mar '19

Hi Richard

Amigo is not part of 1pm I was just using them versus Barclays as two well known names to illustrate that not all credit the same.

Personally, I view guarantor loans to be immoral and much more exploitative than something like a payday loan. I have quite high knowledge of consumer lending as I founded a business a few years back seeking to use a very different tech and networks driven approach of lending to individual non prime consumers (so achieving an APR more like a credit card than the 1500% plus of others). The FCA confused our network with a guarantor loan initially but really the whole focus of the networks we created (like mini and lite cooperatives) was to introduced a feeling of stigma into the lending decision rather than have it all impersonal and sleek automated.

To become authorised was a massive fight with the FCA who were frankly freaked out by our unique approach and worried about the "harm" we might do to customers (despite being massively cheaper and not selling on any bad loans and providing pretty easy forgiveness). I did the whole negotiation with the FCA becoming expert in their regulation and associated legislation. Eventually I won.

Their rules and their interpretation of them are bizarre and they had a total blindspot to guarantor loans.

Best wishes
mojo

mojomogoz

3rd Mar '19

Hi again Gus

All good points in your linked response to earlier 1pm (LON:OPM) post. I accept the risks you identify are real. Here are my responses:

Risk 1: Major credit event with one of their customer

Their customer base is very diversified with no one customer greater than 1% of book. Bad loan reserve of £2.4m accommodates some cyclical and some customer specific risks. In 2008 they were very amateur underwriters and really acted as brokers seeking risk. This hurt them 2009 thro 2011 as bad loans surfaced. Dumbly, they were very active taking on business during this period as customers were, unsurprisingly, hungry for them. Things have changed since then. The last CEO really focused on improving the risk management and recovery process. At the moment they are being cautious on lending given the macro...I need to dig a bit or ask mgt but I think they are broking on a larger portion of loans than they perhaps could so as to avoid balance sheet risk (but collect the commission and have the customer relationship). So it seems they are being conservative.

Risk 2:Wholesale funding

This is a weakness relative to a bank in some regards but as I tried to say above it also has some advantages. 1pm's clients are non-prime. That means that 1pm get to charge them a relatively high rate. By comparison those with their own balance sheet must lend much more to prime customers which means lower rates. Compare 1pm with PCF (LON:PCF) as a relevant comparator in this regard - both make their profit on spread of cost of funding versus rare received on loans made. PCF's spread will be lower than 1pm's (I need to look and work out how much). In PCF's case they effectively create more internal leverage to multiple that spread to get to their current peak margin of 20%. Whereas with 1pm the current lowish margins of 26% are coming more from lending spread than leverage. Its not a like for like comparison really as 1pm don't have balance sheet leverage like a bank but a spread between receivables and payables (currently £25m representing expected cash flows over coming couple of years - earnings created ahead of cash flows).

Cost of funding for 1pm is 4%. That's relatively low. PCF are offering notice savings accounts at approx 1.8% and notice at 2.6% so their cost of funds is somewhere between that. I'm assuming no wholesale funding. They may have it and this will be reduce cost of funding (but brings risk of being pulled like you fear for SME finance cos - its actually more risky than 1pm's if they have wholesale as 1pm's loans are duration matched).

Regulatory requirements limits what PCF can charge their customers and they can't broke on the risky loans like 1pm do. Overall, I think the risks at 1pm are overplayed relative to someone like PCF. PCF are also dealing with bigger customers so more credit risk per customer.

That 1pm are only charged 4% and this rate has been reducing over time suggests that the banks are happy (keen) to lend to them and are biased to having a positive view of their underwriting. In addition, a decent proportion of on book loans at 1pm are asset backed with the providers of funding given security over the asset.

Overall, its not riskless for 1pm but IMO at this stage of the cycle and given relative valuation I think 1pm is better downside risk management. Obvs, if the economy catches fire then there's more upside with someone like PCF that can create balance sheet to meet demand easier and cheaper (they would go to wholesale...perhaps then seek to backfill through deposits but that gets tricky too as seen with many small lenders).

Risk 3: Competition to big banks

I've been in a position whereby big banks have messed with a business of mine on some rather flaky stuff re being competition. Those fears IMO are driven by a fear of disintermediation in part of their business by new approach or technological advantage and they play the game across the spectrum with lots of companies. That said, if your business gets traction and scale then it tends to be the case that one of the big banks wants the business with. Take Wonga as an exmaple of this - it could get very good funding from big banks whilst smaller competitors couldn't even though the banks were afraid that Wonga might become a bank competitor.

1pm is involved in fairly straightforward on the ground lending activities. Things that generally big banks can no longer get to....they've got no interest in giving a plumber a loan for full tooling whereas as this is bread and butter territory for 1pm (and the valuable tools provide security). Funding will always be hard work. Note, that the structure of 1pm lending means that banks cannot pull lending on existing loans so they do not fall into a liquidity crisis (they can of course have credit probs)

I could provide more detail and I will be digging on a number of factors I mention above to back up my view

mojo

jwebster

4th Mar '19

Yes, looks like a cheap stock, for sure. They have form in using acquisitions to grow top line revenue so the stock price is likely held back by the potential dilution.

We are due another global crisis (this is the peak of the credit cycle right now) and remember the key risk last time, i.e. small lenders dependent on wholesale funding found all doors 'closed' regardless of their credit grade. In combination with the loss rates rising (happens with SME lending it's very cyclical) the business falls into loss, covenants are breached, lenders call in their debt etc.

So on that, the first thing I looked for was the term profile of their funding. I can't find it anywhere on the financial statements. The only reference was on their recent webcast the CFO talked about 'a couple of years'. Smart lenders are currently locking in funding for up to six years, knowing they need enough runway to see them through the next downturn. Two years is not enough (if that is their funding profile - I can't actually find it). They could be up for reissue right at the bottom of the cycle, which is potentially life threatening for a small lender.

So, for me, I'll have to pass for now, albeit it's cheap and mgt are making the right comments about organic growth and progressive dividends.

mojomogoz

4th Mar '19

jwebster

Good points.

I have answered acquisition/dilution point above so wont say much here other than management has signalled a change and they have a very meaningful share price based incentive to act differently.

We have too much credit but rather perversely I think we wont have credit crisis mark2 IMO...simply as we cannot let it happen and we have in place a huge number of preventative things to counter a sharp negative shock (for example, see this from BoE particularly pg10 swap line development - https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-paper/2016/stitching-together-the-global-financial-safety-net.pdf?la=en&hash=088E93920A856EF7ADD28244258AF3FFBE4EA7FD )

But we will have credit problem and resolution. I think this will happen through variants of QE (eg QE for the people and things like applied Modern Monetary Theory). From a UK non London small business and regular punter perspective it has already felt tough. Access to credit for a lot of business that 1pm (LON:OPM) service will be low and the customers will be much more cautious about the credit they take on too given 2008.

Pulling of funding is much less likely generally. However, even if this does happen then 1pm are much less vulnerable to it than many others as their on book funding is duration matched with loans (for leases business there's an 85% match). On book also tends to be securitised against asset and recently have reduced their unsecured business lending by 39% (conservative re risk outlook Brexit et al) - this is something I had confirmed direct from mgt as not disclosed in last interim but reported by Cenkos.

Once drawdown funding to lend out it is not callable by funder.

The issue is whether funding dries up for new loans rather than is called on them. This is possible but is an armageddon scenario and 1pm is a reasonably good place to weather in that asset backed loans and good credit underwriting (that could be wrong, its a view) and they will retain their client network and have lots of demand coming through to kick start. Cash rolling in from written loans (receivables minus payable of £25m) keeps things afloat for a while as they ride out.

So, I think 1pm has risk but its risks are much less than priced and its upside quite good....not much good competition in the non prime SME lending space. Good customer are going to repeat and reference.

mojomogoz

4th Mar '19

PS the way their position (regional and small SME) could be undermined is a Labour govt creating meaningful regional investment banks. This would push them up the risk spectrum and reduce their lending spread IMO

jwebster

4th Mar '19

Hi there

Just to drill down a bit further on the specific risk I am worried about (funding). You mention 'Once drawdown funding to lend out it is not callable by funder' is true while the credit facility is open. But all such facilities have an expiry date, by which date 1pm is required to either agree to roll over the facility or arrange a replacement with another funder. As such, all the funding is callable on this date, whether drawn down or not. If 1pm fails on this (as we are in a recession and liquidity dries up) then the creditor can place 1pm into receivership and call in administrators to run off 1pm loans to recover their amounts due.

Now, I'm not saying this will happen. What I am saying this is a standard balance sheet risk to tick off before investing in a lender. Normally, small lenders release a debt profile histogram, so investors can see the redemption profile.

I personally can't find this data, hence flagging this risk, but would love to see it anyone has a link.

mojomogoz

4th Mar '19

Hi again jwebster

Great points again. Thank you for your POV and challenging mine. Look, you may very well be right that what you point out makes 1pm (LON:OPM) no go due to catastrophe risk.

I don't think I will convince you that 1pm is at good point to invest but I have given you responses below. Tell me where I am missing the point (I might be!).

Debt profile:

I'm going to ask the CFO re debt profile information and see what I get (CEO and CFO have been reasonably forthcoming in the past). I'll report back with those specifics when I have them. I know and appreciate there is risk in this as they need to scramble around for their funding not being a bank. I believe this risk is very overplayed due to memories of last cycle and events (I have put in comment at the bottom with thoughts)

IMO not being a bank in this SME space has some key advantages that I believe are particularly pertinent at this point in economic cycle/event horizon. Mainly its to do with systemic mispricing of credit risk and escaping the need to wear risk as the regulator prescribes. 1pm are 100% outside of this game from a lending perspective. They get to set the price whereas banks must stay within certain parameters as dictated by their need to make the regulatory risk weighting of their balance sheets acceptable. Its a complex game that means that banks inevitably have very strong macro risk feedbacks. They only escape this if they really do individually underwrite each risk. Hardly anyone does this (Handlesbanken was just about the last bank of scale in Europe that operated with risk decision making fully at the discretion of each branch and bank manager which is why it survived credit crisis that sunk others in Nordic area).

In addition, as bank credit providers cannot lend to non prime very small SMEs at a rate that underwrites the risk (or pays the cost of doing the work to underwrite the risk which is actually a large part of why many customers are labelled non prime and higher risk rather than the actual risk dynamics) they will just not lend. That these institutions then give funding to 1pm at 4% indicates that they believe the risk is not high and non prime. 1pm have themselves a nice sort of regulatory arbitrage going on.

The above does not make 1pm foolproof but means that it can manage its cycle idiosyncratically through risk underwriting in a way that others can't (note, this is not dissimilar from how non standard credit in consumer credit makes highly sustainable profits...1pm do not gouge customers like some of the non standard consumer credit stuff...the consumer stuff has suffered from regulatory and political heat). Each risk 1pm underwrites is relatively small with nothing greater than 1% of balance sheet (I think its less but I need to check stat...its low). They are not beholden to big single credits

Callable funding:

I believe each drawdown creates its own duration and it is not the case that the whole of the funding from one source is called on a date. However, the availability of the funding will be negotiated for term so the face a cliff edge on its availability from each funder...but this does not translate to credit risk as credit risk is only created when loaned out and they can't do that if not rolled over if they are matching loans to fund called (as I believe they are doing for most of their business...again a point I will clarify more with them).

Creditor placing into receivership:

This is possible but obviously I think highly unlikely. IMO it is primarily a function much more of credit risk rather than funding risk. Their credits are small and diversified and when on balance sheet tend to be collateral backed. Some funding friction whereby a funder bails on them means they are exposed to what they haven't matched related to that funder in terms of duration of funding and loans. In leasing they say they have 85% duration match for example. At this point they need to get a bit of new funding....this seems possible but probably at penalised rate so they eat their profit and take an earnings write down but do not experience negative cash flow event (they just don't get the cash they thought). They lose the ability to write future business but they do not face existential risk (plus they still get positive cash flows on other lending)

I think the above is unlikely unless they show themselves to be very bad risk underwriters. The banks are getting a nice fat spread picking up 4% for them with little work. They have no interest in competing with 1pm.

Now I need to do some work and make sure my knowledge is up with my comments as to some extent I'm relying on old memory from reading through accounts and other material (from their late Noughties IPO onwards....a drastically different business from then). There's been a lot of moving pieces and I need to make sure they are settled correct in my (messy!) head.

I hope the above provide partial answer and perhaps why I see the risk differently. Excuse my long windedness.

Yours
mojo

RELATED ASIDE TO THIS DISCUSSION:

Are we in a regular cycle? Personally I don't think we have really been in a cycle in the West since 2008 but a rather extended ongoing event and it will continue on for the next decade with something akin to a modern version of a debt jubilee taking place or the collapse of Western civilisation as the affluent and liberal thing we know it to be. I think self interest and fear will take us the jubilee route but misstep or stupidity might crash us. I believe all the evidence points to our institutions and increasingly our politicians being fully aware of the risk of not liquifying credit markets. In Corbyn/Labour and emergent Democratic leaders in the US we are seeing this realisation crossing into mainstream politics. In the next downturn and credit stress period we will see a new more potent alternative to counter cyclical Keynesianism kick in under intellectual guise of Modern Monetary Theory. This is a route to large govt backed investment as well as such things as Peoples's QE rather than bankers QE.

Perhaps the most surprising turn of events though will be my belief that Trump will become the first MMT president. He'll do anything to keep things afloat. He has no worry about fiscal orthodoxy as revealed by his massive tax cuts and spending plans. US fiscal deficit is looking like it takes off. He is applying massive pressure to Fed to keep rates down in the 'national interest'. He will readily adopt a position of using govt money creation to make big investments in the US plus the Fed effectively Japanising the US govt balance sheet.

The above may appear a stretch...but the alternative of a massive deflationary credit contraction is just not palatable to modern affluent proletarian societies.

It seems like I've gone off at a massive tangent but my point is I believe it is a mistake to think that the last crisis repeats. That hardly ever happens as we are very attuned to doing what's necessary for it not to happen. This makes me interested in taking some risks in the financial space as risks are misperceived and its much more about whether there is demand for your services than funding concerns or systemic credit crisis. (Note, a credit downturn of sustained nature from here can only be systemic in the West, there is nothing cyclical and normal).

What is the next crisis? IMO its the collapse of the dollar as an international hegemonic currency and the replacement with a more sinocentric system. This will be okay for the US and quite probably the cause of an inflationary boom as, despite fiscal and liability weaknesses, it is a highly functional, diverse and productive economy with a large ability to support itself from a resource pespective. In Europe it will be more mixed. The euro will collapse (it is nothing more than a dollar surrogate as evidenced their reliance on dollar swaps during crisis) and with that event some weaker European countries may enter a down cycle they cannot exact and become failed states.

I could be very wrong. But if I am then taking risk on something else other than 1pm may see you save 20% of your initial capital rather than my big zero :)

1pm: Bad or late lunch?

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Mojomogoz

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