Arrow Global - Maligned and Misunderstood or heading for a fall?

Friday, Nov 09 2018 by
6

Arrow Global (LON:ARW) had their capital markets day on Wed 8th November.

The presentations and material given are available here:https://fotwlive.videosync.fi/2018-11-08-arrow-cmd-2018?seek=5293

Beware it was a half day and there's 115 slides in the pack. I am not sure how long this will be available for.

It is clear that this is the start of the company's response to the fact that it has recently become quite heavily shorted.

I just thought I would put it out there for interested PI's.

I am a holder, and I went in person because I wanted a deep dive to help me decide the fate of this investment, and to see the management team in action. For what it's worth, I was deeply impressed. To the extent that the short interest gave me serious concerns, these have been substantially allayed. I hope the company makes efforts to communicate a bit more with the PI community.

DYOR could not be more appropriate here. If the short interest fizzles out or is the subject of a squeeze, there could be a swift and significant rerating. If the short case has merit, investors capital will diminish, possibly substantially!

Thoughts, comment and debate welcome!

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Arrow Global Group Plc is a United Kingdom-based company engaged in purchase, collection and servicing of non-performing loans. The Company identifies, acquires and manages secured and unsecured defaulted loan portfolios from financial institutions, such as banks and credit card companies, as well as retail chains, student loans, motor credit, telecommunication firms and utility companies. The Company's business activities can be divided into three broad phases: Origination and underwriting, Asset management and Repayment-hybrid collections mode. The Company purchases debt at a discount from its face value and use its knowledge in data, analytics, collections, and asset resolution to help establish repayment plans and settlements with its customers. It advises and manages debt portfolios. more »

LSE Price
206.8p
Change
-1.5%
Mkt Cap (£m)
365.7
P/E (fwd)
5.1
Yield (fwd)
7.1



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24 Posts on this Thread show/hide all

mojomogoz 9th Nov '18 6 of 24
4

Hello Frederick, all

Anyone got hold of a short thesis on Arrow Global (LON:ARW) ?

I've no idea if this is a good or a bad company. I like a bit of controversy and the dissonance it brings and in the past I have been willing to go long heavily shorted stocks as if you can see its not a zero, massive dilution and has a future then there is a chance to make good returns if you can stomach the volatility.

That said, Arrow has some interesting and serious short sellers playing against it:

https://www.shorttracker.co.uk/company/GB00BDGTXM47/

IMO Bybrook, CPMG (Cardinal of Rusty Rose fame from Dallas), Naya, Portsea and Thunderbird are serious short selling foes. They may be wrong or near their target but these are guys that will have made a serious commitment to understanding the case. The other guys are little bit more run it by the numbers IMO and run big low commitment portfolios.

Bybrook is the most interesting as its actually a credit fund (an absolute value credit manager in their words which means they will short as well as long). It'd be interesting to know whether they are just short the equity based on it being the place they can leverage a credit view most or whether they are long the debt and short the equity as an event driven debt and financing covenant driven play.

I'm going to try and look at this if I have time as this is the sort of thing that has frisson and optionality around it. Instinct and past experience tells me that all the short sellers above are awaiting an event that has not yet transpired so to hold the stock got to find the event...and that means that there is likely still negative event surprise ahead. Given the low valuation and the fact that these short sellers are still holding (recently increasing) suggests to me that the price is going to find more meaningful downside action in the near-ish term rather than breakout to the positive so if you like this company longer term you can get a better moment to either buy or top up.

I'm very interested in any further info or views...

Best wishes
Paul

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LovelyLovelyGorgeous 9th Nov '18 7 of 24

I think that is a great company. Basically it buys packages of debt very cheaply and then recovers more than they paid for it. This entails making a spread between their borrowing costs and what they recover. The company also manage defaulted portfolios for others and so get a management fee. They aim to increase this side of the business to 50% of revenue.

I too struggle to work out what the Bears see.

Train about to arrive at station so apologies for rambling and any lack of clear explanation.

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LovelyLovelyGorgeous 9th Nov '18 8 of 24
1

In reply to post #417454

I think that there is a large supply of debt out there. Banks around the world are being forced to clean up their balance sheets and meet capital adequacy requirements. It makes sense for them to package up the debts and sell them to a specialist debt collector. A number of companies like Arrow Global (LON:ARW) have referenced this in results and presentations.

I'm not sure that the debt sellers use a great deal of effort to recover bad debts other than to send out threatening letters. I think most companies pass over debts to specialised debt collectors relatively quickly. When I worked in the lending team of Barclays many years ago we would write off the debt at branch level and pass it on to the collection agency. We rarely knew what success they had.

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LovelyLovelyGorgeous 9th Nov '18 9 of 24
1

In reply to post #417469

The level of debt employed is the "raw material" used by Arrow Global (LON:ARW) to earn profits. It borrows cheaply, buys defaulted debt cheaply and uses the repayments to repay its own borrowings, interest and all the other costs of running the business. Hence a key check is to see how much interest cover on the debt there is, what the average cost of debt is and when it has to be repaid / refinanced.

I think the co said that they have pretty much finished the acquisition stage of the business and were intending to grow organically. They have said that their leverage ratio would be between 3 and 3.5 times going forward, so we need to keep an eye on that.

The acquisitions have diversified the risk of an economic downturn in any one country having a critical impact on cashflows. Increasing the Asset Management Business which they intend to grow to 50% of the business should further diversify risk.

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LovelyLovelyGorgeous 9th Nov '18 10 of 24
1

Last post, I promise. By way of background I have worked for the last 30 years in the legal teams of banks investing in defaulted emerging market debt. I was responsible for drafting up and executing the legal paperwork required to transfer debts and to collect repayments of principal and interest on what we owned. In each of the four banks Emerging Markets was the biggest profit centre of the organisation.

If anyone wants a simple explanation on how to make money by buying defaulted debt let me know and I'll post something.

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mmarkkj777 9th Nov '18 11 of 24

In reply to post #417639

Hi LLG,

With your banking background, at what level of debt would you feel the lenders would start to get twitchy? As a small PI, I don't like to invest in small(ish) companies with high debt levels (better 0 for me), but 3x earnings as a rule of thumb max.

However, I realise their business model is buying bad debt heavily discounted paid for by debt at a good commercial price. But their debt is approx 20x earnings and its been growing at 100M per year. Maybe this is the red flag that some bears have spotted. Are they close to the covenant levels (perhaps)? Or maybe having trouble getting it in as economically as they thought (I honestly don't know), but with those debt levels I'm not really interested in investing (now), or doing the further research necessary, but will keep an eye out.

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mmarkkj777 9th Nov '18 11 of 24

In reply to post #417639

Hi LLG,

With your banking background, at what level of debt would you feel the lenders would start to get twitchy? As a small PI, I don't like to invest in small(ish) companies with high debt levels (better 0 for me), but 3x earnings as a rule of thumb max.

However, I realise their business model is buying bad debt heavily discounted paid for by debt at a good commercial price. But their debt is approx 20x earnings and its been growing at 100M per year. Maybe this is the red flag that some bears have spotted. Are they close to the covenant levels (perhaps)? Or maybe having trouble getting it in as economically as they thought (I honestly don't know), but with those debt levels I'm not really interested in investing (now), or doing the further research necessary, but will keep an eye out.

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mojomogoz 9th Nov '18 12 of 24

In reply to post #417639

Do you own it LLG?

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LovelyLovelyGorgeous 10th Nov '18 13 of 24
1

Lol - I do have a holding but do not own the company

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LovelyLovelyGorgeous 10th Nov '18 14 of 24

In reply to post #417649

Sorry, I have no idea on lending levels.

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fredericktug 12th Nov '18 15 of 24

In reply to post #417519

Hi mojomogos,

As I was at the capital markets day I did ask around during lunch if anyone was aware of a published bear case, from any of the short sellers but no one was aware of any. Several suggested that it may be just a way to take a bearish view in general credit conditions by proxy. There must be better ways to do this though than to go short Arrow Global (LON:ARW). Meanwhile the short interest grows by the week so this is shaping up to be a real tussle.

Mark

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Howard Marx 12th Nov '18 16 of 24
2

Share prices tend to move in the same direction as consensus expectations of company profitability.

Analysts of Arrow Global (LON:ARW) have been persistently less optimistic in the last 12 months:

5be958d922deaARROW.jpg

The share price of Arrow Global (LON:ARW) will no doubt improve as and when when this trend of downgrades reverses.

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mojomogoz 12th Nov '18 17 of 24
1

In reply to post #418034

Hi Mark. Interesting. My guess is that the companies shorting it must have a specific case beyond a generalised credit view as they are taking a fairly chunky positions. Some of the bigger hedge funds that are listed as significant shorters will be a bit more paint by the numbers but the smaller guys are likely to see an issue. All a guess with no specific insight from me. An interesting situation and worth looking at to see if there's an opportunity.

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jwebster 13th Feb 18 of 24
1

The bull case for ARW
1. Cheap, forward PE 4.29
2. Dividend yield 6.73%
3. Experienced mgt team, last update positive
4. Diversifying earnings into contingent work
5. Mgt team insider buying last May

The bear case
1. Shorts at 11.89% today, second highest in the UK
2. Italy going into recession and risk consumers don't make their repayments

It's a tough call, but shorts can be wrong too, they have a habit of shorting leveraged sub-prime companies in the hope something goes bang.

I've bought a few on spec. If ARW make a couple of dividend payments this year, it could shake out.

Next earnings report is 28 Feb - not far away

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Matthew Hadden 13th Feb 19 of 24
1

In reply to post #446728

Hi jwebster,

I'm new here and still working it all out.... But I share your interest with Arrow Global (LON:ARW).

For the bulls, I'd also add in that they appear to have maintained a healthy profit, even if growth has become less even.

For the bears, I'm confused over the debt / cash situation over the past 12 months - might not be a problem but I don't like not understanding!

The technical view is also improving so I'm watching closely to see if this base continues to form.

Matt

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arome1981 14th Feb 21 of 24
2

This is the article in the above link.

JUNE 22, 2018 Print this page31
Hedge funds are stepping up bets against European debt collectors, arguing that opaque balance sheets are masking headwinds for companies that chase down consumers’ unpaid loans and were until recently a favourite of investors.

The debt collection industry has grown rapidly since the eurozone debt crisis, as the continent’s banks find ways to offload bad debts they previously held on their books. The new breed of firms, including the UK’s Arrow Global and Sweden’s Intrum Justitia are often called “debt purchasers”, as they buy defaulted loans for pennies on the dollar and then look to profit by pursuing the delinquent borrowers themselves.

As competition to buy the bad loans has squeezed the industry’s returns, short sellers have raised questions about the debt purchasers’ complex balance sheets. Funds including Bybrook Capital and Naya Capital argue these companies present overly optimistic forecasts of how much debt they will recover, without providing enough transparency on how much it costs to collect.

This is concealing an overheated market, the funds argue, which could leave companies struggling with the substantial debts they have taken on to fund their growth. Debt purchasers in the UK alone have raised £5.5bn of junk bonds since 2012, taking advantage of easy credit conditions in the high-yield debt market.

“You can’t get away from the fact that returns have been falling” across the industry, said Gary Greenwood, an analyst at Shore Capital. Mr Greenwood still has a “buy” rating on Arrow Global, which sponsors the broker for its research, and blames “irrational behaviour” by the group’s competitors for driving up the price of risky loan books.

Five hedge funds have now disclosed short positions in Arrow Global, hoping to profit from a fall in the share price of London’s largest listed debt collector, whose stock touched a record high in August 2017 having surged 164 per cent in the prior 12 months. The Manchester-based company, which employs nearly 1,500 people, has seen its share price tumble more than 36 per cent this year, leaving it with a market capitalisation of £443m.

More than 11 per cent of Arrow’s free float is now on loan to short sellers, according to Markit data, the highest level since its initial public offering in 2013. In Sweden, Intrum Justitia, whose shares rose more than 200 per cent between 2013 and their peak in May 2017, is seeing 23 per cent of its available stock shorted, while its smaller rival Hoist Finance has 7 per cent.

Bybrook Capital, a hedge fund backed by private equity firm Blackstone, was the first investor to disclose a short position in Arrow Global’s stock in September. “We think Arrow and Intrum Justitia have no equity value,” the distressed debt specialist wrote in an October presentation. Hedge funds Naya Capital, Thunderbird Partners, Portsea Asset Management and Polar Capital have now also disclosed short positions.

Research firm The Analyst gave Arrow Global a “short” recommendation and price target of zero when it starting covering the company last month. The independent firm has developed a reputation for spotting short opportunities, having published recommendations to sell Steinhoff and Carillion shares ahead of their stock market collapses.

However, the debt collectors say that their financial reporting is sound and that the funds betting against them have misunderstood the dynamics of the industry.

“The cynics would have you believe that we have something to hide,” said Thomas Moss, chief financial officer at Intrum Justitia, which has a market value of $3.2bn. “Absolutely not”.

Lee Rochford, chief executive of Arrow Global, dismissed the logic behind the short positions as “misleading or drawing the wrong conclusion” and insisted that investors are undervaluing the group.

Yet both companies’ executives conceded they could do more to address transparency concerns. Arrow will provide more detail in the second half of the year, said Mr Rochford, while Mr Moss said the sector “can and should do more”. Although the debt collectors disclose little about how much they are buying the bad loans for, Mr Rochford says that “on average returns are lower. That’s well known in the market.”

Indeed, a bond investor, who is bullish on debt purchasers, said companies in the sector had “consistent, predictable cash flows”. They valued the businesses for their “ability to carry on buying debt that is accretive to its value,” the investor added.

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The US has been home to an industry built around collecting consumer debts for much longer than Europe, and Kevin Stevenson, chief executive of PRA, a US-based debt collector with extensive operations in Europe, said earlier this month that “you’re starting to see the cracks in the market” as he referred to “cash flow issues” at some European competitors.

European loan portfolios are being sold at “escalated” and “irrational” prices, putting stress on the competing buyers, Mr Stevenson told investors.

Away from the publicly listed debt collectors, a number of funds are also betting against debt of the privately held companies, either short selling their bonds or buying credit-default swaps. Bybrook Capital has been shorting the sector through the debt markets for much longer than its publicly disclosed position in Arrow Global’s equity, according to people familiar with the matter.

Several bond investors said the UK’s Lowell Group is under focus for its high levels of leverage. When the company first tapped the bond market in 2012, it reported a 56 per cent loan-to-value ratio, a measure of how much debt it has relative to the amount of money it expects to collect in the next seven years. By the same measure, the company now has 88 per cent leverage, suggesting that its assets now only just cover its debts.

A spokesperson for Lowell said that investors should not be concerned about the increase in leverage, as the company is “a more diversified business today”.

“It’s difficult — I agree with the short thesis, but I just don’t see a catalyst yet,” said one bond investor of the sector. “If you go all-in short the sector it could cost you a lot of money, as this could carry on for many years.”

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jwebster 15th Feb 22 of 24
1

Yes, have read this article from the FT
I agree with the two points:

1. debt buyers balance sheets are opaque, yes this is true. The problem is debt buyers purchase tranches of debt which then have individual run off curves for cash collected, collections costs and funding costs. ARW et al do not disclose this data by tranche, rather just show high level averages, so us investors can't see how individual tranches are doing and thus cant see if things are getting better worse on more recent buys, or see a detailed analysis of predicted versus actual over time by tranche

2. yes, some debt buyers could have paid too much for European debt (I don't know either way), driven by low cost of debt and excessive hunting for yield

But, the mgt team at ARW (any any debt purchaser for that matter) have reams of detailed MIS reports on all their purchases, so they will know if any problems are surfacing or not. To date they have not disclosed any issues as such.

Therefore the bull case is essentially you trust ARW mgt to run a good business and any problems in the industry (if they surface) will be elsewhere. I note ARW mgt actually listed quite a lot of detailed charts in their last presentation, the video is on line, you should watch it.

The bear case is the whole industry chased yield too hard, over paid for European debt, and given their highly leveraged positions, profits will evaporate, you just can't see the miss yet on published high level P&L figures. Also, Europe is heading into a slowdown, the numbers for Germany and Italy were poor recently.

That's they way I read it! Not straightforward I know. Investing in the second highest shorted stock in the UK is not without caution.

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fredericktug 27th Feb 23 of 24
1

Eyes down - FY results tomorrow, you can watch a webcast of the analysts session at 9.30: https://fotwlive.videosync.fi/2019-02-28-arrow-global-group

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fredericktug 12th Mar 24 of 24
2

If anyone is interested - the short interest has recently come off a bit. the SP is now above the 50 day MA, which itself is turning up. I am not well educated at all when it comes to charts - anyone with any thoughts. If the short interest seriously unwinds, I am wondering if this could be the catalyst to a re-rating - but then again I am a believer in the stock generally, and on fundamentals.

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