ARW Arrow Global

18th Jun '19 by jwebster

11 comments 1033 reads

Arrow Global (LON:ARW)

Price has had a bit of a jump up to 233p from the lows around 180p

The negative is ARW is the second most shorted stock in the UK at 10.5% although down from a high of 12.45%

Hedgies love shorting these kinds of companies as they run on leverage. Borrow large sums of money, buy charged off consumer debts, collect the cash out over a few years, pay back costs, interest and debt, remainder is profit. Of course, if the sums don't add up and the debt buyer has over-paid, the debt tranche becomes cashflow negative, which creates severe problems. Also if they don't keep buying debt, they develop a nasty cost overhang.

I get the short view but my view on ARW is the management have signalled in their updates quite a few positives, namely:

1. Costs will average down as cohorts age (older are cheaper to collect on)
2. Only recognising 7 years of collections for assets, reality is longer cash flow curve, about to realise the benefit of this with previous purchases
3. Collections 104% of target, liquidation curves look ok
4. Extended the revolving credit facility to 2024 with no change in margin - so long runway on the funding
5. Expanding into contingent work which provides cash flow buffer in the event of a downturn which compromises new debt purchases not providing cover for overheads
6. dividend policy of a pay-out ratio at least 35% of underlying profit after tax

So I think there's enough to see ARW through the current business environment, unlikely in my view they are about to go bust in the near term (excluding a global recession event)

At 233p it's not quite the bargain it was, yield is around 6% today, so hopefully still some value left on the table. Apologies, I should have posted this earlier.

I hold

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mojomogoz

18th Jun '19

I don't have a view on Arrow. I keep meaning to look in more detail as I like to look at stocks that have mature hate against them.

There was recently a chat on short sellers on another thread re Kier (LON:KIE) . IMO Kier has a lack of true deep dive fundamental shorters whereas Arrow does have real fundamentally committed short sellers. Not a reason not to own but a reason to look a bit harder.

FWIW I'm long AA (LON:AA.) the most shorted UK stock. Nervous but optimistic on the upside. Odey can do a good job to short side but depends on which fund and they do put on short term positions too. Ardevora do some good work but they are driven by a surprise narrative with a heavy element of momentum to it. The rest I don't view as real committed short sellers.....so once the Woodford fug passes perhaps they might be covering? Like I said...nervous...AA for sure isn't pure and a short case can be made

fredericktug

The good news is that the short interest seems to be on a downtrend. And if the price continues to rise, I can see the shorts being squeezed a bit. I'm no expert but I think the charts are positive: golden dross a few days ago.

A proper short squeeze could see a scramble to close and a meaningful price spike.

But apart from this, Arrow Global (LON:ARW) stacks up for me on current fundamentals The stockopedia stockrank is steadily climbing and is now 63 (18 June '19. Recent Q1 results were excellent. H1 results due late August.

I've been to their results presentation (after the shorts came in I wanted to take a deeper dive and meet the management) and I found management to be highly credible. They know what they are doing They too were frustrated at the short interest but take the view that they just have on get on and deliver.

I hold too and can see this coming good. In the meantime the dividends keep coming.

Bonitabeach

Arrow Global (LON:ARW)

Between 2013 and 2018 shareholder equity increased from £105.2M to £191.7M.

In the same period Goodwill and Intangibles increased from £3.45M to £307.0M.

I can fully understand why they have attracted the shorts.

No position; but I'd rather be short than long.

jwebster

19th Jun '19

Arrow Global (LON:ARW)

@Bonitabeach

Yes ARW is carrying a lot of goodwill from the acquisitions, recently Portugal and Italy. No question, goodwill must be underpinned by cash flow, otherwise huge write-offs will come. I'm happy with their cash generation, but debt purchasers are a leveraged entity, so if it goes wrong, it really goes wrong.

@ mojomogoz

The short thesis (as I postulate it) is a few years back firms were backing purchasers of European debt. Prices rose chasing yield. There was an industry conference a couple of years back where this was discussed. Since then, the industry has been under question, and I think quite rightly, potentially overpaying for debt.

The Hedgies seek to express this (I think correct) view on the industry via shorting ARW as a large listed company. But (and this is my personal contrarian view) ARW is not the industry and they are disciplined at portfolio valuations and haven't succumbed to chasing yield or volume.

So my hope is ARW continues to generate cash and pay the dividend. Let's see!

AA (LON:AA.)

@ mojomogoz

The AA! I too like to review extreme positions as they can snap back.

Having a look at their last set of results....

Balance sheet:

Gross debt 2.77B average i-rate 4.52%

Cash finance cost was 131m

200m of Class A3 notes come up 31 July 2020, but I note this was 500m as AA have repaid 300m early. This gives them some leeway on the debt runway but should EBITDA drop the covenants will kick in.

Pension deficit of 218m

Carrying 1.17B goodwill on balance sheet

Cash flow:

Operating Cash Flow 258m

131m cash finance costs
82m Capex
24m pension deficit reduction

237m total cash items above

Also paid a small 12m dividend. Probably to keep the income mandate funds on board.

Essentially, at a snapshot, cashflow just covers Capex, interest and some pension deficit reduction. They don’t have any cash to pay down the huge debt overhang. EBITDA is enough to meet net convents so the bond holders haven’t called in. They are a bit trapped here unless can generate revenue growth. But how? Accidents are a fairly mature sector.

I think the AA is one to trade on the charts as a timing bet, if short covering kicks in. The fundamentals look dire still.

@jwebster

AA (LON:AA.) does look dire hence the valuation. To your negatives I would add an earning quality issue due to the extent to which they have historically capitalised software development so inflating profits relative to cash (although there is a capex allowance in covenants). This earnings quality factor no doubt driving some short interest....but my view is that it is not a killer as profits and margins are high and the investment has been considerable (and some of it bad under past leadership)

Since Breakwell took over profits down and investment up. A necessary move as the old strategy was to bleed company to pay dividends and debt. His background is Expedia (grew business) and Uber (launched it into Europe).

Sudden departure of CFO has helped raise anxieties and along with Woodford investment has taken shares down to current levels. CFO departure good in my view as old private equity guy who was good at financial engineering but not actually running a business (hence the complex cloak and dagger accounts which they will simplify). CEO was clearly frustrated with him and there was some tension.

Next debt due is 2022 as refinanced. Current share price swoon is partly that cost of that refinance out from 2022 going up due to current market conditions (coming off v low rate for current)

This year they should generate £80m FCF. Not bad for £300m market cap company. Obvs debt can't be ignored.

Whilst growth is unlikely to be very high. There is some opportunity to grow (and consolidate the market more in B2B and B2C). Service and technology wise they are way ahead of competition. Connected car and AVs likely a boost to AA rather than a threat as national servicing company required. On breakdown they are becoming increasingly a data company.

AA is a sleeping brand. Brand power is still very strong. There's an ability to use it much more.

Growth also thro expanding their insurance business. They have strong brand there still. Company trimmed back here in the past as they didn't want to risk growth capital in this business and wanted to pay dividend and support debt in very defensive way.

Current investment has been into service as well as tech. Volatility of historic earnings has come from need to use 3rd party breakdown independents when times very busy.

Pensions risks reduced.

Short term the weather has not been very bad.

Rebranded image and campaign coming from July.

There is MAD in the debt-equity relationship. What can the debt guys get from pulling the trigger? Not much. Their best bet is to keep the wheels rolling

With 30% op margin (post extra investment) and £1bn revenue now EV is £3bn with £2.7bn debt. Lets say they can growth revenue to £1.5bn (making big round number) over next 7 years (not stellar growth but decent) and retain op margin around that 30% level (perhaps grow as they invested in capacity of their platform). Along the way they pay back £1bn from FCF (there should be decent ratchet in this from incremental growth). So £1.7bn debt....why wouldn't this be a £5bn EV company? That's £3.3bn of equity - 10x now. And that's conservative given the high and non cyclical margin and domination of market.

The above isn't a forecast just a scenario. Today the equity is cheapish and volatile as crowded by lots of debt. If it can shift slowly to the above narrative then the equity will go up. At present we are at peak negativity. For sure, there's plenty to worry about

andrea34

Looking purely at the MVAs, the break of the 50day up through the 200 looks positive. On a purely eps basis, if one simplistically multiplies the Q1 eps by 4 then the current PER is less than 10. The negatives, which would restrain me from taking a large position would be (1) portfolio purchases are down (and I'd ignore the waffle about saving firepower to later in the year, etc) and (2) how cyclical their business is, and whether we have reached the top of this cycle already.

Howard Marx

"At present we are at peak negativity"

Investors clearly recognise that the £2700 million of debt within AA (LON:AA.) leaves the Equity as just a 'slither of hope'.

However, I fear that the spectre of Pension Liabilities will return to haunt the company.

The word "pension" appears 133 times in the latest Accounts. Gross Liabilities are £2500 million. With the European Central Bank preparing itself to restart QE, it would appear that bond yields are headed lower. Pension Liabilities are hence headed higher.

Hence peak negativity for AA (LON:AA.) is yet to come, in my opinion.

Arrow Global (LON:ARW) share price going bananas, currently up 10% - someone just bought almost 77k shares at 258p

Comrade Marx, obvs peak negativity is a subjective thing.

Perversely and seeming counter narrative (if not factual) yields on govt debt can go up under QE and corporate debt down...is this what you meant?

My main macro view which I don’t risk take to but I do risk risk manage to is that we have end of dollar hegemony (Libra can be viewed as such as not straight dollar backed), radical debt management strategies (QE tip of iceberg - monetisation of deficits and consumer debts coming) and associated much higher inflationary pressures than we’re used to.

The biggest risk to AA is that it cannot inflate its prices or deflate its costs

AA (LON:AA.) have done work to manage pension deficit. And have paid to hedge a significant proportion of liability. How much extra cash (as the non cash yearly blow by blow thro income statement doesn’t really matter) do you expect the AA to have to pay following the next triennial. Results due mid next year so from financial perspective any adjustment to payment likely FY 22 give end of Jan year end

I agree it’s not safe a probability needs to be given to disaster. IMO that’s much lower than current implied

Arrow Global (LON:ARW) - I'm wondering, after a 9% rise to 250p today, whether the next few days could be pivotal. If this is the start of a short squeeze, there's around 18.5m shares (10.5% of the company) that needs to be bought back, to close all the short interest.

There's also a notification today that a US fund has built a 4.2% holding.

I'll be keeping an eye on ShortTracker for sure. if there is short covering and meaningful stake building going on, I don't think it is too late to get involved. I have been a holder for a while (with some bought at the 180p level) but I would seriously consider averaging up if/when the disclosed short interest next falls materially.

V High risk - DYOR.
Of course it the HF's could well double down on their shorts, but maintaining such positions can be costly.

ARW Arrow Global

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Jwebster

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