GLI Finance — Update 19 July 2016

In May 2016, as part of the strategic review, GLI announced that the future development of the group will be built around the following three pillars:

Management also believes FundingKnight (FK) to be a fundamentally good business with strategic value and it has acquired the operating entities from the administrator for £0.75m in cash (a £0.3m outlay after an inter-company loan repayment), but after a write-down (to nil) of its £3.8m interest in the FK holding company. GLI sees good opportunities for FK to benefit from improved funding access and has itself committed an initial £1m in additional capital to FK. GLI has a further 11 holdings in other alternative finance platforms, which are receiving intensive GLI management attention. We expect further announcements in due course regarding GLI’s strategy for each of these. It may choose to keep some and include them in its niche alternative lender or its fintech scalable platforms, sell them, or hold them.

In March, Funding Options was one of three platforms recommended by the British Business Bank (BBB) to go forward for designation by HM Treasury for the Bank Referral Scheme. These platforms will match smaller businesses that have been declined for finance by designated banks with alternative finance providers to help them access the finance they need to grow and expand. The BBB has estimated that c 100,000 small company applications for finance to support the growth of their businesses are rejected every year. In May, the Competition and Markets Authority (CMA) investigation into the banking sector recognised the important role that finance platforms can play in improving choice and transparency in SME banking.

In April, BMS Finance, the operating subsidiary of the now wholly owned BMS Holdings, announced the expansion of its operations in Ireland with the launch of a dedicated €30m fund (“BMS Finance Ireland”) that will provide growth debt finance to high growth SMEs in the Irish market for the purposes of working capital, funding contract wins and capital expenditure, and supporting acquisitions and MBOs. GLI has a 40.7% interest in the fund through Sancus BMS and the Ireland Strategic Investment Fund (ISIF) is also backing it with a c 50% stake. ISIF is controlled and managed by the National Treasury Management Association and has a mandate to invest on a commercial basis in a manner that will support economic growth and activity in Ireland.

At its recent AGM GLI’s shareholders voted to change its status on AIM to that of an operating rather than an investment company. This reflects its new strategic direction. It will continue to publish NAV per share quarterly for the rest of 2016, but will cease thereafter and from 2017 will probably report consolidated results as an operating company with the focus shifting towards an earnings basis.

As part of the consideration for the outstanding interests Sancus (Gibraltar), GLI issued £10m of five-year bonds with a coupon of 7% and maturing on 30 June 2021. It was intending to issue a further £3.5m of bonds through the UK Bond Network and use the proceeds to further pay down Sancus debt, which has a cost to GLI of 8.75% per year. In the market volatility following the UK EU referendum result the issue has been withdrawn but management suggests that it may look to reintroduce the offering at a later date.

In the sections that follow we first provide more detail on the three pillars, and then we discuss the Sancus/BMS transaction and the agreed FK acquisition in more detail.

This pillar now includes Sancus BMS Group, a single operating entity created from the combination of Sancus and BMS, both now wholly owned other than a continuing minority in Sancus (Isle of Man), and the 84% owned Platform Black (to be renamed Sancus Finance).

Through the former Sancus and BMS businesses, Sancus BMS will continue to operate as a traditional lender to businesses and the owners of businesses, in niche markets, targeting a high return on capital. It operates without a banking licence or a branch network, funding itself from shareholder resources and third-party co-lenders. Revenue generally takes the form of a commission (normally 1%) levied on the amount lent, in addition to a lending spread on the Sancus funding and an administration fee charged to co-lenders. GLI’s CEO, Andy Whelan, becomes the CEO of Sancus BMS and GLI management anticipates that Sancus BMS will earn profit before tax of c £2.5m in 2016, rising to £4m in 2017 and more in later years as the businesses become fully integrated and synergies are realised. Management notes the following positive impacts from the combination:

Prior to the recent transaction and the creation of Sancus BMS, Sancus consisted of wholly owned operations in Jersey and Guernsey as well as minority owned operations in Gibraltar (effective holding 15.29%) and the Isle of Man (effective holding 2% with an option to acquire up to 20%). Now that Sancus (Gibralter) is also wholly owned, it is only Sancus (IoM) that is not under the full control of GLI. Management believes that operating in each of these offshore centres provides it with a better knowledge and understanding of the local finance markets, which in turn gives it an advantage in assessing risk. Since the financial crisis of 2008/09 the appetite of the established banks for lending to this sub-sector has declined because of credit quality and compliance (money laundering) concerns.

Sancus (Jersey) was acquired in December 2014, a provider of secured lending to asset rich, cash constrained borrowers. Its customers have been mostly entrepreneurs, SMEs, high net worth individuals and professionals. Sancus (Jersey) has made c £225m of loans since inception, making good progress since acquisition, and management indicates that the pipeline remains strong. Sancus (Guernsey) started its activities in 2015 and has been slower to develop, which management attributes to earlier difficulties in identifying and putting in place the right management team.

Sancus (Gibraltar) was incorporated in March 2015 and began trading around the middle of that year. The business has had a successful start and has undertaken 12 transactions, lending £34.5m of which £12.5m (three loans) has already been repaid. GLI has indicated that in its first 11 months of trading to end April 2016 Sancus Gibraltar generated £1.4m of revenue and earned pre-tax profits of £0.6m, exceeding management targets and ahead of Sancus (Jersey) at the same stage of its development. Its development appears to have benefited from utilising the experience gained by Sancus (Jersey), setting up a base in the locality and courting the local community of lawyers and family offices, which have wealthy clients that wish to borrow and co-lend. Looking forward, GLI management indicates that Sancus Gibraltar has a strong pipeline of business.

BMS provides lending to UK and Irish SMEs that are at or approaching profitability. It lends from its own balance sheet (GLI has provided it with an interest-bearing loan note of £16m) as well as co-lending with others. Among its co-lenders are the British Business Bank and the Ireland Strategic Investment Fund, a c 50% investor in the recently launched €30m BMS Ireland Finance Fund.

BMS provides senior secured lending of up to £5m at interest rates around 12% to 15% in the UK and Ireland. The duration is normally two to five years for cash flow/EBITDA lending or two to three years for asset-backed loans. Although it says it is sector agnostic, most of its lending is in business services, software, IT, media, healthcare and financial services.

GBHL, the 100% holding company owner of BMS, generated net revenue in excess of £6.3m and pre-tax profit of £1.3m in the year ended 31 December 2015. Its net assets at that date were approximately £3.4m. The BMS loan book has been growing and management expects this to continue over time with profitability benefitting from an increasing proportion of third-party capital.

GLI group owns 84% of the ordinary shares and £5m of preference shares of Platform Black (to be renamed Sancus Finance), an online trading platform and a lending business that management considers complementary to Sancus and BMS. The platform matches owners of invoices who are looking for immediate payment with holders of funds looking to invest in both the invoice and supply chain niches. Similar to Sancus and BMS, the borrowers are SMEs and the lenders range from retail clients to institutional investors. At the time of writing, it had financed £131m worth of invoices.

GLI initially identified four of the other 16 platforms in which it holds investments as having the highest opportunity for scalability and value creation. It has subsequently agreed to acquire 100% ownership of the operating subsidiaries of FundingKnight (FK) in which it had an existing minority interest in the holding company. We discuss the FK transaction in detail on page 7 below. In Exhibit 1 we give an overview of the platforms that GLI has so far designated as being prioritised:

Part of GLI’s strategic review is aimed at rationalising the group’s inter-company loans and it reports that it has already made significant progress. Looking ahead, it is management’s intention that GLI will restrict its activities to debt and equity investments in its prioritised platforms, rather than lending through these platforms. It currently still manages a book of loans made through platforms which will be run off and the capital reallocated. GLI does have minority holdings in the investments identified above, but does not control them. Given the lack of direct control, GLI has generally insisted on board representation. In the case of FK, in which it had a minority investment in the holding company, GLI had reservations about the senior leadership of the business and in December 2015 became a passive investor in the FK holding company. On 28 June 2016 the holding company entered administration and we suspect that its ability to attract a wider source of funding was a contributory factor. GLI quickly agreed the acquisition of the operating subsidiaries from the administrator (see page 7 for the transaction details) which it describes as a fundamentally good business with strategic value. It is a UK-based crowd lending platform for growing businesses, green energy projects and property, drawing investment from institutions and larger private investors. We would anticipate that there could be some cost savings at the senior management level, but more fundamentally an improvement in FK’s ability to fund and grow. GLI has made c £1m available to FK in the form of new capital and we also note that Hadrian’s Wall Secured Investments, a UK commercial loan investor that listed recently on the LSE in an £80m initial placing and offer, has disclosed a letter of intent (LoI) with FK, covering loan origination. The non-binding LoI, one of a number signed with asset originators such as FK, applies to an undisclosed amount of annual loan origination value that Hadrian’s Wall will have the option to invest in.

GLI has identified FK as strategically important within the Pillar 2 business group.

GLI owns 50% of this asset manager, with the other 50% owned by Somerston, with which GLI has a strategic relationship (see our April report, Transformation under way). Amberton specialises in managing SME loans and manages the £53m GLIAF fund in which GLI has a 48% holding. In time it intends to grow the GLIAF fund further and perhaps for Amberton to start new funds, which should boost its profitability. We estimate that Amberton Asset Management currently earns around £0.2m in pre-tax profits.

Prior to the recent transaction, GLI owned 15.29% of Sancus Gibraltar Holdings, which in turn owned 100% of Sancus (Gibraltar). The other shareholders of Sancus Gibraltar Holdings were:

In the transaction, GLI has acquired full ownership of Sancus (Gibraltar) and inter-group loan from Sancus Gibraltar Holdings for a total consideration of £23.5m. The payment comprised:

The new GLI shares have been listed on the LSE with a three-month lock-up period. Thereafter, Sancus Gibraltar Holdings will distribute its GLI shares to its own shareholders pro rata to their holdings of ordinary shares in Sancus Gibraltar Holdings, and the bonds will be distributed pro rata to holders of preference shares in Sancus Gibraltar Holdings. GLI will use all reasonable commercial endeavours to arrange for the bonds to be listed on the Cayman Islands Stock Exchange, or another recognised non-UK stock exchange and for the bonds to be tradeable via the UK Bond Network, a 15% owned investment platform in the GLI portfolio.

Prior to the transaction, GLI owned 62.5% of GBHL, which in turn owned 100% of BMS. It has now acquired the 37.5% of GBHL that it did not for £5.2m from Tranquil Capital and the BMS management sellers. The consideration was as follows:

To assist GLI’s cash flow, BMS and Sancus Gibraltar shareholders will not receive the June or September dividend; they will however rank pari passu for the December dividend and onwards.

The value for 100% of GBHL implied by the transaction terms is £13.8m compared with the £2.6m carried value of GLI’s original stake. We estimate that this will generate an accounting gain of £6.0m before the write off of the £1.2m debt due to GBHL and this is reflected in our revised estimates.

Prior to the transaction, GLI had an interest in FundingKnight Holdings (FKH) which owned 100% of FundingKnight (FK). Reflecting GLI’s doubts about the leadership of the business, this became a passive interest in December 2015, representing a 23.4% stake in FKH ordinary shares and a c £1.0m investment in FKH preference shares together with accrued interest of £290k. In addition, GLI had an outstanding loan of £525k to FKH. On 28 June 2016 FKH entered administration, and the same day GLI agreed the acquisition of its operating subsidiaries, FK and two other dormant companies. GLI’s interests in FKH have been written down to nil and it has acquired the FKH operating subsidiaries for a consideration of £750k. From this £750k, £450k will be directed by the administrator towards part repayment of the £525k loan to FKH. Hence, the cash outlay for acquiring these operating subsidiaries is £300k. GLI has also provided FK with c £1m of additional capital to finance its ongoing operations. We have reflected this additional investment in our GLI parent company balance sheet forecast, along with the net £300k cash outflow and a write-down on the existing FKH interests of £3.8m (net of the £450k loan repayment).

FK recorded unaudited turnover of £0.61m and a post-tax loss of £1.17m in the year ended 31 March 2016. Unaudited net assets were c £0.13m at the same date. We have removed interest income from the written-down FKH preference shares in our parent company earnings forecast and carry the new investment in FK at face value, which we assume to be the fair value. GLI clearly expects an improved performance from FK going forward but improvement will likely take time and further losses seem likely. We have insufficient information at this point in time to be able to quantify these but note that any impact on our parent company forecast would be seen in a change in the carried fair value with trading losses carried directly in the consolidated accounts

We have revised our NAV and profit forecasts to reflect the Sancus (Gibraltar), BMS and agreed FundingKnight transactions. These are shown in Exhibit 2 and the following exhibits summarise the main changes.

We have slightly reduced our estimate for cash profits for 2016. The additional interest on the loans acquired from Sancus Gibraltar Holdings is offset by interest on the new 7% bond and interest on borrowing required for the cash payment to acquire the minority in BMS, whilst there is a loss of interest income on the written off FKH preference shares. Our forecast end 2016 NAV per share is reduced by 3.2%, in the main reflecting the write-down of GLI’s interest in FKH. Exhibits 3 and 4 show the details. After these transactions GLI will own 6.64m of its own shares and £1.5m of bonds through its holding of 100% of Sancus Gibraltar Holdings.

The estimated cash profit for 2016 of £2.7m allows for the indicated upstreaming of £2.5m in dividends from Sancus BMS but will not cover the dividend of £5.7m for the full year, based on management guidance of 2.5p per share in dividends for the year. We note that the new shares issued for the Sancus (Gibraltar) and BMS transactions will not qualify for the June and September 2016 dividends, relieving c £68k of cash outflow. We have assumed the difference between cash earnings and dividend payments is met by increased borrowing, and including debt issuance and repayments related to the transactions our revised net debt forecast for end 2016 is £51.4m (previously £39.5m). Our estimated net debt to equity ratio for end 2016 rises slightly to 46.6% compared with our previous forecast of 43%.

Management has guided to a potential £4.0m upstreaming of dividends from Sancus BMS next year which in itself will materially improve dividend cover.

To better reflect the company’s current and future operations, GLI has changed its AIM market classification from an investing company to a trading business. To assist investors in assessing performance and an appropriate valuation, the company plans to introduce additional financial reporting in respect of each of the three pillars. However, we would expect management to provide only limited information on those platforms that remain under the strategic review.

Pending the enhanced disclosure, we expect investors to continue to focus on the yield. There are no comparable alternative finance companies quoted in London with which to directly compare GLI and so we have shown in Exhibit 5 a range of quoted alternative finance investment funds. Compared with these, GLI’s guidance of a 2.5p per share dividend places it at a yield premium to the group. Perhaps reflecting the uncertainty that now exists regarding the prospects for those platforms that remain under strategic review, GLI is trading at a noticeable discount to these listed loan funds on a price to NAV basis. The valuation upside would appear to be dependent on GLI generating progressively higher earnings and distributable profits on its net asset base, thereby improving dividend cover and ROE.