After Their Own Debt Binge, Europe Loan Collectors Seen at RiskBy
Arrow, Intrum, Lowell depend on borrowing, short seller says
Companies’ earnings can’t sustain growth, according to Bybrook
Companies in one of Europe’s fastest-growing industries depend on an unsustainable business model, according to some analysts and investors, with one hedge fund going as far as calling their stock worthless.
Arrow Global Group Plc, Intrum Justitia AB and Lowell Group Ltd., which buy overdue debt such as cellphone and credit-card bills, are funding their purchases with borrowed money instead of earnings, said Bybrook Capital, a $1.4 billion hedge fund that’s betting against them. The companies won’t be able to sustain growth if their own debt costs increase, London-based Bybrook said.
Debt purchasers have taken advantage of record-low borrowing costs in Europe, selling more than 10 billion euros ($11.7 billion) of bonds since 2013, according to data compiled by Bloomberg. They’ve spent a similar amount acquiring bad loans, said Bybrook, which was founded in 2013 and is backed by Blackstone Group LP.
“These companies do not make enough cash flow to grow their book based on our estimates,” Bybrook said in a presentation at a conference in Oslo last month. “We think Arrow and Intrum Justitia have no equity value and Lowell’s unsecured debt is worth zero.”
Bybrook has positions in all three debt collectors, according to the presentation. An official declined to elaborate, but public filings show that it’s short 1.7 percent of Arrow’s outstanding shares. It’s betting against bonds and buying credit-default swaps on Intrum and Lowell, according to people familiar with the matter, who asked not to be identified because they’re not authorized to talk about it.
“These are fundamental, high conviction positions designed to be held until gravity reasserts itself,” Bybrook said in the presentation. Bybrook takes both long and short positions across industries and was betting against at least 24 high-yield companies as of September 2016, according to an investor letter seen by Bloomberg.
A Blackstone official declined to comment on Bybrook’s positions. Peter Grauer, chairman of Bloomberg LP, is a non-executive director at Blackstone.
Erik Forsberg, Intrum’s chief financial officer, disputed Bybrook’s analysis, saying the Swedish company expects to collect more from a growing portfolio of bad loans, helping earnings and debt metrics. Officials at Lowell and Arrow, both based in the U.K., declined to comment on Bybrook’s valuations.
“We believe that Lowell has excellent growth potential and are very pleased with its performance,” said a spokesman for Permira Holdings, one of the debt collector’s private equity owners.
While Bybrook is an outlier in forecasting wipeouts, other investors are betting that the shares of some debt purchasers will fall and are selling unsecured bonds. Analysts have flagged risks including regulatory hurdles, a consumer slowdown in the U.K. and difficulty recovering debt in some markets like Greece.
CPMG Inc., Farallon Capital Management, Hound Partners, Lansdowne Partners and Pelham Capital are among those short Intrum’s shares, according to filings. The funds declined to comment on their positions. Total combined shorts amount to a near-record 20 percent of available shares, Markit data show.
Fraser Duff, a portfolio manager at Aberdeen Standard Investments, has reduced exposure to companies in the sector, including Arrow. He no longer holds Lowell’s unsecured bonds or any from Cabot Credit Management Ltd., another U.K.-based debt collector. A spokesman for Cabot, which is planning an initial public offering, declined to comment on its debt.
Pierre Beniguel, an investor at TwentyFour Asset Management in London, said debt purchasers need to prepare for less favorable financing conditions, but aren’t yet facing problems. The firm oversees 10.1 billion pounds ($13.3 billion), including bonds from Cabot, Intrum and Lowell.
“It is hard to go short on a sector that is still growing,” Beniguel said. “As the cycle matures in Europe and cost of debt increases, debt collectors will have to adjust their balance sheet.”
The securities remain popular with most investors. Intrum’s unsecured bonds and Arrow’s senior secured notes are quoted at about par, while Arrow’s stock is up about 40 percent this year, according to data compiled by Bloomberg.
Investors have also piled into Lowell’s unsecured bonds, which yield more than similarly rated notes, at about 8 percent. While Bybrook has called those securities worthless, they’re quoted at about 110 percent of face value.
“There’s value there, and frankly relative to other corporate high-yield names it still pays us well,” said Duff, referring to the broader industry. Aberdeen Standard oversees $758 billion, including some debt-collector bonds.
Karen Miles, an analyst at Credit Suisse Group AG, which is a client of debt purchasers, disagrees with Bybrook and recommends buying Lowell’s unsecured bonds, saying the company is likely to refinance them next year and cut debt.
Still, even some within the industry are cautious. Kevin Stevenson, chief executive officer of U.S. debt collector PRA Group Inc., said on an earnings call on Wednesday that money being spent on new acquisitions in Europe is becoming irrational, with negative returns on many deals. A spokeswoman declined to elaborate on his comments.
“There is a material portion of sales in Europe transacting at irrational pricing levels,” Stevenson said on the call. “The more mature markets, especially from a regulatory perspective, such as the U.K., continue to be places where we find less irrational pricing and we’re buying deals that make sense from a return perspective.”
Bybrook said that it valued debt purchasers by discounting future cash flows instead of metrics typically used by companies and analysts, such as earnings before interest, tax, depreciation and amortization; estimated remaining collections; or net income. Bybrook said those methods can give an inflated impression of growth by revaluing future collection forecasts and ignoring costs to maintain portfolios.
Intrum, Europe’s biggest debt collector, spent more on loan purchases than it generated in cash flow from operating activities for the nine months through September, although that reversed in the third quarter, according to filings. Lowell and Arrow reported higher spending on new portfolios and negative net cash from operating activities through June, while proceeds from bond sales boosted overall cash.
Arrow said on Thursday that loan purchases slowed in the third quarter, helping boost net cash from operations for the nine months to 741,000 pounds from minus 43.8 million pounds in the first half. Still, its shares fell after the earnings report by the most since July 2016.
Lowell announced plans last week to become the second-largest credit management services company in Europe. It’s buying businesses in the Nordic region from Norwegian debt collector Lindorff AB and Stockholm-based Intrum, which had to be carved out for those companies to merge -- a combination Bybrook called “the craziest deal of the decade.” Annika Billberg, an Intrum spokeswoman, said the integration will create value.
A Lowell spokesman declined to comment on how the deal will affect its debt. S&P Global Ratings affirmed the issuer’s rating at B+, four levels below investment grade, and revised its outlook to developing from stable on Wednesday, saying the impact of the proposed acquisition isn’t yet clear. Moody’s Investors Service, which puts the issuer one level lower at B2, said this week that the deal impedes Lowell’s deleveraging efforts, but will diversify its business. It’s positive for Intrum, which will be able to repay debt, Moody’s said.
Analysts at BNP Paribas SA and CreditSights have recommended selling Lowell’s unsecured bonds and buying its secured notes. The company’s high leverage and cost of capital prevent meaningful free cash flow generation and leave it exposed to declining collections, Phil Bagguley at BNP Paribas wrote in January. A spokesman said on Thursday that this view hasn’t changed.
The only justification for current valuations, Bybrook said, is if the companies “can survive to reinvest at much higher returns than exist today.”
— With assistance by Hanna Hoikkala, Heather Burke, Neil Weinberg, Simon Ballard, and Neil Denslow