Investors are now starting to warm to the company and with good reason too. Not only does the company pay out a hefty 5p a share dividend to shareholders so the shares offer an eye-catching 8.3 per cent dividend yield, but it also offers exposure to the peer-to-peer lending market through a raft of investments in several domestic and overseas companies.
Previously, GLI had principally invested in syndicated corporate loans issued primarily by mid-market companies, with particular focus on the US and the UK. These so-called collateralised debt obligations, or CLOs, are a form of securitisation where payments from multiple middle-sized and large business loans are pooled together and passed on to different classes of owners in various tranches.
But GLI is exiting this business and has just announced the sale of two of its CLO investments to the soon to be listed Fair Oaks Income Fund (FOIF) for a total consideration of $55m, or £33m at current exchange rates. At the end of March 2014, GLI’s CLO portfolio was worth $70m, or £41.6m, and accounted for 59 per cent of the company’s net asset value. Therefore, post the sale to Fair Oaks this means that only 13 per cent of the remaining assets will be CLO investments. These CLO investments will be sold off in due course to leave GLI as a pure play on the peer-to-peer and small- and medium-sized enterprise (SME) lending market in the UK, Europe and the US.
And it’s the exciting prospects in this particular niche of the finance market that prompted me to initiate coverage on GLI Finance shares three months ago (‘Funded for growth’, 25 February 2014). The company’s plan now is to recycle the cash from the CLO portfolio into lending and direct investments in this area.
Peer-to-peer and SME lending taking off
To date the company has made 11 investments in this area, including five in January, and invested £29m in equity and loans. The aim is to target growth companies with potential to generate an annual return of between 10 to 15 per cent on equity across the economic cycle. It’s a good time to do so because the increasing size of the alternative finance market means that the SME segment has entered the investment mainstream as a discrete asset class. In fact, institutional interest in alternative finance is starting to take off.
Moreover, as fund managers seek to gain exposure to SME finance assets as a discrete asset class, it is a distinct possibility that peer-to-peer and other non-bank finance businesses will have an alternative source of funding available to them rather than being reliant on broad based peer-to-peer investors or the banks who have traditionally funded the market. In the US, there are some businesses that would have once launched as peer-to-peer models that are now being entirely institutionally funded. It is only reasonable to expect the same model to migrate to Europe and the UK in time.
To play the growth here, GLI is aiming to find a number of complementary niches that can exploit the areas within SME finance in which the banks are not competing, and so offer potential for sustainable competitive advantage across the economic cycle. It's a sensible approach as large banks are unable to compete in certain niches of the market due to their reliance on a scaleable and efficient model that hampers their ability to service businesses requiring a significant amount of human interaction.
The end game for the peer-to-peer and SME investments GLI is making will either be a trade sale of the business once it has gained scale and profitability, or a stock market float. To put the potential of the market place into some perspective, one industry analyst estimates the market will be worth £12.3bn within the next decade.
Moreover, as the only listed company offering exposure to this area, GLI is one of the few ways investors can gain exposure to this potentially high growth market. Next week, the £200m flotation of peer-to-peer lender P2P Global Investments on the main market can only further highlight the investment opportunity in the shares of small cap GLI Finance.
A peerless portfolio
To date, GLI has invested around £29m in 11 peer-to-peer and SME finance companies, putting it in a good position to benefit from the anticipated high growth rates in the market as well as creating cross-referrals between the various platforms. The largest investment is a £14.6m funding line for BMS Finance, a company that plans to offer loans of between two to three years to high growth SMEs, predominantly in the UK, who do not have a three-year track record. Loan sizes range from £500,000 to £4.5m and business services and technology companies are the target market.
GLI has also made a £2.8m investment in FundingKnight, a provider of SME finance through crowd funding from a broad base of investors. An experienced in-house team of SME bankers, using both quantitative and qualitative analysis, underwrite the loans and offer traditional small business banking in a way that is no longer possible through the "computer says yes/computer says no" approach of the larger banks. GLI invested £1.5m in FundingKnight in return for at least a 20 per cent stake in the business. At the year-end, GLI had a loan book of UK SME loans originated through FundingKnight of £1.3m.
Other investments include a £1.25m shareholding (for 75 per cent of the equity) in a new UK joint venture with CRX, the owner of Finpoint, a business-to-business platform enabling institutions to buy loans directly from SMEs. Finpoint has been operating in Germany for three years where it has completed more than 100 loans totalling €340m (£283m). The platform enables the borrower to gain access to multiple lenders across a number of funding lines, including factoring, invoice discounting and secured loans. Borrowers pay a fee of £499 plus VAT and income is also generated from lenders.
Another investment is in Proplend, a UK secured peer-to-peer lender offering secured commercial loans on property and in which GLI has invested £1m for a 22.5 per cent stake (equity and preference shares). Loans for between £500,000 and £5m with a duration of up to five years are secured on pre-owned commercial property. Lending on that scale is significantly higher than current peer-to-peer platforms, so offering a largely untapped market to service the needs of non-bank borrowers.
Potential for a rerating
True, GLI’s new investment strategy is going to take time to deliver value and there is no guarantee of success. There are risks too such as credit losses; weaker than anticipated demand if growth rates in these new lending platforms soften; and liquidity in matching borrowers with lenders. And of course GLI needs to replace the income stream from its CLO investment portfolio with an equally robust one from these new investments for that 5p a share annual dividend, paid quarterly, to be sustained.
That said, in my opinion there is significant upside to GLI’s shares and I still believe my fair value estimate of 80p is not unrealistic. The insiders are of that opinion too as chief executive Geoff Millar, director James Carthew, new finance director Emma Stubbs and chairman Patrick Firth all made significant share purchases at around 50.5p each a few months back. Mr Millar, Mr Firth and Mr Carthew have topped up their holdings since then too, the latest director purchase being at around the current share price earlier this month.
So with GLI Finance exiting the majority of its CLO investments at a good price, the flotation of P2P Global set to raise investor interest in this niche finance area, and the company funded to make further follow on investments, a valuation of 1.2 times book value doesn’t seem excessive to me. Factor in that bumper dividend, and I continue to rate shares in GLI Finance a buy on a bid-offer spread of 60p to 60.75p.
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