This follows the successful launch in late September of GLI Alternative Finance (GLAF: 102p), a closed-end investment trust that will invest in a range of loans originated principally through the investee platforms in which GLI Finance holds strategic equity investments. GLI Alternative Finance raised gross proceeds of £12.5m at 100p a share from third parties, and issued 40.2m shares to GLI Finance as consideration for a portfolio of loans to give GLI Finance a 76 per cent equity stake in the company. This means that 26 per cent of GLI Finance's assets of £156m is invested in GLI Alternative Finance's shares. The trust will continue to issue new shares to expand and diversify its portfolio, which will mean that GLI Finance's stake will fall over time.
GLI Alternative Finance is targeting to pay shareholders a dividend yield of 8 per cent on its placing price of 100p which will provide GLI Finance with a £3.2m annual pay-out. In addition, the company's regulated asset manager, GLI Asset Management, is managing the fund and receives management fee income of 0.75 per cent of the net asset value, or market value, if lower, of up to £100m. Currently this is worth almost £400,000 in annual fee income to GLI Finance. The management fee rate will fall to 0.5 per cent on any excess net asset value above £100m. It's a sensible arrangement and one that should provide GLI Finance's shareholders with a steady and rising income stream.
In addition, GLI Finance has a direct loan portfolio worth £49.4m which it has made through the 19 SME finance platforms it invested directly in. It's a profitable line of business as GLI Finance generated interest income at an average rate of 10 per cent in the first nine months of this year and the loan losses/provisions represented 0.7 per cent of the closing book.
Potential for acceleration of loan growth
The company's loans and investments in these 19 platforms were last valued at £62.8m and will be revalued next month. One of these investments is in Funding Options, a UK online credit broker that matches lenders with borrowers and acts as a one-stop shop for business finance, and another is in Finpoint, a platform providing financial institutions the opportunity to acquire loans direct from SMEs. It's a similar model to P2P lending, but with larger loan sizes and a solely institutional focus.
Funding Options and Finpoint are so-called 'neutral platforms' that aggregate loan offers from many alternative finance providers and present them to borrowers who decide which one to select. Prospects for both companies are at an interesting juncture right now because at the end of next month, HM Treasury will designate which 'neutral platforms' will be part of the British Business Bank's alternative finance referral scheme. Under this scheme, the main high street banks will be required to give SMEs to which they have refused loans the contact details of alternative finance providers. GLI hopes that Funding Options and Finpoint, which are on the Treasury shortlist, will be selected. If they are, it could considerably increase their business, and their valuations.
Increased focus on asset management
GLI Finance is also at an interesting juncture as the company now offers relatively low risk exposure to a managed fund from which it earns a fee income as well as potential capital upside from a higher risk portfolio of loans and equity stakes in SME platforms. Through its authorised fund manager GLI Asset Management, the board intends to expand the asset management side of the business by launching a range of investment funds with differing strategies. This will have the added benefit of increasing fee income as well as mitigating risk by reducing the risk profile and decreasing direct exposure of the company to loan losses.
Importantly, there is decent appetite amongst investors for peer-to-peer (P2P) investments. For instance, sector leader, P2P Global Investments (P2P: 991p), first listed a fund of £200m in May 2014 and subsequently raised another £200m in January and £400m in June this year. Other listed funds include VPC Speciality Lending (raised £205m) and Ranger Direct Lending (£144m). Funding Circle, one of the leading alternative finance platforms in the UK, is in the process of launching a new £150m fund with admission of the shares expected at the end of this month, while LendInvest, another alternative finance company, plans to raise £150m through a fund listing.
Funding the high dividend
The high growth potential of the P2P market aside, the main reason I recommended buying shares in GLI Finance at 53.25p was its quarterly dividend of 1.25p a share ('Funded for growth', 25 Feb 2014). If you followed that advice you will have picked up seven quarterly dividends of 1.25p a share, so the holding is showing a small posiitve return. I last updated the investment case at the time of the flotation of GLI Alternative Finance ('Platforms for growth', 30 September 2015) since when the company has paid its third quarter dividend of 1.25p.
However, the lacklustre share price performance this year - GLI Finance's share price has fallen from a high of 65p in January, and from 57.5p in mid-August to a current price of 45.25p - has in my view more to do with concerns over the sustainability of the dividend. That's because the payout remains uncovered while GLI Finance's board scales up its P2P operations, having changed the focus of the business from one investing in high yielding corporate collaterised loan obligations (which have all been sold off).
Bearing this in mind, analyst Peter Thorne at Edison Investment Research forecasts GLI Finance's cash earnings at 1.97p per share in 2016, which will be insufficient to fund its 5p per share dividend. At 30 June 2015, GLI had cash on its balance sheet of £2.5m, £16.5m of borrowings from its subsidiary, Sancus, and £21.5m of zero dividend preference shares outstanding, so net debt was £35.5m. At the end of September 2015, the company had net debt of £44.6m, representing 40 per cent of shareholders funds of £110m, of which the zero dividend preference shares accounted for £21.5m. These zeros mature in December 2019.
Mr Thorne estimates that the cash outflow, assuming an unchanged dividend costing £10.7m, will be £6.5m in 2016 and suggests that one way around the funding gap is for GLI to arrange for dividends to be remitted from its subsidiaries and associates. In particular, Sancus, an offshore lender based in Jersey and operating in Guernsey and Gibraltar which was acquired by GLI Finance for £37.8m last December, and BMS Finance, a UK-based specialist finance company specialising in providing senior secured loans to growth businesses that struggle to access bank funding in the current environment, together earn between £2m to £3m, according to GLI Finance's management.
Sancus primarily lends to asset rich but cash poor entrepreneurs and loans are secured on property with a maximum loan-to-value ratio of 50 per cent. Mortgages are between £500,000 to £10m in size and are short-dated for 12 to 24 months with an interest rate charge of between 10 to 12 per cent. At the end of June this year, around half of GLI Finance's loan book of £83m represented loans made through BMS and Sancus.
However, even if these subsidiaries pay dividends to GLI Finance, and after accounting for the aforementioned £3.6m of dividend and fee income from GLI Alternative Finance, it would still leave a £3.5m to £4.5m funding gap for GLI Finance to meet its 5p a share dividend. At the mid-point that funding gap equates to 2p a share of the 5p a share dividend. To fill that gap would require GLI Asset Management to increase its assets under management (AuM) to £1bn in roder to generate £5.3m of annual revenue and operating profits of £4m. This is based on the business earning annual management fees of 0.53 per cent, in line with the current listed closed-end fund fee rate. I have ignored performance fees in the calculations, but clearly if these are taken into account the level of AuM to meet the cash funding gap for the dividend could be significantly less than £1bn.
Clearly, it will take time to build an asset management business on this scale, but equally the spate of fundraises recently shows that there is an appetite for this asset class so there is a strong tailwind behind this speciality finance sub-sector. In the short-term, Mr Thorne believes that a likely £30m issue of additional dividend preference shares early next year - GLI is currently doing some test marketing to refinance some borrowings as well as providing capital for further investments - coupled with the dividend income from GLI Alternative Finance, BMS and Sancus, will enable GLI Finance to cover the 5p a share dividend over the next couple of years from cash earnings.
Target price
The bottom line is that an investment in GLI Finance's shares is a vote of confidence in the board's ability to: meet the funding gap on the dividend; successfully back enough winners in the portfolio of 19 investee P2P companies to generate capital upside in its net asset value; launch additional managed funds to ramp up its asset management business; and for GLI Alternative Finance to expand its portfolio quickly enough to generate additional fee income for GLI Finance. On all four counts I am positive.
So although GLI Finance's shares have drifted back this year, I still believe the odds favour a positive outcome. Trading 12 per cent below net asset value of 51.5p, I remain a buyer at 45.25p as the upside potential of the portfolio of P2P investments is being attributed no value whatsoever in the current share price. That's very harsh.
Please note I have published two columns today, and five so far this week, details of which are in the list of my articles below.
MORE FROM SIMON THOMPSON...
I have published articles on the following companies in the past two weeks:
■ Redde: Run profits at 178.5p; Trakm8: Run profits at 250p; 32Red: Run profits at 95p; Manx Telecom: Run profits at 208p; Burford Capital: Run profits at 189p ('Five companies that keep on delivering', 3 November 2015)
■ Getech: Sell at 38p ('Getech warns', 3 November 2015)
■ Gresham House: Buy at 345p, 12-month target price 450p ('Sowing the seeds for growth', 9 November 2015)
■ Inland: Run profits at 73p, target 80p ('Tapping into hidden value', 9 November 2015)
■ K3 Business Technology: Run profits at 361p ('In the money, 9 November 2015)
■ Fairpoint: Run profits at 190p, target range 200p to 220p ('Riding a seven year high', 10 November 2015)
■ KBC Advanced Technologies: Buy at 129p, new target range 160p to 169p ('Running oily gains', 10 November 2015)
■ Epwin: Run profit at 138p ('Decked out for further gains', 10 November 2015)
■ Plethora Solutions: Speculative buy at 5p, target 7.5p; Renewable Energy Generation: Speculative buy at 49p, target 60p ('Playing the takeover game', 11 November 2015)
■ Trifast: Buy at 116p, target 140p (‘Engineering a chart break-out’, 12 November 2015)
■ Software Radio Technology: Speculative buy at 23.5p, target 40p (‘Break-even beckons’, 12 November 2015)
■ Bioquell: Buy at 137p, target range 170p to 185p ('Bug busting potential for short-term gains', 16 November 2015)
■ Communisis: Hold at 45p ('Communisis slammed for earnings miss', 16 November 2015)
■ AB Dynamics: Run profits at 320p; Stanley Gibbons: Hold at 90p; Pittards: Hold at 94p ('Bargain shares updates', 17 November 2015)
■ Bilby: Run profits at 133p ('Bilby's share price sparked alight', 18 November 2015)
■ GLI Finance: Buy at 45.25p ('High yield P2P play', 18 November 2015)
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
