Duke Royalty (DUKE:46.2p), a company that makes its money by providing capital to companies in exchange for rights to a small percentage of their future revenues over a typical term of 25-40 years, has made two smart announcements in the past few weeks.
Having acquired a small portfolio of royalty partners pursuant of its acquisition of smaller rival Capital Step in February this year, Duke has subsequently modified the terms of existing agreements with three royalty partners: Pearl & Dean Cinemas; Xtremepush, a technology solutions company; and Welltel, a Dublin-based telecom services company that has been the winner for the past five years of the Deloitte “Fast-50” award, an award given to the fastest growing technology company in Ireland
Prior to acquisition, Capital Step offered a 'unitranche' finance product, which is a perpetual royalty paired with a senior secured loan that amortises over a three- to five-year term. A total of £5.5m of capital deployed amongst the three royalty partners was due to be repaid by 31 March 2022. However, by modifying the repayment terms, Duke has been able to boost the gross revenue it will earn by at least £3.7m over the next five years, representing a 25 per cent increase, and importantly at nil cost. To achieve this it has extended the repayment maturity date to April 2024 on the Welltel and Xtremepush senior loan facilities, and agreed to a perpetual royalty on the whole of the Pearl & Dean agreement, half the royalty had previously amortised over three years and the other half in perpetuity.
Neil Johnson, chief executive of Duke rightly points out that the modifications enable royalty partners to increase short-term cash flow, while Duke can maximise near-term revenues and look to deploy further capital at accretive returns through follow-on investments into the acquired royalty partners. That’s exactly what the directors are doing as Duke has just announced a £1.4m follow-on investment in Welltel. The new funds will enable Welltel to settle deferred consideration on two previous acquisitions, boost working capital to support its ongoing strong organic sales growth, and free up cash for new accretive acquisition targets. Duke's exposure to Welltel now amounts to €6.9m (£6.1m), a sum equating to 8 per cent of Duke’s £74.5m royalty portfolio. The Welltel investment is also generating a pro forma cash yield of 16 per cent, thus highlighting the impressive returns that can be made from this niche form of financing.
As I noted when I last suggested buying Duke’s shares a couple of months ago (‘A royal high-yielding investment’, 8 Apr 2019), the company is recycling some of the profits earned back to shareholders through a very progressive dividend policy. In fact, Duke is on course to boost earnings per share (EPS) by more than half to 3.8p in the 12 months to end March 2020 which should support an annual payout of 3.6p a share, up from 2.8p a share in the 2018-19 financial year. The quarterly payout is a bull point too.
On this basis, Duke’s shares are priced on a forward price/earnings (PE) ratio of 12, offer a prospective dividend yield of 7.6 per cent and are rated on a modest 1.3 times book value. Clearly, I am not the only one that has cottoned onto the eye-catching returns Duke is earning from its 12 royalty partners. Indeed, the holding has produced a total return of 13.5 per cent, or more than double the 5.9 per cent total return on the FTSE Aim All-Share index, in the 15 weeks since I first advised buying ('Duke Royalty: A royal high-yielding investment', 18 Feb 2019). The share price is also making steady progress towards my conservative target price of 55p. Buy.
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