Last week brought some welcome respite for Ranger shareholders, with the share price fairly decisively moving above 750p a share. This coincided with an update on the fund’s underlying investments and a London visit by the fund managers. Having waded through the update and talked to the manager’s pf Ranger I think the market got it just about right. The portfolio report was a big improvement on previous affairs and contained no nasty surprises. There was some evidence of defaults in the wider portfolio but nothing beyond what we’d expect anyway from higher risk lending activity. Crucially the fund managers seem fairly confident that they can carry on yielding net to investors between 70 and 80 basis points per month or equivalent. Talk of the board dumping the management seems fairly wide of the mark but there does seem a real commitment to Ranger working with a new strategic partner who will increase origination flow and help narrow that discount. As we’d expect there’s no new news on the Princeton affair – it seems like we should expect some indication of the arbitration decision within the next month or so at most.
So, overall, a cautiously optimistic state of affairs which appears to back my core contention that the shares “should” be trading at a 15% to 20% discount range, which would imply a share price above 800p by my guess. But a good, short note from the funds’ team at Canaccord does raise a crucial issue – if Ranger is having problems at this stage in the current US economic cycle, god alone knows what will happen when we hit the next proper downturn in the next 2 to 3 years (or maybe sooner). I’ve put the whole note from Canaccord below.
As I’ve said my guess is that the shares will settle above 800p, especially if there is the slightest hint of a positive end to the Princeton affair. Above 800p – especially 815p – I’d be tempted to take profits and consider recycling into the single most obvious trade in the world of direct lending: shorting Honeycomb and buying P2PGI. These two lending funds now share the same manager in Pollen Street. There’s also growing evidence that the underlying portfolios will converge over time. One small example: Honeycomb is now investing in the excellent iWoca platform, which is exactly the sort of platform that P2PGI would traditionally consider deploying money into. The distinctions between p2p and direct lending are slowly disappearing anyway and P2PGI was already moving (like VPC) to a more mixed model of lending. Honeycomb was always focused on this form of balance sheet direct lending and trades at an amazing premium – whereas P2PGI still trades at a big discount. Again, my guess is that the Honeycomb discount will narrow closer to par plus a few per cent – especially as those new loans turn into 2 or 3 year vintage loans with higher default ratios. This might help push the P2PGI discount closer to 5 to 10%.
For background into I’ve also included a short summary from today from the funds’ team at Numis on Honeycomb.
Canaccord note on Ranger
We have been encouraged to see an improvement in disclosure, and we met with the manager yesterday. In the short-term we expect the focus to remain on the investment in the Princeton fund. An arbitration ruling is expected by the end of February, and a successful resolution here should facilitate a more effective valuation rather than the current vacuum, and may potentially see the removal of the manager of Princeton. This would be a positive development. Meanwhile, turning to the rest of the portfolio, we take some comfort from the latest update; while there are defaults, these are not out-of-line with those expected from a high-risk asset class, and indeed many of these are secured with the manager expecting a successful outcome.
However, looking longer term, we have fundamental reservations. First and foremost, the Princeton investment begs some difficult questions of the due diligence process and risk controls, and we believe the Board and Manager now face an uphill struggle to restore confidence. Secondly, we wonder what will happen when (not if) we encounter a less benign environment. This is a high-risk asset class; the target unlevered returns are 12-13%, and risks are compounded by relatively high levels of ZDP gearing – we highlight that the KID has an average one-year return of -66.5% in a stress scenario.
On balance, given the current rating (which seems to discount a 100% write-off of Princeton), for existing shareholders we would wait for the arbitration ruling and accordingly we adopt a short-term HOLD recommendation. Thereafter, the ruling would then seem to provide investors with an opportunity to re-assess their long-term aspirations.
Princeton – light at the end of the tunnel or an oncoming train? Having originally said it intended to invest $15-20m in Princeton at IPO, Ranger invested $56m; this is now valued at $30m (c14% of NAV) following impairments. Princeton has been unwilling to provide any meaningful information and this led to a Qualified Conclusion from the auditors in respect of the FYE 31 December 2016 results. Last June, Ranger initiated arbitration proceedings against Princeton, which recommenced yesterday and should conclude early next week. Thereafter, a legally binding ruling should be made within 30 days.
Microbilt Corporation: Ranger recently announced that it had filed a legal action against Microbilt (majority owner of Princeton’s manager). The IPO prospectus described Microbilt as the world’s leading alternative credit bureau – this now has somewhat of a hollow ring. All legal costs are being borne by shareholders.
But what about the rest of the portfolio? While the focus remains on Princeton, the latest portfolio update gives some colour as to the health of the rest of the investments. Indeed, on the face of it, this suggests that perhaps the Princeton issue is unique. Given the high-risk profile of the underlying investments we would expect to see some portfolio defaults. However, it is noteworthy that while loans in default (defined as where collection efforts are in progress) were $20.7m at 30 September 2017, $16.3m of these were in real estate, and here the investment is secured and the average LTV is 50%; accordingly, the manager expects a successful outcome.
More on Honeycomb from Numis
Honeycomb IT launched in December 2015 when it raised £100m, and has grown significantly since with secondary issuance of £50m in May 2016 (at £10.00 per share), £50m in December 2016 (at £10.15) and £105m (at £10.15) in June 2017. As a result, the fund now has a market cap of £340m. Honeycomb has a strong backing from institutional investors which is reflected in a concentrated shareholder register with 36% held by Invesco, 19% by Old Mutual, 14% held by Woodford IM and 7% by Prudential/M&G, according to Bloomberg. The fund targets a dividend of 8% pa on the IPO price, and the last two quarterly dividends have been at a rate of 20p. The last four dividends total 88p, which represents a 7.7% yield on the current price.
● Honeycomb is managed by Pollen Street Capital, which recently merged with MW Eaglewood, the manager of P2P Global Investments (£656m market cap, 16% discount). We understand that the funds will become more similar over time, with P2P GI focusing on assets originated on platforms with which Pollen Street has strategic relationships. Given the combined assets of c.£1bn a key test for Pollen Street will be to generate sufficient deal flow to satisfy both funds. Honeycomb has limited portfolio disclosure, but at 30 June 2017, the assets were all invested in the UK and the fund’s largest exposures by platform were 3.7% in iwoca (SME lending), 3.4% in 1st Stop Group (personal, home and car loans) and 2.7% in Green Deal Finance (lending against energy efficient/renewable energy installations in the home). In December the NAV was up 0.79%, taking the 2017 NAV total return to 9.1%. The fund has consistently delivered on its return targets since launch, but we are wary of the fund whilst it is trading on 12.4% premium, which may be susceptible to a derating if performance disappoints.