DDM - DDM Group

[NewbieD]

Distressed debt management. www.ddm-group.ch

Market cap ~40 MUSD. Share price 40 SEK. 20 employees. All Communications in English.

 

Company based outside Zurich in Switzerland. Listed in Stockholm. Invests in non-performing loans mostly in Eastern Europe.

The Company was listed mid-2014 after which they had a misadventure in Russia where they lost a lot of Money due to a weakening Ruble having borrowed in EUR.

 

Investment thesis:

Looks like the Company is reaching critical mass, and is decreasing the cost of funding quickly. They just replaced their outstanding bonds at 14% with a new one at 9,5% fixed to 2020. The mgmt says they can double the loan portfolio without driving costs.

There should be a good market for buying loans from european banks who want to decrease capital needs.

They have been Active in the market for about 10 years, and seem to have developed good relationships.

My Quick valuation is their valuation is -25% to -50% cheaper on metrics than bigger listed competitors like B2 Holding and Hoist Finance.

Scalable business model where they are focused on their core competence of valuing the portfolio and outsource the debt Collection.

Two young driven guys running the Company backed by two founders who have been Active in the industry for a long time.

 

Risks:

It wouldnt be far fetched for them to issue more Equity to speed up growth which would probably depress the price temporarily. More Money flowing into the market leading to worsening yields. This will surely happen but not too quickly at the smaller size portfolio the Company is working with.

Increasing costs for outsourcing the debt Collection.

 

Have been listening in on their conf-calls for a couple of years but this is the first time I've choosen to buy in any size.

[StubbleJumper]

I have the same question about this company as I had about Lancashire Re:

 

"If much of the value propositioin revolves around two bright, young guys, what's to stop those bright young guys from walking down the street and starting up a competitor?  And, if they do so, what's the remaining value of DDM?"

[NewbieD]

Valid question.

 

Well. One thing is they have a decent amount of stock, like 4%. The other thing is the business model needs more capital than they have on their own, so why not work with the capital they already have access to? It's not like Writing an iphone app which needs no capital.

 

In the capital markets trust is key and from their lowering borrowing COSTs it seems the trust is growing, leaving would probably be a set back in that respect.

 

Also if they tried on their own they wouldn't have access to the network/knowledge of the founders which own 40% and have been Active in these markets for a longer time.

[debtvulture]

How do these guys compete with the big distressed bebt buyers that have been in this market every since the financial crisis, names like OakTree, Avenue, Millenium, etc.? 

[NewbieD]

I don't know? Maybe they're just being small and nimble and not competing? Their deals aren't that big, the biggest portfolio they bought was 17 MEUR in Slovenia. I can see the share being more than a triple if they reach 100 MEUR in AUM which shouldn't be impossible in 1-2 years. But if you have any hints of where to read up on distressed debt markets its more than welcome, I'm clueless:)

[Jurgis]

IMHO, the biggest risk with companies like this one is a blowup. So IMHO unless you are really really really really confident in the people behind the company, it's a "don't invest". YMMV though.

[mateo999]

I met with Kent Hansson in late 2014.  Very impressive guy.  Ex IJ if my memory serves.  He felt his data analysis capabilities gave them an edge on pricing really obscure stuff in Russia, etc. really quickly.  And sometimes sellers wanted to move very quickly which was to their advantage.  Again, paraphrasing him.  We didn't invest.

[NewbieD]

Good decision mateo:) Hopefully they learned a lesson from their adventures in Russia, but I'll watch out for overconfidence signs..btw, who are "we"?

 

Agree Jurgis that there's a blow-up risk. But I can accept a blow-up risk for 5% of portfolio which is fairly non-correlated to other investsments (I have 85% outside financials) as long as the upside is big.

[wachtwoord]

I met with Kent Hansson in late 2014.  Very impressive guy.  Ex IJ if my memory serves.  He felt his data analysis capabilities gave them an edge on pricing really obscure stuff in Russia, etc. really quickly.  And sometimes sellers wanted to move very quickly which was to their advantage.  Again, paraphrasing him.  We didn't invest.

 

What were your core reasons for deciding not to invest?

[NewbieD]

New majority owner in this one, Erik Fällström, through his co. Owns 49%. He used the Money he made exiting Hoist finance.

 

They also announced they'll be applying for a listing on the regulated Nasdaq main market.

[NewbieD]

Doubling their balance sheet aquiring 28 MEUR in Croatia and 50 MEUR in Greece in secured and unsecured NPLs. The greece purchase in supposedly one of the bigger NPLs transactions in Greece so far. The notional value of the Greece portfolio is 1.3 BEUR.

 

As a newbie in this sector, what factors are important in judging how cheap this might be and what the cash-flow over time might look like? Reading suggestions welcome.

 

As there are some investors in greece banks here: what's your view on the availability of NPLs going forward from Greece?

Any insight on if the greek seeming mentality of not caring about the tax collector transfer to not caring about clean credit? A bit scared that they've overpaid based on their profitability experience from slightly different cultures.

[NewbieD]

Realised there is one development I've totally missed here - swiss franc mortgage holders in eastern europe.

Apparently this was sold agressively from about 2000 to 2006 in many countries where DDM is involved - Slovenia, Croatia, Romania, Poland. Many of these are now heavily underwater due to the local FX weakening against the franc. For instance in Poland the zloty has gone from about 2 in 2008 to 4 needed to get one franc.

 

I have no idea how big of a share of DDMs portfolio this is - only that its not zero since they were involved in a dispute in Slovenia.

 

There are processes in at least Slovenia, Poland, Romania aiming to nullify these loan contracts - or force conversion into local fx using fx rates at the time of signing. The basis is the banks didnt inform about the risks but rather sold them as being superior due to being tied to a strong currency (hah).

 

Question is - should I be worried about legal risks as an NPL investor? How big share of the secured portfolios is this likely to be and to what extent has it already been priced into purchases in the last two years? Thankful for any insights.

Apart from this one risk I think the investment looks good. Economy turning around in many invested countries with project GDP growth rates 2018 from 2% (Greece) to 3-4% (Slovenia, Czech, Croatia) and 6% (Romania). Lots of portfolios seem to be coming up for sale.

[NewbieD]

Been selling this for the last month, decreased from 20% at most to 6% now.

 

- information vacuum what's going on. I knew this was likely on the financial front, i.e. you don't really know for a long time how much will be collected eventually, but coupled with below I'm just not confident any more.

- previous CEO Gustav Hultgren who I liked quit after going from CEO to 'Head of Greece' (last big transaction) for < 2 months. And promptly sold all his shares.

- new CEO which is one of the main owners quit due to family reasons. Founder Kent Hansson is back as interim CEO.

- they did not meet their revised investment goal for 2017. Could mean the price of portfolios is going up, which would be a postiive. Could also mean they are too busy handling what they already bought and the personnel changes above.

- other debt collectors e.g. IJ and Hoist have disappointed results wise.

 

 

[compounding]

Buyout offer for SEK 40/share from the largest shareholder Demeter today.

 

http://news.cision.com/se/demeter-finance-s-a-r-l-/r/demeter-finance-offentliggor-ett-kontant-offentligt-uppkopserbjudande-till-aktieagarna-i-ddm-holding,c2701807

 

Erik Fällström, who represents Demeter on DDM's board is an interesting figure in the debt collection business. They bought their current position in DDM for 42.5/share in April 2017 (small premium at that time), from the two founders Kent Hansson and Manuel Vogel.

 

He also founded Hoist Finance in the 90s and attempted a controversial buyout of the company in 2003, which drew criticism from among others Per H Börjesson of the Spiltan investment company. Spiltan started a campaign to defend minority shareholders and contacted all shareholders with more than 500 shares urging them do decline the bid and demand a higher price. Spiltan, and others, at this time criticised management for withholding information and that Fällström & co used the following uncertainty to launch a bid at a basement price. There seems to be some truth to this. Apparently positive news was in short supply at this time, and one of the few positive press releases was issued on Christmas Eve in 2003, comically enough. They eventually managed to get Fällström and his partner to increase their bid from 18/share to 24/share. Fällström later became a billionaire (in SEK) when Hoist re-IPO'd in 2015.

 

It seems like Fällström is following a similar playbook for value creation this time around, attempting to buy out a company he knows well, that has had a lousy recent performance for the equity. The bid seems pretty low as far as I can tell. In terms of ERC the multiple to EV is 0.59, and it's something like 7.67x EV/EBIT. Will be interesting to see what the reaction to this bid will be. If they get the company for SEK 40, I expect it to be a very successful investment for the buying company.

 

I have a small position.

[NewbieD]

Agree with your post, compounding.

 

Long acceptance period seems like a good thing for the buyer too. Still trading at 2,5%+ discount and high likelihood of deal concluding in my opinion it could be a decent yield trade if you, like me, have a lack of good other ideas.

 

I wasn't around the previous instance with Hoist but I don't see any candidates to putting up a fight against the bid this time?

[compounding]

Agree with your post, compounding.

 

Long acceptance period seems like a good thing for the buyer too. Still trading at 2,5%+ discount and high likelihood of deal concluding in my opinion it could be a decent yield trade if you, like me, have a lack of good other ideas.

 

I wasn't around the previous instance with Hoist but I don't see any candidates to putting up a fight against the bid this time?

 

Hansson is still on the board and owns 4.3% of the shares. I guess he isn't a good bet for activism since he sold shares for 42.5 the last time around, even if I would argue that the company has improved since then. There are a few others that perhaps could put up some resistance, but I wouldn't say it looks promising. Perhaps the best bet is some other company taking an interest, like what happened with Hoist, where Aktiv Kapital made a counter offer for 21/share.

 

There are some risks to holding as well. The offer is conditioned on Demeter receiving 90%, and they have announced that they are aiming to delist the company even if they go through with the offer without getting 90%. Seems like Fällström is not intent on doing minority shareholders any favors this time around either.

[NewbieD]

The market is definitely pricing in a pretty big chance of the deal not going through. I think the 90% is not the major reason, to me that seems very likely to be reached. However, condition 3 in the press release may not be as straightforward:

 

"the obtaining of consent from (A) the required majority of the bondholders of bonds

issued by DDM Debt AB (publ)3 with ISIN: SE0009548332 (EUR 85 million currently

outstanding bonds due 30 January 2020) (the “Bonds”) for the following waiver of and

amendments to the terms and conditions of the Bonds: (i) waive the change of control

event that will occur with respect to the transaction contemplated by the Offer; (ii)

extend the final maturity to a date on or later than 30 January 2022; (iii) new interest

rate of 7.00 – 8.50 percent p.a.; and (iv) include permission to pay certain

management fees, the use of certain SPV structures for investments and an Equity

Cure provision, in all material respect similar to corresponding provisions included in

the terms and conditions for bonds issued by DDM Debt AB (publ) with ISIN

SE0010636746 (EUR 50 million currently outstanding bonds due 11 December 2020)

(the “Amendments”); or (B) Bondholders representing at least 60 percent of the

Adjusted Nominal Amount (as defined in the terms and conditions of the Bonds)

irrevocably accept to exchange their Bonds for new bonds on terms and conditions in

all material respect similar to the Bonds but including the above Amendments."

 

The stock is trading down driven mostly by what looks like one big seller. If the deal completes now in slightly less than 3 months you get 17% return, 87% annualized.

About 22% to stock price when offer was announced. Good case for the seller would be some clueless individual or redemption driven fund. Bad case would be someone with better info..

 

Questions I'm wrestling with:

- How should the company become private affect required return by bondholders?

- Is it reasonable to demand a lower financing cost because of implicit backing by the new owner? Or because of market changes? (the bond to be replaced currently 9.5% int)

- Who is selling?

[compounding]

Some interesting developments here which reduced the spread somewhat. The Swedish Securities Council required Demeter to waive the condition regarding the changed interest on the bond, and that they remove the delisting threat from the offer. Demeter responded by doing just that, and the spread contracted quite a bit, even though it's still very wide.

 

NewbieD, I'm guessing this further raises your conviction level that 90% will be reached? I'm not there yet as far as conviction, but haven't done anything with my shares.

[compounding]

The company recently released earning which were, of course, very good.

 

Today the independent bid committee recommended shareholders to decline the bid from Demeter.

 

"The Bid Committee’s assessment of the Offer is based on the fundamental value of DDM – comprising i.e. DDM’s growth opportunities and future potential – and also Handelsbanken´s opinion as to the fairness of the consideration under the Offer from a financial perspective. According to the fairness opinion, which is attached to this press release, Handelsbanken´s view is that the Offer, subject to the qualifications and assumptions stated in the fairness opinion, is not fair from a financial perspective.

 

Against the above background, the Bid Committee unanimously recommends DDM´s shareholders not to accept the Offer."

 

There was also an update on estimated ERC which was raised by €100m to €340m in total. The increase is due to the recently acquired portfolio in Croatia as a JV with B2 Holding. Just as a reminder, the company is now trading at 0.4x ERC. It's also at 6x EV/EBIT on trailing numbers that have a high probability of going higher.

 

For some perspective on those numbers, when Demeter launched the bid for SEK 40, it was at a 0.59x EV/ERC multiple. I personally though that was cheap, but applying that multiple to the updated ERC would imply a current equity value of around SEK 90...

[NewbieD]

Before events today I had a high conviction that the bid would close. This recommendation makes me a bit less certain that they will reach 90%. Also what has not been mentioned here is they announced an agreement with a majority of bondholders (not 2/3, but close) which should make the risk of refinancing the bond a small risk. This new ERC announcement and statement of increasing earnings should make the financing even less of an issue.

 

I have been accumulating at levels 34-37,5, and have about 15% in this stock. I feel like the downside should be limited even if the offer falls through with a decent upside. Given I'm not overly optimistic on the indexes now this type of investment seems okay. Was planning on accepting the offer, now not entirely sure..

[compounding]

Before events today I had a high conviction that the bid would close. This recommendation makes me a bit less certain that they will reach 90%. Also what has not been mentioned here is they announced an agreement with a majority of bondholders (not 2/3, but close) which should make the risk of refinancing the bond a small risk. This new ERC announcement and statement of increasing earnings should make the financing even less of an issue.

 

I have been accumulating at levels 34-37,5, and have about 15% in this stock. I feel like the downside should be limited even if the offer falls through with a decent upside. Given I'm not overly optimistic on the indexes now this type of investment seems okay. Was planning on accepting the offer, now not entirely sure..

 

Personally, I don't really understand why the bondholders would agree to change the terms like that without anything obvious in return. But I guess 56% liked it enough to do it. You have any ideas?

 

The cash flow from the existing portfolios are potentially in the range of SEK 2.5 bn the coming three years (according to the Q4 presentation they have 66% of the ERC in 2019-21, and today's announcement "accelerated the collection curve"), and the net debt is SEK 900 m, so that should provide some comfort for credit owners.

 

The stock is super cheap, but there are some risks. The general sentiment regarding the industry seems pretty lousy, Intrum has a very high short interest and the financing costs for the industry have gone up the last six months. I'm guessing it's related to fears about IRR's going down due to competition, credit losses on existing portfolios, and the leverage/reliance on capital markets. So you could have a scenario where it stays listed, and you have a majority owner that's hostile towards the minority, and all of the above headwinds, which in a levered equity play will have a big effect on the stock. This obviously goes both ways, as I indicated in my earlier post...

 

Not sure about the offer either. Still haven't done anything with my position. Would be nice to hear something from some of the large stockholders, or some activist getting involved.

 

 

[compounding]

Another way to look at it, which makes it look less cheap, is to remove the cash from the net debt calculation. The press release regarding the updated ERC today mentioned they will be "fully invested", whatever that means, so I think the correct calculation is with the cash removed. That would mean net debt is SEK 1557 m instead of 900 m, as I wrote in my previous post.

 

In that case we are at 0.58x EV/ERC, slightly under the multiple implied by the bid in December. Still cheap, but not as insanely cheap as I first thought.

[NewbieD]

Yeah I guess we'll see exactly in the next Q, I would guess somewhere in between those two numbers (0.55?) since fully invested should mean you have some little cash on hand for short term needs. Like 3 months wages.

 

Regarding the bondholders they did get a bait in a 3% of nominal fee. Apart from that I guess part of the bondholders might also be shareholders? Is there a registry for checking who holds the bonds?

 

Also if I understand what's below correctly they made sure they can take on 100-150 MSEK more of low interest debt:

 

"(iii) the reduction of certain senior debt qualifying as Permitted Debt, pursuant to sub-clauses (g) – (i) of the definition of “Permitted Debt” included in Clause 1.1 of the terms and conditions of the Bonds, from 20% to 10% of the outstanding total aggregate financial indebtedness of the DDM Debt group. "

[compounding]

That's true, on the other hand, if the cash is needed for operations it's not exactly excess cash, and probably shouldn't offset the gross debt.

 

Yeah, I saw that. Guess maybe that was enough. Good questions, will have to look into that.

 

I'm thinking that the refinancing ahead and general reliance on capital markets for funding might keep Demeter a bit in check with regards to their behavior. Being delisted will raise the cost of capital, and considering DDM's size, they might even lose access to debt markets without being listed. The company is already subscale, and it doesn't make much sense financially to restrict access to debt and equity funding in that way. I'm tempted to say that the mentioning of delisting in the bid prospectus was an empty threat designed to scare shareholders into giving up their shares, but that might be taking it too far. At least it reduces som negative tail risk.

 

I think it's quite possible that Demeter waives the 90% condition if they don't get that much, and that they just hold on to the shares they get for 40. I think the bid committee decision confirmed the fundamental case enough to say it's a bargain at 40, so why would they not take the shares they can get at that price? Especially considering they have funding benefits from being listed.

 

In summary, I think the merger arb is a decent punt from here, and my current plan is to sell my shares to the bid and see what happens from there. Any criticism welcome.

 

 

 

 

 

 

[NewbieD]

After thinking about this it's clear that I also need to accept the offer. I just don't want to align long-term with these owners. However, if the bid fails I will be semi-comfortable with having to stay. And I agree with your assessment that they will likely follow through and increase their ownership even if they don't reach 90%. Holding cos have done similarly recently in e.g. Stendörren, Karo Bio.

 

Btw, if you are interested in this type of merger-arb play it'd be fun to hear your thoughts on Latvian Forests current situation.