PFG 2017 Annual Report and Rights Issue

Due to my additional investment on February 26 and its recent performance, Provident Financial now constitutes over 50% of my portfolio. On February 27, upon publication of its annual report and announcement of a £300 million Rights Issue, its shares rose 70.41% from 588p to 1,002p. Yesterday they closed at 932p, giving me a 34% return on my investment.

Check out my previous articles about PFG:

The question now is: should I invest in the Rights Issue as well? Let’s begin by analysing the 2017 annual report first…

Pros

  1. Customer numbers rose 4.2% to 2.55 million, up from 2.45 million in 2016 (page 2);
  2. Vanquis Bank adjusted profit before tax of £206.6m (page 4);
  3. Moneybarn adjusted profit before tax of £34.1m (page 5);
  4. Settlement with the FCA regarding Vanquis Bank’s Repayment Option Plan (ROP) of £172.1m. I regard this as a Pro because analysts were estimating a settlement as high as £300m (page 6);
  5. To improve its capital position, the group decided to pursue a Rights Issue to raise about £300m (£331m gross proceeds before deduction of expenses of £31m), which will bring its CET1 capital ratio from 14.5% to 28.7% (page 7);
  6. Malcolm Le May was appointed group Chief Executive Officer on February 2, following his tenor as Interim Executive Chairman since 24 November 2017, and significant progress towards rebuilding PFG has already been made (page 8);
  7. “Our priorities for 2018 are to rebuild trust with our customers, regulators, shareholders and employees…” (page 10);
  8. The group’s dividend policy is to maintain a dividend cover of at least 1.4x. The aim is to restore dividends with a nominal dividend in 2018 and a progressive dividend in line with the above policy in 2019 (page 20);
  9. The group’s main sources of funding are:
    1. Bank funding – committed syndicated bank facility;
    2. Bonds and private placements with UK and European institutions;
    3. Retail deposits taken by Vanquis Bank (page 43);
  10. The main shareholders of PFG are Invesco Ltd, with 24.92%, and Woodford Investment Management Ltd, with 23.04% of the company as at 23 February 2018, with both having increased their share ownership since 31 December 2017 (page 99);
  11. The company has closed its defined benefit pension plan, which had a net pension asset of £102.3m at year-end 2017 (meaning the fair value of its assets is greater than the present value of its funded defined benefit obligation) (page 101);
  12. Removal of matching share awards under the Performance Share Plan from 2018 onwards (page 106);
  13. Reduction of pension benefits for new executive director appointments to align with the lower level provided the wider workforce (page 106);
  14. No performance bonuses or matching awards were awarded in 2017 (page 106);
  15. Malus and clawback provisions strengthened for bonus and awards from 2018 onwards (page 114);
  16. Cash at bank and in hand of £282.9m, up £59.2m from £223.7m in 2016 (page 134).

Cons

  1. 202 pages long;
  2. Adjusted profit before tax of £109.1 million, down about 67% from £334.1 million in 2016, and adjusted basic earnings per share of 62.5p, a bit lower than my 73p estimate when I valued the company (page 2);
  3. Statutory loss before tax of £123 million, down from a statutory profit of £343.9 million in 2016, and basic loss per share of 90.7p (page 2);
  4. Return on assets of 6.9%, down from 15.3% in 2016 (page 2);
  5. Leverage of 4.3x, much higher than 2.3x in 2016 (page 2);
  6. Employee costs rose £18.7 million, up 10% from 2016 (page 2);
  7. Provident adjusted loss before tax of £118.8 million (page 4);
  8. The difference between adjusted profit and statutory profit before tax is due mainly to exceptional costs of £224.6m charged in 2017 comprising:
    • £172.1m for settlement of the FCA investigation into Vanquis Bank;
    • £20m estimated cost of the FCA investigation into Moneybarn;
    • £32.5m related to redundancy, retention, training and consultancy costs to handle Provident’s transition to the new operating model, and subsequent plan to re-establish relationships with customers and stabilise the business (page 18);
  9. Adjusted return on equity (not counting extraordinary items, such as the FCA settlements and Provident restructuring costs) of 18% compared to 45% in 2016, and adjusted equity of £450.2m compared to £597.3m in 2016 (page 42);
  10. Group after tax loss of £134.4m, compared to an after tax profit of £262.9m in 2016, and basic loss per share of 90.7p compared to basic earnings per share of 181.8p in 2016 (page 130);
  11. Total equity of £535.1m, down £255m from £790.1m in 2016 (page 131).

16 Pros and 11 Cons, with the Cons being much better than what the market was expecting. The company is already making progress by improving the home credit division’s performance and settling with the FCA, using the proceeds from the coming Rights Issue to pay for it and to strengthen its capital base. Putting all this behind it, 2018 performance should improve markedly.

Rights Issue

So, what is a Rights Issue? Simply put, it’s an offer that gives the company’s existing shareholders the right to purchase additional new shares at a discount to the market price on a specific date in the future. Before these shares can be bought, shareholders can trade their Rights in the market, just like they trade normal shares. They have a value, to compensate for the future dilution of the shares already owned.

As a shareholder, I essentially have three options: subscribe to the Rights Issue in full and purchase the new shares; ignore my Rights; sell my Rights to someone else. The second option is definitely the least attractive, since I would basically lose money.

The Rights Issue announcement was published on February 27, and the main points are:

  • 17 for 24 fully underwritten Rights Issue of 104,998,731 new ordinary shares to raise £331m (about £300m net proceeds).  Since I own 175 shares, I will receive the right to purchase 123 new ordinary shares (17/24 x 175 rounded down);
  • the issue price of 315p represents a discount of 46.4% to the closing price of 588p on February 26 (the day prior to the announcement) and a 33.7% discount to the theoretical ex-rights price of 475p. Where does this theoretical price come from?
    • 148,100,000 existing shares at 588p – £870,828,000
    • 104,998,731 new shares at 315p – £330,746,003
    • Value of 253,098,731 shares – £1,201,574,003
    • Theoretical ex-rights price per share – 475p
  • PFG will use the proceeds from the Rights Issue to:
    • inject about £50m into Vanquis Bank as an additional management buffer;
    • repay £85m outstanding under a bridge facility;
    • £165m to create more funding headroom, by either increasing cash held on deposit or repaying borrowings, under a Revolving Credit Facility;
  • The Rights Issue is fully subscribed by Barclays Bank PLC and J. P. Morgan Securities plc;
  • Invesco Limited and Woodford Investment Management Limited, who own about 48% of Provident Financial’s shares, are supportive of the company’s plans and the Rights Issue.

To subscribe or not to subscribe?

Yesterday, PFG’s shares closed at 932p, so the new shares represent a discount of 66% to the market price, and a discount of 53.4% to the theoretical ex-rights price of 676p:

  • 148,100,000 existing shares at 932p – £1,380,292,000
  • 104,998,731 new shares at 315p – £330,746,003
  • Value of 253,098,731 shares – £1,711,038,003
  • Theoretical ex-rights price per share – 676p

If I decide to subscribe to the Rights Issue in full, I will have 298 (175 that I already own + 128) new shares worth £2,014.48 (298 x 676p) having invested £1,602 (£1,214.55 + £387.45), which gives me a profit of £412.48 (which is the profit I already have on this investment).

So, basically, a Rights Issue is nothing but a way for the company to raise more capital from its existing shareholders, so that the latter can maintain the ownership percentage they have now. It gives no immediate profit despite the new shares being sold at a huge discount, because the price of the old shares will be automatically adjusted down to reflect the greater number of shares now in issue.

Right now, the company is being sold for 2.6x its 2017 year-end book value (£1,380m / £535.1m). After the Rights Issue, PFG’s book value will be £865.85m (£535.1m + £330.75m). If the market decides to keep the 2.6x ratio, the market value of the company will be £2,251.2m, and the price per share will be 889p, a profit of 31.5% over the theoretical ex-rights price. But this is far from guaranteed.

Tomorrow, the Provisional Allotment Letters will be sent, and on Thursday, March 22, the new ordinary shares will begin trading, nil paid. The theoretical price for each Right is 361p (676p-315p) once they begin trading. If their price rises above this, I might just sell them instead of subscribing to the rights issue. The latest time and date to subscribe and pay for the Rights Issue is 11am on April 9, so I have plenty of time to decide.

Let’s see what happens…

One thought on “PFG 2017 Annual Report and Rights Issue

  1. Pingback: 2018 Q1 Performance: -1.09% – Investing: Move by Move

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