The PNC Event trade was first recommended as a buy on 06 January 2020. Below are each of the updates related to this trade in chronological order.
Current advice: Please see analysis and recommendations below
Update – 25 September 2020, 09:30am
PNC will resume trading this morning after completing its refinancing and providing its FY20 results to the market. We discussed our intention of selling the stock when it resumed trading, but understandably some members have wondered whether it was worthwhile valuing the stock and selling once that value had been attained. While that logically sounds like a wise approach, the problem is that without a potential takeover on the cards there is no real short-term catalyst that could drive the stock’s re-rating to fair value. Over time, as the business performs in line with its expectations, that could change, but we didn’t get into PNC to be passive long-term investors but to take advantage of a takeover bid that has since gone wrong. We will see higher than normal volume today and in the coming days, and that needs to be taken into account as well.
Having said that, members are welcome to have their own approach and for that reason I’ll provide a brief analysis of the stock. The numbers provided yesterday have not been audited but with a detailed due diligence process followed by its new lenders it is likely there is nothing hidden of concern. The company’s NTA (net tangible asset backing) has fallen considerably after writing down the value of its loan book (because of COVID) and wearing the extensive costs of its failed deal with Carlyle. The NTA now stands at 74.33c but this is a trading company and should not be valued at NTA but rather as some multiple of its earnings.
Despite the write-downs, PNC’s core business generated normalised earnings before interest, tax, depreciation and amortisation (EBITDA) of $51m in FY20 and this is expected to increase in FY21 with a larger loan book. At 30c per share, PNC has an enterprise value (EV) of $225m and therefore trades at a low multiple of 4.4 times EV/EBITDA. To put this into context, Credit Corp (CCP) – perhaps PNC’s most similar listed peer but with a longer track record and definitely a higher-quality business – trades at an EV/EBITDA multiple of around 11 times (on a normalised basis).
In time, as the business performs and eventually refinances the credit facility it negotiated on better terms it is reasonable to expect this discount to reduce. Risks from the unwinding of Jobkeeper remain and there is no guarantee that the damage inflicted on the loan book is complete, but it is clear because of PNC’s leverage that a sustained period of performance from the loan book would lead to significant upside.
So, we will leave the final decision to members based on the commentary provided, but for the sake of the track record we will take our medicine today and sell the stock and recommend that members strictly following the Event Strategy advice do the same.
To view the rest of our current Event Trades, please click here.
Update – 24 September 2020, 2:00pm
PNC finally announced the details of its refinancing, and importantly provided its FY20 results and commentary on recent trading. The gist is that the refinancing doesn’t look to be on any better terms than the facility it had with Carlyle but will serve as a place holder until the environment stabilises and avoids the fighting that had begun with Carlyle.
There was no mention of any change of control discussions which is a real shame and suggests that there either wasn’t any interest or that any interest was well short of the value the PNC board expected.
As part of the refinancing, PNC has provided details of a number of significant one-off charges relating to the legal fight against Carlyle and a write-down of the value of the loan book on the back of the pandemic. This amounted to a significant hit to the company’s net tangible assets (NTA), although this is still substantially above the last trading price of the stock.
The shares have still not recommenced trading so we don’t know yet where the price will settle. Without a potential new takeover deal, there is no reason to still be in the stock so unfortunately we are going to have to take our medicine on this investment. We will advise members when the stock starts trading again, and with a good chance of solid volumes it is likely we will look to exit the stock immediately.
Update – 21 July 2020, 10:00am
PNC remains in suspension while it continues negotiations with several parties. These talks have taken longer than initially expected so PNC has agreed to extend the ‘standstill agreement’ with Carlyle. It sounds like there is nothing untoward behind the delays, so we remain hopeful of a good deal for the company that will allow members to regain some of the losses on this investment.
Update – 29 June 2020, 10:00am
A short update was provided by PNC today which advised that refinancing discussions were still advancing but for now it would keep its shares suspended while these negotiations progress. The company also provided an update on the progress of its ordinary business activities which were encouraging, and hopefully an improving environment could lead to a good deal for the company. We will update members further when PNC next updates shareholders.
Update – 22 April 2020, 11:00am
PNC provided a further update this morning, confirming that it has commenced legal proceedings in the Supreme Court of WA for declaratory relief against Carlyle which is now demanding repayment of its secured loans. PNC has also announced that it was terminating the Scheme Implementation Agreement (SIA) under the terms of the deal. This is somewhat surprising but may be a strategy that leaves the company in better stead in its legal action against Carlyle. Having said that, if Carlyle was breaching its commitment under the terms of the SIA then PNC would have legal recourse and the fact that PNC isn’t pursuing that is frustrating. Relations between the two parties have obviously deteriorated rapidly and any chance of the two working well together beyond this period is highly unlikely, so arguably moving on and not being tempted into spending its cash on any pursuit may be the wise course of action.
Ultimately, the bigger appeal of the deal with Carlyle at least from a company perspective was the loans provided which has allowed the company to continue trading and to remain solvent. PNC provided a company update which demonstrated that the company is performing well and generating positive free cash flows. There is a potential for things to deteriorate as the pandemic continues, but we have stated that the government stimulus has likely averted disaster for small businesses in Australia which are the main exposure for PNC. There will undoubtedly be a slowdown in the short-term as far as new debt investment is concerned, but that will be a cash benefit in the short-term anyway even if it hinders future profit growth. And bad debts so far have been at tolerable levels so its last audited debt portfolio balance of $336m (and amortised cost of $274m) may not see too much stress if conditions improve in Australia. Importantly, if this portfolio valuation is anywhere near accurate then the net asset backing of the stock is significantly above where it is trading (and worth $1.27 at last audited value which excludes any revaluation from the coronavirus).
Perhaps the other major reason why PNC has likely moved on from the scheme with Carlyle is that despite receiving several approaches in recent weeks it has been unable to entertain competing offers because of the terms of its agreement with Carlyle. Now unconstrained, PNC is going to restart these conversations with a goal of refinancing the debt facility and finding a new buyer for the company. Typically, we would look to exit a stock once a deal officially falls over but given the very poor liquidity of the stock and the view that improving credit conditions because of government stimulus and improving infection numbers (hence an earlier timeline for the economy restarting) should mean refinancing and/or finding a new buyer is more likely. The stock therefore remains a hold while we await further updates from the company.
Update – 14 April 2020, 11:00am
PNC provided an update after going into a trading halt last week. At the time of the trading halt, PNC announced that it had received a letter from bidder Carlyle regarding the loan facility it had provided PNC so today’s update doesn’t really bring any surprises. Since this deal was announced, credit companies have plummeted well beyond the broader market as the expectation of rising bad debts increases and there’s no surprise that Carlyle would be regretting the timing and price of the deal it struck in December.
Ultimately, we have said that Carlyle is legally compelled to complete the transaction as long as PNC meets the conditions attached to the deal. The main condition at risk is the ‘material adverse change’ clause (MAC) and without knowing how business is being impacted it is impossible to know whether this will be triggered. But that doesn’t mean that Carlyle won’t try to use this clause to exit the deal, and that is what we are seeing now. Carlyle is claiming that PNC is not meeting its obligations relating to its loan agreements and that this could trigger the MAC clause. Interestingly, Carlyle has not notified PNC of its intention to withdraw from the scheme just yet but that is probably its next move.
Not surprisingly, PNC strongly refutes the claims made by Carlyle and without an agreement between the two companies to lower the offer price, it is highly likely that this will now move into a legal fight. As long as PNC is meeting its obligations, Carlyle will remain compelled to buy the company, so PNC really has nothing to lose in spending to ensure Carlyle keeps up its end of the signed deal.
As has been the case for some time, with the stock so far below the value of the offer there is no decision other than to hold in our view. We will update members further as the company provides further updates.
Update – 08 April 2020, 12:30pm
PNC has gone into a trading halt after the company received more communication from bidder Carlyle Group. In our recent update, we stated that it was likely Carlyle would be looking at ways to terminate the deal given the fall in lending assets since its deal was announced, but it was legally bound to complete the deal as long as PNC satisfied the conditions attached to the deal.
It looks like this will be the opening play by Carlyle to terminate or change the deal. As PNC’s senior lender, it looks like Carlyle has made some sort of demand from PNC perhaps in an attempt to trigger the ‘material adverse change’ clause. Undoubtedly, PNC would now be getting legal advice regarding its options. If the PNC board has been truthful and business has been meeting budget, then Carlyle should have no recourse. Of course, the landscape is changing so quickly with this pandemic that a business performing to budget a week ago could be in a totally different situation today.
We will update members further once PNC makes an announcement.
Update – 24 March 2020, 11:30am
This morning we got confirmation that bidder Carlyle is reconsidering its options. As we have said all along, Carlyle is legally bound to complete this deal as long as PNC fulfils all conditions attached to the offer. Given the deterioration in the economy since the deal was announced, there is a good chance a lot of PNC’s loan book is in stress so there is no guarantee its business won’t deteriorate. The key here is that Carlyle is legally obligated to work towards a completion date of within six months (mid-June), so at this stage it looks like Carlyle is trying its best to delay the process to increase the chances that PNC triggers the material adverse change clause in the bid.
There are so many variables here, but while undoubtedly PNC’s bad debt exposure would have increased the recent RBA facility extended to the banks will allow many small businesses to access cheap finance. So, in the short-term PNC’s profit is probably safe, and the company said as much only a few days ago. The stock is effectively being priced for the deal falling over so realistically there’s no decision for us to make here. The result is binary; PNC will either meet its targets and shareholders will receive $1.82 per share, or they won’t, and Carlyle will be able to terminate the deal. Given the price, there is no choice but to continue holding the stock while we await further updates from PNC.
Update – 19 March 2020, 11:00am
PNC provided a timely update this morning to shareholders, stating that the transaction with Carlyle is still on track. There continues to be a flow of information between the two parties and the company expects the scheme booklet to be released to shareholders shortly.
Importantly, PNC also stated that the company is ‘currently performing to the Board approved budget’ which means that the ‘material adverse change’ clause within the agreement with Carlyle would not have been breached as of yet. This means that Carlyle currently has no legal avenue to terminate the deal. Small lending companies are being sold off heavily right now on the expectation that bad debts are about to explode, so the risk remains that PNC’s bad debts are the variable that could cause the deal to fall over. As of time, that doesn’t seem likely to be the case.
So, while PNC may not have rallied today on the update the reality is that the odds that the deal complete are significantly higher than the current share price implies. We continue to recommend members hold the stock on the view that we remain likely to see the deal complete, and for those members holding less than 2% of their portfolio in PNC, the stock remains a buy at current levels.
Update – 3 March 2020, 11:00am
PNC reported its interim numbers on Friday night, which also gave the company the opportunity to communicate how the scheme of arrangement with The Carlyle Group is progressing. From our perspective, the key commentary we wanted to see was that business was performing to expectations as the only concern we have about the deal whatsoever is if the business takes a turn for the worse, triggering the ‘material adverse clause’ condition and allowing Carlyle to walk away.
The good news is that the business is performing to expectations, which means we really need to see something unexpected before the scheme completes in May (according to the current timeline). Amazingly, the stock actually dipped to as low as $1.50 yesterday morning – it has since bounced to $1.60 – which represented an absurd arbitrage of 21% (excluding franking credits). This is likely more a result of the broad panic selling we have seen throughout the last week, and historically we have seen some incredible spreads open up in some of our event trades during times of volatility.
Given the update provided by the company, the odds of the deal completing are higher than a week ago and yet the stock is even lower, so the opportunity at these levels remains compelling in our view. We remain comfortable with members holding the stock (or buying) as a high-risk arbitrage investment and we will provide further updates once the scheme booklet is released.
Update – 18 February 2020, 11:00am
We have been receiving a number of queries from members about PNC since we recommended members in low income tax paying vehicles buy the stock. PNC has slowly traded lower since we recommended the stock such that it is now trading at a 6% discount to the cash value of the proposal put forth by Carlyle.
We have done some digging to see what may have caused the stock to sell-off, but we haven’t been able to find anything of note. The timeline has blown out by a month, but it doesn’t look like anything concerning caused the delay, and my guess is it’s more a result of the Christmas period slowing things down more than anything.
Given the downside if the deal falls over – as unlikely as that may be – we can’t say we’re surprised to see the stock trading at a big discount, but we do consider this an opportunity more than anything. Additionally, PNC would not be on the buying list of any arbitrage funds given its illiquidity, so a little bit of selling can cause a big move in the stock and the volume in recent weeks is nothing worthy of note.
We still feel that the only real risk of the deal falling over is if the ‘material adverse clause’ condition is triggered which would be the result of a significant downturn in the company’s fortunes since the deal was negotiated, and it’s likely the board would have been comfortable with this at the time the deal was signed.
So, we remain comfortable buying or holding the stock. As the downside of this stock is higher than usual, we continue to reiterate that members should consider this a high-risk investment and allocate capital accordingly.
Original Recommendation – 06 January 2020, 11:25am
PNC is a small financial services company that has attracted negative attention recently after languishing in suspension after the company downgraded earnings expectations and breached debt covenants, leaving the market speculating that the company was insolvent. The company has effectively been up for sale while it negotiated with its senior creditors and has fortunately found a proposal from Carlyle Private Equity which will see shareholders receive some value for their shares.
We have been monitoring PNC recently to determine if there was enough liquidity to consider recommending the stock to members and feel that with some patience members should be able to get stock. Outside of cash certainty of $1.82 per share, shareholders are being offered the opportunity to retain part of their shares and additionally – and crucially for us – PNC shareholders will be able to realise the value of the franking credits within the company as PNC will pay a special dividend of as much as $0.24 per share which will come off the $1.82 but will add $0.103 in franking credits to the offer.
With the stock trading at $1.79 (and with almost 200k shares available up to $1.80), there is an arbitrage on offer of 6.8% for those able to take advantage of the franking credits. The deal is subject to standard conditions and importantly is not conditional on financing or due diligence. Completion of the deal is likely to occur in April, so we’re looking at an annualised arbitrage of roughly 20% for those able to take advantage of the franking credits.
As PNC has been looking for a buyer, we find it unlikely that a competing bidder could emerge but as always anything is possible. Having said that, we are recommending PNC with the view that the current offer will be the successful offer.
For those able to take advantage of the franking credits, we therefore recommend buying PNC at no higher than $1.80 for a short-term, high-risk arbitrage opportunity. As mentioned previously, getting set may take some time so please be patient with your orders and we are classifying it as high-risk given the recent events so please allocate capital accordingly.
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