GLI Finance — Update 25 January 2016

Somerston’s investment in GLI and its proposed future investments and asset transactions are being executed through Golf Investments, a newly-formed special purpose vehicle. Somerston Group is a Jersey-based private-owned group of companies. Its origins were in shipping in the 19th century but it sold the last of its shipping interests in 1975. Since then it has concentrated most of its resources on real estate in the UK, Europe and the US. It has a record in corporate restructuring; for instance, it formerly held a 30% stake in Assura, the UK healthcare property company, and was an early investor in the data centre assets that became part of Digital Realty, the $11bn market capitalisation US REIT. In the UK it owns Somerston Capital, which acts as investment adviser and asset manager to the group for its activities in the UK and Europe.

GLI announced on 21 December that it is in negotiations to enter a strategic relationship with Somerston Group. Subject to finalising the negotiations and GLI shareholder agreement, the indicative terms are as follows. Somerston will:

GLI will:

The c £15m cash injection into GLI from the sale of GLIAF shares to Somerston (at the lower of £1 per share or GLIAF’s NAV per share), as well as the £5.5m of cash from the equity issued subscribed by Somerston, will be used to pay down some expensive debt (c £30m) on which it is paying interest at 11% pa. If exercised, the warrant issues could provide GLI with up to £15.1m of additional capital of (+13% on end-2016 estimate) and give Somerston a 17.9% stake in GLI.

Somerston Group's support could be crucial to GLI's success by providing its platforms with the finance that they need to arrange loans to their customers. Somerston is believed to have significant financial resources and as a private company can invest in projects for the long term without the requirement to generate profits, or dividends, in the short term. For GLI’s alternative finance platforms to be profitable they need to grow their businesses to a size at which revenues earned from arranging loans are large enough to cover the mostly fixed costs of their operations. Additional revenue over and above the fixed costs should flow through as profit to the platform owners, including GLI. GLI has already used its own resources that were not used to acquire platform investments to make loans arranged by the platforms, and created GLIAF to channel institutional money to its platforms. Somerston proposes to invest c £10m in GLIAF, increasing its size by around 20%. In the future it may invest more in GLI platform loans either through GLIAF or new funds to be managed by GLIAM.

GLI has investments in 19 alternative finance platforms, as described in our Outlook note of 11 November. Given its limited amount of capital, GLI has revised its strategy to focus on supporting and developing those platforms with the greatest potential to generate incremental shareholder value. It will carry out a detailed strategic review of the platforms in 2016 and has commissioned consultants to help it complete this work.

As a consequence of this review, we expect that GLI will restrict the flow of lending to some of its platform investments, which, in our analysis, could result in write-downs and possibly disposals. GLI has given few financial details on its platforms; most are believed to be loss-making at the moment, though management has indicated to us previously (see our November 2015 note) that it believes that Sancus and BMS Holdings earn profits of around £2-3m per year. In its H115 results statement it stated that it expects most platforms to be profitable by June 2016.

GLI currently values its holding in alternative finance platforms at fair value, in line with IFRS requirements. These are appraised in accordance with International Private Equity and Venture Capital (IPEV) valuation guidelines or other valuation models and techniques that can provide a reasonable estimate of fair value. Factors considered in the valuation analysis include discounted cash flows, comparable transaction analysis and credit spread analysis. Although the appraised fair values are calculated by a leading firm of accountants, the values used in the accounts remain the responsibility of the board of directors, which can substitute its own values if it believes they are more appropriate. This is permitted by IPEV guidelines in exceptional circumstances. GLI believes that it takes a conservative approach in valuing its investments, but has given no details on the average valuations used.

At 30 September 2015 – the last date for which published information is available – GLI’s holdings in alternative finance platforms were valued at £63.5m, 41% of its gross assets. A 10% write-off of the value of its platform investments would reduce its NAV per share by around 6%.

We have adjusted our 2015 and 2016 GLI forecasts to allow for:

Our revised forecasts are shown in the following exhibit.

We have increased our cash EPS forecast for 2015 by 8.3% for 2015. We have now assumed that £34.4m of GLI’s loan book is transferred to GLIAF, rather than £40m previously – the difference was transferred to GLIAF from Sancus. The higher yield on loans compared with GLIAF shares produces a slightly higher level of income for 2015.

Our cash EPS forecast for 2016 falls by 60% compared with our previous estimate, largely due to additional loan interest charges of £2.7m and a 7% increase in the average number of shares. As there will be no issue of zeros, we have assumed that GLI continues with its expensive loan from Sancus.

The decrease in estimated end-2015 NAV by 0.6% arises because net equity increases by 6.2% from the previous estimate, with the share subscription adding £5.5m to net equity and the reduced Q415 dividend adding £1.3m and the number of shares outstanding at year end has increased. Estimated end-year 2016 NAV increases by 3% with an additional four quarters of reduced dividends increasing net assets by c £4m resulting in a 10% increase in net assets compared with the previous forecast, while the number of shares is forecast to be 7% higher than previously.

Our dividend forecast for 2015 reflects a reduced Q4 dividend of 0.625p per share, from 1.25p, in line with GLI's comments that it will pay a reduced level of dividend of at least 2.5p per year compared with 5p previously.

With a 2016 cash EPS forecast of 0.79p per share, we anticipate that there is a 1.7p share shortfall to the 2.5p dividend, or £3.9m in total. Management has previously indicated that Sancus and BMS produce around £2-3m of profits per year, and there is also the prospect of GLIAM becoming profitable and remitting dividends. If GLIAM could increase its assets under management at GLIAF to £200m, from the current £50m, this could produce revenue of around £1.25m and profits of around £0.95m (assuming £0.3m of expenses), which, if distributed to GLI, could enable it to pay its dividend from cash earnings and remitted dividends.

Our revised forecast estimate of net debt at the end of 2016, including zeros, is £49.7m assuming that no dividends are remitted from subsidiaries. Excluding the zeros, net debt would be £26.3m, which is towards the £30m level beyond which GLI will need approval from its zero holders to incur more debt. Remitting dividends from its subsidiaries could reduce this level of debt, as could asset disposal of platforms or loans.

In Exhibit 2 we present our current forecast for 2016 and the key financial numbers as they may look after adjusting for the additional support measures proposed by GLI and Somerston. The figures have been calculated on a pro forma basis on the assumption that they take place at the beginning of 2016. These are still subject to shareholder approval, following which, along with any additional information, we will incorporate them into our forecasts.

If approved, the additional measures would significantly reduce GLI’s outstanding debts and reduce the amount of dividends that would need to be remitted from its subsidiaries to pay the dividends without increasing debt. Acceptance of the proposals would therefore make the GLI 2.5p dividend more secure. GLI set the dividend at a level that can support the growth of its platform assets without increasing its short-term debt. The additional support measures on which GLI shareholders are asked to vote at an EGM (date to be advised shortly) should reduce debt, so make the dividend more secure.

The most obvious comparison for GLI is listed alternative finance loan funds. As we show in Exhibit 3 below, after the cut in dividend to 2.5p per year GLI is trading at a yield discount to the 'pure' loan funds. It is trading at a discount to its NAV, though the latter figure is uncertain given the subjective nature of its fair value calculations and the strategic review of its platform investments, which may result in some write-downs.