Factoring: Scottish Pacific Group

Peter Langham is the CEO of Scottish Pacific Group. Scottish Pacific is a debtor financing company, what we used to call factoring in the old days, where they lend to small businesses against their invoices, well they actually buy the invoices and they then collect the money off the debtors. It’s an old business, the business has been going for a long time. This business has been going for, I suppose in various forms, 30 years. Peter Langham kind of started part of it. It listed on the stock exchange in the middle of 2016. In November 2016, it came out with a profit warning and the shares crashed.

They’d floated at $3.20, they actually got above $4 and then crashed back into the $2 – below $3 – and now they’re still at $3.08 or so per share. They’re still below the price at which they floated coming up to two years ago. Look, a bit of a disappointment so far for people who came in on the float. Peter kind of explains in the interview what happened in November 2016. There were a couple of kind of special things to do with acquisitions that they’d made. But even so, I don’t think that was terribly forgivable really to come out with a big profit warning a few months after listing and I think it kind of blotted their copy book somewhat. 

Anyway, they’ve been climbing back gradually since then. The reason that we are interviewing them is because they pay a fully franked dividend yield of about 5.5-5.7% and they’re currently on a PE of 14. It’s a finance company, it’s a 100% fully franked dividend yield, in the mid-5’s, so in a sense it’s an alternative to the banks for those investors looking for income. It’s a growing business, debtor finance, there’s no doubt that it is growing. Because as Peter explains in the interview, the banks when they lend to SMEs demand that the owners of the companies put up their house.

In a sense, Scottish Pacific is an alternative to that and it’s the biggest debtor finance company in Australia. That’s becoming a more popular form of finance for SME owners who don’t particularly want to put up their house to get some money from the bank to fund working capital. It’s an interesting business, it’s growing, paying a good yield. 

Here’s Peter Langham, CEO of Scottish Pacific Group. 

Perhaps we could start if you could just help me get my head around the history of your business?  It was formed out of a merger between Hallmark Business Finance, which came out of Mercantile Credits and your business which was called Benchmark Debtor Finance in 2007, is that right? 

Sort of.  Hallmark goes back to pre-1988.  Scottish Pacific was created 30 years ago from Hallmark and Scottish Pacific had various owners, including bank of Scotland and St George Bank over the years.  Then my company, Benchmark Debtor Finance, bought the business in 2007 from St George Bank.

Oh right, okay.  I was reading off the prospectus, so obviously the prospectus thing was slightly abridged.

I think they maybe cut some corners, I’m not sure.

The Bank of Scotland – I’m just trying to get my head around it – was Scottish Pacific originally formed out of the bank of Scotland or not?

No, no, it used to be Hallmark and then Bank of Scotland bought the business and hence, the change of name to Scottish Pacific and that was, as I say, just over 30 years ago.

And you worked for Bank of Scotland for a while didn’t you?

I did.  I headed up their sales team in the UK and then came to Australia and worked for Scottish Pacific for about 5 years and then left and then came back and bought it.

There you go.

Yes.

The business was listed in 2016.  What happened with the listing?  Because most of the stock that was listed was existing shares that were sold, so who did the selling?

We were at the time owned by Next Capital, their partner investor was IFM.  It was a PE transaction.

I see, okay.  Because I note that a third of the shares now are owned by something called Scottish Pacific Group and I just don’t understand how that works.  That’s the same name of the company.  Is that Scottish Pacific owning a third of itself or something?

No, I don’t understand that.  The shareholder is mainly institutional.  Next Capital, the private equity firm from Sydney, still has about 8% of the shares.  Then it’s sort of mainly institutional.  I don’t know where that comes from…

That’s from my Iress screen, so obviously it’s wrong.  Obviously, not long after the company listed in November you came out with quite a big profit warning, which caused the share price to fall from above $4 bucks back to $2 dollars-something.  That must have been very disappointing for the shareholders, people who came in on the float paying $3.20 a share.

I’m sure it was.  Interestingly though, a lot of those shareholders who came in at the float are still there today.  I think some bought even more shares when the shares went down and certainly the feedback we get from them today, they’re not totally disappointed with the share price now and the way we’re trading.

Because I wanted to sort of compare how you’re travelling now with what happened in 2016.  What you said in 2016 in November was that trading was nowhere near what had been expected in the prospectus.  Is it back now to where it should have been, where the prospectus forecast said you’d bed?

It’s certainly where we expect them to be.  What we also said in November 16 was that our business was trading well, we were growing every month, we were investing in growth…  What we got wrong was we brought four businesses together and we underestimated the impact of imposing Scottish Pacific credit on some of the acquired books and that caused probably higher client attrition than we anticipated and less borrowing that we anticipated.  The business was trading very profitably and growing and certainly where we are today, we’re happy, we’re the largest player in our field by a country mile and we’re still growing net revenue close to 10% and very low or zero bad debt.  We’re very happy with where we’re trading today.  The November thing, yes, is a new CEO of a public company, that does hurt you but at the time we stated that the basis was growing, profitable, investing in the future.

You might have been at a new public company, but you weren’t a new CEO, you’ve been running these things for years.

That’s right.  We got the numbers…

I guess it’s a bit surprising that you were surprised, in a way?

Yeah.  [Laughs] Yes, most definitely, but when you pull the four businesses together there was probably more fallout than we anticipated.

What do you mean by imposing Scottish Pacific credit on those four businesses, what does that mean?

Scottish Pacific, we’ve been around for 30 years and there’s a reason we’ve been around for 30 years, is because we do good lending to good businesses, have very minimal or no bad debts and we make sure we maintain that philosophy within our business.  One, we keep our clients longer, so you’re not doing deals knowing that the car’s going to fail and then you’ve got to find more.  It means you’re consistently around for 30 years.  If you’re going to do that you’ve got to be pretty strict on your policies and procedures. 

We found that some of the books that we purchased weren’t as strict as we would have liked them to have been.  You’ve got to make sure that you’re running the clerks to your own standards.

When I was a young reporter this was called factoring, I think.  It’s the same thing isn’t it, factoring? 

It is.  In essence, it is, there’s different forms of it, National Australia Bank and Westpac, they have their own invoice finance products, but in essence it’s factoring. 

And how much of your business is that, factoring and how much is other forms of finance?

In terms of debtor finance, factoring is 90% of our net revenue, probably 95% of our loan book.  We’re certainly seeing further expansion and moving into more asset based lending.  Over the years we’ve certainly got to understand SMEs and we’re funding mainly business owners and we understand business owners, what drives them and the sorts of services and facilities they’re looking for.  We’re moving more towards being an asset based lender, primarily using the receivable and understanding the working capital of the business to make sure we’re looking after the clients appropriately.

Perhaps you can help us understand how the business works.  It seems to be that you have two revenue streams, you’ve got a management fee and the spread on the lending or a net interest margin on the lending.  Is that right?  And also it’s fairly capital light?  You don’t need a lot of capital for it?

No, we certainly don’t need a lot of capital.  We grow, generate good profits and therefore we generate good cash flows.  Obviously our shareholders are very happy with dividends.  I think the sort of main thing is that when we charge our clients, we do charge fees.  Some of our clients, we not just give them funding but we also chase the debts for them, we send statements for them, we give them credit, help them with avoiding bad debts by assessing debtors and telling them whether we think they should give them credit or not.  There’s more than just lending money to them.  Hence, you end up with a management fee and then we charge interest on the money.  Some of our clients don’t take much of the service so the management fees are a lot less.  Our income is a mix between management fees and interest and it really just depends on the particular clients and where their tendency is in terms of, do they want additional service or not?

What’s the proportion between management fee and net interest income?  It looks roughly two to one, is that a kind of a standard?

That’s about right, yeah.  It’s about two-thirds management fees and a third interest. 

What is the management fee, what do you charge them? 

Sometimes it can be $500 a month for a client or it might be a percentage of the invoices they send to us.  It really depends on the size of the client and the type of the facility that they have with us and hence, really the workload that’s going to be put in by us behind the scenes to one, make sure we’re secure and the facility we provide to the clients is consistent.

Right, what’s the average size of the debt and the invoices that you take on?

The invoices – we’re buying new invoices every day.  We’re handling about $17 billion dollars’ worth of invoices every year and one client’s invoices might be on average $200 dollars and others might be $50,000.  So in terms of invoice size it’s very varied, it depends on the size of our clients.

Yeah, that’s what I mean, the size of your clients?

Yeah, we’ve got facilities that are come and go facilities.  We’ve got one facility that someone can offer us an invoice for funding and we’ll fund it within 14 hours.  That invoice could be $10,000 dollars or it could be $50,000 dollars.  But then we’ve got other working capital facilities for some larger clients and we can go up to $50-60 million.  On average, our clients are borrowing about $600,000 dollars.  But interestingly, sort of over half the business we write are companies borrowing less than $700,000 and probably about a quarter of the business who write their borrowing less than $250,000. 

We love the smaller deals.  I suppose, we’ve been doing this for 30 years.  We love business owners.  They’re all battlers, SME business owners are very resilient tough people and you love working with them, so we love doing the smaller deals and helping people achieve their aspirations really.

And what percentage do you generally pay on an invoice?

Well, there’s 80%, sometimes a bit more.  It really depends on what the client’s looking for and the nature of business therein.  It’s a bit like carrying an overdraft secured against whatever your receivables are.

You’d pay say, 80% cash for an invoice and then what, you just go and collect the money then?

The money comes in and then the client gets the difference between the 80% and our fees.  Say, on average, we might be charging them 1% of the invoice value.  That will get the remaining 19% when the customer pays the invoice. 

I see, right, okay.  You don’t keep the 20% obviously, you’re just keeping 1%.

I’d be sitting on a beach somewhere if we did that.

[Laughs] That’s right.  And what do you generally charge for the money?  What’s the interest rate?

If you combine whether it’s a management fee or interest margin, the overall cost can be anything from – some of our clients might be 7-8% up to sort of 18% for our normal clients, it ranges. 

That’s how your clients generally see it, they see it as a single percentage but they’re paying you in two separate ways?

Yeah, they certainly do.  I think for the smaller clients, because they’re usually getting added service we’re giving them – it’s a working capital life.  There’s no capital repayments, there’s no interest ratio covenants, there’s no – “Oh, give us your accounts every year, we’re going to give you an annual review.  They don’t have to offer their home as security.  That flexibility for these clients, even if you are charging them 15% as a percentage of their business overheads, it’s very small.  Their biggest costs are going to be wages and their purchases.  It doesn’t prohibit them from growing their business.  But certainly they get that flexibility.  If they double their turnover, they double their facility.  You don’t have to go back to the bank, cap in hands, saying, “Can I have some more money?” It just comes naturally. 

I suppose one important thing is, they don’t have to put up their house to get the money.

Oh yes, as an Englishman – you can tell from the accent – I’m still shocked that business owners in Australia actually offer their homes as security to banks.  You wouldn’t get that anywhere else.

Well they have to, the banks make them do it.

They’re probably more like building societies.

[Laughs] Well, in fact a lot of business lending is buried in the home lending statistics.

It is.  I saw an article last week I think in the Fin Review, Kate Carnell was saying 80% of business is secured by the family home, which if you said to somebody, “You can borrow money, secure it against the family home for your business at 5%, or you can borrow money against the assets of the business at 10%...” it might be twice the rate but I’m sure most people would pay 10%.

Yeah.

I can’t comprehend it, but then again…

There’s a lot of SME lenders springing up now who aren’t the banks because of exactly this phenomenon.  A lot of the money’s going into development construction for apartments and so on.  But still, there’s a lot of SME borrowers and the peer to peer lenders.  Are you finding the environment more competitive now than it’s been in the past?

I wouldn’t actually know.  I mean, for us, before we floated, we acquired a company called BB Financial Services in Australia and New Zealand which was one of our biggest competitors and GE – they were a big competitor.  Both of them wanted to sell, we didn’t go knocking on their doors.  In our space we haven’t seen much, if any, new competition, but what we’re liking is that we see SMEs sort of saying, “Well there are alternatives to banks.”  The headlines that all these fin techs are getting is good.   A lot of those, they’re doing small ticket, short term loans, so we don’t see it as a competitor to us, but we actually like it because it’s raising awareness of non-bank finance.  We produce – and you’re going to get a copy very soon, I know – a growth index twice a year that Eastern Partners do for us.  We started that in September 2014 and the proportion of business owners who now are looking or being funded by non-bank lenders has increased every year since we started that survey. 

Business owners are becoming more and more aware of it, their advisors are becoming more and more aware of it.  But certainly the small ticket short term funding really doesn’t impact us.  Most of our facilities are longer term.  We keep our clients on average for about 5 years and some of our clients have been with us for over 20 years or even 25 years.  Of the way we look at our clients, we want to get a client and keep them for life.

The proportion or the number of businesses who are factoring their invoices increasing?

It’s certainly increasing within our business.  We’re increasing our penetration over 70% of our new business are people who are new to debtor finance.  Overall, we’re not sure what the numbers are because people from National Australia Bank who offer this facility no longer sort of submit their numbers to our industry body and there’s some other people who do this aren’t members.  We haven’t got consistent numbers.   I think I’ve always – obviously we spent a lot of time with investors and they sort of talked about market share.  At Scottish Pacific we don’t care about market share, we basically say, “We just want to help people and if we’re increasing our client numbers and increasing how much money we’re lending and helping more people, that’s fine by us, we’re not concerned about market share.”

What is your market share, just by the way?

We don’t know.  We estimated we’ve certainly got at least 20% of the lending in that space, but it’s more and more of what we do and others do is less.  Although debtor finance is the core, we’ve got other working capital facilities or other facilities that we help our clients with, so it’s more of a sort of whole funding package for SMEs rather than being pigeon holed as, this is a debtor finance company.  It’s just another form of working capital. 

Who are your main competitors?  Is it the banks or are there other businesses like yours?

I’d probably say the banks.  Certainly Westpac and National Australia Bank have got good offerings for the right clients.  Being banks, they’ve got a lot tighter controls and a lot more covenants.  Some people will come to us rather than those banks.  Otherwise, if it fits into the bank pigeon holes, sometimes we’ll say to people, look, go to your bank.  It’s a better option for you and it would probably be a cheaper one.  I’d say the banks are the main competitors.  There’s other players in our field but there’s better offerings we can offer.  We cover a whole spectrum.  As I say, we can do a one-off $10,000-20,000 injection of cash for somebody on a short term basis or we can do a $50 million working capital line for a small public company.  We have a broad range of products.  I’d probably say the banks are our main competitors, but if the deal is suitable for a bank sometimes we’ll just say, “Look, go to your bank.”

Just looking at your 1H results.  One of the things that jumps out at me is the 67% increase in your operational cash flow.  Net profit was up 11% or so to $14.5 million, but cash flow up to $30 million, so I just wonder what’s going on there?  Are you fundamentally a cash business, is that how we should look at you?

Yeah, in essence we are.  We get paid from the receipts.  If we’re charging the client 1% of the invoice, we’re getting paid when those invoices get paid.  But yeah, I think most finance companies should be cash businesses and we are as well.  We’ve got good funding support, minimal additional money we have to put in as we grow and so yeah, in my view I think we’re a typical finance company that the profits you make should turn very nicely to cash. 

That would suggest that your 80% dividend payout ratio is sustainable?

Certainly.  If you again look at finance companies, certainly ones established like ours with good funding support – people like the banks because they pay good dividends and I think that’s the story for us.  If we were a lot smaller we would probably be having to put more of that cash into supporting our funding lines or other things, but I think the size of our business means that we’ve got more than enough support from our funders and cash to support that increase in funding and also pay good dividends and we certainly don’t see that changing.

Where do you get your wholesale funding from?

Our core funding comes from three warehouses, which are securitised warehouses, but through banks.  I’d rather not say which banks, but two of them are the big four high street banks and then one large American bank.   You’ll see in our results we actually do mention the warehouses and the lines we’ve got.  Pleasingly enough, those high street banks have supported our business for over 11-12 years, including through the GFC.  They understand our business, they understand how secure they are and one of those facilities has moved from $50 million up to sort of $700 million in the space of 13-14 years.  It’s interesting when some people start knocking banks, they’ve been great supporters of ours over the years.

One of them is a significant shareholder of yours, CBA?

No, no, they don’t fund this and I don’t think they are shareholders.  From my understanding I think they’re probably shareholders at Colonial.  Colonial have been great supporters of ours from day one.  CBA don’t lend us any money.

Your cost to income ratio went below 50% in the half-year.  Is that an important milestone for you and can you get it down to 40%?

We don’t view cost to income ratio as a carrot or a stick for anybody in the business.  What we do is make sure we keep striving to be the best we can be in delivering a good service to our customers, making life easier for our staff and improving every day how we do business.  By doing that, you do actually improve your cost to income ratio because you could become more efficient, you use technology and so the consequence of that is an improving cost to income ratio.  We certainly see that improving, starting from the 2H of FY18 and going forward. 

Can we get it down to 40%?  I don’t know, and if you did it wouldn’t happen in a hurry.  We’re a business that we know there’s lots of opportunities to keep growing that net revenue line.  I know that we’re well-established but our market’s under-penetrated.  The SME sector’s unloved and there’s a lot more we can do for a wider target audience.  We’re more concentrated on growing that top line and if we grow the top line at a good percentage, if you shave 1% off your cost to income ratio a year, I’m still happy with that because it’s going to deliver a much bigger bottom line.

We’ll leave it there, Peter, I appreciate your time.  Thank you.

Alan, thank you so much indeed.

That was Peter Langham, the CEO of Scottish Pacific Group.