Thorn snags new investor for Business Finance

Buried inside the inconspicuously titled ‘Thorn ABS Warehouse Trust Announcement' was good news for Thorn Group's shareholders. To unpack it all, though, we'll have to enter the arcane world of securitised financing.

Thorn's Business Finance division holds its loans in a trust – the Thorn ABS Warehouse Trust – which is dedicated for the purpose. The financing for those loans comes from selling units in the trust to investors who receive interest payments in return for their investment.

The units are split into different classes, ranging from the riskiest class F units, which incur the first losses and therefore pay the highest rate of interest, all the way up to class A units, which are the last to suffer losses and pay the least interest. That's the securitisation part.

Westpac initially bought the highest-ranking 80%, while Thorn bought the lowest-ranking 20%. But that's not Thorn's only interest. As the trust's originator and manager, the company also receives net interest income – the difference between the interest received from borrowers and paid out to the warehouse's unitholders.

Of all of Thorn's diversification attempts, Business Finance has been the most successful, with total assets reaching $326m after five years. As a result, though, Thorn has had to invest a further $68m – about a third of the company's total shareholders' equity – in order to maintain its 20% stake in the trust.

But that all changed on Friday last week, when Thorn announced that another investor had acquired 17% of the warehouse's units. By selling its own holding down to 8%, Thorn liberated $36m before costs, which it will use to repay part of its corporate debt as well as build a cash pile for any potential class action settlement.

Importantly, Thorn's Business Finance earnings are largely unaffected by the sale. Thorn will receive less interest income as it now holds fewer units in the trust (it nets this off against interest expense in its accounts, so you'll see slightly higher interest expense going forward). But as it still originates and manages the trust's loans, it will still receive the trust's net interest income, which is the most valuable part, as it forms the basis for the Business Finance division's earnings, which investors capitalise.

Vote of confidence

The sale is overwhelmingly positive. For starters, the introduction of a new investor into the securitised warehouse provides a vote of confidence about its credit quality. As a 'large, ASX listed investment management firm', we infer that they're no slouch.

The risk of a capital raising is all but gone, as Thorn's cash comfortably exceeds its corporate debt (which stood at $44m in March, or $13m on a net basis). Thorn may look highly geared in its accounts, but when you back out the securitisation warehouse – which is non-recourse to the parent entity – it's actually debt free.

Better yet, as Thorn's exposure to the securitised warehouse has reduced to just $22m (or 11% of Thorn's total equity), the worst-case scenario is manageable. If Business Finance blew up, Thorn's net tangible assets would fall to around $1.12 (or $1.07 if we also factor in the higher provision from the AASB9 accounting change), leaving Radio Rentals, the crown jewel, unaffected.

And lastly, the possibility for growth has also returned, as Westpac has increased the amount of money it's willing to invest in the warehouse by $50m. We haven't been overly enthused by Business Finance's rapid growth in the past, but now that our downside risk has reduced, we've become a bit more accepting.

After a torrid 24 months, things are finally looking up for Thorn Group, and with the price still at a large discount to net tangible assets, we're sticking with SPECULATIVE BUY.

Note: The Intelligent Investor Equity Growth Portfolio and the InvestSMART Australian Small Companies Fund own shares in Thorn Group. You can find out about investing directly in Intelligent Investor portfolios by clicking here.

Disclosure: The author holds shares in Thorn Group directly and indirectly through his interest in the InvestSMART Australian Small Companies Fund.