Tetragon Financial Group (OTCPK:TGONF) Q2 2022 Earnings Conference Call July 29, 2022 10:00 AM ET
Company Participants
Paddy Dear – Principal-Investment Manager
Paul Gannon – Chief Financial Officer
Steve Prince – Member-The Investment Committee & Risk Committee
Conference Call Participants
Operator
Good afternoon. Thank you for joining Tetragon’s Half Year Investor Call. You are all in listen-only mode. The call will be accompanied by a live presentation, which can be viewed online by registering at the link provided in the company’s conference call press release. This press release can be found on the homepage of the company’s website, www.tetragoninv.com. In addition, questions can be submitted online while watching the presentation. As a reminder, this call is being recorded.
I will now turn you over to Paddy Dear to commence the presentation.
Paddy Dear
As one of the Principals and Founders of the Investment Manager of Tetragon Financial Group Limited, I’d like to welcome you to our investor call, which will focus on the company’s 2022 half yearly results. Paul Gannon, our CFO will review the company’s financial performance for the period.
Steve Prince and I will walk through some of the detail of the portfolio and that performance. Steve will spend some time discussing the outlook. As usual, we’ll conclude with questions taken electronically by our web-based system at the end of the presentation as well as those received since the last update. PDF of the slides are now available to download on our website, and if you’re on the webcast, directly from the webcast portal.
As usual, before I go into the presentation, there are some reminders. First, Tetragon shares are subject to restrictions on ownership by U.S. persons and are not intended for European retail investors. These are both described on our website. Tetragon anticipates that its typical investors will be institutional and professional investors who wish to invest for the long-term in a capital appreciation and income-producing investment. These investors should have experience in investing in financial markets and collective investment undertakings and be capable themselves of evaluating the American risk of Tetragon shares, and they should have sufficient resources both to invest in potentially illiquid securities and to be able to bear any losses, which may equal the whole amount invested that may result from the investment.
I’d also like to remind everyone that the following may contain forward-looking comments, including statements regarding the intentions, beliefs or current expectations concerning performance and financial condition on the products and markets in which Tetragon invests. Our performance may change materially as a result of various possible events or factors.
With that, I’d like to pass over to Paul.
Paul Gannon
Thanks, Paddy. Tetragon continues to focus on three main performance metrics. We look at how value is being created via NAV per share total return. We also look at investment returns measured as a return on equity. And finally, we monitor how value is being returned to shareholders through distributions, mainly in the form of dividends. Fully diluted NAV per share was $28.59, 30th June 2022. After adjusting for dividends reinvested – reinvested at the NAV, the NAV per share total return for last 12 months was positive 10%. In the first six months of 2022, it is minus 3.5%.
Since IPO in 2007, Tetragon has achieved an annualized NAV per share total return of plus 10.8%. For monitoring investment returns, we use an ROE calculation which was minus 5% for the first half of the year, net of all fees and expenses. With reference to long-term target range of 10% to 15%, the average ROE achieved since IPO is now positive 11.7%. Later on the call, we’ll give more color as to how the individual asset classes have contributed so far this year.
Finally, moving on to the last key metric, dividends. Tetragon declared a dividend of $0.11 for the second quarter and which represents a dividend of $0.22 for the half year. Based on the quarter-end share price of $10.40, the last four quarters dividend represents a yield of approximately 4.1%. Finally, on to the NAV bridge. This breaks down into its component parts the change in Tetragon’s fully diluted NAV per share which is $29.86 at the end of 2021 to $28.59 per share at the end of June 2022.
Investment income and losses decreased NAV per share by $1.23. Operating expenses, management and incentive fees further reduced NAV per share by $0.25, with $0.05 per share reduction due to interest expense incurred on the revolving credit facility. On the capital side, gross dividends reduced NAV per share by $0.22. But there was a net accretion of $0.48 per share, which was the net accretion from the share buyback, less dilution from stock dividends and the additional recognition of equity-based compensation shares.
I will now hand it over to Paddy.
Paddy Dear
Thanks, Paul. Tetragon began investing in 2005 and became a public company in April 2007. So the fund has 17 years of investment history and 15 as a fund in the public markets. What we show here is the NAV per share total return which is the thick line. We have the share price total return, which is the dashed line, and the chart also includes the equity indices, the MSCI and the FTSE All-Share.
Lastly, it shows a Tetragon hurdle rate of LIBOR plus 2.65%. As you can see, Tetragon has returned 376% since IPO on a NAV total return basis. During the first half of 2022, the NAV total return was minus 3.5%, and this compares with minus 5% for the FTSE All-Share, minus 17% for the MSCI World Index. And as I think people are aware, the S&P and NASDAQ has performed worse, down 20% and 30%, respectively. So in 2022, so far, we’ve had four absolute returns. And obviously, nobody likes a negative return. But looking on the positive side, we have shown some strong relative performance.
Notwithstanding that with the current war in Ukraine, supply chain disruptions, highest inflation in the generation, interest rates rising and political uncertainty in many Western economies, the outlook remains very opaque for investors. So we continue to remain cautious.
Moving to the next slide and continuing the theme of looking at the longer term, here are some more performance metrics. Our return on equity target is 10% to 15% over the cycles. The average return since IPO, as Paul mentioned, is 11.7%. And the current yield on the shares, that remains just over 4%. The last figure I’d highlight on this table shows that 36.3% of the public shares are owned by principles of the Investment Manager and employees of TFG Asset Management. We believe this continues to be a very important metric as it demonstrates a strong belief in what we do as well as a strong alignment of interest between the manager, TFG Asset Management employees and Tetragon shareholders.
Moving to the next slide. We show the composition of Tetragon’s net assets. So looking at the breakdown of the $2.7 billion of NAV. The colored disks show the percentage breakdown of our asset classes and strategies at the end of June 2022 on the right and comparison with year-end 2021 on the left. And as you can see, there are no notable changes so far this year, so nothing really for us to discuss.
Moving to the next slide, what I’d like to do now is move on to discuss the year’s performance in more detail. The NAV bridge that Paul showed was a high-level overview of the NAV per share. And what this table does is it shows a breakdown of the composition of high level of Tetragon’s NAV at the end of June versus the end of 2021 by, as I say, high-level asset classes, and shows the factors contributing to the changes in NAV.
Thus, what this table does is it shows investment performance plus capital flows and so tying back to the change in NAV. As you can see from the bottom row of the table, the aggregate investment performance, and this is labeled gains and losses, so the fifth – sorry, the fourth of the columns, you see that we generated a gross loss for the period of $116 million, and hence, that has generated a return on equity of minus 5%.
Specifically, TSG Asset Management, which is where we hold private equity holdings and asset management businesses, had losses of $31.4 million. We’ll get into the details in a moment. But this is an unrealized loss based on current valuations and driven mainly by foreign exchange losses, where Equitix is partially exposed to British pound sterling, where we only hedge about half the position currently and also due to market multiples declining. These asset management businesses continue to perform well with aggregate AUM increasing to $37.5 billion in the first half of the year, up from $37 billion at year-end.
You can see that the event-driven equities, converts and other hedge fund strategies lost $6.5 million in aggregate in the first half. Bank loans and this is where we invested in CLOs, generated a gain of $40.9 million for the first half. Real estate in aggregate had a gain of $3.4 million. Private equity and venture capital had a gain of $3.3 million. Legal assets had a gain of $1.3 million. And then the most significant there at the bottom, other equities and credit showed a loss of $127 million. So to go into some detail on each category.
Let’s start with TFG Asset Management. And for that, I’m going to pass over to Steve.
Steve Prince
Thanks, Paddy. So I’m going to move on to the performance of the asset managers that comprise TFG Asset Management. Our private equity investments in asset management companies through TFG Asset Management recorded an investment loss of $31.4 million during the first half of 2022. And as Paddy said that was driven mostly by our investment in Equitix, which is our integrated core infrastructure asset management and primary project platform.
As Paddy said, Equitix generated a loss of $82.5 million during the first half of 2022. That was driven by two factors, first, weakness in the British pound; and secondly, a decrease in market multiples for comparable asset managers. The downward valuation from the market multiples approach was partially offset by the DCF valuation approach as Equitix’s AUM increased from £8 billion to £8.5 billion during the period. TFG Asset Management’s investment in LCM, which is a specialist in below investment-grade U.S. broadly syndicated leverage loans, gained $37.4 million during the first half of the year.
LCM’s AUM has been consistently growing at a five-year CAGR of approximately 11%. In the DCF valuation methodology, a successful track record of AUM growth tends to lead to a higher growth rate applied to future capital raising assumptions. Similar to Equitix, the market multiples for comparable asset managers was reduced during the first half. And so that partially offset the gains from the DCF valuation approach.
Moving on to BentallGreenOak, a manager of real estate investment strategies. That generated an investment gain of $18.3 million, which was due to increasing projected EBITDA and carry, stemming from manager outperformance. Distributions to Tetragon during the period totaled $10.1 million which reflected a combination of three items: fixed quarterly contractual payments, variable payments, and some carried interest.
TFG Asset Management’s other asset managers consists of five other managers, Polygon and Acasta partners, which are managers of open-ended hedge fund and private equity vehicles; Tetragon Credit Partners, which is TFG Asset Management’s structured credit investing business; Hawke’s Point, an investment company focused on mining finance, which provides capital to companies in the mining and resource sectors; Banyan Square Partners, an investment management business focused on providing non-control structured and common equity solutions to financial sponsors; and Contingency Capital, a global asset management business that sponsors and manages legal assets related investment funds. The collective investment loss on Tetragon’s investment and these other managers was $4.6 million during the period.
Paddy is now going to go over our hedge fund investments.
Paddy Dear
Thanks, Steve. Tetragon invests in event-driven equities, convertible bonds and some other strategies through hedge funds. The majority of these continue to be through funds managed by TFG Asset Management entities, namely Polygon and Acasta Partners. Investment in the Polygon European event-driven strategies gained $13.3 million in the first half, and this was offset by a loss of $9.1 million in the Polygon global equity strategy. Investments in Acasta fund – and as a reminder, this is the Acasta Global Fund, which was renamed from the Polygon Convertible Opportunity Fund – and also the new Acasta Energy Evolution fund that was launched in March, collectively lost $8.7 million in the first half.
And investments in hedge funds managed by third parties lost $2 million in the first half. Next is bank loans. Tetragon invests in bank loans predominantly through CLOs, taking majority provisions in equity tranches. Tetragon’s investments are split, as shown here between LCM deals, non-LCM deals, and funds managed by Tetragon Credit Partners. And as you can see, in aggregate, our bank loan exposure recorded a gain of $40.9 million for the first half. And this was as CLOs have benefited from increasing LIBOR and also a continued period of low defaults. Over the first half, the Fed of the U.S. Federal Reserve increased its overnight rates and these have moved three months LIBOR from 21 basis points to 229 basis points, and this flowed through the CLO structures.
So the directly owned LCM CLOs generated $19.2 million of P&L, and they also returned $37.1 million of cash to Tetragon, much of which came from the sale of the equity tranche of LCM 31. During that period, Tetragon also purchased securities at LCM 37 and continues to support the compliance with EU risk retention rules for the LCM transactions.
Tetragon’s investments in vehicles managed by TCP generated profits of $19.5 million. Similar to LCM deals, this was driven by the increase in three-month LIBOR and relatively low default rates. TCP also instituted three refinancings during the period. And TCP investments returned $15.1 million of cash income to Tetragon during the period. And finally, the non-LCM managed CLO segment generated a gain of $2.2 million over the period and distributed $2 million of cash income.
Next is real estate. And as a reminder, Tetragon holds most of its investments in real estate through BentallGreenOak managed funds and co-investment vehicles. The majority of these are private equity style funds concentrating on opportunistic investments that target middle-market opportunities in the U.S., Europe and Asia, and they’re where BGO believes it can increase the value and produce positive unlevered returns by sourcing off-market opportunities where it sees pricing discounts and/or market inefficiencies.
So in summary, in the first half, investments in the U.S. lost $0.7 million, and this is across three funds and three co-investments. European investments had a profit of $2.3 million, and this is across three funds and seven co-investments. And in Asia, a gain of $2.9 million and again, where we’re invested in three funds without co-investments currently. And these are mainly in Japan, which is predominantly Tokyo, and the Pan-Asia portion of the fund, which is predominantly South Korea.
The other real estate bucket here decreased in value by $1.2 million. And this is commercial farmland in Paraguay, managed by an external manager, Scimitar, a specialist manager in South America farmland. And during 2022, the farmlands were revalued by an independent valuation specialist, creating the small movement in that.
And with that, I’ll hand back to Steve.
Steve Prince
Thanks, Paddy. Tetragon’s private equity and venture capital investments are split into the following subcategories: one, investments managed by Hawke’s Point; two, investments managed by Banyan Square Partners; three, other funds and co-investments where Tetragon invests in a nonaffiliated fund as a limited partner or in a special purpose vehicle as a co-investor. And finally, four, direct investments, which are direct private equity investments, which are held on the balance sheet, and those might also include venture capital investments. This segment generated gains of $3.3 million during the first half of the year.
Tetragon’s mining finance investments managed by Hawke’s Point, generated a loss of $17.3 million, driven by project-specific delays against the backdrop of flat gold prices. Tetragon invested $5.2 million into the fund and received a $15.5 million distribution as Hawke’s Point partially divested one of its investments.
Banyan Square’s portfolio companies achieved strong operating results during the first half of the year, particularly within the travel sector. However, this strong performance was partially offset by multiple contraction and foreign exchange headwinds. It still resulted in a net gain of $8 million.
Investments in externally managed private equity funds and co-investment vehicles in Europe and North America made gains of $12.5 million. These investments are spread across 25 different positions. Finally, the direct category produced a small gain of $0.1 million during the year. This category contains a private equity investment as well as two other pre-IPO positions.
Moving on to Tetragon’s investments in legal assets through vehicles managed by contingency capital. Tetragon made its first commitment of $50 million into the asset class in late 2021, $24.9 million of that has been called to date. A gain of $1.3 million was generated from this investment during the first half of the year.
Tetragon’s other equity and credit bucket generated losses during the first half. The other equities bucket lost $126 million. Approximately $90 million of this was driven by biotechnology exposures. Four technology positions contributed an additional $32 million in losses as growth in technology equity sold off during the first half of the year. Finally, exposure to financial equity and credit generated a smaller loss of about $4 million.
In terms of Tetragon’s cash, Tetragon’s net cash balance, which is cash adjusted for known accruals and liabilities, both short and long dated, was negative $99.9 million as of the first half of the year, June 30, 2022. In July 2022, however, Tetragon increased its credit facility from $250 million to $400 million and extended its maturity to July 2032.
As of 30th of June 2022, $250 million of this facility has been drawn and this liability is incorporated into the net cash balance calculation. The company actively manages its cash levels to cover future commitments and to enable it to capitalize on opportunistic investments and new business opportunities.
During the first half, cash usage was as follows: $252 million of cash was used to make investments, $46 million to repurchase shares and $12 million to pay dividends. $231 million of cash was received as distributions and proceeds from the sale of investments. Future cash commitments are approximately $97 million, and they are as follows: we have $36 million of commitments to BentallGreenOak funds, $19.5 million to private equity funds, $10 million to Tetragon Credit Partners, $25.1 million to Contingency Capital funds as well as a potential additional loan of $4.8 million to Contingency Capital and Banyan Square Partner funds of less than $1 million.
Finally, before we go into Q&A, I want to go through some of Tetragon’s future investment expectations. It’s always worth pointing out that one of our advantages is our ability to be opportunistic as it relates to investing in what we see as the most compelling investment opportunities. As you are aware, we launched Contingency Capital with Brandon Baer at the end of 2020, and Tetragon will continue funding its commitments to this business. While we will continue to look at new businesses to buy or build, there’s nothing that we are considering imminently.
We expect our event-driven equity exposure to remain stable, but we also expect to slightly reduce our exposure to our convertible strategy. Our precrisis CLOs are now fully amortized, but we do expect to continue investing in CLOs via various Tetragon Credit Partners vehicles, but at the same time, receiving cash back from some of their initial funds.
While we do have commitments to BentallGreenOak funds, we also expect some of our existing investments to continue distributing capital. So on the whole, we think our real estate investments will be stable over the next 12 months.
In terms of private equity allocations, we would expect them to grow over time. There are a few additional LP commitments that we have yet to fund, and we expect our Banyan Square allocation will continue to grow.
The other equities and credit bucket is a similar one to TFG Asset Management. We expect to continue to invest in opportunities as they come along, but the timing of those investments is less certain. And lastly, we are hopeful that in this current environment, there will be additional asset classes that we will make allocations to.
With that, let’s open up to Q&A.
Question-and-Answer Session
A – Paddy Dear
Great. Thanks very much, Steve and Paul. As usual, we’ve got some live questions from people on the webinar and also we’ve got some that people have e-mailed in over time. I’m going to start with one about valuation process. So this, I’m going to hand over to Paul. But the question is how do you value the equity in the asset management companies to calculate the NAV? So Paul, can you take that one?
Paul Gannon
Sure. So actually, what I would do is I’m going to point you to Note 4 or Page 48 in the interim financial statements. It’s a section called private equity in asset management companies. But I’ll give you a brief summary as well of what’s included there.
So we use a third-party valuation specialist, which has been engaged by Tetragon’s Audit Committee. They use some of the past valuation, valuing each business separately. And typically, for each business, they’ll use a discounted cash flow and/or a market model approach in order to arrive at a valuation. And on Page 49 and as part of that note, we disclosed some of the key inputs that go into that valuation. So there’s a fair bit of information in the interim report, and I’d encourage you to take a look.
Paddy Dear
Thanks, Paul. There is, not surprisingly, a couple of questions about share buybacks. And if I just sort of amalgamate the questions, with the discount, call it, 60% plus, essentially the questions are saying, why are you not more aggressive in the share buybacks?
And I think to give people some context, perhaps those who are a little bit newer to the company, we announced and executed a $50 million share buyback in the first half. I mean, actually, we only completed on about $44 million because even at the top end, that was not fully subscribed. But in the first half, we had just received cash from our sale of our Series C in Ripple. So we had a good cash amount in the business.
As Steve has just said, sort of roughly speaking, at the end of the first half, the company had negative $100 million of cash. So in other words, we don’t have excess cash on the balance sheet. So that’s the reason we’re not announcing a share buyback here and now, amongst other reasons. But Steve did also mention that we’ve increased our revolver line from $250 million to $400 million, and we’ve pushed that out to 10 years from here. So whilst we feel reasonably good about our liquidity, we’re not – we don’t feel we have enough cash to be announcing a buyback at the moment.
And I would say, given market environment, obviously, we’ve got a war in Ukraine, inflation in double digits, some very uncertain politics in – well, obviously, the UK, but also Italy, Germany to some degree, the U.S. to some degree. I think it’s – we expect markets to be relatively choppy from here. We think there’s a lack of clarity and therefore, we want to make sure that we maintain our maximum flexibility.
There was an add-on question on buybacks, which is, why do we use tenders as opposed to market purchases?
And I suppose the answer to that is we’re not necessarily wedded to only using tenders, but we’ve found historically that with the regulatory restrictions, it has just been easier and more efficient to do it that way. But if people feel we should behave differently, happy to listen to different suggestions. But that’s why we’ve done it that way.
I’ve got another question here about the Equitix position, and it refers to – well, the question really is, we talk about FX, can you be sort of more explicit as to the impact of the FX on the Equitix position?
I think everyone is well aware, we’re a U.S.-based fund in terms of that is our sort of base currency. So to the extent that we are investing in non-U.S. currencies, we tend where possible to hedge back into dollars. And I think most people are aware, originally, we hedged the full position of Equitix, but it has grown substantially over the seven, eight years that we’ve held the position and we’ve moved about 18 months ago to hedging about 50% of that position.
And the logic is as follows. There’s always a trade-off between P&L and cash. So if you hedge the P&L, then you’re not hedging your cash position. So if you sort of – if you can imagine that sterling is declining versus the dollar and the position, therefore, is becoming smaller, if we’re fully hedged than what we lose in our dollar NAV value we would recoup in cash, so the NAV doesn’t change. But equally, if sterling increases then what we would gain in the dollar NAV, we would lose in our cash position.
And given the size of the position we want to be and this gets back to uses of cash and volatility of our cash position and buybacks and everything else, we don’t want to be in a position where we have a hugely volatile cash position based on our hedge. So what we’ve seen over the last quarter and we talked in the valuation is the decline in sterling against the dollar. About 50% of that is hedged in P&L terms and therefore, some of the loss that we’ve seen in the first half is the unhedged portion of that equity position.
And the – actually, the last question I’ve got here is just on Acasta. Again, those people that know the business well will know that Acasta is Mike Humphries’ hedge fund business, used to be branded under the Polygon brand, but it was rebranded earlier in this year.
And the other thing that has happened is, Mike and the team have set up a new fund, which is called the Acasta Energy Evolution fund. So the way to think of this is this is a – it’s a hedge fund, it’s run by Mike Humphries and the team at Acasta Partners, so exactly the same team that are running the Global Fund and it sits alongside the Global Fund.
And what the team are trying to do there is target opportunities driven by the transit or the transition, I guess, of energy to renewable resources. Mike has always had a strong focus on metals and mining companies and associated commodities, and so this is trying to capture that long-term trend. Tetragon has about $4 million in the fund, it’s to date, very small, but hopefully will grow over time.
So that actually concludes the questions. But thank you very much indeed for joining us. And as always, if you have further questions, just contact us at Tetragon IR. So thanks for joining us, and have a great weekend.
Operator
Thank you. This now concludes our presentation. Thank you all for attending. You may now disconnect.
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