Commissioned research. DDM Holding. Financials Sweden. Ready, set, go off the starting blocks in CEE. 31 May Key data

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1 Commissioned research Financials Sweden 31 May 2017 DDM Holding Ready, set, go off the starting blocks in CEE Ready to take advantage of an immature market DDM Holding is an investor and manager of distressed assets in Central and Eastern Europe (CEE) founded in With its experienced management team and board, DDM s intention is to take advantage of the growing market for distressed asset portfolios in the region. The European market has witnessed a trend of banks selling off their distressed assets, a trend that has now also started to take off in CEE. Set to gain scale advantage In , DDM s operational expenses were quite stable, even though net collections have more than doubled, illustrating DDM s operating leverage potential. The operating profit turned positive in 2014, followed by net profit in Between 2015 and 2016 net profit almost tripled, again showing DDM s potential for operating leverage. New funding at the beginning of 2017 prepares DDM for new portfolio acquisitions, aiming for an all time high level above EUR 50m in Go for the growth opportunity By reinvesting cash flow from existing portfolios and adding financial leverage, DDM could continue its growth track seen over the last few years. With growth comes a larger entity, which could imply lower financing costs. Also, the operating leverage also could improve DDM s profitability as it grows. Valuation Based on our fundamental DCF approach, and accounting for variations in sales growth, EBIT margin and WACC assumptions, we derive an equity value per share of SEK Our estimates for 2019 imply valuation multiples of P/E 2.9x, EV/EBIT 4.4x and P/BV 0.7x, representing respective discounts to our peer group of larger industry players of 71%, 42% and 57%. The peers are significantly larger than DDM, which could justify a valuation difference. Key data Country Switzerland Bloomberg DDM SS Reuters DDM.ST Share price SEK 37.9 Free float 41% Market cap (m) SEK 521 Website Next report date 03 August 2017 Absolute and relative performance maj 2016 sep 2016 jan 2017 maj 2017 OMX Stockholm PI Source: Thomson Reuters Valuation approach Source: Nordea Markets DDM -1M -6M -12M YTD Absolute 3% 22% 30% 21% Relative 0% 10% 21% 10% DCF SEK 29 SEK Summary table - key figures EURm E 2018E 2019E Total revenue growth n.a. 87% 24% 22% 31% 17% EBIT margin -0.5% 36.2% 28.8% 33.5% 40.2% 40.7% EPS growth n.m. n.m. 149% -4% 66% 23% DPS P/E n.a EV/EBIT n.a EV/Sales RoE n.a. 24.3% 37.0% 26.0% 30.5% 28.0% Div. yield 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% FCF yield -38.1% -28.7% 20.6% -42.0% -29.9% -20.4% ND/Cash EBITDA Marketing material commissioned by DDM Holding 1

2 Table of contents Factors to consider when investing in DDM Holding 3 Valuation 7 Company overview 14 Business model 20 The distressed asset market in CEE 25 Strategy, targets and financials 33 Estimates 42 Detailed estimates 46 Risk factors 47 Reported numbers and forecasts 49 Disclaimer 52 Marketing material commissioned by DDM Holding 2

3 Factors to consider when investing in DDM Holding Investing in DDM gives exposure to the potential growth in the market for distressed assets in Central and Eastern Europe (CEE). Management has accelerated investment activities in recent years and aims for a record-high level of portfolio acquisitions during Given such increased scale, DDM could gain further from the operational leverage of its business model. Financing is a key challenge for DDM, but the company has already received funding by issuing both shares and bonds in Opportunities and risks We believe the following are key factors when evaluating an investment in DDM: Key factors to consider when evaluating an investment in DDM The trend among banks of divesting distressed asset portfolios has reached Central and Eastern Europe DDM s management and board have a 50 years combined experience in the purchased debt industry DDM could take advantage of its operational leverage as the business grows, thanks to its relatively stable operating expenses The company has received funds by issuing both equity and bonds in early 2017, setting DDM up for new portfolio acquisitions. We consider the following key risk factors for DDM: Exposure to the global economic development in general and to CEE in particular. Also, competition could put price pressure on the market, hurting DDM s profitability Net collections are key to DDM s business model. Collection problems could be caused by a third party collector, for example, or by fraud related to a portfolio investment DDM s business decisions depend on the competence of key personnel and on its proprietary IT system FUSION; loss of key staff or a lack of appropriate development into FUSION could hurt DDM s results Management says financing is critical; poor access to capital could hurt DDM s ability to take advantage of market opportunities. The company s issued bonds pose a refinancing risk. NPL deal momentum in CEE The non performing loans (NPL) market in CEE is seeing deal momentum, according to market studies, while DDM also says the market has grown substantially. CEE is an immature and growing market for NPLs CEE is quite an immature market for purchased debt compared with the more mature Western European market, for example, but there is a growing trend for banks in CEE to sell distressed assets to strengthen their balance sheets, thus increasing deal momentum. From a global perspective, DDM s invested and targeted markets are, on average, in the top 20 th percentile of the World Bank s Ease of doing business index. Marketing material commissioned by DDM Holding 3

4 Experienced management team DDM is a young company, founded in 2007, with an acceleration in operations starting in Management s total experience in the distressed asset market, however, totals more than 50 years. Combined, management and the board have overseen thousands of transactions in more than 25 countries. Management also holds a combined 369,000 shares in the company, representing almost 3% of outstanding shares. Set for operational leverage DDM s net collections have increased far more than operational expenses in the past three years, indicating that it can take advantage of operational leverage. As we estimate this trend will continue, DDM s profitability could gain from further growth. DDM aims to increase its volumes Management s intention to grow the business appears an obvious strategy to take advantage of this operational leverage. DDM has mentioned several interesting markets for new portfolio investments and has also raised funds to make this possible. DDM: Net collections and opex EURm % 30% 25% 20% 15% 10% 5% 0% Net collections Opex Opex/Net collections (RHS) Gains from operational leverage may partly reflect recent years swing to net profit. The company turned to positive numbers in Marketing material commissioned by DDM Holding 4

5 DDM: Selected income statement items, EURm Net revenues* Operating profit Net profit *after amortisations and revaluations Source: Company data DDM issued both equity and debt in early 2017 New funds ready to be invested The company received funds by issuing both equity and bonds in early It intends to use the proceeds for portfolio investments and for the repayments of old debt financing. The most recent bond was issued at 9.5% interest rate and the following tapping was corresponding to a rate about 9.0%. That is distinctly lower than the 13% and 18% on the issuances in June and September 2013 respectively, reducing DDM s average interest rate costs and lowering risk in the company. DDM aims for investing more than EUR 50m in portfolio acquisitions in Funded for new portfolio investments DDM could potentially enable growth and take advantage of its operational leverage. DDM: Portfolio acquisitions EURm Portfolio acquisitions DDM's target Source: Company data Marketing material commissioned by DDM Holding 5

6 We discuss the risk factors in more detail at the end of the report Risk factors DDM is exposed to the global economic development in general and that of Central and Eastern Europe in particular. A decreasing supply of distressed asset portfolios or increased competition could put price pressure on the market, hurting DDM s profitability. As net collections are key to DDM s business model, collection problems could have an impact on its business. These could be caused by a third party collector or by investing in portfolios affected by fraud. DDM s business decisions depend on the competence of key personnel and its proprietary IT system FUSION. Any loss of key staff or lack of appropriate development of FUSION could lead to misguided investment decisions, burdening DDM s financials. Management mentions financing as critical. Poor access of and the cost of capital could affect its ability to take advantage of market opportunities and increase its business. The company s issued bonds also pose a refinancing risk. Finally, when it comes to valuation we would like to mention the sensitivity in the WACC assumptions. We review this in detail and provide sensitivity tables in the valuation section. We provide an extended description of identified risk factors associated with an investment in DDM on page in this report. Marketing material commissioned by DDM Holding 6

7 Valuation The main part of our valuation is based on a fundamental DCF model that provides an equity value range of SEK per share, using a WACC of %. Our estimates imply 2019E valuation multiples of P/E 2.9x, EV/EBIT 4.4x and P/BV 0.7x. We note that our valuation is based on a longterm analysis and is not linked to a near-term assessment of the performance of the company. DDM is trading at discounts to the 2019E peer group average of 71% on P/E, 42% on EV/EBIT and 57% on P/BV, even though the different characteristics between DDM and the peer group should be mentioned, as DDM is a significantly smaller company than the peer group average. Our valuation approach is primarily based on a DCF framework One of the most common ways to assess the attractiveness of an investment opportunity is the discounted cash flow (DCF) method, discounting all available cash flows for equity, bond and non equity holders at the weighted average cost of capital (WACC). In other words, WACC represents a blended cost of capital for all capital invested in the company. In fundamental terms, a DCF framework is built on three parts: Discounting the company s free cash flow at WACC Identifying the value of debt and other non equity claims on the enterprise value Deducting all claims to determine the value of the common equity. The fair value per share is then simply calculated by dividing the equity value by the number of outstanding shares. We derive an equity value of SEK per DDM share based on a DCF valuation A DCF valuation is commonly considered by academics and practitioners to be the best way to capture the underlying fundamental drivers of a company such as cost of capital, growth rates, reinvestment rates etc. If applied correctly, it represents the best method to approximate the true intrinsic value of a company. The main appeal of a DCF framework compared with other valuation methodologies is that it also focuses on streams of cash rather than accounting earnings. Its main disadvantage is its relative sensitivity to changes in input values. We rely primarily on our fundamental DCF framework to derive an equity valuation range of SEK per share. We also provide a relative valuation, but point out that the peers are significantly larger than DDM We also provide a relative valuation, including some of the mentioned competitors to DDM and other European industry peers. Our relative valuation implies a range of SEK per share based on our estimates for 2018E. We point out that DDM is significantly smaller than its peers, however, with a market cap of just 5% of the peer group average. DDM being quite different to its peer group being a smaller company, having lower liquidity, operating in a narrower field of operations and in an immature market could justify a valuation difference between DDM and the peer group. Marketing material commissioned by DDM Holding 7

8 Summary of different valuation approaches DCF SEK 29 SEK 78 Relative Valuation SEK 63 SEK Source: Nordea Markets We use a ROIC as equal to WACC and apply a growth rate of 2.5% in the terminal period Time value adjusts for the fact that one euro today is of higher worth than one euro tomorrow Fundamental valuation The tables below show the general assumptions we use to calculate the DCF value. Based on the assumption that DDM can deliver broadly in line with our forecasts, with variations in sales growth, EBIT margin and WACC (weighted average cost of capital) assumptions, we arrive at a fair equity value range of SEK per share. In the terminal period, we model ROIC (return on invested capital) as equal to WACC and apply a 2.5% growth rate. DCF valuation DCF value (SEK) Value Per share NPV FCFF 749 to 1, to 85 (Net debt) Time value 19 to 39 2 to 3 DCF Value 486 to to 67 Source: Nordea Markets WACC assumptions Averages and assumptions Sust. Sales growth, CAGR 13.3% 5.0% 4.0% 2.0% 2.0% 2.0% EBIT-margin, ex associates 39.8% 18.0% 18.0% 16.0% 15.0% 15.0% Capex/depreciation, x Capex/sales 93.1% 50.0% 50.0% 50.0% 50.0% 2.0% NWC/sales -8.6% 0.0% 0.0% 0.0% 0.0% 0.0% FCFF, CAGR n.a. -6.0% 4.3% 0.2% 0.7% 2.0% 2.5% Source: Nordea Markets WACC We apply a WACC range of % as the input for our DCF valuation, with the assumptions behind our WACC outlined in the table below. WACC assumptions WACC components Risk-free interest rate 1.5% Market risk premium 5.5% Forward looking equity beta 1.55 to 2.05 Cost of equity 10.0% to 12.8% Cost of debt 7.5% Tax-rate used in WACC 10% Equity weight 75% WACC 9.2% to 11.2% Source: Nordea Markets Marketing material commissioned by DDM Holding 8

9 DCF sensitivity In the table below, we provide a sensitivity analysis of our DCF valuation, showing varying EBIT margins and sales growth rates. We assume a WACC of % Sales growth versus EBIT margin Sales growth change -1.0pp -0.5pp +0.5pp +1.0pp +1.0pp EBIT margin +0.5pp change pp pp Source: Nordea Markets Sensitivity tables illustrate the share s sensitivity given changes in EBIT margin, sales growth and WACC Below we also illustrate how the equity value varies with changes in WACC and sales growth. WACC versus sales growth WACC 9.2% 9.7% 10.2% 10.7% 11.2% +1.0pp Sales gr. +0.5pp change pp pp Source: Nordea Markets In addition, we provide a sensitivity table to illustrate how the equity value varies with changes in EBIT margin assumptions and WACC. WACC versus EBIT margin WACC 9.2% 9.7% 10.2% 10.7% 11.2% +1.0pp EBIT marg. +0.5pp change pp pp Source: Nordea Markets Terminal year We use a stringent valuation framework, with ROIC=WACC in the terminal period, which prevents the model from extrapolating above market returns in perpetuity. The value is distributed with a negative value in the first period as we factor in DDM using its cash for portfolio acquisitions. The first 15 years provide a net 41% of the fair value. 82% of the total value is distributed within a 30 year period from today. Marketing material commissioned by DDM Holding 9

10 Value distribution 20% 12% 8% 18% 29% 39% -27% 82% Sust. Source: Nordea Markets ROIC versus WACC Valuation wise, a company creates shareholder value when it generates a ROIC in excess of WACC; the return the company generates on its investments has to be greater than the cost of capital. For the very long run, ie in the terminal period, we assume DDM s ROIC will be equal to WACC. From a short to medium term perspective, however, many companies have a ROIC that exceeds WACC, often accomplished when the company has some kind of competitive advantage. For DDM, such an advantage could be management s experience, early entry into a growing market, more accurate valuation methods for portfolio acquisitions and a business model giving operating leverage. Being a larger company also could imply lower financing costs, which could be a driver for a higher ROIC. We know from history that companies with a high ROIC tend to stay at high levels for a long time, while the same goes for companies with low ROIC. As DDM has only ten years of history and turned positive numbers as late as in 2015, the ROIC level that DDM manages to establish in the coming years will be an important measure for the company s ability to continue creating shareholder value. Competitive advantages could enable DDM to generate ROIC greater than WACC In our estimates, we assume DDM will generate a ROIC that exceeds WACC for a couple of years. For 2017E 25E, we estimate ROIC of 16.5% on average, while for the following 20 years we estimate ROIC at an average 12%. As said earlier, we estimate ROIC will be equal to WACC (10.2%) in the terminal year ROIC history and estimates Year ROIC % % % 2017E-2019E 21.0% 2020E-2022E 16.5% 2023E-2025E 11.9% Terminal year % WACC 10.2% Marketing material commissioned by DDM Holding 10

11 We set a relative valuation range based on average discounts of P/E, EV/EBIT and P/BV Valuation multiples We contend that a relative valuation based on P/E, EV/EBIT and P/BV provides the best benchmark for valuing DDM for the following reasons: P/E (price/earnings) is often used to compare companies and to consider the differences in tax rates and financing costs. However, it is biased towards lower multiples for companies with high financial gearing. We believe that certain adjustments should be applied when using P/E in order to appropriately value the company EV/EBIT (enterprise value/earnings before interest and taxes) is neutral to a companyʹs financial gearing. It captures the operationsʹ capital intensity to the extent that depreciation levels approximately correspond to sustainable capex levels P/BV (price/book value) measures the company s valuation in relation to the book value, giving a reality check of the valuation of a company s book value. In general, it is a relevant multiple for financial institutions, as the balance sheet and book value use to be a central part of a financial company. We also present ROE for 2017E 19E and EPS CAGRs for E to offer a comparison between the companies. Peer group valuation We find the DCF method the most flexible and accurate when valuing most companies. However, a stringent relative valuation comparing multiples with a carefully selected peer group could provide a useful check for the DCF forecast. There are three main considerations we find necessary for an accurate relative valuation approach: Finding the right multiple We prefer enterprise value based multiples such as EV/EBIT or EV/EBITDA for comparing different companies. P/E is also commonly used but caution is needed as it does not differentiate between companies with different capital structures Consistency in calculations and adjustments of multiples Finding the right peer group Companies selected for the peer group should have similar growth outlooks and return on capital. The most common starting point is to use industry peers. We present a peer group comparison of six European companies within the purchased debt industry: We compare DDM with a peer group of six European industry peers Intrum Justitia Hoist Finance B2Holding Axactor Arrow Global Kruk All are based in Europe and operate there. We point out that DDM is significantly smaller than its peers, however, with a market cap of just 5% of the peer group average. DDM being quite different to the peer group being a smaller company, having lower liquidity, operating in a narrower field of operations and in an immature Marketing material commissioned by DDM Holding 11

12 market could justify a valuation difference between DDM and the peer group. A short description of each company in the peer group can be found later in this section. Smaller size, lower liquidity, narrower area of operations and an immature market could possibly justify a valuation difference to the peer group To derive a fair value equity range for DDM we calculate averages for 2019E P/E, EV/EBIT and P/BV multiples for peers, arriving at a range of x P/E, x EV/EBIT and 1.2x 2.5x P/BV for our peer group. Implying a value for DDM within the range of the average of each multiple gives a value of SEK per share. Based on our estimates for 2019, DDM trades at discounts to the peer group average of 71% on P/E, 42% on EV/EBIT and 57% on P/BV. Comparison numbers suggest that DDM has a ROE of 28% on our 2019 estimates, compared with the 17% average for the peer group. The EPS CAGR for E is 25% for DDM versus a 22% median for the peer group. As a complement we also provide a comparison of three large global peers, based in the US and Australia. The 2019 estimated multiples of the international peers indicate a discount of 63% for DDM, even though the same arguments apply for these size, liquidity, area of operations and market and could justify a valuation difference between DDM and the peer group. DDM versus European peers Market cap (EURm) EPS Share ROIC CAGR price P/E EV/EBIT P/BV ROE (%) (local) 2017E 2018E 2019E 2017E 2018E 2019E 2017E 2018E 2019E 2017E 2018E 2019E E Company Intrum Justitia 2, % Hoist Finance % B2Holding % Axactor % Arrow Global % Kruk 1, % Average % Median % Min % Max 2, % DDM (Nordea est) % Difference vs average -95% -70% -70% -71% -52% -47% -42% -47% -52% -57% 43% 54% 65% 108% -378% Difference vs median 14% Source: Thomson Reuters and Nordea Markets DDM versus global peers Market cap (EURm) Source: Thomson Reuters and Nordea Markets EPS Share ROIC CAGR price P/E EV/EBIT P/BV ROE (%) (local) 2017E 2018E 2019E 2017E 2018E 2019E 2017E 2018E 2019E 2017E 2018E 2019E E Company Credit Corp % Encore n.a n.a % PRA Group 1, % Average % Median % Min % Max 1, % DDM (Nordea est) % Difference vs average -95% -54% -74% -72% -49% -55% -53% -41% -51% -63% 51% 78% 45% 87% 131% Marketing material commissioned by DDM Holding 12

13 Description of peers We provide a short description of the peers, consisting of larger players within the industry: We compile a short description of the six European peers in our peer group Intrum Justitia Sweden s Intrum Justitia is a leading European player in credit management services, operating across the full value chain including debt purchase and collection and other related services. Intrum Justitia is in a process of merging with Lindorff awaiting approval by competition authorities. Intrum Justitia is already Europe s largest collector, merged with Lindorff it would take an even stronger position in the European market. Hoist Finance Another Swedish company operating in purchased debt in Europe. Hoist describes itself as a leading debt restructuring partner to international banks with experience in handling complicated transactions. B2Holding Norwegian purchased debt firm B2Holding operates in CEE. It began operations in late Axactor The management team of Norway based Axactor has previous experience from Lindorff. Axactor began operations in late It operates in the Nordic region and Central and Western Europe. Arrow Global UK debt purchaser and manager Arrow Global buys debt from a broad range of customers, including banks, credit card and telecom companies. Kruk Poland s Kruk is broadly involved in debt management services, handling both consumer and corporate debt. It began operations almost two decades ago. Since 2007, it has expanded its business into numerous European markets, including Romania, Czech Republic, Slovakia, Germany, Italy and Spain. As a complement we also provide a short description of global peers, consisting of three large players within the industry: We also compile short descriptions of three global peers, outside of our peer group Credit Corp Group Australia s largest provider of sustainable financial services Credit Corp Group operates in the credit impaired consumer segment. Encore Capital Group Encore is a US based debt purchaser operating in 14 countries in the field of consumer receivables which it buys from major banks, credit unions, utility providers, municipalities etc. PRA Group PRA is a global leader of acquisition and collection of NPLs. The company is based in the US and operates in both the Americas and Europe. Marketing material commissioned by DDM Holding 13

14 Company overview Founded in 2007 with accelerated operations during the last three years, DDM is a relatively new player on the market for investing in distressed assets. The management and board have more than 50 years of combined experience in the market, however, and manage about 2.3 million cases. In early 2017, DDM issued new equity as well as bonds worth EUR 11m and EUR 85m, respectively. With the new funds in place, DDM aims to acquire more portfolios of distressed assets in the company s target markets of Central and Eastern Europe. DDM is a specialist acquirer and manager of distressed asset portfolios in Central and Eastern Europe Net collections CAGR of 53% in Portfolio acquisition decisions based on the proprietary IT system FUSION Has made share and bond issue in 2017 DDM was founded in 2007 DDM is a specialist acquirer and manager of distressed asset portfolios in Central and Eastern Europe (CEE), managing distressed assets with a nominal value of more than EUR 2bn, spread over 2.3 million cases. That implies an average face value per case of EUR 870 in the company s portfolio. At the end of 2016, DDM had 22 employees operating from its headquarters in Switzerland. DDM has grown net collections from less than EUR 10m in 2013 to close to EUR 35m in 2016, indicating a CAGR of 53%. It reached positive operating profit in 2014 and positive net profit in The majority of DDM s distressed asset portfolio can be split geographically between Slovenia, Hungary, Romania and the Czech Republic. DDM makes its portfolio acquisitions using its proprietary IT system FUSION, which is continuously developed based on the company s experiences. Collections are made by local agencies, where DDM can tailor a solution for each single portfolio investment. DDM s geographical focus is on Central and Eastern Europe, a market where the company sees a strong trend for increased transaction volumes, a trend it believes will continue in the coming years. Combined with DDM s market experience, its thorough understanding of the collection process and its established contacts with sellers and collecting agencies, DDM seems to have an advantage in the market. New funds added in early 2017 DDM mentions financing as a key challenge to taking advantage of opportunities it has identified in the market. In early 2017, the company finished a fully subscribed equity issuance of EUR 11m as well as a bond issuance of EUR 85m. DDM history: Young company with in-house experience DDM started in 2007, when a group of individuals with previous experience from building a similar business decided to start a new company. Even though the company has a history of only ten years, management and the board s total experience in the distressed asset market is more than 50 years. Combined, management and the board have overseen thousands of transactions in more than 25 countries. After an initial startup phase, DDM made its first investment in Russia during That was followed by a recruitment process for key personnel, the creation of business processes and the development of IT systems, as well as entering new markets Romania, the Czech Republic and Slovakia. DDM was listed on Nasdaq First North in August 2014 Since 2013, the company s focus has been on scaling up the business. This was also the year when CEO Gustav Hultgren joined the company. In August 2014, the DDM stock was listed on Nasdaq First North in Stockholm, enabling further expansion. Since then, the company has invested in distressed asset portfolios in a number of different countries in Central and Eastern Europe. A number of debt issues have also taken place in the last few years to make the expansion possible. Marketing material commissioned by DDM Holding 14

15 DDM aims for a listing on the main market in H In April 2017, the company announced its intention to apply for a listing on the Nasdaq OMX Stockholm s main market. Management mentions increased institutional and international ownership as a possibility, if the company change its listing. It also considers the seal of quality that is associated with a Nasdaq OMX main listing a positive injection for the company s business and one that could improve its relationships with sellers and other stakeholders. The company s target is to move from First North to the main list during H Since its first investment in 2008, the company has added numerous portfolios in different countries and accumulated data to its IT system FUSION. Central functions and the business model are up and running and the company sees additional opportunities in the Central and Eastern Europe market for distressed asset portfolios, hence the focus on scaling up the business continues to this day. DDM: Historical key events, Year Event 2007 DDM was founded 2008 First portfolio acquisition (Russia) 2009 Build up of team, processes, IT system etc starts 2009 Enters three new markets (Romania, Czech Republic and Slovakia) 2010 Enters Macedonia 2013 First bond issue (SEK 300m) 2014 IPO on Nasdaq First North 2014 Enters Poland and Slovenia 2015 Enters Hungary (two acquisitions) 2016 Share capital increase and first Euro bond issued 2016 Landmark acquisition in Slovenia 2017 Share capital increase and largest debt issuance so far in the company's history DDM s headquarters are in Switzerland Has invested in eight countries and targets more CEE countries DDM on the European map Taking a geographical journey in the footsteps of DDM would be an exclusively European trip, starting in Baar, in the canton of Zug in Switzerland, where the company is headquartered and where its central operations take place. Zug is strategically located near collectors across Eastern Europe, providing fast access to meetings with sellers. The canton of Zug is also home to industry peers like Intrum Justitia. Switzerland is popular amongst industry peers due to its stable regulatory environment and VAT efficiency to the debt collection industry. After the company s first portfolio investment in Russia, its focus has broadened from Eastern Europe to also include Central Europe. The expansion has continued and in addition to Russia, DDM has invested in Slovenia, Poland, Hungary, the Czech Republic, Romania, Slovakia and Macedonia. Central and Eastern Europe remain the key region for DDM when targeting new opportunities for portfolio investments. The company is aiming at existing markets as well as some neighbouring countries including Estonia, Latvia, Lithuania, Croatia, Serbia and Bulgaria. The banking sector in the region is subject to stricter capital ratio requirements, so the divestment of distressed assets on banks balance sheets appears advantageous. For DDM, this is a desirable development, as the supply of investable assets will likely continue to increase. Thanks now to ten years of experience, the company has started to build up crucial relationships within these markets. Furthermore, a number of financial institutions, such as banks operating in Central and Eastern Europe, are reconsidering their ongoing presence in the region, according to market studies. As some of these institutions decide to leave, the supply of investable portfolios with distressed assets increases for DDM. Marketing material commissioned by DDM Holding 15

16 DDM has close ties to Sweden Despite DDM s headquartering in Switzerland and its operations in Eastern Europe, a geographical study of the company also requires a journey to the Nordics, as DDM has strong ties to Sweden. Several board members and members of the executive management, including the chairman of the board, the CEO and the CFO, are Swedes. Numerous large shareholders are Swedish, and so Stockholm seemed to be a natural choice for the listing of the DDM share in In addition, a number of bond issues have been carried out in Sweden. DDM: Market entries Marketing material commissioned by DDM Holding 16

17 Experienced management and board Executive management The track record of todays management composition is still only a few years old. With each year of solid performance, however, another piece is added to the puzzle, offering the potential for increased confidence in the management team and thus also in DDM. The management and board have experience from several thousand transactions via portfolio acquisitions in more than 25 countries. Board of directors Besides distressed asset industry experience, the Board of Directors includes experts in tax law, business management, M&A and financial markets. Chairman Kent Hansson and Dr Manuel Vogel are two of the founders of DDM and are large shareholders. Proposal to elect new main owners to the board of directors At the AGM on 31 May 2017, the members will vote on a proposal to admit the new main owners, Erik Fällström and Andreas Tuczka, to the board of directors. We provide more information about the new main owners below. Marketing material commissioned by DDM Holding 17

18 Aldridge EDC Speciality Finance Partners stepped in as new largest shareholder in April 2017 Shareholders The picture of DDM s shareholding has changed significantly this year, with Aldridge EDC Specialty Finance Partners emerging as its largest shareholder. AEDC is run by Erik Fällström, co founder of Hoist Finance, and Andreas H Tuczka, a former partner at Lone Star Europe. Aldridge aims to purchase operating businesses and assets within the financial services sector in Europe and CEE. It is investing in consumer lending platforms, financial solutions and regulated financial institutions such as banks. In April 2017, DDM announced that Aldridge owns 48.8% of the shares, citing DDM s disciplined cost structure, recently well diversified funding base and clear focus on CEE as key reasons for taking a large ownership in the company. The new owners have significant experience in the financial industry in general and the NPL industry in particular, which could be a positive injection for DDM. At the end of 2016, DDM had approximately 244 shareholders. Kent Hansson, the chairman of the board and co founder, was the largest owner with 25.4% of total capital and votes, followed by Dr Manuel Vogel, vice chairman and co founder, holding 18.9% of total capital and votes. After the principal owner change in April 2017, their stakes were reduced to 4.3% and 3.5%, respectively. Management holds a combined 369,000 shares in the company. Marketing material commissioned by DDM Holding 18

19 DDM: Largest shareholders as of 30 April 2017 Owner No. of shares Capital and votes (%) Aldridge EDC Specialty Finance 6,618, % Praktikertjänst Pensionsstiftelse 795, % Strategic Investments 670, % Hansson, Kent 584, % Vogel, Manuel 469, % Göransson, Richard 447, % J.P. Morgan Europe Limited 425, % Nordnet Pensionsförsäkring AB 317, % Hultgren, Gustav 263, % Förvaltnings AB Hummelsboholm 224, % Total; largest owners 10,814, % Summary others 2,745, % Total 13,560, % Corporate structure DDM s current corporate structure is illustrated below. DDM Group AG is the company where the operations take place, while DDM Holding AG is the parent company whose outstanding shares are listed on Nasdaq First North in Stockholm. DDM Debt AB was founded in 2016 with the purpose to fund the DDM Group s growth by issuing corporate bonds. DDM Finance AB is a financing company, acting as a holding company for DDM Debt AB with the purpose of providing credit support for financing. Also DDM Treasury is a Swedish subsidiary with the same purpose as DDM Debt AB. DDM: Corporate structure Marketing material commissioned by DDM Holding 19

20 Business model There are several reasons for banks to divest distressed asset portfolios, but the two main reasons are that distressed asset management is a non-core activity for most banks and that distressed assets are expensive for banks to keep on their balance sheets due to required capital adequacy ratios. DDM buys such assets from banks and other financial institutions at large discounts, thus making its net revenue from the difference between the purchasing price and the final amount collected. Management and the board s market experience and the company s proprietary IT system FUSION, which includes data on about 2.3 million active cases, are two key success factors that make DDM a competitive player on the market. Distressed assets are expensive assets for banks due to required capital adequacy ratios Banks rationale to divest There are a series of reasons for banks to divest debt portfolios amongst them distressed assets is not a banks core activity and the assets are expensive on the banks balance sheets in terms of capital adequacy ratios. We list the main reasons for banks to divest distressed asset portfolios: Non core activity for the bank Non core customers with limited additional income Monetise on already written down assets Reduce operational costs and improving liquidity Regulatory pressure to increase capital ratios Limited in house collection activity and expertise, or too small to get scale advantages. When a bank decides to sell, that offers DDM the chance to opportunistically buy the assets it finds attractive and take over the collection process. Business model overview Since its start in 2007, DDM s management and has used its experience in the European NPL (non performing loans) market to build up processes for analysing, pricing and managing acquired portfolios. When a consumer or corporation fails to make payments on time, the debt is termed distressed. In cases where a customer with a bank loan becomes distressed and, in some cases, stops paying on their loans, the bank usually makes some efforts to collect the money. Sooner or later, however, the bank may choose to divest its distressed assets. This creates a market where DDM can operate opportunistically by calculating valuations of distressed assets and buying when the expected return is attractive. Value is created for the banks, which can focus on their core business, and debtors can find support to settle their debts under terms they can afford. Roughly speaking, DDM s process consists of three parts: acquisition, asset management and debt collection. DDM s expertise is in the two first steps, while it outsources the collection part to different companies within its collection network. It outsources to local agencies, as DDM considers the first two steps more profitable. DDM can hire different agencies depending on the portfolio s unique characteristics. Regardless of the final outcome, all data generated from the operations can be used as input to FUSION, increasing the precision of the data models for future operations. Marketing material commissioned by DDM Holding 20

21 FUSION was created using information based on managements industry experience. Its advanced models are used to evaluate potential acquisitions and manage current distressed asset portfolios. Overview of the distressed assets value chain (orange is where DDM operates) Source: Company image Acquisitions Acquisitions are made at a significant discount to the face value. Greatly simplified, DDM evaluates the estimated cash flow from a specific portfolio and compares that with the price tag of the portfolio and DDM s internal return requirements. If DDM assesses the opportunity as attractive enough, a portfolio acquisition can take place. The difference between net collections made from a portfolio minus the price paid for the portfolio will give the revenue on invested assets. This difference is the key to the monetisation of the industry and for DDM. Net collections also take into account the fees paid to the collection agencies. The illustrative example below shows how revenue occur, although note that these are illustrative numbers and do not relate to DDM. Illustrative example of net collection generation Face value Purchase price Net collections DDM monetises on the difference between price paid and actual collections 10 % Revenue on invested assets 10 % 20 % Source: Nordea Markets In the wider market for distressed assets, DDM is targeting some specific characteristics when evaluating potential portfolio acquisitions. DDM is looking mainly for investment portfolios in the range of EUR 3 30m in Central and Eastern Europe. DDM is focusing primarily on financial institutions as sellers. When it comes to the type of assets, the DDM model is quite flexible, able to accept debt from the consumer and corporate segments, secured and unsecured, and performing and non performing debt. Marketing material commissioned by DDM Holding 21

22 Targets EUR 3-30m portfolios DDM: Key portfolio characteristics Geography Central and Eastern Europe Seller Financial institutions Type Consumer and Corporate Collateral Secured and un-secured Underlying assets Performing and non-performing Portfolio size EUR 3-30m DDM s acquisitions have historically been made through three kinds of methods: open tender, direct sales or forward flow transactions. Open tender DDM is a bidder in a portfolio offered for an open tender Direct sales DDM engages with a seller and negotiates tailored terms. Direct sales are in general more attractive for DDM. Some sellers prefer direct sales to give the deal less attention, as some transactions may be sensitive Forward flow transactions In forward flow transactions, deals are struck on an ongoing basis. These transactions may lead to the development of long term relationships and help to keep transaction costs low. However, such acquisitions account for only a small part of DDM s transactions historically. DDM: Acquisition method (based on acquired nominal value) Open tender 60% Forward-flow transactions 10% Direct sales 30% Asset management When the portfolio acquisition is complete, DDM s focus will shift to the asset management part of the process, focusing on collecting the portfolio values. Efficiency, fair and ethical treatment of the debtor, and data confidentiality are essential in this part of the process. A portfolio s performance depend on the different characteristics it possesses, DDM mentions that collections can generally start a few weeks after acquisition and typically peak within the first 12 months, before starting to decelerate. DDM s estimated remaining gross collections was EUR 79.8m as of 31 December 2016, of which DDM estimates 37% is to be collected during 2017, 25% in 2018 and 16% in This is broadly in line with the company s cash flow distribution guidance for new portfolios. It can give a picture of what is a typical collections distribution from an existing portfolio, although we note that this specific portfolio composition are a bit more short tailed than usual, because some of DDM s most recent portfolio acquisitions consist of performing loans. Marketing material commissioned by DDM Holding 22

23 DDM: ERC Distribution as of 31 December EURm ERC Distribution as of 31 Dec 2016 Referral As DDM outsources the collections, its focus is on choosing the right partner for collecting a particular debt, benefiting from different agencies relative strengths. DDM s experience as a relatively early player in some Central and Eastern European markets and its robust relationships with around 40 different agencies are advantages. DDM can select the collector based on criteria such as size, age, type and geography. Monitoring Once DDM has chosen an agency, focus can shift towards monitoring the collection, which is done through daily updates. Daily data files are sent from the agencies to DDM, including information on the collection s status. DDM can evaluate the collector s progress and if applicable, take actions by changing agency if the expected results are not fulfilled. IT system FUSION is used to evaluate potential acquisitions and current portfolios IT system experience supports company s decisions The last but no means least important step in the process is the transfer of data input to DDM s proprietary data system, FUSION. Different kinds of data, such as investment, case, payment and activity data, will be sent to the database. Over ten years, DDM has accumulated a significant amount of data. FUSION is based on more than 50 years of combined industry experience, 2.3 million active cases and 38 connected debt collection agencies. This makes FUSION an important asset in DDM s business model. The company gives a list of advantages gained from FUSION, including higher accuracy in pricing and evaluation of portfolios, lower credit risk as collection data gives more predictable cash flows, managing and controlling collection agencies and improving collection efficiency as the best fitting agency can be chosen for each specific case. In other words, DDM can use FUSION to as a support for future business decisions. Streamlines the accounting process As illustrated below, FUSION has input data from vendors (sellers such as financial institutions) and debt collecting agencies (DCAs). DDM feed the data into its model and the results help it to select which portfolios to invest in and which DCAs it will choose. Furthermore, the IT system is linked to the company s accounting software, streamlining that process. Marketing material commissioned by DDM Holding 23

24 Overview of IT system FUSION main data flows Source: Company image Marketing material commissioned by DDM Holding 24

25 The distressed asset market in CEE Central and Eastern Europe is quite an immature market for the purchased debt industry, compared with the more mature Western Europe market, for example. However, an accelerating number of market opportunities may come to light as more countries in the region report a growing number of distressed asset deals. Studies find an improved momentum of NPL deals in the region, as more financial institutions follow the trend of divesting distressed asset portfolios. Romania and Hungary, where DDM has already invested, stand out as the two countries with the highest deal activity in the past few years. Studying DDM s invested and targeted markets from a global perspective puts the median in the top 20 th percentile in the World Bank s Ease of doing business index. NPLs development typically follow a cyclical path Cyclicality of debt collection In a typical credit cycle for NPLs and distressed assets, credit growth occurs and distressed assets decrease during the macroeconomic expansion phase. At the peak, the borrower has the leverage and so do the banks, stretching their lending. When the economic climate cools down, consumers and corporates alike might struggle to make payments. Even though credit growth decreases, the amount of distressed debt increases. During the repair phase, the market for sold NPL portfolios takes off. When the economic cycle has returned to the expansion phase, a larger amount of the distressed debt can be paid back. After researching this area, we assume the credit cycle in Central and Eastern Europe is somewhere between phase 4 and phase 1, as shown below, because we can see increased activity in the sale of NPL portfolios, but also signs of credit growth and increased bank profitability. This implies a phase where we could see a favourable environment for NPL debt collection. The credit cycle of NPLs Provisions System leverage Bank capital NPL portfolios sold 4 Repair 1 Expansion Credit growth Bad debt recoveries NPLs Asset prices Bank profitability 3 Downturn 2 Peak NPLs Credit growth Borrower leverage Bank leverage Bank LDRs Source: Nordea Markets Marketing material commissioned by DDM Holding 25

26 CEE an immature NPL market Debt collection is far from a new phenomenon. It is actually as old as the history of debt itself. However, during the savings and loans crisis of the 1980s, the number of foreclosures and written off accounts increased heavily, boosting the debt collection industry. The CEE market was established even later. As an example the first professional debt collection agency in Russia was founded in In Deloitte s research into the NPL market in CEE, most countries in the region fit into the criteria of an introduction or a growth market, according to the diagram below, implying some cultural barriers and large discrepancies between buyers and sellers. On the positive side, prices are generally lower in an introduction market and market opportunities should get larger as markets approach the growth phase. DDM mentions that it sees an untapped potential in the CEE market. NPL markets growth and maturity cycle An immature NPL market implies low prices, but also high spreads between buyers and sellers Source: Nordea Markets CEE accounts for around 5% of the total European NPL market NPL market in CEE is gaining deal momentum Deloitte estimates the total market for NPL volumes in CEE, including the Baltic states, at EUR 51bn at the end of In another study, PwC suggests NPL volumes for Europe amount to around EUR 1,100bn. Based on the numbers combined, CEE accounts for around 5% of the European NPL market. The NPL volumes at banks increased each year from 2011 to 2013 according to Deloitte. In 2014 and 2015, this level turned downward, showing falling NPL volumes among the banks. All CEE countries covered in Deloitte s study achieved positive real GDP growth in 2015, indicating a healthy economic environment in the region. This may be one reason for decreasing NPL volumes among the banks. An increased trend of banks selling their distressed assets to specialised players, such as DDM, may be another reason. Marketing material commissioned by DDM Holding 26

27 The CEE region consists of a wide range of countries with fairly different characteristics. In the NPL market there is a divergence between the CEE countries, observed in the Deloitte study; the NPL ratios (ie non performing loans as a share of total outstanding loans) are significantly lower among the northern than the southern countries in the region. Among the northern countries, including Poland, the Czech Republic, Slovakia, Estonia, Latvia and Lithuania, NPL ratios are between 5% and 10%, while in the southern countries, including Hungary, Romania, Slovenia, Croatia, Bulgaria and Serbia, the levels are between 10% and 22%. In total, the trend for NPL ratios is down, and Deloitte assumes it will resume, given the region s improving economics and the increased interest from NPL investors in purchasing portfolios from the banks. Banks and NPL investors are approaching each other The increased deal activity for distressed assets in CEE shown by Deloitte saw the total face value of completed deals until October 2016 at EUR 5.2bn versus EUR 4.3bn for all of The estimated value of ongoing deals totals an additional EUR 5.4bn. Deloitte assumes the increasing number of active NPL investors in the region is a reason for the increasing deal volumes, as well as greater willingness by banks to divest NPL portfolios. The largest activity over the past two years has been in Romania and Hungary, two markets where DDM is already present. Among ongoing transactions the largest are in Hungary and Croatia. DDM has not yet invested in Croatia, but it has stated that it is among a group of countries where it is currently evaluating portfolios. The higher market activity reported by Deloitte is also confirmed by DDM, the company mentioning a strong trend of increased transaction volumes that it expects to continue. NPL markets growth and maturity cycle 5 4 EURbn Romania Hungary Croatia Slovenia Poland Serbia Bulgaria Lithuania Czech Republic (until Oct) Ongoing Source: Deloitte and Nordea Markets Key market trends identified by DDM In addition to the regulatory changes to bank capital requirements and the general state of the economy in Europe, DDM identifies four major industry trends: Increased adoption of selling loan portfolios Banks continue to strengthen their balance sheets by deleveraging and cutting costs so as to improve their capital adequacy ratios and cash positions. Also, the European wide banks stress test results released in 2016 indicate several banks need to strengthen their balance sheets further. DDM considers this a clear driver for increased activity in the debt asset market. The company has also noted an increased willingness among the banks to sell NPLs in smaller parts, making the market more accessible for smaller investors. Marketing material commissioned by DDM Holding 27

28 DDM sees post financial crisis regulations as a key factor driving NPL deal volumes DDM expects bad banks to increase their sales activity of distressed assets Slovenia, Hungary, Romania and the Czech Republic account for 97% of DDM s portfolio Implementation of regulations The increase in regulations in the financial industry in the wake of the financial crisis is obvious, including stricter capital requirements, as Basel III, which is to be gradually phased in towards 2019, making it more expensive for banks to keep high risk assets on their balance sheets. DDM identifies this as a key factor driving NPL deal volumes. Improved portfolio pricing DDM expects the mismatch between the expectations of buyers and sellers of distressed assets to improve, leading to a more efficient environment for deal making in CEE. This is usually one of the largest challenges for closing NPL deals. The creation of bad banks and government reforms The financial crisis has revived the concept of bad banks. They are designed to take bad debt from commercial banks, moving these debts to government supported banks as an economic aid during tough years, such as in the recovery from the financial crisis. DDM expects an increase in sales activity from these banks. DDM s invested and targeted markets DDM has a flexible approach to what countries it invests in, although it focuses on CEE. Its investment style takes more of a bottom up approach, with DDM looking for the most profitable investments, rather than focusing on expansion in a particular market. It is currently invested in Slovenia, Hungary, Romania, the Czech Republic, Russia and Slovakia the first four together accounting for 97% of its total portfolio. These four economies offer fairly good economic development and a clear trend of lower NPL ratios among their banks, thanks to the strong trend of cleaning up NPLs by selling to specialised bad debt purchasers. Credit and NPL profile of DDM's largest markets Credit growth Slovenia Hungary Romania Czech Republic NPL clean up trend in banks n/a Moreover, DDM is currently evaluating portfolio investments in Croatia, Serbia, Bulgaria and the Baltic countries. A portfolio including more countries could mean a lower country specific risk, as political risks and currency risks get diversified, for example. Marketing material commissioned by DDM Holding 28

29 DDM: Current invested and targeted markets DDM targets the currently invested markets and some neighbouring countries Corporate NPLs within banks decreased 20% in 2015 Slovenia seeing the trend of banks NPL divestments Slovenia s economy has been quite stable in recent years, with real GDP growth around 2.5%. Public debt is 83.7%, placing Slovenia among the most indebted countries in CEE. Its banking sector is still recovering. Retail loan volumes increased by 1.1% in 2015, reflecting the banks appetite for household lending. Corporate loans decreased by as much as 10% in 2015, but corporate loan demand is expected by Deloitte to increase in the near future. NPL volumes among Slovenian banks decreased heavily in 2015, by more than 10% for retail and 20% for corporates, partly owing to the ongoing trend of selling off debt portfolios. Marketing material commissioned by DDM Holding 29