IWG Plc

LSE:IWG

Earnings Call Transcript 2018-Q3

[Operator]

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to today's IWG Q3 Trading Update and Analyst and Investor Call.[Operator Instructions] I must advise you that this conference is being recorded today, on Tuesday, the 6th of November 2018.I would now like to turn the conference over to your first presenter today, Mark Dixon. Please go ahead, sir.

[Mark Dixon, CEO & Director]

Thank you, operator. And good morning, everyone, and thank you for joining us this morning to discuss our third quarter trading update.I'm joined on the call today by Eric Hageman, our Interim CFO.Firstly, I'd like to take you through the key points from the update, and then hand the call over to Eric to comment on the financial performance. And then as usual, we'll be open for questions.So I'm pleased to report that our improved sales activity has driven strong revenue performance in the third quarter. Total group revenues increased by 10% to GBP 637 million, GBP 638 million at constant currency. And revenue from total open centers, that excludes centers that have closed, have increased by 13% on a similar basis. These improvements have been broadly based, with good performance coming from the Americas, EMEA and Asia Pacific. And these 3 together represent more than 80% of our business, and they all delivered good double-digit growth in Q3.As indicated before, the U.K. remains disappointing, but we have action plans in place to address the issues in this market. And we've accelerated our program to close, replace and refurbish specific locations. From mid-August, our new sales and operational structure has also been put in place. And whilst it's early days, we've already seen some of the benefits from this. So in conclusion on the U.K., lots of actions being taken. Please remember, this is still a good, profitable business. It's not a bad business. It's still profitable. It's not just as profitable as it was. We think the actions we're putting in place will restore it to somewhere close to its previous performance. It just takes time to get these things done, but we're absolutely focused on it.Importantly, we -- looking at the whole business, we've seen further improvements in the mature revenue growth on the back of this improved sales activity previously mentioned. Revenue in the quarter increased by 3.9% on mature, with high single-digit growth in Americas and EMEA. Combined, these 2 regions are approximately 2/3 of our mature revenue. Year-to-date mature revenue is therefore up 2.9%, a sequential improvement on the 2.4% that we saw in the first half. Mature revenue performance in the U.K. has stabilized at a rate similar to the first half but with Q3 showing some improvements on Q2 year-on-year.Mature occupancy has increased by 70 basis points to 74.3%. And here we see still plenty of room for growth in the mature estate, and that's obviously a key strategy for us moving forward. We're very focused on trading the business, maximizing occupancy and revenues from the mature estate and, of course, all the estates.So we remain focused equally on the returns we're making for our investments -- on our investments. And on a 12-month rolling basis, the returns for all of those locations opened before 31 December 2013 were 17.5% and well above our cost of capital. And then also, this is after increased CapEx, maintenance CapEx, which is written off of this number prior to calculating the return. And also, just to remind you all, this is a post-tax number as well, so not a bad return even with the U.K. not performing and -- as it should.We've continued to develop our network, 72 locations added in the quarter, taking total new openings to 204. Across all of our brands, we've added 76 new locations in our large -- or sorry. We've added 76 new locations in our large-format brand, Spaces, so these centers substantially higher size than the -- a typical Regus location or the other brand locations. And as at the 30th of September, we're in a total of 154 locations opened and a strong pipeline for the remainder of the year.Year-to-date, we've added 4.7 million square feet of workspace, and our global network now stands at 55.8 million square feet across 3,258 locations.With our network refurbishment program, together with the natural ending of certain leases, 25 locations were closed in the quarter, taking the total for the 9 months to 71. Our growth pipeline for the whole of 2018 remains broadly unchanged at approximately GBP 230 million of net growth investment, representing about 275 locations and an additional 6.7 million square feet of space. This is over 20 more -- 20% more space than we added in 2017.In line with our strategy of lower risk and more capital-light growth, we are experiencing accelerating momentum in our franchising activities. Whilst the numbers are currently relatively modest compared to the total group, this will become an increasingly important part of the next-generation IWG. Historically, we've done franchising in some of the more developing markets, but we're now seeing growing interest in some of our developed markets. And overall, we have a really good pipeline in this area. We have substantially built the operating team to grow our franchise business, and we think this is a very exciting further development in the way we grow the business into 2019 and beyond.So in summary. The good sales activity we talked about before has translated into better sales momentum and occupancy. And we've seen prices -- price increases, in addition, in the mature business. And newer locations have continued to develop strongly, and we believe that this will continue into the fourth quarter.We are continuing to explore a range of potential strategic opportunities. Some of these -- you might have heard some of the noise in the press that they are -- we are busy and at work looking at possibilities. We haven't brought anything that we can talk to you about at this moment, but we do believe that there are things that we can do in addition to focusing on trading, which is the first order of the day, that will deliver increased shareholder value into '19 and beyond. I've already talked about our increased franchising activities and the heightened level of interest that we've got from potential partners in new and existing geographies. You have to remember the interest in, co-working interest in flexible space is very, very high at the moment, so we think it's a good time to be looking at these strategic possibilities. So we will continue to report on the initiatives we have as they become more concrete and as we start moving them into the execution phase.And with that, I'll now hand over to Eric, who'll discuss the performance in more detail.

[Eric Hageman, Interim Chief Financial Officer]

Thank you, Mark. And good morning to everyone on today's call.Now let's look at the financial performance in some more detail.With the headwind from prevailing exchange rates reducing in the third quarter, group revenues in Q3 increased 10.2% at constant currency and were up 8.9% at actual rates to GBP 637.9 million. As Mark said, group revenues for the 9 months to 30th of September increased 8.1% to GBP 1.8 billion at constant currency.The waterfall of the first 9 months revenue development highlights the strong development of our newer centers and the improved mature performance, but with forex and closures having a negative impact. Mature revenues contributed a 2.7% increase to group constant currency revenue. This, together with a 7.6% increase from the additions to the portfolio in 2017 and 2018, helped offset the 2.4% closures impact and the forex headwind of 3%, to deliver a year-to-date 4.9% increase in group revenue at actual rates. The year-on-year 2.9% growth in mature revenues for the first 9 months of the year reflects improving growth during that period from all those centers opened on or before the 31st of December 2015 and the strong development of the 2016 year group additions.Our post-tax cash returns on net investments remained strong at 17.5%, clearly well above our cost of capital. This is achieved after the increased investment in maintenance CapEx over this period, which to remind you, we expensed in this calculation.Our underlying cash generation year-to-date was GBP 120.3 million. This is slightly down on the GBP 129.6 million reported for the same period in 2017. This reflects the slightly higher level of maintenance CapEx and cash tax paid. We have year-to-date invested GBP 204.9 million of net capital expenditure into growth. This compares to GBP 224.1 million in the corresponding period in 2017, which again to remind you included an investment of approximately GBP 110 million on property which we still own to date.Net debt has increased GBP 50.7 million to GBP 433.9 million compared to GBP 383.2 million as at 30th of June 2018. This reflects the continued investment in growth and the share buyback program. During the third quarter, we also acquired some 8.8 million shares for a total consideration of almost GBP 21 million.Our balance sheet continues to remain strong, and we feel very supported by our lending banks. As indicated in the statement, the board remains confident that the group will deliver its full year result in line with management expectation.Thank you, and I will now hand back to Mark.

[Mark Dixon, CEO & Director]

Thank you. Thank you, Eric.So in conclusion, we remain confident with our position in this exciting growth market. We're encouraged by the sequential improvement in revenue growth from the improved levels of sales activity, and we anticipate this continuing into Q4. We remain in a strong financial position with a prudent approach to risk. We will continue to strengthen our business with targeted approach to growth. We expect an increased franchising activity. And we're in active discussions with a number of interested parties, and we'll update you on this in at the full year results. We're also exploring a range of other potential strategic opportunities.We have a great business with this, by far the most cost-efficient business model out there today in our industry. We are the market leader in every country we operate in. Others make claims. We actually are the market leader in all of these places. And the sheer size of our networks really surpass anything else that's out there. We've got a unique suite also of multi-brand formats, so centers and products, to address different customer requirements. And again, a key number when differentiating against the competition is that nearly 30% of our revenues come from ancillary revenues. There's not a single other competitor that gets anywhere close to this. The best they're doing are in the 10s, possibly 15% at very best. We're double that. And that again is testament to the way we run the business and having a great model focusing on the basics that you build this business from.What's clear to us as well is that -- and it's becoming clear as we go along, is that the customers don't want the same thing, so we're seeing also benefits from having multi-brand. So our ability to offer choice both in prices, in formats and in the services to supply to different work styles is working and is working well. And as before, we continue to win more and more corporate customers that increasingly are using the network. And that again is a key strategy for us. It's winning more and more of these customers that want to use the network and not individual sites.With that, I'll hand back the call to the operator, who will explain the procedure for asking questions. Thank you.

[Operator]

[Operator Instructions] And your first question comes from the line of Steve Woolf.

[Steven John Woolf, Analyst]

Just a couple from me. Firstly, I know you've said you'll give us a bit more update on the strategic opportunities that you mentioned as and when you can, but can you just sort of speak more generally about the options you consider available, whether it's in terms of spinoffs, breakups? And I think you can sort of outline more generally in terms of your thinking. Secondly, in terms of the disappointments you've experienced with the U.K. market in terms of how challenging that is, just in terms of sort of general market, whether that's competition, whether how much maybe the investment you're having to put back into that market. And then thirdly, in terms of the franchise network, firstly, in terms of the contribution perhaps, anything you can give us in terms of how much the franchisees at the minute contribute to revenues or profit? And whether that has actually now changed your view of how much capital spend you might be putting into your thinking for 2019, whether it would have been GBP 230 million previously or that might now change to take out GBP 10 million, GBP 15 million that you might save or not be spending now.

[Mark Dixon, CEO & Director]

Okay, that's quite a lot. Look, some of these things, I think we'll update in more detail at the full year. Just if I deal with these spinoffs, it's not really -- it's spinoffs if you want to call it that, but that is we've got -- we're in -- we now have discussions ongoing with various interested parties who are interested in doing more significant partnering deals. This is franchising deals where we're franchising whole countries. We have been doing it in a small way for quite some while, but they're not meaningful. We now have some meaningful ones that are ongoing. So what does this mean? This means that we will partner or franchise a company who we think would grow the country in question or the countries in question much more quickly and -- but would also be buying our business, our operating business that actually exists in that country as well. So we think we get a double benefit. If we are able to achieve this one, we will be able to start to get incoming cash, if you like, from the sale of a business. And we get further annuity income. We have to work for it because we've got to provide franchise services, et cetera, et cetera, but income then from a more significantly sized business in one country or another. So -- but they continue to be part, very much part, of the network. They continue to be an integral part of the overall business, but we're doing it with partners. We've -- as I say, we've been doing this for the last 5, 6, 7 years but in a small way. We're now doing it in a more meaningful way. So what does this mean to shareholders? This means some capital coming back the other way as we sell these countries. And it means an annuity or a revenue going forward that's more significant than what we would get today. And so it's making use of the platform we already have, accelerating the growth. And there's a whole difference in terms of returns on capital. In the cost of capital, there's taxation issues, taxation advantages if you're local. There's funds movement, in some countries quite difficult, much easier if local money is doing it. And so there's a whole range of benefits, but it is an important part of our strategy going forward. And it's part of our strategy that we have universally about releasing the value in this business which we think is not reflected in today's share price. We also are considering clearly, in Spaces, the spaces have a higher value than the value of the rest of the group. And so -- but we're just investigating that. And if it does, then we will consider what we do with that. So very, very early stages. I would say, except for the franchise and partnering discussions, more significant ones, they are more advanced.Turning to this so-called U.K. challenge. I think some of the tone again and the way we're talking about it, U.K. is disappointing, but it's still a profitable, very good business. What we have are problems around the edge of it that we're sorting out. It's not the fundamental core business that there is a problem with. The new centers do well in the U.K. It's not sort of an overall U.K. -- it's not a competition problem. It's a problem with some of the old acquisitions that we did that need to be sorted out now, and that's what we're doing. So we don't see anything in the U.K. that would say, okay, the U.K. is somehow different to our business in France, to our business in Germany or to our business in the United States. It just needs some repair work. And some very good investments we made some years back, they were very good. We've had our cash back many times over. We're very happy with the investments. They need sorting out now. We're sorting them out, period. That's it. Obviously, the economy is weak because of the uncertainty surrounding Brexit. That's clear. And demand's slightly down. However, we are doing well in -- when the centers are in good shape, when they're at the right rents and so on, we do well, not a problem, okay? Now we would expect the U.K. to keep coming back to health during '19. We can't see anything that's sort of making us feel that we're staring down the end of the cannon here. It's certainly not that. So it's a bit of sorting out. It's disappointing, but we're getting on with it.If we look then at your question about franchise contribution. At the moment, frankly, it's too small to worry about, but sitting together with Eric, we are now working on the forecast of what this will look like and when we're going to start to -- we'll start talking about it when it's more significant and it makes a difference. You don't want us talking about small numbers on this call. So when the numbers get more meaningful, we'll start to talk about it.Capital spend, will it change? It is likely to change for a number of reasons. We -- first of all, there's a probability that we will have incoming cash as we start to sell countries. So clearly, for shareholders, we will start to get money coming back into the treasury from sales of countries. Secondly, the rate of organic [ full fact ] we take all the liability growth will be likely to be less in 2019 for many reasons, but the main reason is we're taking much more -- we're putting much more of our efforts into franchising and partnering than we've ever done before. And we're taking a slightly more cautious view with a backdrop of the more uncertain economy. Overall, that's just the general thing. It's not country specific. It's a general feeling, a general view. So capital spend will still be there, but it will be, I think, the numbers you use, without going into those, we may update you more -- we'll update you more when we next speak, but will be highly likely to be less. And we'll give firm-up on that when we next speak. Thank you on that question, Steve, which I'm not sure if anyone else has any new questions, but go ahead.

[Operator]

And your next question comes from the line of Calum Battersby.

[Calum Battersby, Analyst]

Two questions from me. Firstly, just to follow up slightly on the franchising question, hoping you could give more color on the likely economics of this model or how it works at the moment. So say, is it that you get a percentage of the revenues of the franchisees? They take up all of the upfront CapEx costs themselves? And secondly, on Spaces, you're now up to 170 centers or so. Just wondering kind of the contribution of Spaces as a proportion of overall revenues at this point. How large is it of the overall group now? As well, is that business profitable in of itself? I'd imagine it's not just because of the time line of most of these sites have been open since start 2017, but just wondering if there's any more color you can give us there.

[Mark Dixon, CEO & Director]

Okay. So first of all, franchises. I mean you had it. The franchisee puts the CapEx in and pays us basically for -- makes a contribution to overhead; and effectively pays a royalty fee, which is it's about 4%, 5% for the use of the IP and everything else. So -- but basically -- and pays a small upfront opening fee in some of them, which all of which are just contributing to overheads. So overall, this is -- it's a different model. It's not a 17% return on capital invested. It's -- but it's a way for us to -- what we're most disappointed about is the fact that, this year, we're only opening 250 centers, whatever the number. We should be opening in the thousands of centers, but clearly, doing that with our own capital is not going to work. So we need franchising and other forms of partnership but rapidly get the number of centers up. We are a believer as a board, and certainly myself, network wins the day. This is about coverage. It's always been about coverage. It's not about having a load of sites in London. You've got to be everywhere, every single part of the country. Then you win, and that's it. And with franchising on -- going much more quickly, we expect that we can both create a better business for ourselves and at the same time a great business for franchisees. The ones we've got already, we've done quite a -- are doing well. And it can work for both sides. And clearly, in an IFRS 16 world there were many -- there's a big additional benefit that is not coming onto our balance sheet.Turning to your question on Spaces. Is it profitable? Well, actually, all the first ones are doing very well. They're making -- they're not more profitable than Regus, just to be clear. Everyone's got this idea that co-working somehow is a recipe to mint gold coins every day. It's the same business. It -- that's not different. So that we make very good margins out of the centers, the early ones that were done. And the first ones opened in -- about 10 years ago, so it's not -- so the growth has been in recent years, but even though it's the first ones, nicely profitable. So good, profitable model helped by, obviously, we're very economical on overhead, very tight on managing them. They are good. And what was the other question? Sorry, I wrote...

[Eric Hageman, Interim Chief Financial Officer]

It was economics, the economics of the franchise model and Spaces.

[Mark Dixon, CEO & Director]

Economics, yes, yes...

[Calum Battersby, Analyst]

No, that was clear. It was just if you could say as well how large Spaces is as a proportion of overall group revenues now.

[Mark Dixon, CEO & Director]

It's -- this is -- I don't know the number, but it's -- I know what the number will be when they're all matured -- when they're all mature.

[Eric Hageman, Interim Chief Financial Officer]

Yes. I mean, if I may add. This is Eric. If we want to say something more clearly about Spaces on the size and the contribution, whether it's revenue or profit, we will do so. Personally, I would then favor to do something like that at the full year results. And we're not doing it [indiscernible].

[Mark Dixon, CEO & Director]

[ Of trading update ].

[Eric Hageman, Interim Chief Financial Officer]

Yes. Listen, if at the end of the year we are at 157 locations, which is the exact number, out of 3,500 that we will then have, more or less, of the total group, I mean, it's a meaningful number.

[Mark Dixon, CEO & Director]

It's a meaningful number because they're generally speaking 2, maybe even 3x, the size -- no, actually more, maybe 4x the size, each one. So -- but we will update you with those numbers. It's -- it will be a significant number. Because of the size, there are -- the economics are different. Margins are the same, okay?

[Operator]

And your next question comes from the line of Andy Grobler.

[Andrew Charles Grobler, Analyst]

Just a couple from me. Firstly, on the balance sheet. Net debt was a bit higher than I had thought. And back in August, the guidance for the full year was around GBP 330 million, and it seems like it's going to be a fair bit more than that from this point. Can you just kind of walk us through the bridge of how we get to that number? Secondly and kind of a similar theme, you mentioned IFRS 16 earlier. Have you got any updates on what impacts you think that will have on your balance sheet and P&L if you were to report under IFRS 16 right now? And then lastly, just back to franchising. I mean, you've talked a fair amount about it, but I just wondered why now. What's changed to make you think that this is the time to push that forward?

[Mark Dixon, CEO & Director]

Let me do the franchising first, and then I'll pass over to Eric on the other questions. So what's changed? We painfully have restructured the business over the last 2 years, nearly 3 years now, to make it franchise-able. Now to make your business franchise-able, you have to make it very easy for the franchisees. And our business, 3 years ago, it was not easy. You need to be a rocket scientist to actually work it out at center level. So the whole business has been restructured in such a way that it's relatively easy to run each operating unit, and it -- the business therefore becomes franchise-able in a much more significant way than before because all of the difficult stuff is done centrally in our 3 global hubs and in our big operation center that sits behind them. And so there's very little that occurs at center level, so there's less things -- much easier for someone to develop a business locally and get it done. And of course, it's much more efficient for them. They need less people. So their returns on capital is significantly enhanced by the business being franchise ready. So that's number one. Number two, I think, is maybe we should have put more resource into franchise earlier. We have been doing it during 2018 so that we will go into '19 with a much more significant franchise team. Again, you can pick up noise about this in the -- I'm seeing in the newspapers, but pretty much globally we are putting in franchise teams, getting some markets regulated. We've done all the regulation work. And we are ready to go and ready to sell and are selling, and -- number two. Number three, we think it's the only way to get into the deep countryside and suburbs and smaller towns of the country. If you believe in national coverage, if you believe in that, that is what is key, then what we know from our own experience is it's difficult for us to run very remote places, very remote businesses. There will be a difference in performance when they're running Fargo, I'm not sure if it's North or South Dakota, to us running something in Chicago. So we believe that local businesspeople will make a much better job of it. The people we've franchised so far, and there's been tremendous momentum in the second half of this year once we really got going, people aren't buying individual franchises. They're buying them in groups of 10, possibly groups of 20. And they are very experienced businesspeople that generally, so far almost universally, I think, have other franchise businesses where they'll have a group of Pizza Huts, a group of McDonald's. They have quite a few other businesses. That's what they do. So right time. We were a bit slow in resourcing up. We've now done that. And we believe in national networks. That's it.

[Eric Hageman, Interim Chief Financial Officer]

All right, let me take the other two, and let me start with the net debt. So the guidance, I think, was given at the half year results. So why is it a bit higher was your question. Well, let's start to break it out in buckets, which is basically at the beginning of the summer, end of spring, we signed a new revolver, which basically meant that, rather than having GBP 550 million as capacity, it went up to GBP 750 million. So the reason why you do that is because you want to use that capacity. On the one hand, part of it is -- are used for guarantees. And part of it is obviously being deployed. And what do we deploy it for is, as per the statement today, one is in growth CapEx, of which we've done GBP 75 million; and GBP 40 million of maintenance CapEx. But equally important is obviously we started with a share buyback program, which was also announced at that time, of which we have done just over GBP 31.5 million year-to-date. And we've also seen a bit of an increase in our cash tax of around GBP 10 million, which together with in 1 or 2 other small individual balances explains the delta that you have seen. Two more points to make is, one, that we also still hold GBP 140 million of properties on our balance sheet which we are able to sell. And lastly, maybe just to put the context of the third quarter net debt increase versus the June one and what do we actually expect for the end of the year: What we are expecting is net debt-to-EBITDA will -- that will be just a little bit higher than what we saw at the half year. And so we're a bit higher than the 1.1x net debt-to-EBITDA. With that, we think that we still have a very solid balance sheet.And then your other question, which was on IFRS 16. There is nothing more that we can add or say other than we've done at the half year results, but maybe just a bit of color. As you can imagine, this is a big part of what the central finance team is working on and has been working on for a long time because this has been flagged. We talked about it in the annual reports at length in the last 2 years. The organization is making sure it's ready to do what it has to do with its reporting obligations. And so people have been working on it. Systems are in place, so we feel as a company and, as this is my seventh week, I feel that we're doing -- putting everything in place for it.

[Andrew Charles Grobler, Analyst]

And just on IFRS 16. At what point will you start reporting under that standard? Will it be the -- for the full year so we have comparables? Or will it be...

[Mark Dixon, CEO & Director]

Exactly.

[Eric Hageman, Interim Chief Financial Officer]

Exactly.

[Andrew Charles Grobler, Analyst]

Yes, full year '18 will be comped.

[Eric Hageman, Interim Chief Financial Officer]

No, no. So the idea is, what you're going to see, you're going to have them parallel. You're going to have both so people will be able to see comparables. You can see what '18 would have looked like under both standards. And needless to say, as you would expect from us, Wayne and myself, together with the central finance team, we'll make sure that, well ahead of our full year results, we will have teach-in so we can take everyone through it, which should give you ample time to be able to update your models in time for publishing results when the results come out the beginning of next year.

[Operator]

We don't have further questions.

[Mark Dixon, CEO & Director]

Okay, thank you very much indeed for all your questions. As usual, Wayne and Eric will be available for any further questions you may have later on today. Thanks very much.

[Operator]

That does conclude our conference for today. Thank you for participating. You may all disconnect.