Sprott Inc

TSX:SII

Earnings Call Transcript 2019-Q1

[Operator]

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to Sprott Inc.'s 2019 First Quarter Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded today, May 10, 2019. On behalf of the speakers that follow, listeners are cautioned that today's presentation and the responses to questions may contain forward-looking statements within the meaning of the safe harbor provision of the Canadian provincial securities law. Forward-looking statements involve risks and uncertainties, and undue reliance should not be placed on such statements. Certain material factors or assumptions are implied in making forward-looking statements and actual results may differ materially from those expressed or implied in such statements. For additional information about factors that may cause actual results to differ materially from expectations and about material factors or assumptions applied in making forward-looking statements, please consult the MD&A for the quarter and Sprott's other filings with the Canadian securities regulators. I will now turn the conference over to Mr. Peter Grosskopf. Please go ahead, Mr. Grosskopf.

[Peter F. Grosskopf, CEO & Director]

Thanks, operator. Good morning, everyone, and thanks for joining us today. With me today is our Sprott team: Whitney George, the President of Sprott; Kevin Hibbert, CFO; and John Ciampaglia, CEO of Sprott Asset Management. Our Q1 results were released this morning and are available on our website where you can also find our financial statements and MD&A. I'll begin on Slide 4. While ending 2018 and beginning 2019 strong, precious metal prices sold off late in the first quarter, as the central banks prodded general markets higher and encouraged risk-taking behavior. Currently, gold and silver prices are moving in a range as investors await the current trade war resolution.At Sprott, we continue to believe that global debt levels are dangerously high and that investors will benefit ultimately from a hedge provided by an allocation to gold. During the quarter, our AUM was flat at approximately $10.6 billion. Our adjusted EBITDA was $9.2 million for the quarter, down from $10 million in the first quarter of last year. We continue to build scale in our lending business, adding more than $230 million in new AUM during the quarter. The total assets under management for that business now stand at $730 million. We currently have more than $1 billion in committed capital in our lending funds and our deployment rate is expected to increase in the near future. In January, we launched a new Korean co-managed private equity fund with KB Securities which is named the KB Solar Fund, raising $75 million in fee-earning AUM in the process and we expect that fund to grow as well over the next year.We should mention that after serving on Sprott's Board of Directors since the company completed its public listing and IPO in 2008, Jack Lee has decided to retire as the Chairman of our board. On behalf of our board of directors, Sprott management and all of our employees, I'd like thank Jack for his wise counsel and many contributions to the company over the years. We are pleased to announce that Ron Dewhurst who has a wealth of experience and a long track record in global wealth management, will take over from Jack as chair. Ron has been a member of our board since 2017. With that, I'll pass it over to Whitney, who also has enjoyed a long relationship with Ron, to tie things together. Over to you, Whitney.

[W. Whitney George, President]

Thank you, Peter. Good morning, everybody. It is a personal wonderful moment for me to have Ron chair our board here at Sprott. Ron and I have worked together in various organizations since 2007, when Ron arrived at Legg Mason, which was the owner of affiliate, Royce & Associates. In 2008, he joined the Royce board where I had a chance to get to know Ron. And Ron was instrumental in helping me come to the decision to try a second career here at Sprott and leave Royce, as things were becoming more difficult there, challenging and the opportunities here at Sprott were becoming more obvious to me. So Ron has been on our board here at Sprott since January of '17, was very much involved in our transformation that year and I expect will be a very active chairman and will help us with lots of growth opportunities looking forward.Moving on to the business update on Slide 5, we're happy to report that our engagement levels at Sprott are very, very strong, owing in part to the volatility of the markets in the fourth quarter, where people began to notice the benefits of some gold ownership as a diversifier. In addition to our ramped up content, our modernized website. Website traffic in the first quarter was up 18% over the first quarter and far exceeded any other period that we've experience. Our Insights commentary, traffic was up 82% with an average customer engagement of 3 minutes and 41 seconds. Our email opening rate is currently running at 43.4% versus an industry average of 15% to 20%. So while we endure the lull in precision metals markets, we are connecting with our constituents, our customers, at a more rapid and engaged rate than ever before. We also are pleased that the addition or the re-hiring of Dr. Neil Adshead is going very well. He's assisting Rick with his exploration partnerships, doing a full review. He's organized the geological team and engineering team to be more responsive than the high level they were already operating at. And we would expect that he will be launching his own partnership sometime in the second half. Finally we continue to explore in-market acquisition opportunities. We have a very strong brand. We have a desire to grow as others retreat. And at the same time, we'll continue to maintain very tight expense controls until we wait for our markets to recover. Thank you. To John?

[John Ciampaglia, Senior Managing Director]

Hey, good morning, everybody. Just we'll talk a few minutes about our exchange traded products. Just building on Whitney's comments, I think what's very important for us is the level of engagement we're experiencing with prospects in the marketplace. And although the S&P 500 and the bond markets had a very sharp v-shaped recovery over the last few months, helped by the Federal Reserve's U-turn in their policy, there still remain a lot of investors that are skeptical, and have remained very cynical and are concerned about some of the underlying risks in the marketplace: the trade wars, geopolitical issues, slowing economy, slowing earnings growth and so forth.So the types of investors we tend to engage with are very different than investors that are more short-term trading oriented. So for example, products like the GLD, which have lost over $2 billion year-to-date, GDX and GDXJ which have lost $2 billion year-to-date; we haven't experienced anything near those kinds of relative outflows, because we don't deal with rapid traders and high-frequency traders. Our fund has generally brought in modest amounts of capital this year, which has helped to offset what we think are manageable levels of redemption. The redemptions are moderating in the month of April. We had $17 million in total across the physical bullion trust, which is a percentage of assets that's very manageable. We don't like to see redemptions, obviously, but every fund in the world has a natural rate of redemption that comes with people that just want their money back for other purposes. So we feel we are very well-positioned right now. As Whitney said, that level of engagement really sets the table for future flows. And as the markets strengthen, we think we're well-positioned to get our fair share of that.And I will pass it over to Kevin.

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

Thanks, John, and good morning, everyone. So I'll start on Slide 7 with a look at our earnings summary. Adjusted base EBITDA in the quarter was $9.2 million, down $800,000 or 8% from the prior period. The decrease was primarily due to lower net commissions on lower equity origination and placement activities in our brokerage segment and lower fee income earned in our exchange-listed products and managed equities segments as a result of lower AUM. These decreases more than offset higher management fees, commitment fees and co-investment income in our lending segment that arose from ongoing capital calls and new commitment fee earning AUM. For more information on our revenues, expenses and EBITDA, you can refer to the supplemental information section of this presentation, as well as our 2019 Q1 MD&A filed earlier this morning. On Slide 8 you'll see a summary of our AUM. AUM, as Peter noted earlier, was $10.6 billion as at March 31 of this year, down slightly from December 31, 2018. We benefited from $264 million of additional AUM arising from a combination of new commitment fee earning assets and new capital calls in our lending LPs. We also benefited from $118 million of new AUM from fund launches in our managed equity segment and our Korea-based businesses that Peter and Whitney alluded to earlier. However, these net sales items were more than offset by physical trust redemptions, a weaker U.S. dollar and lower silver prices in our exchange-listed product segment. Lastly, I'd like to turn your attention to Slide 9 for a look at our investable capital. As you know, historically we funded investment opportunities primarily through the balance sheet, given the more than $300 million of investable capital we carried on average. Investment opportunities over the last few years, some of which are shown on this slide, reduced our investable capital to approximately $200 million with the majority of what is left being held in longer-term investments, hence would not fully be available for new investment opportunities arising in the near future. In anticipation of this, we renegotiated and upsized our credit facility towards the end of 2017 to extend its duration, increase its size, lower the borrowing cost and increase drawdown flexibility, thereby ensuring the new facility is a highly efficient source of additional capital for us to leverage. During the quarter, we drew on the term portion of this facility to avoid its expiry and to partially fund current and anticipated growth in the business, in particular, the anticipated pace of capital calls in our lending LPs over the next 12 to 18 months. That said, I'll turn it back to Peter for some final thoughts. Peter?

[Peter F. Grosskopf, CEO & Director]

Thanks, Kevin. So looking out for the rest of the year, we'll do a few things. We will continue to drive scale in our lending business with its newly enlarged committed capital. We are committed to rebuilding our managed equities business, an area in which we think there are tremendous opportunities in the current market. As some of you will recall, this is really the core business that we came from. It's a business that for us used to be over $5 billion in size, generated large base fees and also substantial performance fees. The Sprott Hathaway JV is an important step in this process, as we launch a new, we think a very exciting product into a tough market. It's obviously been a vexing challenge to us for 2 reasons. First, there's been a general lack of momentum in gold equities. And second, there's been the increasing indexation of our marketplace in general. But in the meantime, we're not going to stand still. And as Whitney said, we are looking to grow while others in our sector are shrinking. And we are going to pursue acquisition opportunities involving our core expertise. These are expected to include both other niche managers, as well as related investment management contracts. And finally, we are continuing to grow our digital gold platform. We do believe digitization in the next step in the evolution of the gold markets and it's an important development that will see gold enter the mainstream consumer and payments markets. We expect that the next year in digital gold will be completely focused on AUM growth, as the products that we've invested in have now been fully developed and it's really coming to the start of an execution phase for those businesses. So with that, I'll wrap it up and turn it back to the operator to see if we can answer some questions.

[Operator]

[Operator Instructions] Our first question comes from Gary Ho with Desjardins Capital.

[Gary Ho, Analyst]

Just the first question, I just want to get an update on the lending platform. I'm just wondering if you can walk us through kind of how the lending fund II fundraising in progressing, And when do you expect to have the final close there?

[Peter F. Grosskopf, CEO & Director]

It's going well, as we expected. There's a lot of interest. We've had a couple of closing already. We expect a couple more during the year. And we expect to be fully capped in that business by the end of this year, meaning we're just going to be focused on deployment. So it's really just a question of coordinating closings.

[Gary Ho, Analyst]

So deployment likely at the beginning of 2020?

[Peter F. Grosskopf, CEO & Director]

Well deployment is harder to forecast, of course, because it depends on taking pipeline and term sheets into final deal-committed form and also drawing them down. We only count as AUM once we're drawn and committed on those funds. So we are well engaged in the deployment process now. And in general we usually close somewhere on the order of 1 to 2 deals per month.I'm sorry, Gary, not to be able to give you more exact guidance on drawdowns. It's just sometimes it's all lumpy and $200 million or $300 million will come in a month. And other times we won't get anything for a couple of months.

[Gary Ho, Analyst]

Yes. Okay, no that's fair. And then second, I just want to get an update on the ETF redemptions. Were those CFCL related? And you mentioned kind of April redemptions leveled off. Any outlook you can share with us over the next few quarters?

[John Ciampaglia, Senior Managing Director]

Sure, hey Gary, it's John here. The redemptions I guess for the quarter were sprinkled around a couple of funds. The majority of them are in the old Central Fund of Canada. It is hard to predict. When metals prices are very strong, we see a very quick reaction in the marketplace in terms of trading volumes and interest in the funds. And that's part of their purpose. So as I said, it's very hard to predict, but we're generally seeing a moderation in redemptions to more normal levels. As I said earlier, we don't want to see redemptions in any of the funds. But there is always a natural rate of redemption and if you look at the redemptions we're seeing as a percentage of the AUM of the block of funds, it's still very modest and low single-digit percentage. So we really are looking for metals markets to give us some help. I would say we're very strong on the gold side. We've not had redemptions. We've had sales there. Gold prices have been generally very buoyant, as investors are looking for safe haven and cash alternatives. The metal that's hurting us a little bit is on the silver side. It obviously has a dual purpose in terms of monetary metal and also industrial. And we do think it's been caught up in the trade war a little bit. Palladium at one point in the quarter hit an all-time record high. It's since pulled back, but there's been a lot of interest in palladium. Platinum has been coming back to life after lagging for a while. So those two metals have been pretty interesting in terms of investor interest in the marketplace. So if you were asking me one thing, I'd like to see the silver price firm up a bit.

[Gary Ho, Analyst]

Got it, okay that's helpful. And then just lastly, Whitney you mentioned in your prepared remarks in-market acquisition opportunities. Can you remind me what you're interested in most, perhaps aside to these acquisition opportunities?

[W. Whitney George, President]

Well, clearly we're in a period where there is little or no interest in products relating around precious metals. That is our core key franchise globally. So in an environment like this, you find yourself talking to some very, very talented people that are in a very difficult market. As a value investor, I can say that's not necessarily just true of precious metals. But again, as you can see from what we've done so far this year, we are getting great opportunities because of our interest in growing and our commitment to talk to just about anybody out there. The Sprott Hathaway Joint Venture is one example. Getting Dr. Neil Adshead to rejoin is another. We are providing a stable sensible home for people who are committed to our sector and expect that we will take tremendous market share when things recover.

[Operator]

Our next question comes from Geoff Kwan with RBC Capital Markets.

[Geoffrey Kwan, Analyst]

Just the comments you've made around the precious metals markets and trying to think about your different strategies that you have out there and the sensitivity on flows to that. In other words, on kind of the ETS and that side of the business, my guess is that's probably the most sensitive on flows when you get gyrations in precious metals pricing then on the lending fund as an example, because the money is kind of locked in. Like there's not really much, if any, sensitivity there. If you can maybe talk about with some of your strategies, how to think about again when you get movements in the precious metals market, how that impacts flows.

[John Ciampaglia, Senior Managing Director]

Sure, hi. It's John here. Well obviously when we get any kind of lift in metals prices, we get a lot of operating leverage in our business model, which is great. So first and foremost, metals prices have the biggest factor in terms of our bottom line profitability. We do see, as you said, we do see the liquid exchange traded products are the first to react in the marketplace. And then generally we tend to see people moving to bullion first, as their kind of core allocation to the sector. And then when bullion prices are firm, we do see rotation over to the equities, as people are looking for alpha in their portfolios. But I think what's nice about our suite of funds is that we've got the whole spectrum covered. And depending on your view of each metal or equities versus metal or if you want to be more defensive on the debt side, they each play a role in our portfolio. They each cater to different segments. And so we feel very well-positioned in terms of being your one-stop shop. Talk to us about the metals. And I think that's where we make a difference in the marketplace is we may not be the biggest in the marketplace, but we're always in the marketplace. Many of our competitors are very quiet and not seen. So we always find that institutions and family offices are amazed at how quickly we respond to inquiries and we work very closely to educate and consult them on how to use precious metals in their portfolio. So we want to be that first call.

[Geoffrey Kwan, Analyst]

Okay. And just my other question was how to think about on the lending fund demand for resource loans over the cycle. Especially when the markets are good, is there still as much demand if companies are getting better pricing, they're getting better cash flows, and even if they expand they can maybe fund it internally. Any thoughts on that would be great.

[Peter F. Grosskopf, CEO & Director]

Sure. The demand is actually quite consistent across the cycle. And the reason for that is at a time like now, where there's generally no interest in equities, companies are tight on cash. They have needs that require them to meet to build projects. And so they turn to the debt markets. So our pipelines are very strong now. On the other hand, when metal markets themselves and equities are flying, they're doing more things. They're building more projects. So you need to get inside of that cycle and say, when is the best time to deploy and when is the best time to harvest? Now is the best time to deploy capital. The opportunities are with under-valued producers. We can arrange bonuses that are quite attractive now, at attractive valuation levels. So it's the best time to deploy capital now. It's the best time to harvest when equities are flying. That's the nice thing about the strategy. The holdup right now in the pipeline, like we have this massive pipeline of opportunities. The holdup is the lack of equity. Because every project that we lend to requires a certain debt-to-equity and loan-to-value ratio. And with the projects being generally held up a lot longer than they want to be, we've had a lot of term sheets that have been slow to draw. So the holdup is the lack of equity. That said, I think right now the pipeline is so robust that I expect pretty good deployment over the next year.

[Operator]

Our next question comes from Graham Ryding with TD Securities.

[Graham Ryding, Research Analyst of Financial Services]

Maybe I'll just start with the expansion of the credit facility. How should I think about that? Is that related to your M&A appetite? And just your investable capital at $200 million seems pretty solid. Why are you increasing the credit side of your balance sheet?

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

Right. So hey Graham, it's Kevin here. So as I mentioned in my opening remarks, so we brought the investable capital down from $300 million to $200 million. But if you look at the composition of our investable capital, you can see it in our 8-quarter summary. What you'll see is that $200 million is essentially tied up in current EBITDA-generating activities. So for example, if you look at the long-term investments, a big chunk of that is co-investments, for example, in the lending fund. So we obviously wouldn't be drawing from that to fund any near-term items. We also have the legacy loans on balance sheet that will run off over time. And then lastly, if you look at for instance the prop book positions, the large majority of those public positions are equity kickers that we received from old lending deals as well as some of the deal flow in our brokerages. So those wouldn't be immediately available. A portion of it though, to your point, will recycle down over time and be redeployed into other opportunities. But with the majority of the flexibility from the balance sheet now gone, it just makes sense for us to have a facility that's flexible, cheap and that is readily accessible in instances where at the time that an opportunity arises, we may not have the ability to recycle out of what's currently on the balance sheet.

[Graham Ryding, Research Analyst of Financial Services]

Okay, got it. That makes sense. Peter, your comment around your digital gold investments in the next stages, about AUM growth. I assume this is a reference to your Tradewind investment. Can you just elaborate on that a little bit more as to specifically what you're targeting or what you're looking for and remind us what the economics are to you in terms of either your earnings or the sort of investment gains that you would like to see?

[Peter F. Grosskopf, CEO & Director]

Well, the total size of the portfolio for us, which is all comprised of strategic investments, is about $20 million. All of the companies, the underlying companies, are growing their platforms now. So they are the ones who are going out and getting the customer AUM. In order to be profitable, all of them need different levels of AUM. So Tradewind's is a product. And in order for it to become profitable, it requires a larger AUM balance to be invested in that product. OneGold is a platform. So as a fairly low-cost digital platform, it needs much lower AUM levels to become profitable. And so each one is different. I think what's becoming clear is that the products work and that they offer amazing efficiencies for customers that have not traditionally been able to invest in the gold market and that eventually those tokens, if you will, and I'm calling them that loosely. But those token will be able to be used in a payment system and across the financial system to populate other financial accounts. So it's just a C change. It's very similar to the change that took place when ETFs first came in the market and offered everyday investors the chance to buy physical bullion listed on exchange, like they can with our own product. So that was a big change for the gold market. I think this is going to be the next big change.

[Graham Ryding, Research Analyst of Financial Services]

Great, okay that color is helpful. The Korean fund, what the mandate there? Is that precious metals or is that -- I know you have some energy mandates already in Korea that's in that area.

[Peter F. Grosskopf, CEO & Director]

Well we put a team on the ground there that was associated with Sprott Resource Holdings that were doing some energy investing. We had a relationship with one of the institutions there through the mining side. And that institution partnered with Korea's largest fund, the national pension system, to do an alternative energy production portfolio, a global one. And they asked us to become the manager. So that was, I think now about 6 years ago. And what we're seeing is that somewhat surprisingly, we're one of the only managers in Korea that's managed to build a small profitable business there as a foreigner. And those clients are now coming to us with additional mandates. And in this case it's actually an in-Korea solar mandate, where our team there is qualified to deploy money into the tax-assisted and grid-assisted solar program that's going on in Korea, which is a big push over there.

[Graham Ryding, Research Analyst of Financial Services]

Okay, interesting. So is that the $72 million that we see as a net inflow in your net sales?

[Peter F. Grosskopf, CEO & Director]

Yes, it is.

[Graham Ryding, Research Analyst of Financial Services]

Okay, and then Kevin, just last two questions, but quick ones. IFRS 16, how much of an impact did that have on base EBITDA in the quarter? And then stock-based comp, is this a reasonable run rate?

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

So on the EBITDA front, the answer is no impact or at least not a material impact, maybe a few hundred thousand dollars, as you re-class some of the rent into D&A. And as far as run rate on the LTIP amortization, I'd probably say it's -- are you asking for the rest of the year or over the duration of the program?

[Graham Ryding, Research Analyst of Financial Services]

Yes, well I know it sort of steps down, if I remember correctly. So this year was supposed to be a stepdown.

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

Yes, so it will be even smaller next year and then it should be completely run off at the end of 2021.

[Graham Ryding, Research Analyst of Financial Services]

Okay, but it's a reasonable run rate?

[Kevin Lloyd Hibbert, Senior MD, CFO & Co]

So there's -- if you look, Graham, at -- it may have been a few quarters ago. But I gave an analysis that showed the runoff, the amortization runoff. See if you can find that in one of those old analyst decks. If you can't, just flip me a note and I'll send it to you.

[Operator]

Thank you, and this does end today's question-and-answer session. I would now like to turn the call back to Mr. Grosskopf for any closing remarks.

[Peter F. Grosskopf, CEO & Director]

Thank you, operator, and thank you, everyone, for participating in this call. I want to take the opportunity to acknowledge the great support of our shareholders and employees while we built our platform over the past few years. We feel we're in great shape to continue to fight the good fight to provide our clients with a true alternative to the general financial markets. We appreciate your interest in Sprott and we look forward to speaking with you again after our Q2 results.

[Operator]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone have a wonderful day.