Alaris Royalty Is Getting An Undeserved Premium Valuation

Alignvest Capital Management’s presentation on Alaris Royalty.

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Company Snapshot: Alaris Royalty (TSX:AD)

  • Alaris Royalty (“AD” or the “Company”) was created as a royalty finance business
  • Alaris Royalty  provides financing to mid-size businesses in Canada and the U.S. through a unique structure, whereby it purchases a “top line” royalty from the business for an up front cash payment
  • For example, Alaris will “lend” $50 million to an underlying business at a coupon of ~16.5%. These loans are perpetual in nature, in order to replicate a “revenue royalty.” In this example, Alaris will earn $8.25 million per year for this loan into perpetuity

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Alaris Royalty – Glossary of Key Terms

  • Distribution: payment received by Alaris monthly; determined twelve months in advance and adjusted each year based on the percentage change in a mutually agreed upon performance metric
  • Earnings Coverage Ratio (ECR): a measure of a portfolio company’s ability to pay distributions to Alaris; defined as adjusted EBITDA divided by interest, principal repayments, unfunded capital expenditures and distributions to Alaris
  • Collar: a maximum or minimum change in distribution based on the portfolio company’s performance metric
  • Business Development Corporation (BDC): a form of unregistered, closed-end investment company in the U.S. that invests in small to mid size businesses. BDC’s invest primarily in fixed income instruments and pay little taxes

Royalty Companies

  • The equity market loves royalty businesses. Why?
    • They are capital light, generating attractive returns on capital and free cash flow
  • As a result of these characteristics, the market has consistently rewarded royalty/franchise businesses with premium valuation multiples

Royalty Companies – Public Comparables

Alaris Royalty

Alaris Royalty: A Unique Business Model…

  • Given the unique “royalty” model, Alaris has been rewarded with a similarly high multiple by investors
    • “Alaris’ unique business model allows for the company to receive monthly distributions from its partners on investments made from day one rather than on an exit, which greatly reduces the risk of each investment”
    • “Alaris is an attractive business model for investors looking for yield and dividend growth as it is a specialty investment management firm that uses innovative financing structures to invest primarily in well-managed private companies through preferred shares”
    • “The primary reasons to invest in private equity are: the portfolio diversification, exposure to fast-growing industries/companies, and absolute returns or historical returns that typically exceed public-market returns. Alaris offers a unique strategy to investors looking to invest in private equity”
    • “Key benefits of Alaris’ model are: Smaller deployment of capital, access to well-run companies, high visibility of revenues, distributions grow with partner companies, minimizes cyclical returns and returns are on a monthly basis”

Alaris Royalty: …But Is it Really a Royalty Company?

  • The short answer is NO. Though Alaris bills itself as a pure-play royalty company, it differs from these companies in many respects
  • In our view, Alaris is a provider of expensive mezzanine financing to small/mid size businesses with a high degree of cyclicality and limited access to capital
  • Unlike a typical mezzanine lender, Alaris is a preferred, non-voting equity holder in these underlying companies; in the event of liquidation, Alaris is the last creditor to be paid
  • Does Alaris Pass the Test of a Real Royalty Company?
  • Is Alaris Capital light?
    • NO. Alaris must carry significant capital to finance and grow its business. Every new loan originated must be funded with fresh capital given the company pays out majority of its cash flow in the form of dividends
  • Can Alaris Grow with minimal Capital outlay?
    • NO. If Alaris wants to grow, it must raise additional capital to fund investments.
  • Is the business highly leverageable?
    • NO. Lack of visibility on cash flow makes significant leverage imprudent.

Alaris Royalty: More like a BDC than Royalty

  • Alaris’ mezzanine financing is lower quality than Business Development Corporations (BDCs), as it is covenant light with limited recourse and financial oversight
  • The company pays out majority of cash flow through dividends, but is ultimately required to raise capital to fund new investments?
    • We do not believe this is an efficient structure
  • Alaris has invested ~$734 million since 2011, yet pre-tax income has gone up by ~$75 million, or a 10.3% return on that capital. What happened to the 16-17% coupons the company cites on new investments?

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