Cannae Holdings, Inc. Q3 FY2023 Earnings Call

Good afternoon, ladies and gentlemen, and welcome to the Cannae Holdings Inc. Third Quarter 2023 Financial Results Conference Call. As a reminder, this conference call is being recorded, and a replay is available through 11:59 p.m. Eastern Time on November 14, 2023. With that, I would like to turn the call over to Jamie Lillis of Solebury Communications. Please go ahead.

Thank you, operator, and all of you for joining us this afternoon. On the call today, we have our Chief Executive Officer, Rick Massey; Cannae's President, Ryan Caswell; and Bryan Coy, our Chief Financial Officer. Before we begin, I would like to remind listeners that this conference call and the Q&A following our remarks may contain forward-looking statements that involve a number of risks and uncertainties. Statements that are not historical facts, including statements about Cannae's expectations, hopes, intentions or strategies regarding the future are forward-looking statements. Forward-looking statements are based on management's beliefs as well as assumptions made by and information currently available to management. Because such statements are based on expectations as to future financial and operating results and are not statements of fact, actual results may differ materially from those projected. The company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. The risks and uncertainties to which forward-looking statements are subject include, but are not limited to, the risks and other factors detailed in our quarterly shareholder letter, which was released this afternoon and in our other filings with the SEC. Today's remarks will also include references to non-GAAP financial measures. Additional information, including a reconciliation between non-GAAP financial information with GAAP financial information, is provided in our shareholder letter. I would now like to turn the call over to Cannae's CEO, Rick Massey.

Thanks, Jamie, and thanks, everyone, for joining us on our third quarter conference call. As Jamie mentioned, Bryan Coy, our CFO; Ryan Caswell, our President. They're both here with me. I want to remind you that we filed two things; one of which is our shareholder letter, which we filed about half an hour ago. That's got a much more detailed discussion of our various portfolio companies, cash position, etc. And secondly, we filed some of the parts, which essentially was our net asset value per investment and then broken down on a per share basis. We do that on a monthly basis. If that's right?

Yes, yes.

So I recommend you check in on those, you'll get more than I can tell you on this short call. So I'll be brief since all that information is public. We still believe our own stock is our best investment with our precious capital. As you may have noted from our shareholder letter, our buyback authority was replenished by our Board a couple of weeks ago. We have over 10 million shares authorized for buyback. We bought back 2.7 million shares in the third quarter, which turns out to be about roughly 4% of the company in that 3-month period. Since we started our buybacks, we've bought back almost a quarter of the company with about $0.5 billion. We have no reason to discontinue that operation. Everything we see out there leads us to believe that we don't see anything better than buying back our own stock. It's hard to turn down a double on liquidation value if that comes into play. I'll just mention a couple of portfolio companies in alphabetical order. Alight had a really good quarter with 8.4% revenue growth, which excited the market. The 26% BPaaS growth is their comprehensive enterprise offering that is really selling well and providing increasing margins to Alight. For those of you who are cash flow enthusiasts like me, the most encouraging news out of Alight was that they spiked their EBITDA margin by about 175 basis points to nearly 20%, which is excellent. They performed extraordinarily well on cash flow. Their cash flow was a multiple over the corresponding quarter. They're finally getting the benefits of this restructuring along with the automation embedded within the shift from call centers to mobile. Stephan mentioned in his earnings call that during the Q&A, he mentioned that they were able to handle hundreds of thousands, maybe 1 million more employees during this enrollment period, and yet the number of calls and the number of call center personnel remained flat. Their mobile uptake has tripled over the past year during last year's enrollment period. This aligns with the plan, and you're starting to see the benefits of automation. The company is performing well. The stock is significantly undervalued, mainly due to private equity overhang. This specific private equity firm sold off its shares, which adversely affected the stock price. We hope to see some increased volume and that they might exit shortly. D&B is another one that is significantly undervalued; this morning, I calculated that they are trading at about a 40% discount relative to peer multiples despite the fact that they're growing in line with peers. Revenue-wise, they grew 5.8% on a constant currency basis in the third quarter compared to the third quarter of 2022. Their margin expanded a little, and they managed to reduce their leverage somewhat. They do carry a bit too much leverage, and we're brainstorming strategies to reduce that as we aim to help leverage those businesses and promote share buybacks. Ceridian, as usual, excelled in the third quarter. I'll just note that UBS just initiated coverage on Alight and Ceridian with a $10 price target on Alight and an $87 price target on Ceridian, which is quite bullish. I'll turn it over to Bryan to discuss a handful of topics.

Sure. I wanted to briefly touch on what Rick Massey referenced regarding our monthly updates, just to illustrate the discount in our net asset value. We started the year with an aggregate net asset value of $2.7 billion, which was about a 43% discount relative to our stock at that time, which was trading at $20.65. As of today, our aggregate net asset value is $2.3 billion against a stock price of $17.80. This means that each Cannae share has an intrinsic value of $31.79, representing a 44% discount. The discount has remained relatively steady, which is why we continue to buy back shares month after month. You'll notice a slight decrease in that aggregate fair value, reflecting the sale of 20% of our Ceridian shares. We have taken a few hits on fair valuations: System1, Dunn & Bradstreet, Alight, and Ceridian. All of these are marked to fair value every month in line with the stock price. This month in particular, we made a further write-down for System1, reflecting the market's perception of the stock at that time. We also took a significant mark on Sightline. In our second quarter earnings call, we discussed that Sightline has encountered many challenges recently, including ease of signing up for the app and acceptance rates from processors. The product rollout has been slower than anticipated, and we have been questioning their plans and timelines. As a result of these issues, we engaged a third-party firm to evaluate Sightline, and the valuation range came in well below Cannae's recorded book value as well as third-party investor value from late 2022. Consequently, we recorded about a $70 million impairment to its book value and reduced the fair value by another $157 million across various components. The fact that we are holding steady at $2.3 billion with a 44% discount validates our decision to continue buying back our shares.

Yes. I'll quickly address Black Knight football. We've continued to make good progress over the quarter and year-to-date. Commercial revenues are up about 30% year-over-year, which reflects what Jim and some of the new hires have accomplished in increasing sponsorship, hospitality, and ticket sales. That's positive. We also invested in some players and re-signed some of our top players to enhance the contract and financial value of those players over time. Lastly, we raised a bit of capital for Black Knight; Cannae contributed about $25 million, with third parties comprising the remainder. So we raised just over $60 million in the quarter.

With that, operator, we'll turn it over to questions.

And the first question comes from Ian Zaffino of Oppenheimer.

So I wanted to ask you about the company's philosophy. Are we going to see new investments on the horizon, or what's your outlook on investments? Maybe selling down D&B, given how significant it is in your portfolio? At what point does it make sense to collapse the structure instead of continuing to buy back shares? How about just returning everything to shareholders?

Great questions all. I'll try to address them generally. As I said, we are not actively looking for new investments. We are on a path to buy back our shares within the limits set by law. It would be imprudent and likely illegal for us to signal what we intend to do with our publicly traded portfolio companies and our ownership. There are shares we own that are significantly below our basis that could serve as tax harvesting opportunities while also providing us with cash for buybacks. I'm not going to get into further details about that. Regarding collapsing the structure, it's extremely tax inefficient to go that route. The main reason being that if we buy back more than a certain number of shares, we lose the ability for our capital loss carryforwards and carrybacks, which are critical for us. If we decided to buy back control of the company, we would severely limit our opportunity for those carryforwards. We're a C-corp, meaning those losses are vital to prevent double taxation when distributing assets. So we must be cautious with how quickly we operate while maintaining these valuable tax assets. We also have a limit on our daily volume for buying back shares. Our average daily trading volume hovers around 425,000 shares, and we plan to gradually increase that over time.

Yes. And as far as possibly raising more capital for buybacks, how do you view O'Charley's and 99?

Well, we would welcome a bid for O'Charley's. If you have ideas, we would love for Oppenheimer to get back into the restaurant business. I’m not being facetious. We think 99 is an acceptable restaurant chain. O'Charley's generates cash. We're currently in a restructuring mode to pare down to a small number of cash-generating restaurants. We're disposing of fee properties if we haven’t already and exiting undesirable leases. However, if you look at the current market, there's not a lot of mergers and acquisitions in restaurants or consumer discretionary sectors. We'd love to receive a bid. We previously entertained a few opportunities, moving a little down that path, but that market has been quite limited. We also attempted to sell System1, but that possibility did not pan out. We are exploring every avenue for liquidity.

Okay. I guess there’s just one more. Regarding O'Charley's, what kind of EBITDA do you think that could eventually generate post-restructuring?

I think, Ian, post-restructuring, the combined restaurant group could generate $15 million to $20 million per year annualized after we eliminate the negative cash flows.

That figure includes 99?

Yes, that includes 99. That's the entire group. They have closed nearly 80 underperforming stores in the last year, effectively rationalizing negative cash flow operations to focus on better-performing locations.

The next question comes from Kenneth Lee of RBC Capital Markets.

In terms of the book value impairment for System1, could you elaborate on what triggered that decision? Was it simply based on the share price trading below a certain level?

Sure, Ken. The impairment stemmed from a prolonged market value below our recorded book value. We typically write down our equity method investments in accordance with their losses each quarter, but the market lowered the valuation below even the losses recorded. We effectively mark down our public investments if they remain below our book value for an extended period. We have done this with Paysafe in the past as well.

Okay. Very informative. Regarding private investment valuations, considering you performed a third-party valuation for Sightline, how do you feel about the rest of the private investments in the portfolio?

I don’t think there's anything in there that is concerning us, Ken. The amounts are not large, as indicated by the total. The rest of the private investments are primarily valued in the $50 million range, composed of about half a dozen smaller investments. The only other notable one we've mentioned is Minden Mill, which is valued at $50 million, and we recently entered that investment. We believe that investment is going to yield positive results.

We paid one-third of liquidation value for Minden, making it an exceptional purchase amidst a lack of superior deals in the market. As for CSI, it's an $84 million investment and performing well, growing at about 8% or 9% top line and expanding margins, which is as expected from a Frank Martire-led company. However, there's no liquidity event on the horizon, as we acquired it last summer about 1.5 years ago.

Got it. Very enlightening. Lastly, you mentioned the $25 million capital raise for BKFC, which Cannae participated in. Could you provide more details about that capital raise and the potential long-term outlook?

Yes. We raised approximately $62 million for BKFC, with around $25 million coming from Cannae. This capital was aimed at acquiring additional talent and securing opportunistic funding to grow the business. We introduced Ryan Sports Ventures, an institutional investor with interests in other sports properties, as a long-term partner. This acquisition not only allows for potential player acquisitions but also strengthens our capital position.

Understood. Regarding AFC Bournemouth, can you clarify if the transfer budget aligns with BKFC funding?

The funding for transfers comes from a mix of operating revenues within the business and, in certain instances, we may inject additional capital for incremental player purchases. It's essentially a blend of both. We hope that in the future, as we begin selling players, the funding will become solely internally sourced.

Our next question will come from John Campbell of Stephens Inc.

Rick, thanks for the insights on the buybacks. It’s evident that you've completed your due diligence, and you understand what can and cannot be done. So we have no further questions on that; it's clear that buybacks will be your main focus moving forward. However, regarding Bournemouth, have you begun to see the benefits from the operational improvements implemented this season? Ryan, I know you mentioned overall BKFS revenues being up 30%. Can you isolate Bournemouth regarding key metrics such as revenue per match, attendance, sponsorships, etc.?

Yes. On the commercial side, we are performing well. As we've discussed earlier, we are constrained by stadium capacity. However, Jim and the team have excelled at increasing ticketing, hospitality, and sponsorship. In each of these categories, we've seen substantial growth; ticketing is up over 10%, attributed solely to price increases since the stadium capacity remains constant. Hospitality has surged nearly 40%, attributed to price boosts and converting certain non-revenue areas of the stadium into revenue-generating spaces. Sponsorship is also up significantly, resulting from higher pricing on existing sponsorship deals and acquiring new partnerships. The team's switch to focus on regional sponsors versus national or international sponsors has also proven fruitful. We are thrilled with our current performance, and we hope the on-field success will eventually follow track.

That’s insightful. It seems you are nearing a majority investment at 48%. Moving forward, have you identified a specific investment cycle or are you looking to maintain a minority position during any future raises?

We don’t have a strict plan for retaining this percentage—it is not set in stone. We are unclear if further capital will be required. We entered with a 5- to 7-year investment horizon, and we are still early in the process. Our goal is to oversee the operations, enhance performance, and subsequently exit. Thanks a lot for joining our call. You're welcome to schedule a side call with Bryan, Ryan, myself, or anyone else in the coming days. We have numerous calls lined up, but we can always accommodate a few more. Please feel free to reach out to us. We appreciate your interest in Cannae Holdings.

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.