Two weeks ago, I wrote that Pepper Group Ltd (ASX: PEP) was at 52-week lows and looked interesting due to its combination of Australian mortgage loans and unsecured overseas lending. On Friday afternoon, the company announced its intention to form a new partnership in Spain, a venture that holds promise. Here’s what you need to know:

  • Pepper Group and Spain’s Banco Popular to combine businesses to form a 50-50 Joint Venture (“JV”) in Spain’s unsecured consumer finance market
  • Additionally, both partners will act together to pursue new business opportunities in other territories
  • Banco Popular will subscribe for a 5% equity stake in Pepper Group in order to align the businesses
  • Banco Popular will subscribe to up to $100 million worth of Pepper’s shares over the next five years, subject to shareholding cap of 19.99%
  • The JV will be the 5th largest in Spain’s Point Of Sale finance market and will have access to Banco Popular’s customer base
  • Pepper Group will recognise a one-off gain on sale of $14 million – $16 million (inc transaction costs) from the sale of its consumer finance assets to the Joint Venture (Pepper will be issued 50% of shares in the JV in return)
  • Deal is subject to conditions precedent, including Bank of Spain approval and other (unstated) funding conditions

So What?

It’s a smart partnership, with Pepper able to access Banco Popular’s consumer data, which should provide more evidence to analyse consumer creditworthiness. Pepper will also be able to leverage Banco Popular’s existing branch network to sell its products. At a stroke, Pepper gains additional funding and creates what should be highly effective synergies between two complementary businesses. On the downside, existing shareholders will be diluted over time.

Now What?

The deal looks like a real positive for Pepper Group. Although some investors will turn their nose up at the idea of unsecured lending in Spain – which has unemployment above 20% – the bull case says that under-served areas are great places for investment due to less interest from big corporations, and the higher returns that can be earned. Pepper Group has been operating in Spain for a while now, which reduces the risk of management making an incorrect decision in that market.

The bear case is that the vast majority of Pepper Group’s loan assets are located in Australia, and higher risk lending activities overseas runs a gauntlet of risks not limited to regulatory changes, competition, and incorrect evaluation of risk.

There are a number of interesting businesses writing higher-risk unsecured loans in Australia like Cash Converters International Ltd (ASX: CCV) and Money3 Corporation Limited (ASX: MNY) which could give the higher margin loan exposure, without the mortgage liabilities of Pepper.

Ultimately, Pepper Group is not suitable for investors without a knowledge of finance and lending practices, but it could be worth a closer look for those willing to dig a little deeper.

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.