Stockwatch: An AIM newbie for the long term

by from interactive investor |

Boasting a seam of quality earnings, companies analyst Edmond Jackson believes shares in this recent IPO could sail onwards and upwards on the tailwind of financial regulation. 

Last week I expressed concern about the durability of demand for investment funds, should financial sentiment change, which would lower asset managers' earnings due to their operational gearing.  A less risky alternative linked to consumer financial services – which ought to have good long-term prospects as more people seek advice – is a £153 million AIM company that floated in April, recently declaring sound progress.  

SimplyBiz Group was founded in 2002, shortly before the Financial Services Authority (FSA) came into being - direct authorisation making it easier for capable financial advisers to set up their own firm than work as representatives of large networks.  

Together with life's complexities boosting the need for advice, the FSA's successor - the Financial Conduct Authority (FCA) – has cited the number of UK firms providing it, rising well over 5,000.  A dilemma for them is meeting regulatory needs without the cost of hiring a compliance officer, which has enabled SimplyBiz to build a strong leadership in support services. 

Revenues involve compliance and marketing services

Half of the group's £44.1 million 2017 revenues came from "intermediary services" – a monthly subscription service to maintain compliance with regulatory requirements, enabling IFA firms to focus on advice. Scope extended to mortgage advisers and consumer credit brokers when these came under FCA regulation in 2005 and 2014 respectively.  

There's a strong element of "essential service" here, given it doesn't make much sense for IFA firms to hire a dedicated compliance officer.  Interim group results show the number of member firms up 5.7% to 3,628 in the first half of 2018, with "SimplyBiz strategically well placed to support and guide them through FCA registration and assist in a constantly evolving and increasingly complex regulatory environment".  

A financial planning system "Centra", launched last March, has notched up over 1,600 users, although Zest Technologies, an employee benefits software solution, saw revenues slip 24% like-for-like in the first half-year "as customers move away from the legacy application".  This month, the latest one was selected by Benni, a new workplace benefits service, offering "a high-quality employee experience whilst reducing the administrative burden".  


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The other side of the group - "distribution channels" - enables some 135 product providers among them asset managers, life assurance and pension companies, mortgage and insurance providers, to reach the group's financial intermediary members e.g. via annual contracts.  Income from such agreements jumped 20.9% to £3 million in the first half, albeit partly due to service delivery timing.

Altogether, over the last five years group revenue has expanded 151%, with the intermediary membership base up around 55% - affirming how regulation is a useful tailwind. Management has responded to various landmark developments like the introduction of auto-enrolment pensions, regulation of consumer credit, the mortgage market review and MiFID II.

£26.3 million raised in April, slashed net debt

Some £35million of debt was taking over a third of operating profit in costs.  Instead, and as at end-June - with a new £15 million revolving credit facility "at a significantly lower interest rate" – there was £10.7 million unrestricted cash and £10 million debt, which should improve the income statement going forward and boost corporate development.

Maiden results as a listed company are attractive: interim group revenue up 13.7%, the normalised operating margin up from 20.7% to 22.2%, enabling adjusted profit/earningsper share (EPS) measures to advance over 60%.  

Statutory results were "loss-making" in that £22.9 million operating expenses (inclusive of flotation costs) and £2.5 million net finance costs, meant a £1.2 million statutory loss, although the tax charge rising near £0.6 million affirms improving underlying profit.  

Operating cash conversion did reduce from 84% to 65% year-on-year due to above-average working capital balances, hence a slight reduction in operating cash flow to £3.5 million. 

Source: TradingView (*)  Past performance is not a guide to future performance

Management says cash conversion should improve over 75% in line with previous rates in the second half of 2018, part-explaining a 0.98p interim dividend (with payout flexibility also enhanced by the capital-raising).  Mind, this dividend was said in respect of nine months trading to end-2018, as if to caution against a read-over to H2, which implies a scant dividend yield on a share price of 200p.  

Moreover, intangible assets constitute 102.4% of net assets, so perception of value will focus on the earnings trend, making for a volatile stock should it falter any time.

SimplyBiz Group - profit and loss summary          
Year ended 31 Dec 2015   2016   2017
           
Revenue 38,480   40,815   44,066
Operating expenses -30,929   -32,492   34,921
           
Operating profit pre-exceptionals 7,551   8,323   9,145
Operating margin 19.6%   20.4%   20.80%
Exceptional items -6,081   -66   -342
           
Operating profit 1,470   8,257   8,803
Net finance costs -1,992   -3,316   -3,322
           
Pre-tax profit -522   4,941   5,481
Taxation -151   -864   -694
Post-tax profit -673   4,077   4,787

Source: Admission Document, March 2018

Wider business cycle risk looks the key one

Given the "essential" nature of SimplyBiz's intermediary services, linked chiefly to regulation, risk on this side of the business relates more to an economic jolt serious enough to halt start-ups.  

Controversy over direct benefit pension transfers may lead to regulatory change that disrupts the advice industry, if more likely to support SimplyBiz.  The "marketing services" flavour of the group's distribution channels side looks relatively more exposed to a weaker UK economy as firms and individuals hunker down, possibly leading to lower levels of financial transactions.  

The January 2018 acquisition of a surveying company, said to be "highly aligned and complementary" to an existing group surveyor, appointed by the majority of UK bank/building society panels, looks a sensible integration, if unlikely to buttress the group's service revenues if the housing market slows further amid financial uncertainty.

This is relevant in terms of whether a growth rating – presently about 20 times likely 2018 earnings – is justified, also in respect of perceived earnings quality, or whether in due course SimplyBiz will be affected by any wider downturn.

Management has part cashed-in, yet retains strong equity

Note 6 in the prospectus on page 101 shows Ken Davy, the founder (currently non-executive chairman) reducing his interest from 33.4 million to 30.5 million shares – 39.9% of the enlarged equity following the placing.  The joint CEO's halved their stakes to about 2% each, although one has since added 100,000 shares at 188.5p for his SIPP – presumably in part for the income tax benefits – taking his holding to 1,661,975 shares.  

Both the joint CEO's are aged around 40 years versus the chairman at 74, hence it is positive that they're retaining sizable equity.  Further down note 6 on page 105, Davy's daughters have sold over 14 million shares, accounting for most of their interests, albeit retaining about 2 million each.  

Despite the insiders' selling, however, collectively they control about 62% of the business which could be seen as excessive anyway - certainly for a publicly listed company - but it is a motivator for generating sustainable long-term value.

At around 200p, the stock appears fairly priced, yet in the current highly challenging environment for stock-pickers it has merits as a tuck-away.  

A cynic might say its flotation was well-timed to cut/revamp debt before interest rates rise, and for insiders to take some profits lest UK economic downturn undermines various services.  But taking a long view, SimplyBiz could end up a useful bolt-on for a support services group seeking better quality earnings - consider how Capita (CPI) has come to dominate a lot of shareholder services nowadays.  

If the stock's earnings were to falter at some point ahead, and the loss of growth rating triggering a sharp drop, it could create a takeover situation.  You could watch and wait, but SimplyBiz may continue to sail onwards and upwards on the tailwind of financial regulation.  So, despite an aspect of cyclical risk, the shares rates a Long-Term Buy.   

*Horizontal lines on charts represent previous technical support and resistance.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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