Interactive Investor

Stockwatch: financial sector takeovers a bullish signal

Various takeovers hint that UK share values are in an early bull trend. If true, financial shares will respond in due course. Analyst Edmond Jackson explains the rationale.

12th March 2024 11:03

Edmond Jackson from interactive investor

Takeovers in the financial sector are a possible forebear of better economic times ahead. This sector tends to lead the stock market up or down, so if whole companies are being bought, what might that imply?

Nationwide is buying mid-cap Virgin Money UK (LSE:VMUK) at a circa 35% premium, and Pollen Street Group Ltd (LSE:POLN) a slightly higher 40% premium for Mattioli Woods (LSE:MTW), an AIM-quoted wealth manager with £15 billion of assets under management from some 20,000 clients.

I am interested in this piece to consider the irony of how a freshly listed private equity group is buying Mattioli on a rationale that the stock market is not nowadays a good place to be for growth companies.

Pollen’s cash offer of 804p per share implies a value of £432 million, representing nearly 15x the consensus for normalised earnings per share (EPS) of 54.3p in Mattioli’s financial year to end-May 2025.

On the long-term chart it looks a low-ball deal 

After listing at the end of 2005, Mattioli traded broadly sideways in a 150-300p range until early 2013, then began a bull run from around 200p to 800p by early 2017. The price again traded volatile sideways until a slide from a 900p peak at the end of 2021 took it briefly below 600p in October 2022. Last October it even dipped below 500p.

Agreed terms thus only restore market value (pre-dividends) that persisted for nearly five years. Admittedly, the table shows net profit and EPS being quite volatile, although consensus has been for record earnings going forward.

Broadly it does look a right time to be buying, and perhaps Pollen and Mattioli could say that “the likes of you were not saying so though”. While I drew attention to the shares as a “buy” variously from 455p in July 2014, I shifted to “take profits” in September 2018 at 855p and, despite noting in January 2019 that 650p was a multi-year low, I concluded: “Buy on weakness...with fresh money I wouldn’t hurry to enter.” While that stance was fair relative to sub-500p seen recently, I have missed the bid.

Mattioli Woods - financial summary
Year end 31 May

 201820192020202120222023
Turnover (£ million)58.757.558.462.6108111
Operating profit (£m)9.69.312.24.27.311.5
Net profit (£m)8.27.89.51.44.17.7
Operating margin (%)16.416.220.96.810.312.1
Reported earnings/share (p)31.129.234.74.98.314.9
Normalised earnings/share (p)31.831.037.310.812.117.8
Operational cashflow/share (p)62.132.934.963.233.144.0
Capital expenditure/share (p)33.37.43.62.94.23.8
Free cashflow/share (p)28.825.531.360.328.940.2
Dividend per share (p)17.020.020.021.026.126.8
Covered by earnings (x)1.81.51.70.20.30.6
Return on total capital (%)11.611.413.74.32.74.3
Cash (£m)23.723.326.021.954.245.3
Net debt (£m)-23.7-23.3-23.1-19.3-50.4-42.0
Net assets (£m)79.076.481.586.1230229
Net assets per share (p)302285303306452443

Source: historic company REFS and company accounts.

A public listing compromises ability to invest

If Mattioli’s takeover announcement is fair, it is an indictment of the stock market that investors might as well abandon hope of fresh growth plays replacing companies taken over.

The need for dividends is blamed for compromising investment in technology to meet client needs, although the last (interim) cash flow statement showed a modest £329,000 spent on software after £557,000 for the last year, relative to £3.2 million interim net cash inflow.

I am unconvinced. Admittedly, £9.3 million was paid out in dividends over the six months, although £6.6 million trade payables were also paid down within working capital.

If Mattioli was to stay listed, it says: “delivery of the group’s growth strategy would be both slower and more uncertain without considerable further capital funding, which would be difficult to raise in the public markets at the current share price without materially diluting existing shareholders”.

A new ownership structure, it is said, will achieve strategic benefits and operating efficiency, enabling appropriate investments for the long-term benefits of the business.

In between the lines, it feels as if management has tired of the costs/duties of an AIM listing, the founder with 6% of the shares might prefer a liquidation, in due course to retire, and ongoing managers would be re-incentivised by Pollen.

This all effectively rules out a re-flotation in say five years’ time to crystallise gains. They could not argue a listing would be appropriate, so a trade buyer would have to be found.

A timely move by Pollen Street Capital

On 6 February, Mattioli Woods’ interim results cited “increased demand for high-quality wealth management and financial planning advice driven by proposed pension and investment reforms, and market conditions”.

First-half operating profit rose over 54% to £7.1 million, although “adjusted EBITDA” which strips out depreciation, amortisation and various exceptional costs, rose a more modest 10% to £16.5 million.

Perhaps investors have wearied at figuring Mattioli’s true earning power given it keeps making acquisitions – the historic table shows quite a gap between reported and normalised earnings. So, which one to rely on? Yes, it can be appropriate to add depreciation and amortisation, and eliminating costs of acquisition and integration enables a “see-through” to how the businesses are performing. But such costs are still borne by shareholders.

The operational review cites “a pipeline of potential acquisition opportunities” and I suspect this is a more likely developmental reasons rather than technology upgrades that Mattioli seeks an alternative capital provider for.

Privately owned, independent financial adviser (IFA) firms have, for example, become sought-after as the industry consolidates, with exit multiples for earnings being agreed in the mid-teens. If Mattioli had issued additional shares at say around 600p, with its 12-month forward price/earnings (PE) ratio around 12 times, this would have been earnings dilutive – and worse, say if shares had to be issued at 550p (a PE of 11, assuming consensus for EPS around 50p).

Acquisitions are the key to financial growth here. Interim organic revenue growth nearly doubled, albeit only to a 4% growth rate, while acquisitions aided reported growth of 8% to £59 million.

Organically, there have been a few challenges. An increase in new business during the financial first half-year was partially offset by lower fees – even on just a 0.4% reduction in client assets to £15.2 billion. The group’s highest cost is employee benefits which edged up to 55.6% of revenue from 54.3% “reflecting recent inflationary pressures.” The shares were thus flat at around 580p in immediate response to these results.

Yet similar dilemmas apply to fund management groups on even lower ratings – for example Jupiter Fund Management (LSE:JUP) and Liontrust Asset Management (LSE:LIO), on forward PE multiples around 10x and 9x respectively. If share values are in an early bull trend – and various takeovers within UK plc hint at this – then financial shares will respond in due course. Asset managers in particular, given fees will rise with clients’ portfolio values.

In its May 2023 financial year, Mattioli spent nearly £25 million on acquisitions if you include £10 million “contingent remuneration” for such, versus £13.6 million on dividends. This compared with £22.5 million net cash generated from operations.

So, yes, if the group seeks to continue acquiring at a similar pace, then it is not going to be internally financed while also maintaining the dividend.

Ironically Pollen Street Capital is listed

They say: “We believe Mattioli Woods would benefit from a transition to private ownership, which would accelerate its growth strategy...”

They are attracted by a business model “with clear growth opportunities across its wealth and asset management and employee benefits business...ability to capture the full wealth value management chain by offering a full range of services...”

In which case, why did Pollen – founded in 2013 – list itself? If Mattioli is throwing in the towel because the stock market does not value it properly, the same could happen with Pollen, for example, its shares rated at chronic discount to net asset value.

In a fourth-quarter trading update, it cited “a good pipeline of opportunities”, implying scope for exacting value. In which case, frustrated Mattioli shareholders could switch into Pollen, which achieved a near 9% investment return in 2023. I would still prefer to see how it establishes itself as a listed company before rating its shares, currently at 560p.

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

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