Exchanges and HL: Financial Grime - 15 April 2018

News

Lighthouse announces it has renewed its affinity contract as the preferred provider of financial advice to the Royal College of Nursing with 435,000 members.  A reminder of the low cost asset harvesting model this company enjoys.

Cenkos AGM reveals a “disappointing” Q1 when investor sentiment was impacted since when the pipeline has improved while the balance sheet has improved due to asset realisations

Thinksmart – Afterpay Touch – the Australian listed comparator announces the launch of its point of sale instalment product into the US market moving the shares of this $1.5bn market cap company up 7%.  Thinksmart has recently launched its product into the UK. Market Cap £9m.

Markets and Exchanges   

Market: This is a time to maintain discipline. As the ten year treasury tops 3% and oil reaches $80 on the back of geopolitical tensions the market is in schizophrenic mood swinging between the benefits of budget surplus and increasing wage inflation against the rates and oil headwinds.  Any investment whims get found out out in this environment. Personally I am on the side of capital remaining cheap and wage inflation bailing us out.  The bear market from 2000-2004 was when a turning point for rates.  The 2004 rate increases were a buy signal

Last time I am reminded of 2000 which was soon after ICAP (or Inter Capital Group as it was then known) had recently demerged from DMGT. It came out in 1998 and the low rate environment had encouraged the proliferation of financial products enabling them to become market leaders in non traditional exchange products. Then they became an exchange. The share price increase from 37p in June 2000 to 716p in 2007.  These low rates are really helpful to build a franchise as an exchange of financial products.

Now: And we have highly rated companies that are effectively exchanges of a number of products today. We have fund exchanges (HL, AJ Bell), Mortgage exchanges (MAB1) and business exchanges (K3C) while is see Crowdcube funding an auto parts exchange as well as online property exchanges growing.

Conclusion: Exchanges have higher ROE than any other companies and a market leader  has high barriers to entry as well as an inbuilt growth engine resulting in lower customer acquisition costs. This virtuous circle is powerful. Meanwhile they are always protected by consolidation potential due to the influence of market leadership and the cash generative nature of the model.  As debt remains cheap we should get worried about the valuation of young market leading exchanges.

Hargreaves Lansdown – Trading Update  

• Share Price 1875p
• Mkt Cap £8.9bn

Update: £3.3bn net inflows over 4 months is 2.9%. Revenue over 9 months is £366.6m, 16% up. In the four month period revenue was up 15% year on year while AUM was up while average AUM was up 19% year on year. The company refers to strong trading volumes in the period but the revenue yield appears to be reducing.  I enjoyed the footnote which refers to excluding the £77m withdrawal of funds by a founder.

Estimates:  June 18 revenue estimate is £442m from AUM of £87.4bn. In H1 the company produced 49% of the full year revenue estimate from period end AUM of £86.1m. In the 9 month period the company has achieved 83% of full year revenue expectations. Forecasts look conservative.

Valuation: EV/AUM is 9.6%.  June 18 PER 37.4X falling to 33X.  Yield 2.1% rising to 2.4%. Forecast EBITDA margin is 71%

Conclusion: Breathtakingly expensive but this is a market leading cash generative exchange with high barriers to entry.  It is likely to stay expensive until the challengers arrive. Did someone say A J Bell is coming to market?

Jeremy Grime | jgrime@finncap.com