Shore Capital Group — Counter-cyclical investment strengthens the group

As at the half-year stage, SGR’s FY18 results demonstrated the benefit of the diversity of the group’s activities with overall group revenues ahead of the prior year despite the difficult background for the Capital Markets activities. Before looking more closely at the result compared with 2017, we show the average revenue analysis over the five years to 2018 (Exhibit 1) and the segmental evolution of revenues over the same period (Exhibit 2). The first chart makes clear that the Capital Markets business remains the dominant part of the group but Asset Management made a significant and growing contribution, as shown in the second chart; in 2018 Asset Management accounted for 36% of revenue. The other point to note is that while Principal Finance accounts for a relatively small part of revenues (and has recorded a pre-tax loss for the last three years), it has periodically made significant contributions to profits as is evident in 2015 when the £9m revenue contribution related to the profit on sale of German radio spectrum licences owned by an investee company.

Our next table sets out the half- and full-year revenue progression for revenue, pre-tax profit and earnings per share for 2017 and 2018.

Key features of the results included the following points with comparisons between FY18 and FY17 unless stated.

Capital Markets

Here the most important development has been the acquisition of Stockdale Securities, which was announced in February 2019 and completed at the end of March; we discuss this further in the outlook section. Within Capital Markets the company reported that income from corporate mandates and transactions increased in 2018, demonstrating the development of the franchise that has taken place reflecting investment in the business over a number of years.

During the year Shore Capital advised on five admissions (two IPOs and three reverse takeovers), undertook 18 secondary fundraisings and advised on three public takeovers. Exhibit 4 shows a selection of the transactions together with Shore Capital’s role and the funds raised or value as appropriate. These illustrate diversity within its client base, a feature that should be enhanced following the acquisition of Stockdale Securities.

The retained client base has increased with nine new clients added including Marks & Spencer and Sirius Minerals (respectively FTSE 100 and FTSE 250 constituents). The retained corporate client count stands at 75.

On the research and sales side of the division, the group acknowledged the disruptive effect on the industry of MiFID II implementation, but highlighted extensive engagement with investors and has been focusing on extending its coverage, particularly in industrials and providing cross-sector commentary on the impact of digital technology.

The equity market downturn in the final quarter had an adverse impact on the market-making activity, as would be expected, but it remained profitable in this period and for the year as a whole is reported to have achieved a solid, profitable result, albeit on lower revenues.

Asset Management

As highlighted above, the divisional AUM increased by 6.4% to £920m; since 2014 AUM has grown at a compound rate of 7.8%. Divisional activities fall into two areas: Puma Investments, the UK fund management activity and Institutional Asset Management, which primarily comprises the management of Brandenburg Realty and Puma Brandenburg real estate investment companies, both with asset portfolios in Germany.

Puma Investments’ mainly tax-efficient products are managed by teams with expertise in private equity, property finance and listed equities. In the private equity area, Venture Capital Trust (VCT) funds raised have totalled more than £240m with over £140m returned to investors in the form of dividends. The most recent offering was closed early due to strong demand. Enterprise Investment Scheme (EIS) funds under management have reached over £75m in March this year versus c £65m at the same time last year.

The Puma Property Finance activity provides first charge loans of £3m to £30m through three main offerings: pre-development bridging, development finance and development exit loans. By sector, loans are made across residential, commercial and more specialist areas. Individual investors can access the team’s expertise through Puma Heritage, an investment in which is intended to qualify for business property relief from inheritance tax. The NAV of Puma Heritage has grown from over £50m last year to over £75m in March through trading profits and additional subscriptions.

In November 2018 Puma Investments reached a funding agreement with RoundShield Partners for £200m for deployment by Puma Property Finance, effectively endorsing the management credentials of this team and providing an opportunity to meet the demand from borrowers that the business is experiencing. RoundShield has the right to acquire an equity stake of up to 25% in the property finance business as the funding line is deployed, providing it with an interest in the broader development of the activity. Puma Property Finance will earn management and transaction fees on loans executed over a four-year period. As the agreement came towards the end of the year, the impact will only be felt from 2019 onwards.

The listed equities area, which is responsible for the AIM IHT Service, continued to attract assets that stood at £24m at the year end. The team has been enlarged, enabling the business to plan for availability of the service on a wider range of platforms in 2019, broadening the scope for asset gathering.

The group has substantial experience in providing finance for social care property and as a result has built a network of contacts in this area and the ability to offer a service sourcing, structuring and negotiating transactions. This generates fee income without any associated AUM, helping to boost the overall divisional revenue yield on average AUM (for 2018 this was 1.75% compared with 1.56% for 2017). In addition to this advisory role Shore Capital invested £0.8m during 2018 to take a 75% stake in a business (EA Capital) that invests in social care property.

Institutional Asset Management has continued its active management of assets for Puma Brandenburg and Brandenburg Realty. As an illustration, for Brandenburg Realty this included taking possession of new assets, submitting applications for condominium titles for them and planning renovations; a debt financing was also arranged. The team also oversaw the participation of both investment companies in Mixer Global, a Tel Aviv-based provider of co-working spaces that is expanding globally.

Principal Finance

Here the main development took place post year end with an announcement relating to its radio spectrum investment in Germany. A 59.94% interest is held in 32 regional licences via DBD. It has now been concluded that the licences will be reallocated to an adjacent frequency at no cost and will continue be for a perpetual duration. The licences will be more flexible, enabling use of the spectrum for services such as 4G and 5G. There is no indication on the timing of further developments but management is confident on the future of DBD and the potential to generate value from the investment. The investment is held at a gross value of £2.3m, before minority interests.

Starting with the equity market background the next two charts illustrate the weakness seen in Q418 with raised volatility.

Subsequently volatility has subsided and indices have regained some of the ground lost in 2018 (Exhibit 7). The AIM index experienced greater weakness and is further from its five-year high point than FTSE All-Share and FTSE Small Cap indices.

Our next two charts (Exhibits 8 and 9) show the monthly trend in new and follow-on issuance on the Main and AIM markets to February this year.

While the monthly pattern is bumpy, the second half of 2018 was relatively subdued and January was particularly quiet for both markets, even in the context of prior January levels. Although equity indices have seen a recovery since Q418, as shown above, sentiment remains uncertain with the difficulties surrounding Brexit an important contributor. Resolution of these issues at some point should provide corporates with greater confidence to take decisions currently on hold and could therefore prompt a surge in activity. Even ahead of this, we note that Numis, in its H119 update, indicated that its pipeline has strengthened in recent weeks and that it had seen a notable increase in M&A opportunities.

Leaving aside the uncertain equity market background, SGR notes the recent developments within each of its business areas and underlines its optimistic view for the business with its diversified range of activities.

Acquisition of Stockdale

As noted earlier, the integration of Stockdale Securities will be an important feature of the current year and it is set to strengthen the group’s franchise, potentially enlarging its corporate client base to c 128 and further broadening its client diversity. The earnings and book multiples to be paid appear undemanding. A summary of the terms and characteristics of the business, drawn from our February note on the transaction, is given below.

Stockdale Securities (previously Westhouse Securities) is an investment banking and institutional stockbroking firm with 41 employees, 53 small and medium-sized corporate clients and dealing relationships with 200 institutional clients. It restructured in 2015 to focus its efforts primarily on winning and carrying out transactions for good-quality corporate clients. SGR sees Stockdale as complementary to its existing corporate advisory, broking, research, sales and trading expertise. The initial acquisition cash consideration was £4.9m with a maximum deferred cash consideration of £4.0m subject to reaching various revenue targets at the end of an 18-month period following completion. The price to book and earnings multiples to be paid, based on reported FY18 numbers, would be 0.9x and 4.1x, respectively, using the initial consideration only, or 1.6x and 7.5x on the maximum potential payment.

The recent history of Stockdale revenue, profit, and per client and per head revenues are shown in Exhibits 10 and 11. Profitability has clearly improved since the restructuring in 2015, with revenues per client and per head also ahead, although the figures for 2018 were below the 2017 level.

Next, we include an updated version of a table that collates a number of metrics including revenue, the number of retained corporate clients and revenue per client and per staff member for Shore Capital, Stockdale and, for reference, Arden, Cenkos and Numis. This shows the different scale and financial profile of the businesses. Stockdale is closest in terms of size to Arden but the latter company recorded a loss in FY18 (albeit this was partly caused by restructuring and a second-half profit was achieved on an underlying basis). Stockdale’s return on equity was over 20% and the valuation measures, even on the maximum potential consideration, do not appear demanding (price to book 1.6x and price to earnings 7.5x). Revenue per corporate client of £214,000 was below the figure for Shore Capital (and below figures for Cenkos and Numis). Stockdale highlighted that while it completed 45 transactions during FY18, none of them generated a fee of over £1m, in contrast to FY17. This is likely to have reflected a combination of market conditions and a natural variation in the incidence of corporate transactions within the client base.

We intend to publish 2019 estimates in due course pending further detail once the integration of Stockdale has made further progress.

As noted earlier, the balance sheet remains strong with end December gross cash of £31m and net cash of £26.7m. In addition there was £2.8m invested in gilts and bonds and £6.8m held in funds advised by the group.

One point to note on costs for 2019 is that the group is to move to a new head office (expected to take place in June) and has entered into a lease for the property in St James’s that will provide space to accommodate staff from Stockdale and allow for future expansion. The group expects the move to give rise to one-off costs of £0.5m.

An updated peer valuation is shown in Exhibit 13. Given the lack of 2019 estimates for most of this group we have omitted a prospective earnings multiple. The historical SGR P/E ratio is above peers but prospectively the diversifying character of asset management earnings and benefits from the Stockdale acquisition may be supportive for Shore Capital relative to others. The price to book ratio for Shore Capital at 0.8x is below the peer average (1.3x).

On this price to book, the market price at time of writing of 224p implies a cautious assumption for return on equity of 7.2% within a ROE/COE model (other assumptions include a cost of equity of 8%, growth of 3% and a book value of 269.4p). The implied return is above the 2018 level (4.7%) but, on a longer view, successful integration of Stockdale would accelerate the move towards a higher sustainable return supporting the valuation.