Simplybiz (SBIZ) – Modest growth, massive returns

Simplybiz (SBIZ) – Modest growth, massive returns

Simplybiz (SBIZ) is listed in the business support services sector and on face value is not exciting. The group provides services to financial intermediaries such as Independent Financial Advisors (IFAs). However, this enables Simplybiz to act as a highly profitable marketing platform for financial product providers.

Simplybiz (latest share price 155p, market cap £118 million) was founded in 2002 and listed on the AIM market in April 2018 at 170p. With the shares trading below the listing price, it is a good time to take a closer look.

A notable investor in Simplybiz is the quality-focused Liontrust UK Smaller Companies Fund (link). The fund has performed well (link) and is run by the respected fund managers Anthony Cross and Julian Fosh.

Simplybiz is number 1

(Source: Simplybiz.)

Management and share ownership

While AIM IPOs are tricky it is reassuring that founder and non-exec chairman Ken Davy (76) owns 40% of the group. Joint CEOs Matthew Timmins and Neil Stevens each own over 2%, having bought additional shares after the IPO.

Mr Timmins (39) has been with Simplybiz since inception while Mr Stevens (40) joined in 2003. Mr Stevens is responsible for strategy while Mr Timmins is responsible for sales and marketing.

Simplybiz’s Joint CEOs: leading the group since 2010

(Source: Simplybiz.)

Valuation backdrop

Simplybiz trades on a modest 12X forecast P/E for 2019 and 10.3X in 2020. Subscription (membership) income gives Simplybiz a high degree of recurring revenue and makes the business cash generative.

In my view, the current valuation is low given the quality of the underlying business and the growth prospects.  The current share price (155p) appears to offer the best risk/reward ratio of all the stocks I have covered to date at Cube.

Simplybiz is expected to deliver profitable growth

(Source: SharePad.)

Forecast P/E ratio: a low multiple going forward

(Source: Google Finance.)

What does Simplybiz do?

Simplybiz has two divisions: Intermediary Services and Distribution Channels. Intermediary Services supports financial intermediaries and in particular UK-based Independent Financial advisors (IFAs) with their compliance, marketing, technology and other needs.

Intermediary Services is the market leader with around 30% market share of directly authorised UK IFAs. This division has an impressive Net Promoter Score of 59 in this area (NPS ranges from -100 to +100).

Distribution Channels uses the group’s intermediary relationships to help financial services groups distribute their products (events, brochures etc). Simplybiz therefore offers a targeted marketing platform for financial services companies.

Simplybiz: “enabling retail financial services”

(Source: Simplybiz.)

Market backdrop

It is estimated that 80% of retail investment products in the UK were sold through intermediaries in 2016. In the mortgage market the figure is estimated at over 70%. So much for disintermediation in financial services!

Independent Financial Advisors (IFAs) in the UK can either be directly authorised or act as appointed representatives. The appointed representative route is deemed to be “more expensive and inflexible”, according to the Simplybiz prospectus.

The number of directly authorised IFA firms grew by 2.9% a year from 2012 to 2017 and is expected to grow at this pace from 2018 to 2021. Simplybiz only deals with directly authorised IFAs and is therefore well placed.

(Source: Simplybiz)

Simplybiz’s two divisions

Nearly all membership revenue generated by the Intermediary Services division is recurring in nature. Financial intermediaries need a regulatory compliance function, for example, if they are to operate legally.

Revenue generated by the Distribution Channels division may be more volatile given that it depends on spending by financial services firms. When markets are weak they are likely to be less willing to spend heavily on marketing

Simplybiz generated half of 2017 revenue from the Distribution Channels division and half from the Intermediary Services division. However, the Distribution Channels division generated 64% of adjusted EBITDA profit in 2017.

EBITDA profit breakdown: driven by Distribution Channels

(Source: Simplybiz)

Simplybiz: growth backdrop

Simplybiz saw organic revenue increase at an annualized pace of 7% in the two years to the end of 2017. In the first half of 2018, organic revenue increased by 5.1% on a year ago.

The group didn’t make any acquisitions in 2017 or 2016 but did buy Landmark Surveyors for £3.8 million in January 2018.

Growth drivers include the increasing number of UK directly authorised IFAs and market share gains. The group’s Verbatim asset management business allows third parties to manage funds for IFAs and is seeing rapid growth.

Simplybiz revenue growth

(Source: Simplybiz)

Simplybiz: return backdrop

The lease-adjusted ROCE excluding goodwill for Simplybiz came in at a robust 27% in 1017. However, the group’s leases are short-term in nature and if we factor this in the ROCE increases to around 77%.

Cash conversion has been strong with free cash flow per share exceeding earnings per share in two of the last three years. Free cash flow conversion is a good test of whether shareholders are being rewarded in cash.

Simplybiz generates strong free cash flow

(Source: Simplybiz)

Risks

Whether IFAs have a long-term future given the rise of robo-advisers and investment platforms is up for debate. There has been some evidence that IFAs help individuals to avoid emotional biases when it comes to investing.

In my view, some of us will prefer to deal with people rather than robots given the volatile nature of markets. IFAs don’t just help on the investment side; they also help in areas such as tax planning.

A severe downturn will hit the marketing budgets of financial services groups along with the number of UK IFAs. Simplybiz should be resilient given the group’s net cash position and 21% operating profit margin.

Simpybiz share price since listing at 170p

(Source: Google Finance)

Summary

Simplybiz is not a rapid growth business but does generate a high return on capital and has robust cash generation. Modest growth and high returns tends to deliver better result for investors than rapid growth and low returns (link).

It is set to payout a third of earnings in the form of dividends and this should result in a 2.8% dividend yield in 2019. Net cash is expected to be 15% of the current market cap by the end of 2020, in the absence of acquisitions.

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  • comment-avatar

    Compliance Director buys £48k of shares. Adds to the previous director buys. Fairly rare for directors to buy shares so this is reassuring for me.

    • comment-avatar

      Hi Andrew, it does indeed look like a quality business. With it being a recent IPO I’m inclined to be a little more cautious. Which leads me to a couple of observations that I would welcome your thoughts on 1) the level of accruals appear high, although not crazy high. Is it something to worry about? 2) over £2m of software development cost has been capitalised in the 2015-17 accounts, but notability the software was not in use at the time of the admission document. Once in use the amortisation will hit profits but perhaps the bigger concern is the time/cost of getting the project completed, its ultimate valuation and it’s amortisation period. Any thoughts would be gratefully received

      1+
  • comment-avatar

    Thanks DMac some great points there. I can offer the following thoughts:

    1) Recent IPO – Yes these can be a bit hairy. If you go to the London Stock Exchange website you can see the IPOs that have listed in recent years. I haven’t done the numbers but my impression that only about 1 in 20 has done well. However, this figure increases massively if you exclude certain sectors. I know some people are of the view to never buy IPOs. However, I don’t think it is rocket science to pick IPOs. You want companies in good sectors, with good track records, with management share ownership etc. Just a few factors like this can massively increase your odds. A good example is AJ Bell. A number of people said to avoid it because it was an IPO. However, in my view the company is very high quality and so I covered it in detail for Cube. It is fair to say, though, that IPOs contain more than their fair share of nasty surprises. It is also fair to say that there is no need for investors to buy IPOs. There are plenty of other fish in the sea! I understand that the research shows that IPOs underperform in the medium-term in aggregate. They have an initial share price pop but generally don’t do well. So I agree that it pays to be cautious on IPOs.

    LSE webpage and link to IPOs:

    https://www.londonstockexchange.com/statistics/new-issues-further-issues/new-issues-further-issues.htm

    2) Accruals – By accruals I assume you mean trade debtors or receivables. I have to admit I get confused on the accounting terms as there are so many words that meant the same thing! But essentially amounts owned are what we have to worry about. Are customer paying more promptly. I worked out that receivable days have been in decline. In 2015 the figure was 89 but it fell to 78 in 2016 and then 62 in 2017. I have to admit I haven’t looked at the interim results. However, it may be impacted by seasonality. The broader question underlying payment terms is whether customers will pay and if there is credit risk. This is a good question as I am I think the IFA business is somewhat cyclical. But the bottom line is that the companies have to pay Simplybiz if they want to be in business. So the only way they won’t pay is if they go under. The financial strength of the average IFA is hard for me to judge but certainly the number of DA IFAs is increasing. This suggests that the sector should be doing well. Speaking to one IFA and it is a fairly tough business to get started in. However, after you have been going for say 5 years it can be very good. This is because clients are very much driven by personal relationships i.e. who they trust. But the IFA I spoke to did say that things get more difficult in a downturn i.e. getting new business while fees are related to assets under administration.

    If you want a closer look I did a longer report on Simplybiz shortly after the IPO that covers payment terms (see page 7):

    https://www.dropbox.com/s/y0uojdd0i4b2n3h/Simplybiz30April2018.pdf?dl=0

    3) Software development cost, capitalisation and ammortization.

    Thanks for pointing this out. I have to admit I haven’t looked at it in depth. Given that Simplybiz isn’t a software business it isn’t something I focused on which may have been a mistake. But I would assume that it won’t be overly material. For example, Simplybiz is forecast to make £10m pre-tax profit this year. If we ammortize the £2m development cost over say 10 years that is an extra £200k cost per year. So only a 2% impact on profit. A 5-year period would result in a 4% impact on profit. So for me it isn’t something to be overly worried about.

    Just by way of general backdrop and obviously the capitalization of development costs is something that can be prone to manipulation. But I don’t think it is material for Simplybiz. Companies are encouraged to capitalize as I understand under the accounting rules under the accounting principle of “matching.” But this is only if they believe there is reasonable certainly that the asset created will result in revenue.

    So let us assume a £200k ammortization extra cost a year there should also be extra revenue when the software is deployed. Otherwise there would have been no point doing it. The software can either relate to a new service to be sold to the customer base or replacing a third party service. My understanding is that it may be the latter.

    The bottom line, though, is that unless Simplybiz has wasted money on developing new software the extra revenue from it should be higher than the ammortization cost. They shouldn’t be developing new software if they didn’t think they could get any revenue from it. Otherwise they would be forced to write off the intangible asset. But I agree it is a risk as lots of software projects go wrong. Simplybiz also isn’t a software company and so could make an error here. If the £2m spent on software development was written off it would be a pain but hardly make or break for the company IMO. It would hit investor sentiment though and the credibility of management. So you are right to highlight this risk. The ammortization charge only kicks on when the software is staring to generate revenue.

    Other points –

    It is always the case that you learn new things about a company over time. Some things that I am concerned about on Simplybiz include:

    1) The high lease costs in the business. I may be missing something but these appear very high. I haven’t looked in depth but I couldn’t quite understand why property rental costs were so high. The fixed cover charge isn’t that high at almost 1.8X. The high lease costs are the reason why the lease adjusted ROCE is about 20% versus a much higher ROCE if we factor in the short-term nature of the leases. See my dropbox longer report.

    2) Recurring revenue. Looking at the Admission document for Simplybiz and it states as I recall that over 90% of group revenue is recurring in nature. I can’t see how this can apply to the distribution side of the business which is a marketing platform. So that looked quite odd to me. I’ll have to look closer at it.

    Overall – My overall impression, though, is that Simplybiz is a high quality business. I could be missing something but on face value it looks good to me. The broader point is that on any particular company you can be wrong. I could be wrong on Simplybiz. But a portfolio of companies that have attractive attributes should do well. I hope the above comments are useful.

    In case of interest some other people have also covered Simplybiz:

    https://www.sharesmagazine.co.uk/article/simplybiz-looks-fascinating-on-paper-but-is-it-a-good-investment-at-the-current-price

    https://pdfs.investorschronicle.co.uk/IC_Alpha_SimplyBiz.pdf

  • comment-avatar

    Dmac – forgot to say that one thing that reassures me on Simplybiz is the cash conversion and net cash position on the balance sheet. If they do nothing cash is expected to hit 14.3% of the current market value by the end of 2020. Of course this excludes the impact of dividends paid. In other words the share price will fall after the shares go ex-dividend. So factoring this in the cash balance could be over 17% of the current market cap by the end of 2020. Cash is king and Simplybiz appear to be generating a lot of it.

    If all goes to plan then shareholders should get a reasonable return over the next few years. Of course things rarely go to plan. An added upside is the potential for acquisitions. The group didn’t do any acquisitions in 2015 or 2016. There was a small acquisition in Q1 2017. I would expect further deals and they should be earnings enhancing. This is because they can be financed with cash and low cost debt. Whether Simplybiz gets good acquisition takeover valuations is another matter.

    If you have time for further research I would try to talk to IFAs about the market, their prospects etc. There should be lots of IFAs where you live. I spoke to IFAs to research the market and found it very useful to do so.

    Thanks, Andrew

  • comment-avatar

    DMac- Just thinking about it and I probably misinterpreted your point on accruals. I guess you are saying that the absolute customer payment time is long at 62 days in 2017. This is not something I have looked closely at. Do comparable companies have shorter payment times for customers? If you have any evidence here I’d be interested to see it. For me I am not overly concerned as there should be a high probability of customer payment. Given that Simplybiz provides regulated functions for IFAs they need to keep paying Simpybiz if they want to stay in business.

    A good test in my view is whether you can build a bearish case for a company. It seems pretty hard to do for Simpybiz unless I am missing something. I think a potential decline in IFAs and disruption in the IFA market is a risk i.e. if we all start using robo-advisors. But I think only 1 in 10 people use an IFA in any event. There have been some good recent features in the FT and the Investors Chronicle on the role of IFAs and if they add value. Perhaps worth reading with regards to Simplybiz.

    Thanks, Andrew

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