Friday Notes from Mello 2018

This is the Friday follow-up to my notes here from the day before. Despite a rip-roaring awards ceremony, and poker being played until the early morning, most people managed to make it on time to the opening sessions. Private investors are nothing if not concerned with getting their money's worth. Still I managed to see another decent batch of companies on the second day and, again, all deserve consideration.

New River Retail

I've been invested in New River Retail for a number of years now and wrote a fairly lengthy article on the company three years ago. At the time I said that this was a share for the patient and how right I was: the share price has gone nowhere since then but we have been rewarded with a 6-7% yield for waiting. Of course the macro-economic environment has been far from kind with Brexit uncertainty, and numerous high-street retailers going to the wall as on-line stores steal their lunch, but good managers play the hand that they're dealt. Fortunately I believe that Allan Lockhart, CEO, is a good manager based on his long and successful history in property and capital markets. This is why New River Retail specialise in retail and leisure, particularly in the discount and convenience sub-sectors, and have almost no exposure to department stores or mid-market fashion retailers. They want clients who are trading well, and should continue to do so, and actively manage the 2000 occupiers in their portfolio to ensure that their trading success is put front and centre. Another differentiating factor for New River Retail is that they mainly operate community shopping centres, where the average travel time for customers is 30 min or less, rather then high-end, capex intensive destination centres which charge high rents to mid-market retail clients. It's all about reducing risk and keeping occupancy levels high.

Since listing in 2009 this REIT has grown to a portfolio size of £1.3bn, with an average yield of 8.5%, and much of this growth has been fuelled by equity raises (i.e. £500m in the last 3 years). However the business is now large enough to access the debt markets and £730m has been raised here in just the last 6 months. The big benefits of this unsecured bond funding (which was 2x over-subscribed even when they raised the amount being looked for and decreased the coupon) are that the cost of debt has fallen substantially to 3.1% while the average debt maturity is around 8 years. The gap between this cost and the 8.5% yield of the portfolio provides great arbitrage for New River Retail and significantly improves its profitability at lower risk. These funds are being put into acquisitions and development of retail parks, alongside investment into the local pub part of the portfolio, with Allan confident that the high-yield (currently >7%) will be properly covered when all funds are deployed. This is all positive and I learnt, while talking to Allan, that there isn't a lot of rent reduction pressure from tenants; instead New River Retail aim to offset pressure on their clients by being more efficient and negotiating reduced rate and service charges on their behalf. This focus on satisfying their tenants is probably why their retention rate is 90% and the occupancy rate has never been below 94%. I still see this as a quality business but make no mistake that patience is required if holding the shares!


It's hard to believe but I've seen David Hornsby from Ideagen present both in 2016 and 2017 and still haven't bought any shares in the company. Quite possibly an oversight as the company has doubled in value over that time as it steadily increases the level of recurring revenues generated from its SaaS platform (63% now and heading towards a maximum of ~75%). Knowing and focusing on these key numbers is a real characteristic of the business and David has always been keen to indicate the targets that they have in mind. For example organic growth is controlled at around 10% and it's important that the EBITDA margin is ~30% so that these numbers sum up to ~40%; but if the opportunity for additional growth arose at a lower margin then this would be acceptable so long as they offset each other equally. In other words the company isn't going to chase business where it can't make enough of a return. At the same time David is looking for 20-25% EPS growth, while maintaining 90% cash conversion, which means that acquisitions will continue (there have been 11 in the last 9 years). Now I'm fundamentally wary of companies which rely on buying other businesses to drive growth but I can see how it can work in a fragmented market with management who are absolutely focused on integrating new purchases efficiently (rather than buying them as an ego trip).

The second part of the presentation covered this more fully than I've seen before with a tour through their sales process and absolute belief in the power of well-set KPIs. The point is that with 30-35% employees in R&D, and 30% in sales, then consistent execution relies on them creating the right culture with training and KPI communication. These KPIs, which measure 100s of metrics around sales performance (like sales goodness - how well you communicate with the client and what they think of you), are designed to communicate clear sales expectations and take uncertainty out of the process. So rather then create an artificial quarterly target, which distorts motivations, people are assessed on how they perform and manage their sales in pursuit of the longer term goal, e.g. targeting activity around a sale to see if the sale is likely to close in the right time-frame or whether remedial action is required. With 3500 companies on the books (250 hospitals, 300+ aviation companies, 7/10 of the top UK accounting firms, 7/7 of global aerospace/defence giants and 15/20 of the top pharmaceutical companies) I can see why David is so focused on the sales pipeline. Otherwise how are they going to grow internationally and double revenues in the next 3 years, with US/global acquisitions, without coming a cropper? I certainly left with the feeling that they've got a pretty good chance of doing just as well in the next decade as they've done in the last one.

HarbourVest Global Private Equity

I'd seen Richard Hickman from HarbourVest present once before, back in 2015, and was impressed with the fund's performance and focus at the time. I didn't see that it had a place in my mid-cap portfolio though and so missed out on a 50% rise in share price. Nothing has really changed, in terms of approach, over this time as the fund still invests in the Private Equity universe in the understanding that PE persistently outperforms by 3-5% over the long term. This is partly because public companies provide a small pool of investment as there are 40x more private companies (4,000 vs 160,000) and so PE investors have vastly more choice about where to place their funds. It is also easier to invest in global trends via PE as many of the venture-capital backed companies in these hot areas are privately held and can remain so for a long time. So HarbourVest is a Fund of Funds manager that invests in the best PE managers and HVPE is the listed, closed-end investment vehicle which provides access and liquidity to the underlying assets; an additional side-benefit of HVPE is that it provides more transparency than most PE vehicles and even more than HarbourVest does. So it's a decent way to gain access to a low volatility fund which has tripled its NAV over the last ten years despite launching into the teeth of the financial crisis.

From a practical perspective the fund trades at an 18% discount to NAV at the moment. This is less than the maximum discount of 33% seen in July 2016 but higher than the minimum of 9.6% hit in May 2017; more usefully it's broadly in line with the 3-year and 5-years averages of 19.7% and 20.7%. The fund would like to reduce the discount but it's difficult as they don't really generate a regular income with which to pay a dividend and they would have to sell investments, to raise capital, if they wanted to buy back shares. If a special distribution could be shown to be effective they might do that but similar listed vehicles have done this with little success. The most likely outcome is that the fund will be bought at some point (like Electra, SVG Capital and Aberdeen PE) and the hidden value unlocked through a liquidation of assets. This doesn't mean that the fund is up for sale though and any exit via this route is likely to be a medium to long-term proposition. Finally there were a few questions regarding fees and it's true that there are several layers. Underlying PE managers cost around ~2% of NAV, HarbourVest FoF charges 1% (but this is reducing to 0.25%, from now on, with performance fees of ~0.5% in some situations) and then there are the running costs of the investment company. All in all this costs around 4% in total which sounds high but is probably fair given the performance history and may not be so much higher than active managers if all underlying costs are taken into account. Sounds like a decent investment if you're looking for a relatively uncorrelated fund.

Simply Biz Group

A brand new company to just about everyone Simply Biz listed a few weeks ago although, to be fair, it's been in existence since 2002 and thus has a solid trading history. The USP is that the group is a disruptive innovator in financial services intermediation that provides services to both the demand-side (IFAs) and supply-side (institutions) of the marketplace. The Intermediary Services Division provides compliance and regulation services to over 3,400 individual financial intermediary Members, including IFAs, mortgage advisers, workplace consultants and consumer credit brokers. Each of these members pays a modest, but regular fee, and then purchase additional services or software as required. The Distribution Channels Division provides marketing and promotion, product panelling and co-manufacturing services to more than 135 financial institutions, including 43 asset managers, 26 life assurance and pension companies, 46 mortgage lenders, 13 general insurance providers and 7 credit lenders. These providers enter into annual contracts and this is a significant source of income. What's attractive about this set-up is that >90% of the revenue is recurring (from software, fees and additional services) with this earning an EBITDA margin of >20% and cash conversion comes in at ~90% (which means that a dividend is on the cards with this ~3x covered by profits).

Still a good question with any recent IPO is why now? As Neil Stevens, joint CEO, explained Ken Davy, founder and chairman, is taking the opportunity to reduce his holding from 56% to 40% and take some money off the table (he is 76 after all) while the group is raising £26.3m in order to pay off debt and allow for further acquisitions. The latter is part of the group's strategy with Staffcare Ltd being bought in 2013 to provide exposure to employee benefits while Home Information Group and Landmark Surveyors came on board to beef up their mortgage lending business. In this arena the board believe that regulatory change is a key driver for growth and this will lead them to acquire services that are complementary to existing customers. The approach makes sense as more members and services will give Simply Biz more clout in the marketplace and an ability to negotiate better deals - which will encourage more members to join. It's the tried and tested network approach and the group should be able to make excellent returns on the limited amount of capital that it needs to invest.

My only real concerns centre on the risks outlined in the admission document since this is where the company is legally obliged be rather honest. To my mind exposure to the housing market, through mortgage lending and surveying, will be an issue at some point in the future as is revenue from the Zest employee benefits platform since it's already known that the largest customer, by seat volume, is bringing all of its small schemes in house. Finally there are the usual issues with a newly listed family business in that family members, such as COO Sarah Turvey, still work in the business and there are the usual related party transactions which are part and parcel of any private business. Hopefully none of this will be a problem, and it's all in the admission document, but it's worth being aware of what you're buying into when the information is so current. Still Simply Biz looks like a simple business with a lot of operational leverage so it really could do well as it matures.

SRT Marine

My final company presentation was with Simon Tucker, CEO of SRT Marine. I last saw Simon present in October 2016 and the future looked bright despite this company being a poster-child for the risks of relying on lumpy contracts. The fact is that nothing has changed since then in the world of maritime surveillance and monitoring. It's still a big market of 26 million boats, 8 million of which are commercial and dealing in some way with the 95% of global trade that travels by sea. Customers such as coast guards, fisheries, ports and boat owners still want to precisely identify, track and analyse traffic which is what the Automatic Identification System (AIS) gives you. On this basis SRT Marine have developed, and sell, AIS transponders along with the GeoVS data view and monitoring. They also buy in satellite data and use other sensors (CCTV, Radar) which feed into the SRT solution; the end result being a system that combines a control centre, data centre, transceivers, coastal surveillance sensors and satellite monitoring to provide an end-to-end package for customers. Who wouldn't want to buy into this?

It turns out that plenty of customers do want the SRT Marine system which is why the validated sales pipeline contains 14 projects worth +£200m in advanced discussion but it takes time (3-4 years at least) to conclude these negotiations. The upside is that once you've installed an affordable system for a client then they can upgrade and grow their installation which means additional revenue without the initial pain. There's also the possibility of AIS taking off in the leisure market, leading to maybe 20% growth, and so it's not all about big and unpredictable installations. Still Simon has been burnt in the past from putting out positive statements that then came back to bite him; now revenue is only recognised at the end, with no partial completion in the accounts, which means that the analyst forecasts are right at the bottom end and are set so as to be beaten. I'm sure that the share price would react somewhat impressively should such an earnings beat occur but it could take a while.

Disclaimer: the author holds some, but not all, of the shares discussed here

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