Following an earlier announcement that it was in talks, Shore Capital Group Ltd (LON:SGRS) has agreed to acquire Stockdale Securities. The combined company would have c 128 retained corporate clients, potentially ranking fourth in London on this measure. Both companies are profitable and the enlarged group will benefit from scale, increased client diversity and, we assume, some cost synergy. Given successful integration, the deployment of part of Shore’s available capital into an operating activity should benefit both returns and the valuation.
Acquisition of Stockdale
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. Shore Capital sees Stockdale as complementary to its existing corporate advisory, broking, research, sales and trading expertise. The initial acquisition cash consideration is £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.
Background and outlook
Near-term corporate activity levels have been affected by the Q418 weakness in markets and macro uncertainties, but brokers like Shore Capital have been focused on client service to build their long-term franchises. The acquisition should further this aim, adding the expertise of the Stockdale team, including a specialist investment funds capability, and broadening the corporate client list. In its outlook comments in January, Stockdale noted that its medium-term pipeline was better than for some time and raised the possibility that, with expectations low, 2019 could be a much better year than some expect.
Valuation: Still cautious
Shore Capital shares continue to trade below book value, which appears cautious in the context of the potential growth in Asset Management and now the prospective benefits from the Stockdale acquisition.
Business description
Shore Capital Group is an independent investment group with three main areas of business: Capital Markets, Asset Management and Principal Finance (on-balance sheet investments). It has offices in Guernsey, London, Liverpool, Edinburgh and Berlin, and has over 160 staff serving 75 retained corporate broking and advisory clients.
Stockdale metrics compared
We have collated 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 in this context (price to book 1.6x and price to earnings 7.5x). Revenue per corporate client of £214,000 was below our estimate for Shore Capital (and also 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 reflect a combination of market conditions and a natural variation in the incidence of corporate transactions within the client base. As noted earlier, the increase in the number of corporate clients through the acquisition should provide Shore Capital with greater diversity and potentially greater consistency in transaction revenues.
The recent history of Stockdale revenue, profit, and per client and per head revenues are shown in Exhibits 2 and 3. 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.
Our estimates for Shore Capital for FY18 are unchanged and we have not introduced a forecast for FY19 at this stage (FY18 results are due to be announced in March), so we have not formally modelled the potential impact of Stockdale on Shore Capital numbers. Near-term trading has been more challenging for Stockdale, as for other brokers; however, looking through this market fluctuation and assuming a reversion to more normal levels of corporate activity there would appear to be a high probability that the acquisition will have an enhancing impact on earnings and return on equity.
Other points on the transaction
The acquisition is subject to FCA approval, the timing of which is not fixed but we assume completion is likely before the end of Shore Capital’s first half.
The majority shareholder in Stockdale, with 55% of the company, is financial services investor Somers Ltd. Employees own the remaining 45%.
The Somers annual report for the period to September 2018 included a value of £4.1m for the investment in Stockdale and grossing this up gives a value for Stockdale as a whole of £7.5m.
The acquisition would take Shore Capital’s retained corporate client list to c 128 companies (potentially fourth largest in London behind JP Morgan, Numis and Peel Hunt).
Valuation
Our updated peer valuation is shown in Exhibit 4; the usual caveats over significant differences between the companies as well as the potentially volatile and lumpy nature of earnings apply. The historical Shore Capital P/E ratio is above the average, but this is based on reported earnings and current market conditions are likely to put capital markets earnings under pressure. In these circumstances, Shore Capital is likely to benefit relative to peers from the earnings contribution from its asset management activity. The price to book ratio at 0.9x is below the peer average (1.5x).
With the shares trading below book value (0.9x), the market price at time of writing of 230p implies a cautious assumption for return on equity of 7.3% within a ROE/COE model (other assumptions include a cost of equity of 8%, growth of 3% and a book value of 270.5p). While the implied return is above the H118 level (5.5% annualised) on a longer view this appears cautious and successful completion and execution of the integration of Stockdale would accelerate the move towards a higher sustainable return supporting the valuation.
