Shore Capital Group — Update 9 May 2016

Shore Capital Group — Update 9 May 2016

Shore Capital Group

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Shore Capital Group

Modern day merchant bank

Initiation of coverage

Financial services

9 May 2016

Price

320p

Market cap

£70m

Net cash (£m) at 31 December 2015

12.5

Shares in issue

21.8m

Free float

43.5%

Code

SGR

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(4.5)

(24.3)

(22.4)

Rel (local)

(3.8)

(27.6)

(13.6)

52-week high/low

425p

320p

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 c 130 staff serving over 60 corporate broking clients.

Next events

Interim results expected

September 2016

AGM expected

December 2016

Analysts

Andrew Mitchell

+44 (0)20 3681 2500

Martyn King

+44 (0)20 3077 5745

Shore Capital Group is a research client of Edison Investment Research Limited

Shore Capital’s diversified mix of activities has proved itself through a number of market cycles. An entrepreneurial approach and the long tenure of key staff has helped deepen and broaden its client network and hence revenue potential. Like a successful merchant bank, opportunistic investments have periodically provided supernormal profits, while asset management provides a growing stream of recurring earnings. Balance-sheet strength dampens near-term returns on equity, but increases resilience and provides the means to seize further opportunities. Our central valuation of c 360p may prove conservative in the event of further investment realisations or a more buoyant market.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/13

35.8

5.4

13.9

8.0

23.0

2.5

12/14

40.6

8.3

20.8

10.0

15.4

3.1

12/15

42.0

11.7

26.1

0.0

12.3

N/A

12/16e

35.6

4.9

11.2

10.0

28.6

3.1

Note: 2015 figures include radio spectrum sale.

Diversified, opportunistic

Shore Capital has three divisions: Capital Markets (which includes research-led broking, corporate finance and market making), Asset Management (institutional and private client products) and Principal Finance (on-balance sheet investments). There are different drivers for each division and this provides a measure of diversification that is helpful in periods of market volatility. Since its formation in 1985, Shore Capital has had an entrepreneurial approach, which is evident in the range of on-balance sheet investments that have significantly enhanced NAV total returns for shareholders. Last year a partial realisation of an investment in German radio spectrum licences generated net revenue of £9.2m, making a significant contribution to earnings and prompting a £10m capital return.

Mixed near-term, promising longer-term prospects

The uncertain macroeconomic and political background may restrain short-term activity levels for the Capital Markets business but, on a longer view, the experience, capability and client relationships of the team should stand it in good stead. In Asset Management, given the focus on property and SME lending and the generally sticky nature of assets managed, the prospects are more stable with potential for good growth from products providing inheritance tax shelter. Principal Finance could provide significant additional value at some point through further realisations.

Valuation: Potential for positive surprises

At this stage we think the central output of our ROE/COE model of c 360p represents a reasonable valuation assumption, but note the potential for positive surprises arising from further radio spectrum licence disposals and from a more positive market background once some of the current uncertainties are resolved.

Company description: Three legs to the business

Shore Capital is an independent investment group with three main areas of business, each with its own drivers providing a measure of diversification and alternative opportunities for generating income: Capital Markets, Asset Management and Principal Finance. Over the last four years these activities have on average contributed respectively 67%, 21% and 12% to revenues (Exhibit 1). Pre-tax profits over the same period have mainly arisen from the Capital Markets activities, but the potential for Principal Finance to make a substantial contribution is evident in the latest results, for 2015, in this case reflecting profits from the sale of German radio frequency spectrum licences (Exhibit 2).

Exhibit 1: Revenue split – four-year average, 2012-15

Exhibit 2: Pre-tax profit – four-year average and 2015

Source: Shore Capital Group

Source: Shore Capital Group

Exhibit 1: Revenue split – four-year average, 2012-15

Source: Shore Capital Group

Exhibit 2: Pre-tax profit – four-year average and 2015

Source: Shore Capital Group

Background

Founded in 1985 by Howard Shore (then in his mid-20s), the company celebrated its 30th anniversary in 2015.

Taking the operating businesses only, management indicates that the company has been profitable since it listed in 2000.

Shore Capital has offices in Guernsey, London, Liverpool, Edinburgh and Berlin.

In 2015 the average number of employees was 134.

Howard Shore (41.07%) and his brother Graham Shore (9.01%) together own just over 50% of the company.

Most of the senior management have been with the company for a significant period (see Exhibit 3), providing continuity and strengthening links with its network of clients and contacts.

Senior executives have bought minority shareholdings in subsidiaries engaged in the stockbroking and corporate adviser activities (20.3%) and the private client investment management business (27.1%), providing incentive and alignment with external shareholders in the group. In the years prior to 2015 the minority share of post-tax profits fluctuated significantly but averaged 22% in the eight years to 2014. In 2015 the minority share rose to 28%, reflecting the profit realised on the sale of radio spectrum licences (see below).

Traded on AIM from 2000 and admitted to the Official List in 2001, the group rejoined AIM in 2009 at the time it acquired Puma Brandenburg, a residential and commercial property business investing in Germany. Subsequently, a restructuring fully demerged Puma Brandenburg (now unlisted) from a new holding company, which was listed on AIM in 2010, and this is the existing listed entity.

Affinity with entrepreneurs

Management notes that since the company’s formation it has had an affinity with entrepreneurial businesses and individuals, aiming to provide them with a professional and personalised service to meet their needs, which might include funding a business, corporate development advice or providing an asset management product/service.

The group’s own entrepreneurial approach is illustrated by its involvement with and investment in a range of businesses including technology, hotel and property companies. This has included the establishment and subsequent acquisition of Puma Brandenburg to allow it to realise the potential of its investments. The acquisition of Puma Brandenburg led to a one-off profit of £63.1m arising from the fair valuation of the assets acquired. This made a substantial contribution to a compound growth in the group’s net assets per share plus dividends of 28% between 1 January 2000 and 31 December 2015 (this calculation includes the end September 2015 NAV of the holding in Puma Brandenburg, demerged in 2010). In 2011 an investment was made in Spectrum Investments, a company formed to acquire an interest (59.9%) in radio spectrum licences across Germany. Some of these licences were sold in 2015, generating net revenue of £9.2m.

Management

Howard Shore (executive chairman), as founder, has overseen the development of the company and is responsible for the strategic direction of the business. Also on the board is Lynn Bruce, a chartered accountant with experience as CFO of wealth management and leasing companies; she chairs the audit committee and is company secretary. Details of board members, including the non-executive directors James Rosenwald III and Dr Zvi Marom, are given on page 13.

Other members of the senior management team are detailed in Exhibit 3, with a notable feature being the average time with the company of over 13 years.

Exhibit 3: Key senior management outside group board of directors

Executive

Role

Joined

Shore Capital

Background

Michael van Messel

Head of finance and tax (also responsible for operations at Shore Capital Group)

1993

Degree in physics, Fellow of Institute of Chartered Accountants

David Kaye

Chief executive of Asset Management

2006

Law degree and practised as barrister for five years

Simon Fine

Chief executive Shore Capital Markets

2002

Former MD and co-head of equity cash trading at Lehman Bros

Dr Clive Black

Head of research

2003

PhD on Northern Ireland food industry, then worked at the NFU and in industry before entering the City

Malachy McEntyre

Head of stockbroking sales

2004

Degree in business studies with roles as equity trader and portfolio manager before joining Shore Capital

Thomas Marlinghaus

Shore Capital Germany – chief operating officer

2006

Degree in business administration, time as MD of private equity business and CFO of ProMarkt prior to its sale to Kingfisher.

Eamonn Flanagan

Head of Liverpool office

2003

Degree in mathematics, Fellow of Institute of Actuaries, rated insurance and specialty finance analyst.

Dru Danford

Chief executive of Shore Capital and Corporate (head of corporate finance)

2004

Qualified chartered accountant (South Africa) before move into investment banking.

Source: Shore Capital Group, Edison Investment Research

Capital Markets

This business has three components: market making, research-led broking and corporate finance. Management guide that they have tended to contribute broadly equally to revenues over time, although in any particular period the lumpy nature of transactions may bias the mix significantly.

Within corporate finance the team offer a full range of services including capital raising, initial public offerings, investor relations, advisory and corporate broking. They act as advisers to a wide range of companies from small to larger cap, aiming to provide services through the life of a company including flotation, mergers, disposals and secondary transactions. Fixed income capability was last year expanded from retail bonds by the addition of corporate bond specialists from Edmond de Rothschild; this is intended to provide mid-cap companies with additional funding options. The combination of the corporate finance team’s collective expertise and the in-house research and market-making teams mean that Shore Capital is able to present itself as a one-stop shop. It regards this and its entrepreneurial approach as differentiating characteristics.

Shore Capital is appointed as broker/joint broker to over 64 companies and, within this number, as Nomad (nominated adviser for AIM-listed companies) to 25 companies. Selected transactions and appointments since the beginning of 2015 are presented in Exhibit 4, giving a flavour of the variety of mandates that have been won and the breadth of the Capital Markets network.

Exhibit 4: Corporate finance selected recent transactions and appointments

Company

Transaction/event

Value

Role

Date

Vernalis

Placing

£40m

Joint bookrunner

Apr-16

Stride Gaming

Appointment

Mkt cap £120m

As joint broker

Apr-16

Amryt Pharmaceuticals

AIM IPO and £10m placing

Mkt cap £40m

Lead manager, Nomad, joint broker

Apr-16

Yü Energy

Placing and AIM IPO

£10m

Nomad and sole broker

Mar-16

Cerillion

Placing and AIM IPO

£10m

Nomad and sole bookrunner

Mar-16

Earthport

Appointment

Mkt cap £125m

As joint broker

Feb-16

Dairy Crest

Appointment

Mkt cap £830m

As joint broker

Feb-16

Market Tech

Move to Main Market

Mkt cap £850m

Joint broker

Jan-16

Telford Homes

Placing

£50m

Nomad and joint bookrunner

Oct-15

Next Energy Solar Fund

Placing

£39m

Sponsor and joint bookrunner

Sep-15

FBD

Bond issue

€70m

Co-lead manager

Sep-15

Poundland

Placing

£50m

Co-lead manager

Sep-15

Barr Soft Drinks

Appointment

Mkt cap £674m

As joint broker

Aug-15

Wm Morrison Supermarkets

Appointment

Mkt cap £4.2bn

As joint broker

Jul-15

Market Tech

Placing

£200.7m

Joint global coordinator and joint bookrunner

Jul-15

Styles & Wood

Refinancing

£13m

Nomad and sole broker

Jun-15

Playtech

Secondary placing

£227m

Lead manager

Jun-15

AJ Bell

Private placing

£21m

Broker

Jun-15

Applegreen

Placing and AIM/ESM admission

£66.9m

Nomad and joint bookrunner

Jun-15

Real Good Food

Disposal of Napier Brown

£34m

Financial adviser

May-15

Inspired Energy

Secondary placing

£3.6m

Nomad and sole broker

Mar-15

Redx Parma

Placing and AIM admission

£15m

Nomad and sole broker

Mar-15

Market Tech

Convertible bond

£112.5m

Joint broker and bookrunner

Mar-15

Next Energy Solar Fund

Placing

£61.4m

Sponsor and joint bookrunner

Feb-15

Nova Biotics

Private placing

£5m

Financial adviser and broker

Feb-15

Avanta Serviced Office Group

Appointment

£44.4m

Rule 3 adviser

Jan-15

Source: Shore Capital Group

Within the research and sales activity, the sales team was ranked among the top 10 teams for small and mid-cap distribution in Extel surveys for 2014 and 2015 and brings an average of 25 years of experience in financial markets to the task. An average tenure at Shore Capital of over 10 years also provides continuity in relationships with institutional investors.

Research is carried out by 19 analysts, providing IPO, secondary and thematic coverage of over 200 companies. Sector coverage includes consumer, real estate and construction, financials, support services, technology, natural resources and healthcare. The team rank sixth among UK small and mid-cap brokers, with seven sectors ranking within the top five in the 2015 Extel survey.

In market making Shore Capital is the third largest market maker on the London Stock Exchange by volume of trades and number of securities (over 1,500 stocks are covered by the team of 10 market makers). The market making platform is connected to a range of trading platforms including dark pools and crossing networks and has an electronic distribution network including links to institutional and retail brokers and major institutions. Management indicates that on an annual basis the market making activity has been profitable since it commenced 20 years ago and the risk framework helps the team of 10 traders ensure that loss days are a rare occurrence.

Asset Management

The Asset Management business comprises two elements, private client and institutional investments, with total AUM of approximately £770m.

Shore Capital’s range of private client tax-efficient investment products are grouped under the Puma Investments brand and started with the provision of a limited life venture capital trust (VCT) in 2005. The company has raised £30m for its 12th VCT (Puma VCT 12) and the previous fund also raised £30m; they were the largest single company VCT fund-raisings for the 2015/16 and 2014/15 tax years respectively. In total £200m has been raised for Puma VCT funds and £85m returned to investors. The first five funds have been repaid and have each returned the highest total return of their respective peer-groups. The investment approach is to seek asset-backed businesses providing relatively low risk in the context of smaller companies. The Puma EIS product has a similar approach applied to Enterprise Investment Scheme (EIS) qualifying companies and has so far invested in five contracting/asset-backed companies with AUM of £35m.

Two products are intended to provide a shelter from inheritance tax through business property relief: Puma Heritage plc and the Puma AIM Inheritance Tax Service. In both cases holding periods of only two years are required to secure tax relief. The particular appeal of these structures is that the investor retains control of their assets, avoiding the uncertainty that can arise if they are transferred earlier or put in trust. Puma Heritage concentrates on secured lending to SMEs and property finance with the aim of preserving capital and earning stable returns to offset inflation, while the Puma AIM Inheritance Tax Service invests in qualifying AIM stocks, again with a focus on capital preservation. Management sees these products as having particularly strong growth potential, reflecting investor demand and an ageing demographic profile.

Funds managed or advised on the institutional side of the business include Puma Brandenburg, Brandenburg Realty and St Peter Port Capital. As noted earlier, Puma Brandenburg was established by Shore Capital and then acquired, supported with additional capital and demerged. It invests in a mixed portfolio of properties in Germany including 3,000 apartments in Berlin, 32 Lidl stores (following sale of 13 in the first half of 2015) and hotels and commercial units. The Brandenburg Realty fund completed fund-raising in June 2015 (€150m, predominantly from the US) and focuses mainly on the acquisition of high-quality residential buildings in major German cities, particularly Berlin. Shore Capital has made a commitment of €12.5m to the fund, has a 20% interest in the Investment Adviser and Carry Vehicle and will provide local advisory services. The group has a team of 20 in Berlin, including asset managers, architects, finance, legal, sales and lettings staff.

St Peter Port Capital is a pre-IPO fund with significant exposure to natural resources. At the September 2015 half year end, total and net assets were just under £30m and the company reported that, since inception in April 2007, £65.9m has been realised generating a gain of 49% on the cost of those investments. Given the difficult environment in this area and investors’ interest in securing a return of cash, the emphasis is now on realising liquidity or value from its remaining portfolio holdings (currently 25) where possible.

Principal Finance

Shore Capital invests its own capital on an opportunistic basis where it sees the potential for attractive returns. In the past investments have been made in property related companies, including Dawnay Shore Hotels and Puma Brandenburg, and a Black Economic Empowerment investment company in South Africa. Currently the main investment is in German radio spectrum licences via Spectrum Investments, as mentioned earlier. Following the sale of national and six regional licences in 2015 to Deutsche Telecom for €15.45m (and net revenue of €12.5m or £9.2m) there are 32 regional licences remaining. These give the right to use the 3.5 GHz range of frequencies (increasingly used for 4G services) in perpetuity. There can be no certainty regarding the potential value that can be realised from these licences, but the group highlights that the licences cover Germany’s largest metropolitan centres including Berlin, Leipzig, Dresden, Düsseldorf and Hanover. Discussions with the regulator are currently ongoing regarding the status of the licences and potential use of the frequencies. The investment was recorded on the year-end balance sheet as an intangible with a gross value, before minorities, of £1.8m.

Market background and outlook

In this section we describe the recent context in equity market issuance and trading volumes and and touch on the evolution of assets under management within the Asset Management division.

Equity market background – bumpy

Our first two charts (Exhibits 5 and 6) show the trend in new and follow-on issuance on the AIM market, where Shore Capital is a leading player as a Nomad and market maker. The run up ahead of the financial crisis is evident in Exhibit 5, followed by a dramatic slowdown in the volume of IPOs subsequently. The subsequent recovery has still left the level of new equity issuance at relatively muted levels, with 2015 marking a sharp retreat from the prior year, largely mitigated by an increase in further issues by existing AIM-quoted companies.

Exhibit 5: AIM new and further funds raised since 2002

Exhibit 6: AIM funds raised since 2011

Source: London Stock Exchange

Source: London Stock Exchange

Exhibit 5: AIM new and further funds raised since 2002

Source: London Stock Exchange

Exhibit 6: AIM funds raised since 2011

Source: London Stock Exchange

For the Main Market, the pattern has been broadly similar, although the peak of the financial crisis was marked by substantial further issuance by banks to help support balance sheets. More recently, as for AIM, new issues fell last year, but further issues meant total equity raised was similar to the prior year (Exhibit 7).

Turning to equity trading activity, this hit a peak as the financial crisis approached and then collapsed with market confidence, subsequently fluctuating in a lower band more recently (Exhibit 8). A softening market in the second half of 2015 appears to have held back trading activity levels, although they ended 2015 only 10% below the average since 2011.

Exhibit 7: LSE Main Market equity issuance since 2011

Exhibit 8: Average daily value traded LSE order book

Source: London Stock Exchange

Source: London Stock Exchange

Exhibit 7: LSE Main Market equity issuance since 2011

Source: London Stock Exchange

Exhibit 8: Average daily value traded LSE order book

Source: London Stock Exchange

Looking at equity returns as represented by the FTSE All-Share, FTSE AIM All-Share and FTSE Small Cap indices (Exhibit 9), the impact of uncertainty and weakening expectations during 2015 are evident in each case. The chart also underlines the outperformance of small caps over the period and the significant relative weakness of the AIM Index explained in part by weakness in commodity stocks within the index.

Exhibit 9: FTSE AIM, All-Share and Small Cap indices

Exhibit 10: FTSE All-Share and FTSE 100 Volatility Index

Source: Thomson Datastream. Note: Total return series.

Source: Thomson Datastream

Exhibit 9: FTSE AIM, All-Share and Small Cap indices

Source: Thomson Datastream. Note: Total return series.

Exhibit 10: FTSE All-Share and FTSE 100 Volatility Index

Source: Thomson Datastream

Looking ahead, while market volatility has pulled back from the spike early in the year (see Exhibit 10, FTSE 100 Volatility Index), the economic and political background remains uncertain. Concerns include tapering global growth expectations, the outcome of the UK’s EU referendum and evolution of central bank monetary policy. Given this, further episodes of heightened volatility would be unsurprising with an accompanying dampening of the market’s animal spirits and the deferral of new issue plans, for example. On the other hand, global growth is being sustained and with most market participants reporting a good pipeline of transactions, a period of stability could see a strong rally in equity issuance.

New products, performance drive asset management growth

The growth in Shore Capital’s private client AUM (Exhibit 11) has so far reflected growth in VCT assets, which in turn have been driven by strong demand (see recent industry issue in Exhibit 12) and the performance of the Puma VCTs. VCT demand looks set to remain robust, potentially helped by changing legislation on pensions. Changes in VCT rules narrowing the scope of possible investments is limiting sector capacity, creating a greater opportunity for the Puma offering, which so far has been less affected than perhaps some of its competitors. Prospectively, however, the bigger opportunity may be in the products providing an inheritance tax shelter, which are not size limited, are flexible and sold throughout the year (Puma Heritage, Puma AIM Inheritance Tax Service).

Exhibit 11: Shore Capital private client AUM

Exhibit 12: VCT issue by tax year

Source: Shore Capital Group

Source: The Association of Investment Companies

Exhibit 11: Shore Capital private client AUM

Source: Shore Capital Group

Exhibit 12: VCT issue by tax year

Source: The Association of Investment Companies

Institutional assets under management/advice are dominated by the two German property investment companies, where growth will reflect management of these portfolios and trends in the German markets (with an emphasis on Berlin residential). Puma Brandenburg’s NAV has increased threefold from its demerger in 2010 to end September 2015 and the Berlin residential market prospects (not the only factor) still appear favourable based on population growth and supply that continues to lag demand.

Results for 2015 – diversification pays off

The group reported revenues up 3.4% to £42.0m, pre-tax profit of £11.7m, an increase of 40.8%, and earnings per share of 27.1p (+25.5%). No interim or final dividends were declared for 2015 (interim and final payments were 5p each for 2014). Following the sale of German radio spectrum licences, the group also returned cash of £10m to shareholders in November through a tender offer for up to 9.91% of outstanding shares.

The divisional performance highlights the diversification benefit of the group’s different revenue streams. The Capital Markets division was held back by more difficult market conditions. While Shore Capital was the leading Nomad on AIM in terms of IPO proceeds in 2015 and total capital raised for clients was £900m, this compared with a particularly strong figure of £2,400m in 2014. Secondary commissions and market making also faced headwinds and divisional revenue fell by 22%. Pre-tax profits fell by 52% with operational gearing moderated by the profit-related element of costs and the margin was still just above 20% (32%). Selected mandates and appointments in the year were shown earlier in Exhibit 4, including Shore Capital’s first role as a broker to a FTSE 100 company, Wm Morrison Supermarkets. Asset Management recorded a 12% increase in revenue and a similar, 11%, increase in pre-tax profit. Assets under management were £770m at the year-end compared with £680m in 2014, helped by the successful fund-raising for Brandenburg Realty. The implied revenue yield on average assets was 1.3%, an increase from the prior year figure of 1.1%, helped by strong progress in the private client business where management fees on AUM are augmented by administration charges levied on companies to which loans are made. Principal Finance saw a swing into pre-tax profit on the back of the radio spectrum licence sale. As noted earlier, this generated net revenue of £9.2m and, net of a write down of £1.1m relating to the group’s investment in St Peter Port Capital and other costs, pre-tax profit was £5.1m compared with a loss of £1.6m in 2014.

The balance sheet remains strong with available liquidity (cash, gilts and corporate bonds) of £28.7m including cash of £22.1m. Net cash stood at nearly £12.5m and at the year end the group’s £20m working capital borrowing facility was unused.

Sensitivities

Shore Capital’s profitability has an obvious sensitivity to market confidence, which can have a positive or negative impact on commission, market making, new issuance and M&A related revenues. Asset management revenue may also be influenced at the margin by swings in investor confidence and hence AUM net flows, but the asset base is likely to be relatively sticky (tax-efficient wrappers and property funds), while specific product launches and product and fee margin mix are other potentially important variables. The group’s on-balance sheet investments may have a lumpy impact on profitability in an individual period as gains (or losses) are crystallised.

Thematically, prospective implementation of MiFID II (January 2018) and the existing downtrend in institutional commissions are likely to maintain pressure on this element of the group’s earnings (fortunately not a major determinant of revenue individually and mitigated by the strength of the Shore Capital offering). Key man risk is a consideration, particularly where a business relies on the entrepreneurial skills of key team members. Here the organisational structure with delegated responsibilities and diversification act to moderate the exposure. Regulatory change could affect a number of areas: within asset management, tax legislation could open or close opportunities for tax products and Shore Capital’s experience in structuring and identifying qualifying investments should stand it in good stead. Capital requirements could be increased for the business as a whole, although with capital resources over three times the requirement for 2015 this seems unlikely to be a constraint for the group.

Valuation

In this section we consider some peer valuations, a historical comparison of Shore Capital’s own price to book value over time and the sensitivity of the output of a ROE/COE model to assumptions.

Our peer valuation table, Exhibit 13, shows the small number of listed UK brokers. While we suggest it should be treated with considerable caution, given the differences between the companies, it does serve as a reminder of the relatively small number of listed, independent survivors in the market and the significant differences in their size, the returns they earn and the valuation multiples they command. Shore Capital is among the companies that were profitable in the last reported financial year and, while the ROE is some way short of those recorded by Cenkos or Numis, its decision to return capital did help strengthen the return while leaving a generous capital cushion in place.

Exhibit 13: Quoted UK broker comparison

Price (p)

Market cap (£m)

Hist P/E (x)

Price to book

Yield (%)

ROE (%)

Shore Capital

327.5

71.3

12.1

1.2

0.0

9.2

Arden

25.5

5.2

-2.4

0.7

0.0

-22.0

Cenkos

144.5

81.9

5.3

2.9

9.7

43.0

Numis

207.0

232.4

10.6

2.1

5.6

19.1

Panmure Gordon

58.0

9.0

-0.5

0.6

0.0

-67.6

WH Ireland

91.5

23.6

-32.6

1.7

2.2

-5.2

-1.2

1.5

2.9

-3.9

Source: Edison Investment Research. Note: Prices as at 5 May 2016.

Exhibit 14 shows how Shore Capital’s price to book ratio has varied over time. The current price to book ratio stands close to its average level over the last 10 years, not suggesting a strong immediate valuation message in either direction, although maintenance of an ROE at or above last year’s level could warrant a higher valuation as outlined next.

Exhibit 14: Evolution of the price to book ratio for Shore Capital

Source: Thomson Datastream , Edison Investment Research

We show the output from a simple ROE/COE model adjusted for different ROE and COE assumptions in Exhibit 15 (other assumptions include growth of 5% and a book value of 268.7p). As for any broking/investment banking business, the potential volatility of earnings makes it difficult to assign a sustainable ROE, but for our central assumption we take a return modestly above the central cost of equity of 8% (risk free rate 3.5%, equity risk premium 4.5% and beta 1.0). For comparison, Shore Capital was able to produce an average return of 6.3% between 2007 and 2015, a period that included the financial crisis and a small negative reported return in 2011. The balance sheet also carried excess capital providing resilience and the ability to invest when opportunities arose at the cost of suppressing the reported ROE over these years.

Exhibit 15: ROE/COE valuation output variations (value per share, p)

Cost of equity

7.0%

7.5%

8.0%

8.5%

10.0%

Return on equity

6%

134

107

90

77

54

8%

403

322

269

230

161

9%

537

430

358

307

215

11%

806

645

537

461

322

15%

1,344

1,075

896

768

537

Source: Edison Investment Research

Finally, we include a share price performance comparison to show how the market is attempting to discount broader and stock specific changes in the outlook for the UK-listed brokers. Shore Capital has fared somewhat better than the average over a year, but has been weaker than others more recently. This could reflect a combination of tempering of expectations for earnings reflecting general market background and/or more cautious assumptions about possible realisation prospects. From this point, the scope for positive surprises could therefore be more favourable even though the near-term market background remains challenging. At this stage we think the central output of our ROE/COE model of c 360p represents a reasonable valuation assumption until there are clearer signals on market direction.

Exhibit 16: Share price performance comparison (%)

One month

Three months

One year

Ytd

From 12m high

Shore Capital

-3.7

-22.5

-20.6

-22.9

-22.9

Arden

-12.1

-7.3

-45.2

-13.6

-45.2

Cenkos

13.3

-1.4

-24.9

-13.7

-25.3

Numis

-2.4

-3.5

-19.8

-15.5

-25.5

Panmure Gordon

-1.7

6.4

-57.8

-11.5

-62.2

WH Ireland

-1.1

5.2

-9.9

1.7

-28.8

Average

-1.3

-3.8

-29.7

-12.6

-35.0

Source: Bloomberg, 5 May 2016

Financials

In our forecasts for 2016 we have assumed that conditions remain challenging for the remainder of the first half, with continuing macroeconomic and political uncertainty acting as a drag on activity levels in the market. Once the EU referendum has taken place one element of uncertainty may be removed (not in the event the vote is to leave), perhaps paving the way for a more robust end to the year. We have not allowed for any further radio spectrum sales given the ongoing discussions with the regulator. Our EPS estimate of 11.2p (diluted, 12.0p basic) is as a result between the levels seen in 2012 and 2013, prior to the stronger conditions seen in 2014 and the disposal-enhanced 2015 outcome. There would be scope for significant upside if our assumptions prove too conservative.

On the balance sheet, we have flagged earlier the position of strength with net cash of over £12m, available liquidity of more than £28m and a capital surplus of over £20m. In the context of the 1,500 stocks in which markets are made, the net bull positions recorded on the balance sheet are modest with an average level of £1.1m over the last five years (and £1.7m at end 2015). Turning to cash flows, growth in working capital in total has absorbed a net £10m over five years, leaving operating cash flow of approaching £14m, which was augmented by net flows from investing of £3m, supporting the payment of dividends totalling £8m and share repurchases of £11m.

Exhibit 17: Financial summary (£000s except where stated)

Year end 31 December

2010

2011

2012

2013

2014

2015

2016e

PROFIT & LOSS

Year to 31-Dec

Capital Markets

26,268

22,545

22,653

25,796

30,129

23,350

24,500

Asset Management

9,952

8,563

6,331

7,334

8,478

9,500

10,094

Principal Finance

(737)

(1,595)

3,837

2,635

1,968

9,102

1,000

Total revenue

35,483

29,513

32,821

35,765

40,575

41,952

35,594

Cash costs

(25,673)

(29,163)

(28,805)

(29,262)

(31,117)

(29,086)

(29,477)

EBITDA

9,810

350

4,016

6,503

9,458

12,866

6,117

Depreciation and amortisation

(921)

(868)

(1,114)

(1,102)

(1,064)

(1,039)

(1,010)

Share-based payments

(161)

(52)

(54)

0

(17)

(4)

(10)

Operating profit

8,728

(570)

2,848

5,401

8,377

11,823

5,096

Net interest

(359)

(354)

(321)

8

(68)

(126)

(164)

Other

0

49

0

0

0

0

0

Profit before tax

8,369

(875)

2,527

5,409

8,309

11,697

4,932

Tax

(1,977)

(189)

(494)

(1,100)

(1,804)

(1,002)

(986)

Non-controlling interests

(1,872)

(24)

(46)

(911)

(1,297)

(4,250)

(1,327)

Profit after tax (FRS 3)

4,520

(1,088)

1,987

3,398

5,208

6,445

2,619

Average number of shares outstanding (m)

24.7

24.3

24.2

24.2

24.2

23.8

21.8

Average, fully diluted no. of shares (m)

25.5

24.8

24.3

24.5

25.1

24.7

23.5

EPS (p)

18.3

(4.5)

8.2

14.1

21.6

27.1

12.0

EPS (p) fully diluted

17.7

(4.4)

8.2

13.9

20.8

26.1

11.2

Dividend per share (p)

8.8

5.0

5.0

8.0

10.0

0.0

10.0

EBITDA margin (%)

27.6

1.2

12.2

18.2

23.3

30.7

17.2

Operating margin (%)

24.6

-1.9

8.7

15.1

20.6

28.2

14.3

BALANCE SHEET

Non-current assets

24,598

21,653

20,210

19,901

19,100

19,555

19,145

Intangibles and goodwill

381

4,632

4,436

4,406

4,002

2,222

2,160

Property, plant and equipment

12,710

12,516

11,669

10,897

10,969

10,864

10,516

Investments and other

11,507

4,505

4,105

4,598

4,129

6,469

6,469

Current assets

113,210

98,113

100,435

111,185

95,406

103,250

113,218

Bull positions

11,201

7,048

4,058

4,557

4,636

9,344

10,715

Cash

44,249

47,305

30,443

41,395

30,658

22,113

20,188

Debtors and other

57,760

43,760

65,934

65,233

60,112

71,793

82,316

Current liabilities

(42,439)

(26,758)

(43,441)

(52,883)

(32,445)

(45,972)

(52,663)

Bear positions

(1,343)

(786)

(1,395)

(1,033)

(846)

(946)

(1,085)

Short-term borrowings

(339)

(345)

(327)

(321)

(341)

(360)

(360)

Other current liabilities

(40,757)

(25,627)

(41,719)

(51,529)

(31,258)

(44,666)

(51,218)

Long-term liabilities

(25,596)

(27,579)

(10,817)

(9,241)

(9,640)

(9,791)

(9,791)

Long-term borrowings

(25,424)

(27,264)

(10,549)

(8,892)

(9,105)

(9,256)

(9,256)

Other long-term liabilities

(172)

(315)

(268)

(349)

(535)

(535)

(535)

Net assets

69,773

65,429

66,387

68,962

72,421

67,042

69,910

CASH FLOW

Net cash from operations

(2,750)

4,225

846

15,123

(7,181)

774

(381)

Fixed asset investment

(570)

(525)

(614)

(340)

(412)

(363)

(600)

Acquisitions/disposals

0

(914)

0

(1,731)

0

0

0

Other investing activities

(4,916)

459

93

297

211

7,121

144

Share issuance

484

166

0

0

0

0

0

Share purchases

(3,419)

(946)

0

0

0

(10,047)

0

Ordinary dividends

(2,154)

(2,132)

(604)

(2,175)

(2,175)

(1,208)

(1,088)

Other financing

(1,525)

824

(514)

230

(1,070)

(4,914)

0

Other

(337)

(187)

654

1,342

(574)

(530)

0

Net cash flow

(15,187)

970

(139)

12,746

(11,201)

(9,167)

(1,925)

Opening net (debt)/cash

33,637

18,486

19,696

19,567

32,182

21,212

12,497

FX

36

240

10

(131)

231

452

0

Closing net (debt)/cash

18,486

19,696

19,567

32,182

21,212

12,497

10,572

Source: Edison Investment Research, Shore Capital Group accounts

Contact details

Revenue by geography

Bond Street House
14 Clifford Street
London, UK
W1S 4JU
+44 (0)20 7408 4090
www.shorecap.co.uk

Contact details

Bond Street House
14 Clifford Street
London, UK
W1S 4JU
+44 (0)20 7408 4090
www.shorecap.co.uk

Revenue by geography

Board of directors

Executive Chairman: Howard Shore

Non-executive director: James Rosenwald III

Howard Shore founded Shore Capital in 1985. He began his career in private client discretionary fund management with Grieveson Grant & Co. After obtaining a degree in economics from Cambridge, he worked as a financial futures broker when LIFFE was being established. As executive chairman he is responsible for the strategy of the group. Shore is also a director of Puma Brandenburg Limited and chairman of Spectrum Investments Limited.

James Rosenwald is a co-founder and the managing partner of Dalton Investments, LLC, an asset management company. He previously co-managed Rosenwald, Roditi & Company, which he co-founded with Nicholas Roditi, and between 1992 and 1998 was an advisor to a number of Soros Group funds. A CFA charterholder with more than 35 years’ experience investing in the Pacific Rim, he is a director of numerous investment funds. Rosenwald also has experience of investing in real estate, co-founding Beach Front Properties in California (1997), Grand River Properties (Shanghai, 2003) and Dalton REIT 1 (Berlin).

Director: Lynn Bruce

Non-executive director : Dr Zvi Marom

Lynn Bruce is a chartered accountant (Scotland), having trained at KPMG. She was the CFO of an international wealth management group, Stenham Limited, for 11 years where she was also a member of both their risk and audit committees. Prior to that Bruce was the CFO for The Leasing Corporation plc and financial controller at AT&T Capital Europe. She chairs the audit committee.

Dr Marom is founder and CEO of BATM Advanced Communications Limited. A former first lieutenant in the Israeli Navy, he graduated first (with excellence) in electronics from the Naval Academy and from the Advanced Naval Command Course. He has a post-graduate degree in medicine from the Sackler School of Medicine, Israel, and an MSc in industrial electronics. Dr Marom is on the boards of several national and international academic committees for computing and communications. He has close links with governmental bodies funding research for Israeli high-tech companies. He is a member of the audit committee and the remuneration committee.

Principal shareholders

(%)

Howard Shore

41.07

Graham Shore

9.01

J P Morgan Asset Management

7.78

Aralon Resources & Investment Company

5.82

Kevin Spencer

4.95

Helium Special Situations Fund

3.20

Companies named in this report

Arden (ARDN), Cenkos (CNKS), Numis (NUM), Panmure Gordon (PMR), WH Ireland (WHI)

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Avanti Communications — Update 9 May 2016

Avanti Communications

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