Numis Corporation — Update 19 May 2016

Numis traces its history to the formation of Hemsley & Co Securities by CEO Oliver Hemsley in 1989 and its merger with long-established Raphael Zorn in the same year. The company developed its corporate finance business as a leading adviser to Lloyd’s of London corporate vehicles in the early 1990s and has been listed on AIM since 1996. It subsequently grew its institutional broking and market making activities and established a US office in 2004. Exhibit 1 sets out the evolution of its corporate client base from 2008 by number and average market capital: there are now 185 corporate clients with an average market capital of over £500m. A top ranked UK mid- and small-cap broker (Thomson Reuters Extel survey, 2015), the average size of client companies has increased over time with 41 now in the FTSE 250 index and one in the FTSE 100.

The progression of revenues and normalised profits is shown in Exhibit 2. Profitability was maintained through the financial crisis on this basis although 2009 saw a reported loss of £10.5m, primarily reflecting a fair value loss on investment holdings (the other main adjustment to calculate normalised profits being an add-back of share-based payments). Revenue and profits have moved to a substantially higher level over the last three years, progressively benefiting from the growth in client numbers and size noted above.

Numis has 213 employees with offices in London and New York. While UK focused in terms of corporate client base, the company has a broad network of relationships with institutional investors in continental Europe and North America (the latter accounting for 23% of secondary trading income).

At the time of the interim results the group announced that Oliver Hemsley, the founder and chief executive of the group, would step down from his role in autumn this year but will remain on the board as an executive director. He has said he will continue to play a part in developing the business while leaving new joint CEOs, Alex Ham and Ross Mitchinson (both in their thirties) to drive the business forward. Alex Ham, who joined Numis in 2005, is currently head of Corporate Broking & Advisory while Ross Mitchinson is head of Equities and joined in 2008.

Other changes are that David Poutney, chairman of Corporate Broking, stood down from the board in February while non-executive chairman of group, Gerald Corbett has indicated that he will not seek re-election at the AGM in February 2017.

These changes appear to reflect a considered succession process and seem unlikely to result in marked alterations in Numis’s approach or strategy given the continuity provided through internal appointments to the joint CEO roles and the continued presence of established executive directors (Oliver Hemsley, Lorna Tilbian, Simon Denyer and Marcus Chorley).

Numis reported figures for the half year to end March on 6 May; key features were as follows with comparisons made against the first half of the prior year unless stated.

The analysis within the revenue numbers is shown in Exhibit 3 with figures for both 2015 and 2014 included to provide a slightly longer period for comparison. From our perspective, key points to pick out are the resilience of institutional income despite a difficult environment in the second quarter (first calendar quarter of 2016) and the relatively high level of placing commissions in the period (30% above the average of the prior four half-year periods.

UK activity levels in both primary and secondary markets are important for Numis although the successful growth of its franchise is a more important factor over the longer term. In this section we provide an overview of the recent market context and make brief comments on the outlook.

The recent trend in new and further issuance on the AIM and LSE Main markets are shown in Exhibits 4 and 5. As noted above, Numis’s recent share of total equity issuance on the LSE has increased to 8.6%. For AIM, the run up ahead of the financial crisis saw new issuance peak at more than £18bn in Numis’s financial year to end September 2007, followed by a dramatic slowdown in the volume of IPOs. The subsequent recovery from a trough of just over £3bn in FY12 to £6.3bn in FY14 leaves new equity issuance at relatively muted levels (Exhibit 4).

For the main market the pattern would have been broadly similar if the financial crisis had not been marked by very substantial further issuance by banks to help support balance sheets. For both AIM and the Main market, a feature in the last three half-year periods has been the relative strength in further issuance that has largely compensated for a lower level of new issuance (Exhibit 5).

Turning to mergers and acquisitions activity (M&A), the value of UK transactions (as tracked by Bloomberg) increased from £100.1bn in calendar year 2014 to £114.9bn in 2015 with a broadly similar number of transactions (1,572 versus 1,532). The activity level in the first quarter of 2016, though lower than the recent quarterly average, was marginally up on the prior year.

While the market environment can have a considerable influence on the level of transactions generally, the incidence of activity among Numis’s clients and the success of the team in winning business is also important. A list of selected transactions since the beginning of the current financial year in October 2015 is shown in Exhibit 7. This illustrates that the size and diversity of Numis’s client list together with its established network of institutional clients helps generate a continuing flow of deals, even when conditions are less favourable.

Equity returns as represented by the FTSE All-Share, FTSE AIM All-Share and FTSE Small Cap indices are shown in Exhibit 8. The negative impact of uncertainty and weakening expectations during 2015 are evident in each case, although the sharp market dip seen in the first quarter of 2016 has been recovered. The chart also underlines the outperformance of small caps over the period shown and the significant relative weakness of the AIM index, explained in part by weakness in commodity stocks within that index.

Over the last five years the value of equity trading on the London Stock Exchange order book (Exhibit 9) fluctuated within a range that appears relatively narrow in the context of the pre-crisis peak. In 2015 the value traded was 6% above 2014 and 10% below the average since 2011. For 2016 to end April the value traded was 6% below the same period in 2015.

Looking ahead, market volatility has pulled back from a spike in February this year but the economic and political backgrounds remain 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 market confidence 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. Numis has commented that the second half has started well with a strong pipeline and the completion of a number of transactions, including its role as sole book runner in the c £700m placing of Saga shares by Acromas.

We have made only very minor adjustments to our estimates for FY16 and FY17. Compared with our FY16 forecast Numis has made a strong start (H1 revenues are 55% of the full-year estimate and underlying PBT 56%) but, as we set out in our market outlook section above, we are conscious that H2 may pose more of a challenge. At this early stage, we see no reason to make material changes to our FY17 forecast, although we do show the sensitivity to a range of alternative outcomes below.

The base from which Numis generates revenue is increasing in overall size, broadening its exposure by company and sector. As shown earlier in Exhibit 1, it has seen a steady growth in the number of clients (185 currently), which indicates an attractive offering to corporates with which it seeks long-term relationships. The business portfolio is diversified and not dependent on a few specific areas, which may be 'hot' one year and generate little business the next; half of the sectors served each generated over £3m in deal fees in 2015. A rising proportion of clients are FTSE 250 companies (now 22%, with one FTSE 100 client), which should increase the opportunities for involvement in larger transactions.

Given that Numis also remains reliant on market conditions, we think it is sensible to supplement our “spot” forecasting, particularly for FY17, with a scenario analysis of potential outcomes to revenues that may be either higher or lower than we have forecast.

Our FY16 forecast revenues of £102.8m would represent a record for the group, just as the reported H1 revenues were a record half-yearly result. As noted above, we have prudently not increased that full year forecast, which implies a decline in H2 revenues to £46m from £57m in H1. £46m would be in line with the average half-yearly revenues over the past five years. Our central case forecast for FY17 looks for modest revenue growth to £105.9m with “secondary” revenues (market making and institutional commissions) up 2% and “primary” revenues (from corporate retainers, deal fees and placing commissions) up 3.5%.

Alongside this base case forecast, in Exhibit 11, we provide an illustration of the potential effect of revenues either exceeding our forecast by 15% or under-shooting by a similar amount.

We start with a table showing a peer group of quoted UK brokers (Exhibit 12). This is a relatively short list and the companies are differentiated by size, profitability and activity; given this we would treat a direct comparison of valuation measures with some caution. Within the group Numis has the largest market cap by some distance and trades on an above average price to book, ranking second on this measure and in terms of return on equity.

Exhibit 13 shows that Numis is trading modestly above its 10-year average price to book ratio (2.2x versus 1.8x) but at the lower end of its more recent range, probably reflecting the more muted market confidence in 2016 to date.

In Exhibit 14 we show a comparison of returns on equity and price to book: although this a small sample, Numis appears to be aligned with the selected peers based on these historical metrics. Prospectively, relative valuation will depend on the relative movements in growth and returns among these companies. On this front the breadth of Numis’s client base may dampen volatility and provide the potential to boost returns on equity (see scenario analysis, Exhibit 11).

As a further step we examine the output of our updated ROE/COE model to provide an absolute valuation indication. Here we have assumed a cost of equity of 10% (slightly below our previous 10.75% figure, reflecting lower risk free rates and equity risk premium), used the half year end book value of 102.4p, assumed a central sustainable return on equity of 20% and growth of 5%. This gives an indicative central value of 307p per share. If we allow for a one-off return of excess capital of £25m this results in a return on remaining equity of 25.5% and after adding back the capital return (22p per share) takes the central value to 351p. These values compare with the ‘base case’ value of 284p indicated in our last note. We have set out a sensitivity table below that shows the values that result when using different growth rates and returns on equity (in this case excluding a return of capital). As an alternative, taking the current share price of c 215.5p this would be equivalent to assuming a growth rate of about 2.5% (other assumptions as above and no one-off capital return): quite a conservative scenario.

Finally, for reference, we include a table showing the share price movements for the peer group shown earlier. Here we can see the group as a whole has seen a significant retracement from its 12-month high and is down over most of the periods shown, reflecting the weakening of market sentiment, particularly in the first quarter of 2016. Numis has followed a similar pattern and this could be seen as setting the scene for a marked bounce back were the market to enter a less volatile phase and risk aversion to subside.