Share — Update 29 March 2016

Share’s main business is The Share Centre, launched in 1991 to provide self-select stockbroking services to individual investors. In addition to share dealing accounts, The Share Centre offers a range of other accounts including ISAs, SIPPs and those for investment clubs. It has c 248,000 customer accounts and £2.8bn of assets under administration. Customers are signed up individually and through corporate partnerships such as those with Henderson (ISA service to investment trust investors) and Barclays (certificated and investment club dealing services). Revenue is generated from three sources: account fees, trading commissions and interest income, split 45%, 46% and 9% respectively for 2015. Share’s account fee structure is differentiated from many peers by being fixed per account rather than based on the value of assets under administration. This means that the accounts frequently rank favourably in comparisons of providers (depending on portfolio size and frequency of trading, for example in the Financial Times’ ISA Guide 2016).

Share’s vision is to be people’s first choice for investment knowledge, advice and fair value and its strategy remains to achieve superior growth through: (1) a focus on the core business; (2) continuing to put customers first; and (3) establishing partnerships and making selective acquisitions.

In terms of focus, Share announced in February that it intends to transfer its Authorised Corporate Director role to another party (this service provided to OEICs sits within the small Sharefunds, fund administration business, which accounted for less than 5% of revenues in 2015). Net of likely associated cost reductions, management indicates this move will not have a significant impact on this year’s results.

The priority given to customer service is evident in the decision to increase investment in IT to, for example, improve the workings of the website (one of the few critical recent comments on Trustpilot suggested the website was relatively ‘clunky’, albeit value and service were otherwise deemed sufficient to stick with The Share Centre). The company is also planning to launch an app and renew some of its underlying legacy systems to be able to meet evolving customer expectations and to broaden its appeal from its ‘heartland’ customer base, which is more than 45 years old with a reasonable level of savings. Management indicates that spending will be significant, which we estimate at around £1m. It also highlights that in-house development and management of technology, with third-party support, means that were a significant acquisition opportunity to arise, it would be possible to reschedule work to allow the business to focus on assimilation before resuming work on updating systems.

The focus on the core business informs the emphasis on establishing corporate partnerships and narrowing the scope of potential acquisitions. While unable to disclose details of potential agreements, Share describes the pipeline of opportunities for partnerships as healthy, helped by the credibility provided by the existing partnerships with Henderson and Barclays.

Share describes its market competitors as falling into three groups: first, independents such as itself, Interactive Investor and TD Investing in the middle ground where there could be consolidation (Share sees itself as a consolidator rather than a target, a point underlined by its IT investment); second are companies that were traditionally fund distributors, which include Fidelity and market leader Hargreaves Lansdown; and third, businesses that form part of banks and insurance companies that risk orphan status in larger organisations. While greater concentration seems likely in order to reap the benefits of scale, it is not possible to anticipate when there might be a combination of willing buyer(s) and seller(s). Consolidation among other players could be either positive or negative for Share, depending on how this affects competitive behaviour, although at some point the need to generate economic returns would seem to provide some reassurance. Also, Share’s fixed account fee structure appears less at risk than percentage-based models, as it reflects the nature of platform costs.

Exhibits 1 and 2 show a three-year history for the FTSE All-Share Index and the FTSE 100 Implied Volatility Index (UK equivalent of the US VIX, sometimes characterised as a ‘fear gauge’). They highlight how, against a background of increasing macroeconomic and geopolitical uncertainty, the equity index rolled over during 2015 and volatility increased, particularly in the second half of the year. The current year began on a sharply negative trend for UK equities, but there has been a bounce, still leaving volatility at heightened levels.

How does this translate into activity levels for a stockbroker serving individual investors? As Share’s results indicated, the background in the second half of 2015 was particularly difficult. Activity levels can be stimulated when there are sharp market moves and Share reports that 24 August 2015 (‘Black Monday’, when markets experienced a major sell-off) was a record for its trading volume. Subsequently, however, deterred by the level of volatility, investors stood back from the market, which affects the level of dealing commissions. Exhibits 3 and 4 show how this experience was shared across the retail execution-only market in the UK, with second-half trading volumes moving below the longer-term average and experiencing significant percentage declines compared with the same period in 2014. The current year has started with year-on-year comparisons still in negative territory but seemingly on an improving trend.

The factors that adversely affected equity market confidence in the second half of 2015 remain in place, with principle concerns including the rate of economic growth in China, changes in key central banks policy and commentary and, domestically, the referendum on the UK’s EU membership. Positively, however, the ECB’s extension of its monetary easing measures and the possible reduction in uncertainty following the June referendum could make for a more positive background. As noted above, execution-only London Stock Exchange trading volumes appear to be on an improving trend, but are still showing negative year-on-year changes.

On balance, it would seem a reasonably favourable outcome if retail share trading activity in 2016 were to match 2015. However, for Share there is the potential for further market share gains, helped to some extent by the partnerships agreed so far and in prospect.

In this section we consider a comparison of peer valuations and the assumptions and outputs of a discounted cash flow valuation. Our comparison with investment platform operators Alliance Trust Savings and Hargreaves Lansdown does not give a clear valuation steer, but does suggest that once Share’s investment programme begins to demonstrate traction there should be scope for multiple expansion, as well as earnings revisions. A discounted cash flow valuation suggests the current share price is consistent with a return to significant profit in the medium term following the current investment phase; for 2018 our central DCF valuation of 28p would still put the shares on a tentative normalised earnings multiple of c 30x. However, moving forward from this point, there would still be potential for substantial operationally leveraged profit improvement.

There are limited relevant quoted peers for Share and, in the current investment phase for the company, the comparison is complicated by depressed near-term profitability. In the table below we have collated comparative figures for Share with two other investment platform businesses: Hargreaves Lansdown and Alliance Trust Savings (subsidiary of Alliance Trust: click here for Edison research). Alliance Trust Savings has been in a sustained investment phase and last year recorded an FY15 loss (before an unusual provision) of £3m, although management expects it to move into profit in FY16. The valuation of Alliance Trust Savings of £54m is an external valuation for the board of Alliance Trust based on discounted cash flow, revenue and EBITDA multiples. The valuation metrics (Exhibit 5) show a considerable range between industry leader, Hargreaves Lansdown, Share and Alliance Trust Savings. Hargreaves Lansdown benefits from scale and has a strong growth record. Not only does it trade at a substantially higher percentage of AUA and multiple of revenues, but also commands a prospective P/E ratio of more than 30x for both FY16 and FY17 (Reuters collected consensus). Compared with Alliance Trust Savings, Share trades on a markedly lower multiple of revenues but, reflecting a higher revenue yield, a higher value in relation to assets under administration.

Alliance Trust Savings acquired Stocktrade, the execution-only stockbroking business, from Brewin Dolphin last May for £14m, equivalent to 0.3% of assets under administration and c 1.6x revenue. This suggests there may be acquisition opportunities at relatively attractive prices, but also reflects uncertainty over the stickiness of assets in the event of such a change in ownership.

Conclusions from this comparison are not clear-cut, but we would not see the Share valuation as expensive in this context, subject to successful execution of its investment programme. Further partnership deals or an accretive acquisition could augment scale and earnings, prompting a higher valuation on the measures shown.

Our amended forecasts for Share currently assume a move into loss this year as spending rises, followed by a continuation but significant narrowing of this loss in 2017. To capture the expected benefits of the investment for growth we have made a tentative forecast for 2018 that assumes a recovery to an operating profit of c £0.3m (still somewhat below the 2014 figure). In the following two years (2019-20) we have applied a high growth rate (60%) to net cash flow and then assumed seven years of growth at 5%. Other assumptions include a discount rate of 10% and a terminal multiple of 10x. Exhibit 6 shows variations around our central valuation of 28p as a result of flexing the discount rate and the scale of 2019-20 growth.

The main changes in our estimates are driven by the assumption of significantly higher costs as Share invests in upgrading its IT infrastructure to improve the customer experience and to help attract a broader age range to its services. Costs for 2016 are estimated to increase by c £1.6m (nearly 11%). While some of this spending may reduce in subsequent years, much will be ongoing. Our revenue assumption is lower, reflecting the uncertain investment background. We have cut back our dividend assumption reflecting the new policy linking the payout with earnings, although a sale of the remaining holding in the London Stock Exchange could be a factor in the board deciding on a higher payment.

The balance sheet remains strong with year end total capital resources standing at £17.9m compared with a regulatory requirement of £5.0m. The company had no debt and cash of £11.7m, together with available for sale investments of £7.6m (the remaining holding of London Stock Exchange shares is currently worth c £4.2m compared with £4m at the year end).