Share — Update 15 August 2016

The Share Centre, Share’s main business, was launched in 1991 to provide execution only stockbroking services to individual investors. In addition to share dealing accounts, The Share Centre also offers accounts for ISAs, SIPPs and Investment Clubs. It has c 248,000 customer accounts and £3.4bn of assets under administration. Customers are signed up individually and through corporate partnerships such as those with Henderson (ISA service to investment trust investors), Barclays (certificated and investment club dealing services) and Computershare (certificated and corporate sponsored nominee dealing). Revenue is generated from three sources: account fees, trading commissions and interest income, split 45%, 48% and 7% respectively for H116. 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. Transaction commissions are on a per bargain basis rather than varying with value. This means that the accounts frequently rank favourably in comparisons of providers (depending on portfolio size and frequency of trading).

The first half saw a subdued equity trading background ahead of the EU referendum and continued downward pressure on interest income earned on client deposits, reflecting persistently low rates. Nevertheless, helped in part by the partnership agreements with Barclays and Henderson, Share was able to record increased dealing commission and fee income, limiting the reduction in total revenue compared with H115.

Share has previously made clear that 2016 will be a year of investment to improve the customer experience, with the aim of underpinning its long-term growth potential and the scalability of the business model. Reflecting this, costs in the first half increased ahead of revenues resulting in an increased operating loss and reduced normalised pre-tax profits.

Key data points from the results were as follows:

Partnership agreements

In addition to the first half results, Share announced the name of the counterparty in the first of the two partnerships it agreed during the first half. This is with Australian-listed Computershare which, among its activities, is a leading UK share registrar with over 900 corporate clients in the UK, Ireland and Channel Islands. Share is to provide certificated dealing and corporate nominee dealing services under Computershare’s brand. Computershare has 25 corporate nominee service clients including major companies such as Aviva, E.on, Rio Tinto, Standard Chartered and Vodafone. The second partnership agreement announced at the AGM is with a wealth management business. For both partnerships, services are expected to launch in early next year adding materially to revenue and profit from 2017 onwards. There will be revenue sharing and some development and incremental personnel costs associated with these agreements, but the services will generally leverage Share’s core platform contributing to our expected improvement in profitability once the current investment phase is completed.

The agreements are a sign that the existing agreements with Barclays and Henderson are providing valuable references for new business and support Share’s record and emphasis on customer service, a key requirement for partners such as these.

Strategically, management sees such partnerships as an attractive way of expanding the business with fewer risks than would be the case with an acquisition, unless an opportunity arose with a target that was closely aligned in terms of approach. Management continues to monitor industry developments closely and foresees consolidation as businesses seek scale benefits.

Digital transformation

Linked to the central theme of customer service is the current programme of investment in the company’s IT infrastructure that will result in an improved customer experience and facilitate profitable expansion of the business in future. While specific numbers for the costs involved have not been given, management has indicated that they are significant which we estimate could be in the region of £1m. So far, key milestones achieved have been the transfer of the customer database to a new system and the launch of the first version of a mobile app which, on quick inspection, appears to work smoothly and is easy to navigate. Prospectively, work includes updating of the website and the second version of the app that will include dealing functionality (due the end of this year, or early next).

Exhibits 2 & 3 show a three-year history for the FTSE All-Share Index and the FTSE 100 Implied Volatility Index (UK equivalent of the US VIX). These show how the equity index started to trend down during 2015 and volatility increased, particularly in the second half of the year. While this year started on a negative note the subsequent recovery has been surprisingly strong despite a range of macroeconomic and political uncertainties. On this timescale, the index weakness and sharp spike in volatility related to the EU referendum seem a very short-term disruption.

While the market did stage a strong recovery from early 2016, increased volatility associated with macro uncertainty appears to have acted as a headwind to retail trading volumes. Exhibits 4 & 5 show the level and year-on-year change in retail trading in the UK. The current year started with year-on-year comparisons still in negative territory but seemingly on an improving trend, which was accentuated dramatically at the end of the first half by the spike in trading following the referendum result (Share reports that its investors were predominantly buyers). The net result was that there was still a modest, 2%, reduction in H116 retail trading volume compared with H115.

Looking ahead, Share has reported that activity levels have continued to be positive since the EU referendum and are somewhat ahead of last year as investors implement deferred investment decisions. We note that with the manner of the UK’s withdrawal from the EU still to be determined and associated risks to economic growth, there may well be further periods of elevated volatility that could dampen retail investor appetite for trading. However, if the market’s sanguine reaction so far is warranted then there could be scope to make more positive assumptions in our forecasts about the level of dealing activity.

For Share, successful completion of its digital transformation project will be key to enhancing customer service and hence growth prospects while contributions from its new partnerships from 2017 should help underpin the longer-term organic growth expected to flow from rising numbers of self-directed investors.

We have updated our estimates to reflect the first half figures and there are only minor changes in our revenue numbers for this year and next, as shown in Exhibit 6. Reflecting the first half experience and comments on recent trading we have a slightly higher proportion of revenue arising from dealing commissions than previously. As the level of profit/loss is relatively low over the forecast period shown, the proportionate changes can be large but this is misleading (hence the ‘N/A’s in the table). We have shown a 2018 forecast for the first time with assumptions including revenue growth of nearly 11% bolstered by contributions from the partnership transactions and cost growth contained at 3%. The resulting operational leverage produces a strong swing back into profit.

The balance sheet remains strong; cash stood at £16.1m at the end of June but this was inflated by an unusually high level of cash held in trust on behalf of customers, reflecting the volume of trading following the EU referendum. At the end of July, with trades settled, a cash level of £13.3m was reported. With normal seasonal variations and continued investment in IT we estimate year-end cash in the region of £10m compared with £11.6m at the end of 2015.

We start by refreshing the comparison we used in our last note that includes unquoted Alliance Trust Savings and quoted market leader Hargreaves Lansdown as well as Share (Exhibit 7. This highlights the significant differences in scale with Hargreaves Lansdown’s AUA of over £60bn well above either Share or Alliance Trust Savings. Alliance Trust Savings has been in a lengthy period of investment and hence losses while Hargreaves Lansdown has recorded sustained strong growth and profitability. The Alliance Trust Savings valuation is as reported by Alliance Trust, based on discounted cash flow, revenue and EBITDA multiples.

The wide range within the valuation measures is striking (adjusted value to assets under administration ranges from 0.5% to 10.2%, for example), but perhaps not surprising in view of the different profiles of the three companies. Hargreaves Lansdown’s market leadership and profitability are clearly reflected in a much higher valuation than the other companies on each measure. Share has a lower value to revenue than Alliance Trust Savings but, reflecting a higher revenue yield, a higher value to assets under administration. While we would not draw any specific valuation conclusion from this comparison we would argue it suggests that further success with Share’s initiatives on technology, partnerships and potentially M&A could be the catalyst for a higher valuation as well as growth.

To give a more specific steer on valuation for Share we turn to our discounted cash flow model. While we expect the current investment programme to result in losses/negative cash flow in 2016 and possibly 2017, we look for a swing back into significant profitability subsequently. To capture this for the purposes of the DCF exercise we have assumed two years of very strong growth (60%) in 2019 and 2020, followed by seven years at 5%. Other assumptions include a terminal multiple of 10x and a discount rate of 10%. Our central value is slightly higher at 29p versus 28p previously reflecting the modest changes in estimates mentioned earlier and the discount unwind. Exhibit 8 shows the sensitivity of the valuation to variations in the discount rate and growth assumptions for 2019/20.